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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

|  |  |                                                                                                                                                         
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------
|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003                   
|  |  |                                                                                                                                                         
|o |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to _____________.

Commission file number: 000-25271

COVAD COMMUNICATIONS GROUP, INC.
(Exact name of registrant as specified in its charter)

|                                                                                        |  |                                                  
|--------------------------------------------------------------------------------------- |  | -------------------------------------------------
|Delaware(State or other jurisdiction
of incorporation or organization)                  |  | 77-0461529(I.R.S. Employer
Identification Number)
|                                                                                        |  |                                                  
|3420 Central Expressway
Santa Clara, California(Address of principal executive offices) |  | 95051(Zip Code)                                  

(408) 616-6500(Registrants telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes
x      No o

APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes x      No o

As of
May 13, 2003 there were 223,741,333 shares outstanding of the
Registrants Common Stock, including Class B Common Stock.



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TABLE OF CONTENTS



|                              |                                                                                               |                                                                                                    |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | Item 1. Condensed Consolidated Financial Statements (Unaudited)                              
|                              |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2003 AND DECEMBER 31, 2002                  
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2003 AND 2002
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2003 AND 2002
|                              |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                              
|                              | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                              | ITEM 3. MARKET RISK                                                                          
|                              | ITEM 4. CONTROLS AND PROCEDURES                                                              
|PART II. OTHER INFORMATION   
|                              | ITEM 1. LEGAL PROCEEDINGS                                                                    
|                              | ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                            
|                              | ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                      
|                              | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                              | ITEM 5. OTHER INFORMATION                                                                    
|                              | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                   
|CERTIFICATIONS               
|EXHIBIT 99.1                 
|EXHIBIT 99.2                 



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##### Table of Contents



COVAD COMMUNICATIONS GROUP, INC.

FORM 10-Q

TABLE OF CONTENTS

|                                                                                                         |                                                                                                         |  |      |   | 
|-------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------- |  | ---- | - | 
|                                                                                                         |                                                                                                         |  | Page
|                                                                                                         |                                                                                                         |  |     
|PART I. FINANCIAL INFORMATION                                                                            |                                                                                                         |  |      |  
|ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)                                          |                                                                                                         |  | 1    |  
|                                                                                                         | CONDENSED CONSOLIDATED BALANCE SHEETS AS OF MARCH 31,
2003 AND DECEMBER 31, 2002                        |  |      | 1 | 
|                                                                                                         | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE
THREE MONTHS ENDED      MARCH 31, 2003 AND 2002 |  |      | 2 | 
|                                                                                                         | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE
MONTHS ENDED      MARCH 31, 2003 AND 2002 |  |      | 3 | 
|                                                                                                         | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                                    |  |      | 4 | 
|ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF            OPERATIONS |                                                                                                         |  | 15   |  
|ITEM 3. MARKET RISK                                                                                      |                                                                                                         |  | 29   |  
|ITEM 4. CONTROLS AND PROCEDURES                                                                          |                                                                                                         |  | 29   |  
|PART II. OTHER INFORMATION                                                                               |                                                                                                         |  |      |  
|ITEM 1. LEGAL PROCEEDINGS                                                                                |                                                                                                         |  | 31   |  
|ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                                        |                                                                                                         |  | 33   |  
|ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                                  |                                                                                                         |  | 33   |  
|ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                              |                                                                                                         |  | 33   |  
|ITEM 5. OTHER INFORMATION                                                                                |                                                                                                         |  | 33   |  
|ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                                 |                                                                                                         |  | 33   |  
|SIGNATURES                                                                                               |                                                                                                         |  | 34   |  
|CERTIFICATIONS                                                                                           |                                                                                                         |  | 35   |  





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##### Table of Contents






PART I. FINANCIAL INFORMATION




Item 1.Condensed Consolidated Financial Statements (Unaudited)

COVAD COMMUNICATIONS GROUP, INC.




CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share and per share amounts)

|                                                           |                                                                                                                                                                                             |                                      |         |            |             |   |              |            |   |  | 
|---------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------ | ------- | ---------- | ----------- | - | ------------ | ---------- | - |  | 
|                                                           |                                                                                                                                                                                             |                                      |         |            | March 31,   |   | December 31,
|                                                           |                                                                                                                                                                                             |                                      |         |            | 2003        |   | 2002        
|                                                           |                                                                                                                                                                                             |                                      |         |            |             |   |             
|                                                           |                                                                                                                                                                                             |                                      |         |            | (Unaudited) |   | (Note 1)    
|                                                           |                                                                                                                                                                                             | ASSETS                               |         |            |             |   |              |           
|Current assets:                                            |                                                                                                                                                                                             |                                      |         |            |             |   |              |           
|                                                           | Cash and cash equivalents                                                                                                                                                                   |                                      | $       | 24,758     |             |   | $            | 96,491     |  
|                                                           | Short-term investments                                                                                                                                                                      |                                      |         | 152,640    |             |   |              | 108,076    |  
|                                                           | Restricted cash and investments                                                                                                                                                             |                                      |         | 400        |             |   |              | 501        |  
|                                                           | Accounts receivable, net of allowances of $5,354 at March 31, 2003
($5,388 at December 31, 2002)                                                                                            |                                      |         | 24,536     |             |   |              | 21,746     |  
|                                                           | Unbilled revenues                                                                                                                                                                           |                                      |         | 4,717      |             |   |              | 3,921      |  
|                                                           | Other receivables                                                                                                                                                                           |                                      |         | 506        |             |   |              | 1,385      |  
|                                                           | Inventories                                                                                                                                                                                 |                                      |         | 6,386      |             |   |              | 5,096      |  
|                                                           | Prepaid expenses and other current assets                                                                                                                                                   |                                      |         | 5,481      |             |   |              | 5,524      |  
|                                                           |                                                                                                                                                                                             |                                      |         |            |             |   |              |            |  
|Total current assets                                       |                                                                                                                                                                                             |                                      | 219,424 |            |             |   | 242,740      |           
|Property and equipment, net                                |                                                                                                                                                                                             |                                      | 101,005 |            |             |   | 108,737      |           
|Collocation fees, net                                      |                                                                                                                                                                                             |                                      | 40,739  |            |             |   | 43,284       |           
|Investments in unconsolidated affiliates                   |                                                                                                                                                                                             |                                      | 810     |            |             |   | 1,026        |           
|Deferred costs of service activation                       |                                                                                                                                                                                             |                                      | 37,113  |            |             |   | 40,286       |           
|Deferred customer incentives                               |                                                                                                                                                                                             |                                      | 5,858   |            |             |   | 3,540        |           
|Other long-term assets                                     |                                                                                                                                                                                             |                                      | 2,443   |            |             |   | 2,548        |           
|                                                           |                                                                                                                                                                                             |                                      |         |            |             |   |              |            |  
|Total assets                                               |                                                                                                                                                                                             | $                                    | 407,392 |            |             | $ | 442,161      |           
|                                                           |                                                                                                                                                                                             |                                      |         |            |             |   |              |            |  
|                                                           |                                                                                                                                                                                             | LIABILITIES AND STOCKHOLDERS EQUITY |         |            |             |   |              |           
|Current liabilities:                                       |                                                                                                                                                                                             |                                      |         |            |             |   |              |           
|                                                           | Accounts payable                                                                                                                                                                            |                                      | $       | 14,514     |             |   | $            | 10,915     |  
|                                                           | Accrued
compensation and employment-related taxes                                                                                                                                           |                                      |         | 19,854     |             |   |              | 12,774     |  
|                                                           | Current portion of capital lease obligations                                                                                                                                                |                                      |         | 122        |             |   |              | 165        |  
|                                                           | Accrued collocation and network service fees                                                                                                                                                |                                      |         | 11,590     |             |   |              | 16,537     |  
|                                                           | Accrued transaction-based taxes                                                                                                                                                             |                                      |         | 42,678     |             |   |              | 45,426     |  
|                                                           | Accrued interest                                                                                                                                                                            |                                      |         | 7,058      |             |   |              | 5,683      |  
|                                                           | Accrued market development funds and customer incentives                                                                                                                                    |                                      |         | 7,241      |             |   |              | 6,422      |  
|                                                           | Unresolved claims related to bankruptcy proceedings                                                                                                                                         |                                      |         | 7,369      |             |   |              | 7,381      |  
|                                                           | Other accrued liabilities                                                                                                                                                                   |                                      |         | 5,889      |             |   |              | 8,581      |  
|                                                           |                                                                                                                                                                                             |                                      |         |            |             |   |              |            |  
|Total current liabilities                                  |                                                                                                                                                                                             |                                      | 116,315 |            |             |   | 113,884      |           
|Long-term debt                                             |                                                                                                                                                                                             |                                      | 50,000  |            |             |   | 50,000       |           
|Collateralized customer deposit                            |                                                                                                                                                                                             |                                      | 66,261  |            |             |   | 68,191       |           
|Deferred gain resulting from deconsolidation of subsidiary |                                                                                                                                                                                             |                                      | 53,963  |            |             |   | 53,972       |           
|Unearned revenues                                          |                                                                                                                                                                                             |                                      | 70,441  |            |             |   | 73,815       |           
|                                                           |                                                                                                                                                                                             |                                      |         |            |             |   |              |            |  
|Total liabilities                                          |                                                                                                                                                                                             |                                      | 356,980 |            |             |   | 359,862      |           
|Commitments and contingencies                              |                                                                                                                                                                                             |                                      |         |            |             |   |              |           
|Stockholders equity:                                      |                                                                                                                                                                                             |                                      |         |            |             |   |              |           
|                                                           | Preferred stock, $0.001 par value; 5,000,000 shares authorized;
no shares issued and outstanding at March 31, 2003 and December
31, 2002                                                    |                                      |         |           |             |   |              |           |  
|                                                           | Common Stock, $0.001 par value; 590,000,000 shares authorized;
223,525,621 shares issued and outstanding at March 31, 2003
(223,182,511 shares issued and outstanding at December 31, 2002) |                                      |         | 224        |             |   |              | 223        |  
|                                                           | Common Stock  Class B, $0.001 par value; 10,000,000 shares
authorized; no shares issued and outstanding at March 31, 2003
and December 31, 2002                                            |                                      |         |           |             |   |              |           |  
|                                                           | Additional paid-in capital                                                                                                                                                                  |                                      |         | 1,615,207  |             |   |              | 1,612,319  |  
|                                                           | Deferred stock-based compensation                                                                                                                                                           |                                      |         | (124       | )           |   |              | (160       | )
|                                                           | Accumulated other comprehensive loss                                                                                                                                                        |                                      |         | (837       | )           |   |              | (747       | )
|                                                           | Accumulated deficit                                                                                                                                                                         |                                      |         | (1,564,058 | )           |   |              | (1,529,336 | )
|                                                           |                                                                                                                                                                                             |                                      |         |            |             |   |              |            |  
|Total stockholders equity                                 |                                                                                                                                                                                             |                                      | 50,412  |            |             |   | 82,299       |           
|                                                           |                                                                                                                                                                                             |                                      |         |            |             |   |              |            |  
|Total liabilities and stockholders equity                 |                                                                                                                                                                                             | $                                    | 407,392 |            |             | $ | 442,161      |           
|                                                           |                                                                                                                                                                                             |                                      |         |            |             |   |              |            |  

See accompanying notes.

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COVAD COMMUNICATIONS GROUP, INC.




CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except share and per share amounts)
(Unaudited)

|                                                                                                |                                                                      |                          |             |                    |         |      |             |        |         | 
|----------------------------------------------------------------------------------------------- | -------------------------------------------------------------------- | ------------------------ | ----------- | ------------------ | ------- | ---- | ----------- | ------ | ------- | 
|                                                                                                |                                                                      |                          |             | Three Months Ended
|                                                                                                |                                                                      |                          |             | March 31,         
|                                                                                                |                                                                      |                          |             |                   
|                                                                                                |                                                                      |                          |             | 2003               |         | 2002
|                                                                                                |                                                                      |                          |             |                    |         |     
|Revenues, net                                                                                   |                                                                      | $                        | 90,860      |                    |         | $    | 101,666     |       
|Operating expenses:                                                                             |                                                                      |                          |             |                    |         |      |             |       
|                                                                                                | Network and product costs                                            |                          |             | 69,024             |         |      |             | 90,194 |        
|                                                                                                | Sales, marketing, general and administrative                         |                          |             | 37,379             |         |      |             | 37,204 |        
|                                                                                                | Provision for bad debts (bad debt recoveries), net                   |                          |             | 198                |         |      |             | (73    | )      
|                                                                                                | Depreciation and amortization of property and equipment              |                          |             | 14,593             |         |      |             | 30,853 |        
|                                                                                                | Amortization of collocation fees                                     |                          |             | 3,996              |         |      |             | 3,629  |        
|                                                                                                | Litigation-related expenses                                          |                          |             |                   |         |      |             | (3,767 | )      
|                                                                                                |                                                                      |                          |             |                    |         |      |             |       
|                                                                                                |                                                                      | Total operating expenses |             |                    | 125,190 |      |             |        | 158,040 | 
|                                                                                                |                                                                      |                          |             |                    |         |      |             |       
|Loss from operations                                                                            |                                                                      |                          | (34,330     | )                  |         |      | (56,374     | )     
|Other income (expense):                                                                         |                                                                      |                          |             |                    |         |      |             |       
|                                                                                                | Interest income                                                      |                          |             | 716                |         |      |             | 1,469  |        
|                                                                                                | Realized loss on short-term investments                              |                          |             |                   |         |      |             | (17    | )      
|                                                                                                | Provision for impairment of investments in unconsolidated
affiliates |                          |             | (112               | )       |      |             |       |        
|                                                                                                | Equity in losses of unconsolidated affiliates                        |                          |             | (104               | )       |      |             | (391   | )      
|                                                                                                | Gain on disposal of investments in unconsolidated affiliates         |                          |             |                   |         |      |             | 360    |        
|                                                                                                | Interest expense                                                     |                          |             | (1,379             | )       |      |             | (1,375 | )      
|                                                                                                | Miscellaneous income (expense), net                                  |                          |             | 487                |         |      |             | (511   | )      
|                                                                                                |                                                                      |                          |             |                    |         |      |             |       
|                                                                                                | Other expense, net                                                   |                          |             | (392               | )       |      |             | (465   | )      
|                                                                                                |                                                                      |                          |             |                    |         |      |             |       
|Net loss                                                                                        |                                                                      | $                        | (34,722     | )                  |         | $    | (56,839     | )     
|                                                                                                |                                                                      |                          |             |                    |         |      |             |       
|Basic and diluted net loss per share                                                            |                                                                      | $                        | (0.16       | )                  |         | $    | (0.26       | )     
|                                                                                                |                                                                      |                          |             |                    |         |      |             |       
|Weighted-average number of common shares used in computing
basic and diluted net loss per share |                                                                      |                          | 223,444,624 |                    |         |      | 216,857,650 |       
|                                                                                                |                                                                      |                          |             |                    |         |      |             |       

See accompanying notes.

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COVAD COMMUNICATIONS GROUP, INC.




CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)

|                                                   |                                                                             |                                                                      |                                                     |                                       |         |                    |         |         |        |         |         |  
|-------------------------------------------------- | --------------------------------------------------------------------------- | -------------------------------------------------------------------- | --------------------------------------------------- | ------------------------------------- | ------- | ------------------ | ------- | ------- | ------ | ------- | ------- | -
|                                                   |                                                                             |                                                                      |                                                     |                                       |         | Three Months Ended
|                                                   |                                                                             |                                                                      |                                                     |                                       |         | March 31,         
|                                                   |                                                                             |                                                                      |                                                     |                                       |         |                   
|                                                   |                                                                             |                                                                      |                                                     |                                       |         | 2003               |         | 2002   
|                                                   |                                                                             |                                                                      |                                                     |                                       |         |                    |         |        
|Operating Activities:                              |                                                                             |                                                                      |                                                     |                                       |         |                    |         |        
|                                                   | Net loss                                                                    |                                                                      | $                                                   | (34,722                               | )       |                    | $       | (56,839 | )     
|                                                   | Adjustments to reconcile net loss to net cash used in operating
activities: |                                                                      |                                                     |                                       |         |                    |         |         |       
|                                                   |                                                                             | Provision for bad debts (bad debt recoveries), net                   |                                                     |                                       | 198     |                    |         |         | (73    | )      
|                                                   |                                                                             | Depreciation and amortization                                        |                                                     |                                       | 18,589  |                    |         |         | 34,482 |        
|                                                   |                                                                             | Loss on disposition of property and equipment                        |                                                     |                                       | 13      |                    |         |         | 574    |        
|                                                   |                                                                             | Non-cash litigation-related expenses                                 |                                                     |                                       |        |                    |         |         | (3,767 | )      
|                                                   |                                                                             | Amortization of deferred stock-based compensation                    |                                                     |                                       | 36      |                    |         |         | 66     |        
|                                                   |                                                                             | Other stock-based compensation                                       |                                                     |                                       | 3       |                    |         |         | 248    |        
|                                                   |                                                                             | Other non-cash charges                                               |                                                     |                                       | 322     |                    |         |         |       |        
|                                                   |                                                                             | Amortization (accretion) of interest on investments, net             |                                                     |                                       | (316    | )                  |         |         | 36     |        
|                                                   |                                                                             | Realized loss on short-term investments                              |                                                     |                                       |        |                    |         |         | 17     |        
|                                                   |                                                                             | Equity in losses of unconsolidated affiliates                        |                                                     |                                       | 104     |                    |         |         | 391    |        
|                                                   |                                                                             | Provision for impairment of investments in unconsolidated affiliates |                                                     |                                       | 112     |                    |         |         |       |        
|                                                   |                                                                             | Gain on disposal of investments in unconsolidated affiliates         |                                                     |                                       |        |                    |         |         | (360   | )      
|                                                   |                                                                             | Net changes in operating assets and liabilities:                     |                                                     |                                       |         |                    |         |         |        |        
|                                                   |                                                                             |                                                                      | Restricted cash                                     |                                       |         | 101                |         |         |        | 1,260   |        
|                                                   |                                                                             |                                                                      | Accounts receivable                                 |                                       |         | (2,988             | )       |         |        | (10,576 | )      
|                                                   |                                                                             |                                                                      | Unbilled revenues                                   |                                       |         | (796               | )       |         |        | 393     |        
|                                                   |                                                                             |                                                                      | Inventories                                         |                                       |         | (1,290             | )       |         |        | 1,314   |        
|                                                   |                                                                             |                                                                      | Prepaid expenses and other current assets           |                                       |         | 922                |         |         |        | 728     |        
|                                                   |                                                                             |                                                                      | Deferred costs of service activation                |                                       |         | 3,173              |         |         |        | 3,700   |        
|                                                   |                                                                             |                                                                      | Accounts payable                                    |                                       |         | 3,599              |         |         |        | 68      |        
|                                                   |                                                                             |                                                                      | Unresolved claims related to bankruptcy proceedings |                                       |         | (12                | )       |         |        | (126    | )      
|                                                   |                                                                             |                                                                      | Collateralized customer deposit                     |                                       |         | (1,930             | )       |         |        | (1,555  | )      
|                                                   |                                                                             |                                                                      | Other current liabilities                           |                                       |         | (1,113             | )       |         |        | 2,645   |        
|                                                   |                                                                             |                                                                      | Unearned revenues                                   |                                       |         | (3,374             | )       |         |        | (4,529  | )      
|                                                   |                                                                             |                                                                      |                                                     |                                       |         |                    |         |         |       
|                                                   |                                                                             |                                                                      |                                                     | Net cash used in operating activities |         |                    | (19,369 | )       |        |         | (31,903 | )
|Investing Activities:                              |                                                                             |                                                                      |                                                     |                                       |         |                    |         |        
|                                                   | Purchases of short-term investments                                         |                                                                      |                                                     | (82,643                               | )       |                    |         | (45,104 | )     
|                                                   | Maturities of short-term investments                                        |                                                                      |                                                     | 38,305                                |         |                    |         |        |       
|                                                   | Sales of short-term investments                                             |                                                                      |                                                     |                                      |         |                    |         | 40,000  |       
|                                                   | Purchases of property and equipment                                         |                                                                      |                                                     | (7,371                                | )       |                    |         | (3,805  | )     
|                                                   | Proceeds from sales of property and equipment                               |                                                                      |                                                     | 53                                    |         |                    |         | 123     |       
|                                                   | Recovery of internal use software costs                                     |                                                                      |                                                     | 435                                   |         |                    |         |        |       
|                                                   | Payment of collocation fees                                                 |                                                                      |                                                     | (1,451                                | )       |                    |         | (919    | )     
|                                                   | Proceeds from sales of investments in unconsolidated affiliates             |                                                                      |                                                     |                                      |         |                    |         | 360     |       
|                                                   | Decrease of other long-term assets                                          |                                                                      |                                                     | 105                                   |         |                    |         |        |       
|                                                   |                                                                             |                                                                      |                                                     |                                       |         |                    |         |         |       
|                                                   |                                                                             | Net cash used in investing activities                                |                                                     |                                       | (52,567 | )                  |         |         | (9,345 | )      
|Financing Activities:                              |                                                                             |                                                                      |                                                     |                                       |         |                    |         |        
|                                                   | Principal payments under capital lease obligations                          |                                                                      |                                                     | (43                                   | )       |                    |         | (11     | )     
|                                                   | Proceeds from common stock issuance                                         |                                                                      |                                                     | 246                                   |         |                    |         | 101     |       
|                                                   |                                                                             |                                                                      |                                                     |                                       |         |                    |         |         |       
|                                                   |                                                                             | Net cash provided by financing activities                            |                                                     |                                       | 203     |                    |         |         | 90     |        
|                                                   |                                                                             |                                                                      |                                                     |                                       |         |                    |         |         |       
|                                                   | Net decrease in cash and cash equivalents                                   |                                                                      |                                                     | (71,733                               | )       |                    |         | (41,158 | )     
|                                                   | Cash and cash equivalents at beginning of period                            |                                                                      |                                                     | 96,491                                |         |                    |         | 207,810 |       
|                                                   |                                                                             |                                                                      |                                                     |                                       |         |                    |         |         |       
|                                                   | Cash and cash equivalents at end of period                                  |                                                                      | $                                                   | 24,758                                |         |                    | $       | 166,652 |       
|                                                   |                                                                             |                                                                      |                                                     |                                       |         |                    |         |         |       
|Supplemental Disclosures of Cash Flow Information: |                                                                             |                                                                      |                                                     |                                       |         |                    |         |        
|                                                   | Cash paid during the period for interest                                    |                                                                      | $                                                   | 4                                     |         |                    | $       |        |       
|                                                   |                                                                             |                                                                      |                                                     |                                       |         |                    |         |         |       

See accompanying notes.

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COVAD COMMUNICATIONS GROUP, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2003 and 2002
(All dollar amounts are presented in thousands, except share and per share amounts)
(Unaudited)

1. Basis of Presentation and Summary of Significant Accounting Policies

The condensed consolidated financial statements include the accounts of
Covad Communications Group, Inc. (Covad) and its wholly-owned subsidiaries
(collectively, the Company). All significant intercompany accounts and
transactions have been eliminated in consolidation.

The condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial information, the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring adjustments) considered necessary
for a fair presentation of the condensed consolidated financial statements have
been included. Operating results for the three months ended March 31, 2003 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2003.

The Companys 2003 business plan includes certain discretionary spending
that is based on several assumptions, including growth of the Companys
subscriber base with a reasonable per subscriber profit margin and improvements
in productivity. If necessary, the Company will curtail this discretionary
spending so that it can continue as a going concern at least through December
31, 2003 using only the Companys unrestricted cash, cash equivalent and
short-term investment balances in existence as of December 31, 2002.
Additionally, on February 20, 2003, the Federal Communications Commission
(FCC) announced the results of the Triennial Review of its rules for network
unbundling obligations of Incumbent Local Exchange Carriers (ILECs) (Note 8).
Among other things, the FCC announced that it will phase out its rule requiring
line-sharing over a three-year period. While the FCC has not yet issued its
order pursuant to the Triennial Review, the ultimate impact of the FCCs
February 20, 2003 announcement on the Companys business, which relies on
line-sharing to serve certain consumer end-users, will depend on the Companys
ability to negotiate prices with the ILECs that allow the Company to maintain
acceptable profit levels. Management does not believe the FCCs revised
unbundling rules will have a material adverse effect on the Companys ability
to continue as a going concern at least through December 31, 2003.

The condensed consolidated balance sheet as of December 31, 2002 has been
derived from the audited consolidated financial statements at that date but
does not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements.

All 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, 2002.

Use of Estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities 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 these estimates. The Companys critical accounting estimates
include (i) revenue recognition and the establishment of accounts receivable
allowances, (ii) inventory valuation, (iii) useful life assignments and
impairment evaluations associated with property and equipment and collocation
fees, (iv) reorganization and restructuring liabilities, (v) anticipated
outcomes of legal proceedings and other disputes, (vi) transaction-based tax
liabilities, (vii) employment-related tax liabilities, (viii) liabilities for market development funds and customer
incentives and (ix) valuation allowances associated with deferred tax assets.

During the three months ended March 31, 2003, the Company changed its
estimates of certain accrued liabilities for customer incentives based on the
compilation of sufficient historical data with which to estimate sales
incentives that will ultimately be claimed by customers. This change in
accounting estimate increased the Companys revenues by $1,585 and decreased
the Companys net loss by $1,850 ($0.01 per share) during the three months
ended March 31, 2003.

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Stock-Based Compensation

The Company accounts for stock-based awards to (i) employees using the
intrinsic value method and (ii) non-employees using the fair value method.

Under the intrinsic value method, when the exercise price of the Companys
employee stock options equals or exceeds the market price of the underlying
stock on the date of grant, no compensation expense is recognized. The
following table illustrates the pro forma effect on net loss and net loss per
share for the three months ended March 31, 2003 and 2002 had the Company
applied the fair value method to account for stock-based awards to employees:

|                                                                                                                                                                 |             |   |           |       |      |   |         |       |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------- | - | --------- | ----- | ---- | - | ------- | ----- | -
|                                                                                                                                                                 |             |   | March 31,
|                                                                                                                                                                 |             |   |          
|                                                                                                                                                                 |             |   | 2003      |       | 2002
|                                                                                                                                                                 |             |   |           |       |     
|Net loss, as reported                                                                                                                                            |             | $ | (34,722   | )     |      | $ | (56,839 | )    
|Stock-based employee compensation expense
included in the determination of net loss, as
reported                                                                 |             |   | 36        |       |      |   | 297     |      
|Stock-based employee compensation expense that
would have been included in the determination of
net loss if the fair value method had been
applied to all awards |             |   | (2,080    | )     |      |   | (6,321  | )    
|                                                                                                                                                                 |             |   |           |       |      |   |         |      
|Pro forma net loss                                                                                                                                               |             | $ | (36,766   | )     |      | $ | (62,863 | )    
|                                                                                                                                                                 |             |   |           |       |      |   |         |      
|Basic and diluted net loss per common share:                                                                                                                     |             |   |           |       |      |   |         |      
|                                                                                                                                                                 | As reported |   | $         | (0.16 | )    |   | $       | (0.26 | )
|                                                                                                                                                                 |             |   |           |       |      |   |         |      
|                                                                                                                                                                 | Pro forma   |   | $         | (0.16 | )    |   | $       | (0.29 | )
|                                                                                                                                                                 |             |   |           |       |      |   |         |      

The weighted-average grant date fair value of stock-based awards to
employees was $6.35 and $8.64 per share during the three months ended March 31,
2003 and 2002, respectively. Such weighted-average grant fair values were
estimated using the Black-Scholes option valuation model and the assumptions
listed in Note 7.

Basic and Diluted Net Loss Per Share

Basic net loss per share is computed using the weighted-average number of
shares of the Companys common stock outstanding during the period, less the
weighted-average number of outstanding common shares subject to repurchase.

Diluted per share amounts are determined in the same manner as basic per
share amounts, except that the number of weighted-average common shares used in
the computations includes dilutive common shares subject to repurchase and is
increased assuming the (i) exercise of dilutive stock options and warrants
using the treasury stock method and (ii) conversion of dilutive convertible
debt instruments. However, diluted net loss per share is the same as basic net
loss per share in the periods presented in the accompanying condensed
consolidated statements of operations because the impact of (i) common shares
subject to repurchase and (ii) the assumed exercise of outstanding stock
options and warrants is not dilutive.

The following table presents the calculation of weighted-average common
shares used in the computations of basic and diluted net loss per share
presented in the accompanying condensed consolidated statements of operations:

|                                                                                                |  |                    |             |      |  |  |             | 
|----------------------------------------------------------------------------------------------- |  | ------------------ | ----------- | ---- |  |  | ----------- | 
|                                                                                                |  | Three Months Ended
|                                                                                                |  | March 31,         
|                                                                                                |  |                   
|                                                                                                |  | 2003               |             | 2002
|                                                                                                |  |                    |             |     
|Weighted-average number of shares of common
stock outstanding                                   |  |                    | 223,444,624 |      |  |  | 216,903,234 | 
|Less weighted-average number of shares of
common stock subject to repurchase                    |  |                    |            |      |  |  | 45,584      | 
|                                                                                                |  |                    |             |      |  |  |             | 
|Weighted-average number of common shares used
in computing basic and diluted net loss per
share |  |                    | 223,444,624 |      |  |  | 216,857,650 | 
|                                                                                                |  |                    |             |      |  |  |             | 

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Comprehensive Loss

Significant components of the Companys comprehensive loss are as follows:

|                                                           |  |            |            |      |  |                    |         |   |  |   |         |  
|---------------------------------------------------------- |  | ---------- | ---------- | ---- |  | ------------------ | ------- | - |  | - | ------- | -
|                                                           |  |            |            |      |  | Three Months Ended
|                                                           |  |            |            |      |  | March 31,         
|                                                           |  | Cumulative |            |     
|                                                           |  | Amounts    |            | 2003 |  | 2002              
|                                                           |  |            |            |      |  |                   
|Net loss                                                   |  | $          | (1,564,058 | )    |  | $                  | (34,722 | ) |  | $ | (56,839 | )
|Unrealized gains (losses) on available-for-sale securities |  |            | 125        |      |  |                    | (90     | ) |  |   | (82     | )
|Foreign currency translation adjustment                    |  |            | (962       | )    |  |                    |        |   |  |   |        |  
|                                                           |  |            |            |      |  |                    |         |   |  |   |         |  
|Comprehensive loss                                         |  | $          | (1,564,895 | )    |  | $                  | (34,812 | ) |  | $ | (56,921 | )
|                                                           |  |            |            |      |  |                    |         |   |  |   |         |  

Recent Accounting Pronouncements

In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) number (No.) 148,
Accounting for Stock-Based Compensation  Transition and Disclosure. SFAS
No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to
provide alternative methods of transition for an entity that voluntarily
changes to the fair value method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure provisions of
SFAS No. 123 to require prominent disclosure of the effects of an entitys
accounting policy with respect to stock-based employee compensation on reported
operating results, including per share amounts, in annual and interim financial
statements. The disclosure provisions of SFAS No. 148 were effective
immediately upon issuance in 2002. As of March 31, 2003, the Company has no
immediate plans to adopt the fair value method of accounting for stock-based
employee compensation.

In November 2002, the FASBs Emerging Issues Task Force (EITF) reached a
final consensus on Issue No. 00-21, Accounting for Revenue Arrangements with
Multiple Deliverables, which is effective for revenue arrangements entered
into in fiscal periods beginning after June 15, 2003. Under EITF Issue No.
00-21, revenue arrangements with multiple deliverables are required to be
divided into separate units of accounting under certain circumstances. The
Company will prospectively adopt EITF Issue No. 00-21 on July 1, 2003, and it
does not believe the adoption of EITF Issue No. 00-21 will have a material
effect on its condensed consolidated financial statements.

In November 2002, the FASB issued interpretation (FIN) No. 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN No. 45 requires certain
guarantees to be recorded at fair value, which is different from current
practice, which is generally to record a liability only when a loss is probable
and reasonably estimable. FIN No. 45 also requires a guarantor to make
significant new disclosures, even when the likelihood of making any payments
under the guarantee is remote. The disclosure provisions of FIN No. 45 were
effective immediately in 2002. The Company adopted the recognition and
measurement provisions of FIN No. 45 on a prospective basis with respect to
guarantees issued or modified after December 31, 2002. The adoption of the
recognition and measurement provisions of FIN No. 45 had no effect on the
Companys condensed consolidated financial statements as of and for the three
months ended March 31, 2003.

On January 1, 2003, the Company adopted SFAS No. 146, Accounting for
Costs Associated with an Exit or Disposal Activity. SFAS No. 146 revised the
accounting for exit and disposal activities under EITF Issue No. 94-3,
Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring), by extending the period in which expenses related to
restructuring activities are reported. A commitment to a plan to exit an
activity or dispose of long-lived assets is no longer sufficient to record a
one-time charge for most restructuring activities. Instead, companies record
exit or disposal costs when they are incurred and can be measured at fair
value. In addition, the resultant liabilities are subsequently adjusted for
changes in estimated cash flows. SFAS No. 146 is effective prospectively for
exit or disposal activities initiated after December 31, 2002. Companies may
not restate previously issued financial statements for the effect of the
provisions of SFAS No. 146, and liabilities that a company previously recorded
under EITF Issue No. 94-3 are grandfathered. The adoption of SFAS No. 146 had
no effect on the Companys condensed consolidated financial statements as of
and for the three months ended March 31, 2003.

On January 1, 2003, the Company adopted SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS No. 145 rescinds SFAS No. 4, Reporting Gains and Losses
from Extinguishment of Debt, which required all gains and losses from
extinguishment of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. SFAS No. 145 requires
that gains or losses from extinguishment of debt be

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classified as extraordinary items only if they meet the criteria of APB
Opinion No. 30. The adoption of SFAS No. 145 had no effect on the Companys
condensed consolidated financial statements as of and for the three months
ended March 31, 2003.

On January 1, 2003, the Company adopted SFAS No. 143, Accounting for
Asset Retirement Obligations. SFAS No. 143 requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying
amount of the long-lived asset. The adoption of SFAS No. 143 had no effect on
the Companys condensed consolidated financial statements as of and for the
three months ended March 31, 2003.

Reclassifications

Certain balances in the Companys 2002 condensed consolidated financial
statements, including certain operating expenses, have been reclassified to
conform to the presentation in 2003.

2. Revenue Recognition

Revenues from recurring service are recognized when (i) persuasive
evidence of an arrangement between the Company and the customer exists, (ii)
service has been provided to the customer, (iii) the price to the customer is
fixed or determinable and (iv) collectibility of the sales prices is reasonably
assured. Revenues earned for which the customer has not been billed are
recorded as Unbilled revenues in the condensed consolidated balance sheets.
Amounts billed in advance of providing service are deferred and recorded as an
element of the condensed consolidated balance sheet caption Unearned
revenues. Included in revenues are Federal Universal Service Fund (FUSF)
charges billed to customers aggregating $958 and $2,988 for the three months
ended March 31, 2003 and 2002, respectively.

As of March 31, 2003, the Company had over 180 resellers. For the three
months ended March 31, 2003 and 2002, the Companys 30 largest customers
collectively comprised 76.1% and 82.2% of the Companys total net revenues,
respectively. As of March 31, 2003 and 2002, receivables from these customers
collectively comprised 75.4% and 73.5%, respectively, of the Companys gross
accounts receivable balance.

For the three months ended March 31, 2003, EarthLink, Inc. and AT&T Corp.
(AT&T), two of the Companys resellers, accounted for 21.1% and 11.4% of the
Companys total net revenues. As of March 31, 2003, receivables from these
customers comprised 25.3% and 11.1% of the Companys gross accounts receivable
balance. No other individual customer accounted for more than 10% of the
Companys total net revenues during the three months ended March 31, 2003.

For the three months ended March 31, 2002, Earthlink, Inc. and XO
Communications, two of the Companys resellers, accounted for 20.6% and 10.7%,
respectively, of the Companys total net revenues. As of March 31, 2002,
receivables from Earthlink, Inc. comprised 21.3% of the Companys gross
accounts receivable balance. The Company began recognizing revenues from XO
Communications on a cash basis (as described below) during the fourth quarter
of 2001. Therefore, the Companys contractual receivable from XO
Communications of $2,791 as of March 31, 2002 was not recognized in the
Companys condensed consolidated balance sheet as of such date. However, the
Company resumed the recognition of revenues from XO Communications on an
accrual basis during the fourth quarter of 2002.

Some of the Companys resellers are experiencing financial difficulties.
During the three months ended March 31, 2003 and 2002, certain of these
customers either (i) were not current in their payments for the Companys
services or (ii) were essentially current in their payments but, subsequent to
the end of the reporting period, the financial condition of such customers
deteriorated significantly and certain of them have filed for bankruptcy
protection. Based on this information, the Company determined that (i) the
collectibility of revenues from these customers was not reasonably assured or
(ii) its ability to retain some or all of the payments received from certain of
these customers that have filed for bankruptcy protection was not reasonably
assured. Accordingly, the Company classified this group of customers as
financially distressed for revenue recognition purposes. Revenues from
financially distressed customers are recognized when cash for those services is
collected, assuming all other criteria for revenue recognition have been met,
but only after the collection of all previous outstanding accounts receivable
balances. Payments received from financially distressed customers during a
defined period prior to their filing of petitions for bankruptcy protection are
recorded in the condensed consolidated balance sheet caption Unearned
revenues if the Companys ability to retain these payments is not reasonably
assured.

Some of the Companys customers are currently in bankruptcy proceedings.
Revenues from these customers accounted for approximately 3.1% and 5.6% of the
Companys total net revenues for the three months ended March 31, 2003 and
2002, respectively.

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Although WorldCom, Inc. (WorldCom) filed for bankruptcy protection on
July 21, 2002, the Company continued to recognize revenues from WorldCom on an
accrual basis during 2002 and 2003 based on its specific facts and
circumstances in relation to the revenue recognition criteria described above.
Consequently, the disclosures in the following paragraph related to financially
distressed customers exclude amounts pertaining to WorldCom because the Company
does not currently classify it as a financially distressed customer for revenue
recognition purposes. The Company continues to attempt to migrate end-users
from some of its financially distressed customers to the extent it is legally
and operationally feasible.

During the three months ended March 31, 2003 and 2002, the Company issued
billings to its financially distressed customers aggregating $2,677 and
$18,774, respectively, which were not recognized as revenues or accounts
receivable in the accompanying condensed consolidated financial statements.
However, the Company ultimately recognized revenues from certain of these
customers when cash was collected (as described above) aggregating $2,402 and
$16,862 during the three months ended March 31, 2003 and 2002, respectively,
some of which relates to services provided in prior periods. In addition,
revenues recognized during the three months ended March 31, 2002 include
payments totaling $3,307 from certain bankrupt customers that the Company
received prior to January 1, 2002 and recorded as unearned revenues in its
condensed consolidated balance sheet as of December 31, 2001 because the
Companys ability to retain these payments was not reasonably assured as of
that date. However, as a result of subsequent developments in the bankruptcy
proceedings of such customers, the Company determined that its ability to
retain these payments was reasonably assured prior to March 31, 2002.
Consequently, the Company recognized these payments as revenues during the
three months then ended. The Company recognized an additional $34 of such
payments as revenues during the three months ended March 31, 2003. The Company
had contractual receivables from its financially distressed customers totaling
$6,204 as of March 31, 2003 that are not reflected in the accompanying
condensed consolidated balance sheet as of such date.

The Company has obtained information indicating that some of its
customers, including WorldCom, who (i) were essentially current in their
payments for the Companys services prior to March 31, 2003, or (ii) have
subsequently paid all or significant portions of the respective amounts
recorded as accounts receivable as of March 31, 2003, may become financially
distressed. Revenues from these customers accounted for approximately 25.6% and
23.7% of the Companys total net revenues for the three months ended March 31,
2003 and 2002, respectively. As of March 31, 2003, receivables from these
customers comprised 31.9% of the Companys gross accounts receivable balance.
If these customers are unable to demonstrate their ability to pay for the
Companys services in a timely manner in periods ending subsequent to March 31,
2003, revenues from such customers will be recognized when cash is collected
(as described above).

The Company has billing disputes with some of its customers. These
disputes arise in the ordinary course of business in the telecommunications
industry and their impact on the Companys accounts receivable and revenues can
be reasonably estimated based on historical experience. In addition, certain
revenues are subject to refund if the end-user terminates service
within thirty days of service activation. Accordingly, the Company maintains
allowances, through charges to revenues, based on the Companys estimates of
(i) the ultimate resolution of the disputes and (ii) future service
cancellations. These charges to revenues amounted to $671 and $1,260 during the
three months ended March 31, 2003 and 2002, respectively.

3. Customer Warrants

On January 1, 2003, in conjunction with an amendment to an Agreement for
Broadband Internet Access Services with AT&T, the Company granted AT&T three
warrants to purchase shares of the Companys common stock as follows: 1,000,000
shares for $0.94 per share; 1,000,000 shares for $3.00 per share; and 1,000,000
shares for $5.00 per share. Such warrants were immediately exercisable, fully
vested and nonforfeitable at the date of grant. Accordingly, the measurement
date for these warrants was the date of grant. The aggregate fair value of such
warrants of $2,640 was recorded as a deferred customer incentive during the
three months ended March 31, 2003 and is being recognized as a reduction of
revenues on a straight-line basis over the three-year term of the agreement
because management believes that future revenues from AT&T will exceed the fair
value of the warrants described above. This value was determined using the
Black-Scholes option valuation model and the following assumptions: closing
price of the Companys common stock on December 31, 2002 of $0.94 per share;
expected life of seven years (which is also the contractual life of the
warrants); dividend yield of zero; volatility of 1.52; and a risk-free interest
rate of 3.36%.

4. Asset Purchase

On January 3, 2002, the Company purchased substantially all of the assets
of InternetConnect, a related party, in an auction supervised by the United
States Bankruptcy Court for the Central District of California. The purchase
price for these assets was $5,470 in cash, $235 of which had been deposited
with InternetConnects agent prior to December 31, 2001. (Under the terms of
the asset purchase agreement, the Company may be required to pay additional
cash of up to $1,880, depending upon the outcome of a previous

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post-petition bankruptcy claim filed against InternetConnect by the
Company, which is still pending before the court.) The Company did not assume
any liabilities or obligations of InternetConnect or hire any of
InternetConnects employees. In addition, the Company does not believe the
assets acquired from InternetConnect constitute a self-sustaining, integrated
set of activities and assets that would constitute a business.

The tangible assets of InternetConnect purchased by the Company consisted
of accounts receivable, refundable deposits and property and equipment. The
Company also purchased the right, but not the obligation, to assume
InternetConnects customer contracts. However, the Company did not exercise
this right. Instead, the Company solicited the approximate 9,250 digital
subscriber line (DSL), T-1, virtual private network (VPN) and dial-up
customers of InternetConnect, and approximately 6,200 of such customers
executed new contracts with the Company and its resellers subsequent to January
3, 2002.

The Company has allocated the aforementioned purchase price based on the
estimated fair values of the elements of this transaction as of January 3,
2002, as follows:

|                           |  |   |       | 
|-------------------------- |  | - | ----- | 
|Accounts receivable        |  | $ | 1,386 | 
|Refundable deposits        |  |   | 349   | 
|Property and equipment     |  |   | 61    | 
|Customer acquisition costs |  |   | 3,674 | 
|                           |  |   |       | 
|                           |  | $ | 5,470 | 
|                           |  |   |       | 

The customer acquisition costs of $3,674 described above were charged to
network and product costs for the three months ended March 31, 2002 (i) because
the Companys relationship with InternetConnects former customers did not
exist as of January 3, 2002 and (ii) based on the Companys accounting policy
for costs of this nature that are not accompanied by up-front fees (Note 2).

5. Property Sale

During the fourth quarter of 2001, the Company tentatively decided to sell
land, a building and certain improvements located in Manassas, Virginia. This
property was part of the Companys Covad Strategic Partnerships business
segment. In March 2002, the Company entered into a non-binding letter of intent
with a third party to sell such property for $14,000, which was subject to
approval by the Companys board of directors. In April 2002, the Company
received the necessary approval from its board of directors to proceed with the
sale of this property (at which time the Company suspended depreciation of the
building and related improvements when such assets had an aggregate carrying
value of $13,201). In June 2002, the Company completed the sale of this
property and recognized a gain of $133, which represents the net proceeds of
$13,334 less the aggregate carrying value of the property as described above.

6. Reduction in Force

During the first quarter of 2003, the Company reduced its workforce by
approximately 70 employees, or 5.4%. The reductions covered employees in the
areas of sales and marketing, operations and corporate functions. In connection
with this reduction, the Company recorded a charge to operations of $631 during
the three months ended March 31, 2003 relating to employee severance benefits
that met the requirements for accrual. $148 of such amount was charged to
network and product costs, and the remaining $483 was charged to sales,
marketing, general and administrative expenses. During the three months ended
March 31, 2003, the Company paid severance benefits of approximately $569. The
Company paid the remainder of the accrued severance benefits in April of 2003.
$72 and $29 of the cost of this reduction in force related to the Companys
Covad Strategic Partnerships and Covad Broadband Solutions business segments,
respectively. The remaining $530 was related to the Companys Corporate
Operations.

7. Pro forma Stock-Based Compensation Information

Pro forma information regarding the results of operations and net loss per
share (Note 1) is determined as if the Company had accounted for its employee
stock options using the fair value method. Under this method, the fair value of
each option granted is estimated on the date of grant using the Black-Scholes
option valuation model.

The Company uses the intrinsic value method in accounting for its employee
stock options because, as discussed below, the alternative fair value
accounting requires the use of option valuation models that were not developed
for use in valuing employee stock options. Under the intrinsic value method,
when the exercise price of the Companys employee stock options equals or
exceeds the market price of the underlying stock on the date of grant, no
compensation expense is recognized.

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Option valuation models such as Black-Scholes 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 estimates, in
managements opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of the Companys employee stock options.

For the three months ended March 31, 2003 and 2002, the fair value of the
Companys stock-based awards to employees was estimated using the following
weighted-average assumptions:

|                                  |  |           |       |      |  |  |       |  
|--------------------------------- |  | --------- | ----- | ---- |  |  | ----- | -
|                                  |  | March 31,
|                                  |  |          
|                                  |  | 2003      |       | 2002
|                                  |  |           |       |     
|Expected life of options in years |  |           | 4     |      |  |  | 4     |  
|Volatility                        |  |           | 132.4 |      |  |  | 143.4 |  
|Risk-free interest rate           |  |           | 2.08  |      |  |  | 4.31  |  
|Expected dividend yield           |  |           | 0.0   | %    |  |  | 0.0   | %

8. Contingencies

Litigation

On December 13, 2001, the Unites States Bankruptcy Court for the District
of Delaware (the Bankruptcy Court) entered an order confirming the Companys
pre-negotiated First Amended Plan of Reorganization as modified on November 26,
2001 (the Plan). On December 20, 2001 (the Effective Date), the Plan was
consummated and the Company emerged from bankruptcy. Under the Plan, the
Company settled several claims against it. These claims include:



| |  |  | The class action lawsuits filed in the United States District Court
for the Northern District of California, provided that this settlement
will not be final unless it is approved by that court. This settlement
is described in more detail below.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The lawsuits filed in the Superior Court of the State of California
for the County of Santa Clara by six purchasers of the convertible notes
that the Company issued in September 2000.                                                             
|
| |  |  | Disputed claims made by former shareholders of Laser Link.net.                                                                                                                                                                                      
|
| |  |  | Disputed claims made by GE Capital and its subsidiary, Heller Financial Group.                                                                                                                                                                      

As of March 31, 2003 and 2002, there were approximately $8,331 and $27,200
in unresolved claims related to the Companys Chapter 11 bankruptcy
proceedings. As of March 31, 2003, the Company had recorded $7,369 for these
unresolved claims in its condensed consolidated balance sheet. However, it is
reasonably possible that the Companys unresolved Chapter 11 bankruptcy claims
could ultimately be settled for amounts that differ from the amounts recorded
in the Companys condensed consolidated balance sheet.

Purchasers of the Companys common stock and purchasers of the convertible
senior notes the Company issued in September 2000 filed complaints on behalf of
themselves and alleged classes of stockholders and holders of convertible notes
against the Company and certain present and former officers of the Company in
the United States District Court for the Northern District of California (the
District Court). The complaints have been consolidated and the lead plaintiff
filed its amended consolidated complaint. The amended consolidated complaint
alleges violations of federal securities laws on behalf of persons who
purchased or otherwise acquired the Companys securities, including common
stock and notes, during the period from April 19, 2000 to May 24, 2001. The
relief sought includes monetary damages and equitable relief. In 2001, the
Company and the officer and director defendants entered into a Memorandum of
Understanding (MOU) with counsel for the lead plaintiffs in this litigation
that tentatively resolves the litigation. The MOU sets forth the terms upon
which the Company, the officer and director defendants and the plaintiffs agree
to settle the litigation. Pursuant to the MOU, the plaintiffs agreed to support
and vote in favor of the Plan if it provided for the distribution of $16,500 in
cash to be funded by the Companys insurance carriers and 6,495,844 shares of
the Companys common stock. The plaintiffs voted in favor of the plan.
Consequently, the Company recorded a liability of approximately $18,578 in its
condensed consolidated balance sheet as of December 31, 2001 through a charge
to litigation-related expenses for the year then ended

10



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##### Table of Contents



in connection with this anticipated settlement. As a result of changes in
the fair market value of the Companys common stock, the Company decreased this
liability to $14,811 and $6,950 as of March 31, 2002 and December 31, 2002,
respectively, through credits to litigation-related expenses in the amount of
$3,767 and $11,628 for the three months ended March 31, 2002 and year ended
December 31, 2002, respectively. The settlement provided for in the MOU was
subject to the approval of the District Court and, on December 18, 2002, the
District Court issued its final judgment and dismissal order. One class member
has filed an appeal pertaining to the final judgment, but this appeal only
relates to the allocation of the settlement proceeds between the plaintiffs and
their attorneys.

In April 1999, the Company filed a lawsuit against Bell Atlantic (now
Verizon) and its affiliates in the United States District Court for the
District of Columbia. The Company is pursuing antitrust and other claims in
this lawsuit arising out of Verizons conduct as a supplier of network
facilities, including central office space, transmission facilities and
telephone lines. In December 2000, the Company also filed a lawsuit against
BellSouth Telecommunications and its subsidiaries in the United States District
Court for the Northern District of Georgia. The Company is pursuing claims in
this lawsuit that are similar to its claims against Verizon. Both courts
dismissed some of the Companys claims based on the ruling of the Seventh
Circuit in Goldwasser v. Ameritech. The court in the Verizon case also
dismissed the Companys remaining claims on other grounds. The Company
voluntarily dismissed its remaining claims in the BellSouth case so it could
pursue certain issues on appeal. The Company appealed these decisions to the
United States Court of Appeals for the Eleventh Circuit and the United States
Court of Appeals for the District of Columbia. On August 2, 2002, the Eleventh
Circuit Court of Appeals reversed the lower courts decision in the BellSouth
case and remanded the case for further proceedings. BellSouth is seeking an
appeal of this decision before the United States Supreme Court. In addition,
the United States Supreme Court has agreed to review a decision from the United
States Court of Appeals for the Second Circuit entitled Verizon Communications
v. Law Offices of Curtis Trinko, which rejected the Goldwasser decision. The
Eleventh Circuit relied in part on the Trinko decision when it reversed the
lower courts dismissal of the Companys claims against BellSouth. The Court of
Appeals for the District of Columbia has indicated that it will not act on the
Companys appeal in the Verizon case until the Supreme Court decides the Trinko
case. The Company cannot predict the outcome of these matters.

On June 11, 2001, Verizon Communications filed a lawsuit against the
Company in the United States District Court for the Northern District of
California. Verizon is a supplier of telephone lines that the Company uses to
provide services to its customers. In its amended complaint, Verizon claims
that the Company falsified trouble ticket reports with respect to the phone
lines that the Company ordered and seeks unspecified monetary damages
(characterized as being in the millions) and injunctive relief. The current
complaint asserts causes of action for negligent and intentional
misrepresentation and violations of Californias unfair competition statute. On
November 13, 2002, the District Court entered summary judgment in favor of the
Company and dismissed Verizons claims against the Company in their entirety.
Verizon has appealed the dismissal of its lawsuit. The Company believes it has
strong defenses to this lawsuit, but litigation is inherently unpredictable and
there is no guarantee it will prevail.

Several stockholders have filed complaints in the United States District
Court for the Southern District of New York, on behalf of themselves and
purported classes of stockholders, against the Company and several former and
current officers and directors in addition to some of the underwriters who
handled the Companys stock offerings. These lawsuits are so-called IPO
allocation cases, challenging practices allegedly used by certain underwriters
of public equity offerings during the late 1990s and 2000. On April 19, 2002,
the plaintiffs amended their complaint and removed the Company as a defendant.
Certain directors and officers are still named in the complaint. The plaintiffs
claim that the Company and others failed to disclose the arrangements that some
of these underwriters purportedly made with certain investors. The Company
believes it has strong defenses to these lawsuits and intends to contest them
vigorously. However, litigation is inherently unpredictable and there
is no guarantee that the Company will prevail.

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. In September 2000,
COVID 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. The United States District Court recently
dismissed COVIDs lawsuit.

In June 2002, Dhruv Khanna was relieved of his duties as the Companys
General Counsel and Secretary. Shortly thereafter, Mr. Khanna alleged that,
over a period of years, certain current and former directors and officers
breached their fiduciary duties to the Company by engaging in or approving
actions that constituted waste and self-dealing, that certain current and
former directors and officers had provided false representations to the
Companys auditors and that he had been relieved of his duties in retaliation
for his being a purported whistleblower and because of racial or national
origin discrimination. He has threatened to file a shareholder

11



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##### Table of Contents



derivative action against those current and former directors and officers,
as well as a wrongful termination lawsuit. Mr. Khanna was placed on paid leave
while his allegations were being investigated.

The Companys Board of Directors appointed a special investigative
committee, which initially consisted of Dale Crandall and Hellene Runtagh, to
investigate the allegations made by Mr. Khanna. Richard Jalkut was appointed to
this committee shortly after he joined the Companys Board of Directors. This
committee retained an independent law firm to assist in its investigation.
Based on this investigation, the committee concluded that Mr. Khannas
allegations were without merit and that it would not be in the best interests
of the Company to commence litigation based on these allegations. The committee
considered, among other things, that many of Mr. Khannas allegations were not
accurate, that certain allegations challenged business decisions lawfully made
by management or the board of directors, that the transactions challenged by
Mr. Khanna in which any director had an interest were approved by a majority of
disinterested directors in accordance with Delaware law, that the challenged
director and officer representations to the Companys auditors were true and
accurate, and that Mr. Khanna was not relieved of his duties as a result of
retaliation for alleged whistleblowing or racial or national origin
discrimination. Mr. Khanna has disputed the committees work and the outcome of
its investigation.

After the committees findings had been presented and analyzed, the
Company concluded in January 2003 that it would not be appropriate to continue
Mr. Khanna on paid leave status, and determined that there was no suitable role
for him at the Company. Accordingly, he was terminated as an employee of the
Company. While the Company believes Mr. Khannas contentions referred to above
are without merit, and will be vigorously defended if brought, it is unable to
predict the outcome of any potential lawsuit.

The Company is also a party to a variety of other pending or threatened
legal proceedings as either plaintiff or defendant, or is engaged in business
disputes that arise in the ordinary course of business. Failure to resolve
these various legal disputes and controversies without excessive delay and cost
and in a manner that is favorable to the Company could significantly harm its
business. The Company does not believe the ultimate outcome of these matters
will have a material impact on its consolidated financial position and results
of operations. However, litigation is inherently unpredictable and there is no
guarantee the Company will prevail or otherwise not be adversely affected.

The Company is subject to state public utility commission, FCC and other
regulatory 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 bound by or 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 the Companys agreements. The
results of any of these proceedings could harm the Companys business.

Other Contingencies

On February 20, 2003, the FCC issued a press release announcing the
results of its Triennial Review. Based on the Companys understanding of such
press release, the FCCs Triennial Review is a significant development for the
Company for the following reasons:



| |  |  | The FCC announced that it is phasing out its rule requiring
line-sharing over a three-year period. Line-sharing currently allows
the Company to provision services using asymmetric DSL
(ADSL)
technology over the same telephone line that the local telephone
company is using to provide voice services. The federal rules requiring
line-sharing will be phased out over a three-year period, during which
the Company will be required to transition its existing line-sharing
customers to new arrangements. New line-sharing customers may be
acquired at regulated rates only during the first year of the
transition. During each year of the transition, the FCC-mandated
maximum price for the high-frequency portion of the phone line will
increase incrementally towards the cost of a separate phone line. This
means that, unless the Company reaches agreements with the local
telephone companies that provide the Company with continued access to
line-sharing, it will be required to purchase a separate telephone line
in order to provide services to an end-user. The cost of a separate
phone line is significantly higher than the cost of a shared line. As
of March 31, 2003, the Company had approximately 211,200 subscriber
lines using line-sharing agreements.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The FCC also announced that the local telephone companies would not
be required to allow the Company to access the packet-switching
functions of fiber-fed telephone lines to provision DSL services. This
means that, unless the Company reaches agreements with the local
telephone companies, the Company will be unable to provide its most
commonly-used services to end-users served by fiber-fed lines. This is
significant for the Companys business because it preserves a                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

12



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##### Table of Contents





| |   |  | substantial limit on the addressable market for its services, thereby
limiting its growth. In addition, the local telephone companies are
increasing their deployment of fiber-fed remote terminal architectures.
The Company currently has no lines in service using packet-switching
capabilities of fiber-fed telephone lines.                                                                                                                                                                                                                                                                                                                      
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The FCC announced that, if the state public utilities commissions
deem it appropriate, companies that compete with the local telephone
companies would continue to have access to the local telephone
companies networks in order to provide their services under an
arrangement known as the Unbundled Network Element platform (UNE-P).
Under this arrangement these competitive telecommunications companies
purchase phone lines in order to provide voice and data services. The
continued existence of the UNE-P provides the Company with the
opportunity to potentially bundle its data services with the voice
services of these companies.

The FCC has not yet issued its order in the Triennial Review and it is
uncertain when that order will be released. Without that order, it is difficult
for the Company to evaluate the full impact of the FCCs decision on its
business. However, based on the FCCs announcement, it appears that at some
point the Company will be required to purchase a separate telephone line in
order to provide services to an end-user, unless it reaches agreements with the
local telephone companies that provide the Company with continued access to
line-sharing. The cost of a separate phone line is significantly higher than
the cost of a shared line. If the Company is unable to obtain from the
traditional telephone companies reasonable line-sharing rates substantially
below the cost of a separate telephone line, it may stop selling stand-alone
consumer grade services, which would slow the growth of its revenue and require
it to significantly change its business plan.

In addition, one of the traditional telephone companies has notified the
Company that it claims the decision in the Triennial Review is a change in
law that triggers a renegotiation of its interconnection agreements with the
Company. These agreements contain the prices and other terms for the telephone
lines the Company purchases from this traditional telephone company.

As of March 31, 2003, the Company had disputes with a number of
telecommunications companies concerning the balances owed to such carriers for
collocation fees and certain network services. The Company believes that such
disputes will be resolved without a material adverse effect on its consolidated
financial position and results of operations. However, it is reasonably
possible that the Companys estimates of its collocation fee and network
service obligations, as reflected in the accompanying condensed consolidated
balance sheets, could change in the near term, and the effects could be
material to the Companys consolidated financial position and results of
operations.

In addition, the Company is engaged in a variety of negotiations,
arbitrations and regulatory and court proceedings with multiple telephone
companies. These negotiations, arbitrations and proceedings concern the
telephone companies denial of physical central office space to the Company in
certain central offices, the cost and delivery of transmission facilities and
telephone lines and central office space, billing issues and other operational
issues. An unfavorable outcome in any of these negotiations, arbitrations and
proceedings could have a material adverse effect on the Companys consolidated
financial position and results of operations if it is denied access to, or
charged higher rates for transmission lines or central office spaces.

As of March 31, 2003, the Company was analyzing the applicability of
certain transaction-based taxes to (i) sales of its products and services and
(ii) purchases of telecommunications circuits from various carriers. This
analysis includes discussions with authorities of significant jurisdictions in
which the Company does business to determine the extent of its respective
transaction-based tax liabilities. It is the Companys opinion that such
analysis will be concluded without a material adverse effect on its
consolidated financial position and results of operations. However, it is
reasonably possible that the Companys estimates of its transaction-based tax
liabilities, as reflected in the accompanying condensed consolidated balance
sheets, could change in the near term, and the effects could be material to the
Companys consolidated financial position and results of operations. During
the three months ended March 31, 2003, the Company changed its estimates of
certain accrued liabilities for transaction-based and property taxes based on settlement
agreements reached with the tax authorities of certain jurisdictions in which
the Company does business. This change in accounting estimate reduced the
Companys net loss by $2,506 ($0.01 per share) for the quarter ended March 31,
2003.

The
Company is analyzing the applicability
of employment-related taxes for certain stock-based compensation provided to employees in prior
periods. Due to the probable applicability of these
taxes, the Company recorded an estimated liability through a charge to
operations, in the amount of $5,938 during the three months ended
March 31, 2003. The Company intends to engage in discussions with state and federal
tax authorities to settle these estimated tax liabilities. It
is the Companys opinion that such discussions will be concluded without a
material adverse effect on its consolidated financial position and results of
operations. However, it is reasonably possible that the Companys estimates of
these tax liabilities, as reflected in the accompanying condensed
consolidated balance sheet as of March 31, 2003, could change in the
near term, and the effects
could be material to the Companys consolidated financial position and results
of operations.

13



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##### Table of Contents



9. Business Segments

The Companys business segments are strategic business units that are
managed based upon differences in customers, services and marketing channels,
even though the assets and cash flows from these operations are not independent
of each other. Covad Strategic Partnerships (CSP) focuses on delivering
services to enterprise, corporate, small business, small office/home office
(SoHo) and consumer customers primarily through wholesale relationships with
large Internet service providers (ISPs), telecommunications carriers and
other large resellers. Covad Broadband Solutions (CBS) focuses on small
business and SoHo markets by selling services directly to end-users as well as
through independent authorized sales agents and small ISPs and resellers. All
other business operations and activities of the Company are aggregated and
reported as Corporate Operations. These operations and activities are primarily
comprised of general corporate functions to support the Companys revenue
producing segments as well as costs and expenses for headquarters facilities
and equipment, depreciation and amortization, network capacity and other
non-recurring or unusual items not directly attributable or allocated to the
segments, gains and losses on the Companys investments, and income and
expenses from the Companys treasury and financing activities.

The Company evaluates performance and allocates resources to the segments
based on income or loss from operations, excluding certain operating expenses,
including depreciation and amortization, and
other income and expense items. The Company does not allocate such operating
expenses and other income and expense items to its business segments
because it believes that these expenses and other income items are not directly managed by
the business segments.

Segment information, including a reconciliation to the respective balances
in the Companys condensed consolidated financial statements, as of and for the

three months ended March 31, 2003 and 2002 are as follows (the Companys 2002
segment information has been restated to conform to the Companys
organizational structure in 2003):

|                                                      |  |     |        |     |  |          |        |            |  |              |        |           |  |              |         |              |  |   |   |  |  |   |         |  
|----------------------------------------------------- |  | --- | ------ | --- |  | -------- | ------ | ---------- |  | ------------ | ------ | --------- |  | ------------ | ------- | ------------ |  | - | - |  |  | - | ------- | -
|As of and for the                                     |  |     |        |     |  |          |        |            |  |              |        |           |  |              |         |              |  |   |   |  |  |   |         |  
|Three Months Ended                                    |  |     |        |     |  |          |        |            |  | Total        |        | Corporate |  | Intercompany |         | Consolidated
|March 31, 2003:                                       |  | CSP |        | CBS |  | Segments |        | Operations |  | Eliminations |        | Total    
|                                                      |  |     |        |     |  |          |        |            |  |              |        |          
|Domestic revenues
from external
customers, net        |  | $   | 56,449 |     |  | $        | 34,411 |            |  | $            | 90,860 |           |  | $            |        |              |  | $ |  |  |  | $ | 90,860  |  
|Network and product
costs                             |  | $   | 39,949 |     |  | $        | 17,440 |            |  | $            | 57,389 |           |  | $            | 11,635  |              |  | $ |  |  |  | $ | 69,024  |  
|Sales, marketing,
general and
administrative
expenses |  | $   | 2,902  |     |  | $        | 8,380  |            |  | $            | 11,282 |           |  | $            | 26,097  |              |  | $ |  |  |  | $ | 37,379  |  
|Depreciation and
amortization                         |  | $   |       |     |  | $        |       |            |  | $            |       |           |  | $            | 18,589  |              |  | $ |  |  |  | $ | 18,589  |  
|Other expenses, net                                   |  | $   |       |     |  | $        |       |            |  | $            |       |           |  | $            | 590     |              |  | $ |  |  |  | $ | 590     |  
|Net income (loss)                                     |  | $   | 13,598 |     |  | $        | 8,591  |            |  | $            | 22,189 |           |  | $            | (56,911 | )            |  | $ |  |  |  | $ | (34,722 | )
|Total assets                                          |  | $   | 52,135 |     |  | $        | 20,089 |            |  | $            | 72,224 |           |  | $            | 335,168 |              |  | $ |  |  |  | $ | 407,392 |  

|                                                      |  |     |        |     |  |          |        |            |  |              |         |           |  |              |         |              |  |   |   |  |  |   |         |  
|----------------------------------------------------- |  | --- | ------ | --- |  | -------- | ------ | ---------- |  | ------------ | ------- | --------- |  | ------------ | ------- | ------------ |  | - | - |  |  | - | ------- | -
|As of and for the                                     |  |     |        |     |  |          |        |            |  |              |         |           |  |              |         |              |  |   |   |  |  |   |         |  
|Three Months Ended                                    |  |     |        |     |  |          |        |            |  | Total        |         | Corporate |  | Intercompany |         | Consolidated
|March 31, 2002:                                       |  | CSP |        | CBS |  | Segments |        | Operations |  | Eliminations |         | Total    
|                                                      |  |     |        |     |  |          |        |            |  |              |         |          
|Domestic revenues
from external
customers, net        |  | $   | 60,218 |     |  | $        | 41,448 |            |  | $            | 101,666 |           |  | $            |        |              |  | $ |  |  |  | $ | 101,666 |  
|Network and product
costs                             |  | $   | 47,216 |     |  | $        | 19,543 |            |  | $            | 66,759  |           |  | $            | 23,435  |              |  | $ |  |  |  | $ | 90,194  |  
|Sales, marketing,
general and
administrative
expenses |  | $   | 3,090  |     |  | $        | 7,285  |            |  | $            | 10,375  |           |  | $            | 26,829  |              |  | $ |  |  |  | $ | 37,204  |  
|Depreciation and
amortization                         |  |     |       |     |  |          |       |            |  | $            |        |           |  | $            | 34,482  |              |  | $ |  |  |  | $ | 34,482  |  
|Other (income)
expenses, net                          |  | $   |       |     |  | $        |       |            |  | $            |        |           |  | $            | (3,375  | )            |  | $ |  |  |  | $ | (3,375  | )
|Net income (loss)                                     |  | $   | 9,912  |     |  | $        | 14,620 |            |  | $            | 24,532  |           |  | $            | (81,371 | )            |  | $ |  |  |  | $ | (56,839 | )
|Total assets                                          |  | $   | 74,208 |     |  | $        | 18,519 |            |  | $            | 92,727  |           |  | $            | 518,528 |              |  | $ |  |  |  | $ | 611,255 |  

14



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Item 2.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 unaudited condensed
consolidated financial statements and the related notes thereto included
elsewhere in this Report on Form 10-Q and the audited consolidated financial
statements and notes thereto and managements discussion and analysis of
financial condition and results of operations for the year ended December 31,
2002 included in our Annual Report on Form 10-K filed with the Securities and
Exchange Commission on March 20, 2003. This discussion contains forward-looking
statements, the accuracy of which is subject to risks and uncertainties. Our
actual results could differ materially from those expressed in forward-looking
statements for many reasons including, but not limited to, those discussed
herein and in the Risk Factors section of our Annual Report on Form 10-K,
which is contained in Part I, Item 1, Business  Risk Factors, of that report.
We disclaim any obligation to update information contained in any
forward-looking statement. See  Forward Looking Statements.

(All dollar amounts are presented in thousands, except per share amounts)

Overview

We are a leading provider of high-speed Internet connectivity and related
communications services, which we sell to businesses and consumers indirectly
through Internet service providers (ISP), telecommunications carriers and
other resellers. We also sell our services directly to business and consumer
end-users through our field sales force, telephone sales, referral agents and
our Web site. Our services include a range of high-speed, or
broadband, Internet access connectivity and related services using digital
subscriber line (DSL), T-1, Virtual Private Network (VPN) and firewall
technologies.

We have a relatively short operating history. We introduced our services
commercially in the San Francisco Bay Area in December 1997. As of March 31,
2003, we believe we have one of the largest nationally deployed DSL networks
based on approximately 1,800 operational central offices that pass more than 46
million homes and businesses in the United States. As of March 31, 2003, we had
approximately 417,000 high-speed Internet access lines in service using DSL
technology (approximately 1.7% of these lines are associated with customers for
which we recognize revenue when cash for services rendered is received due to
their financial condition, primarily concentrated among six such customers). We
also provide dial-up Internet access service to over 48,000 customers through
our direct sales channel. We are also developing a variety of services that are
enhanced or enabled by our high-speed network.

Since our inception, we have generated significant net and operating
losses and we continue to experience negative operating cash flow. As of March
31, 2003, we had an accumulated deficit of $1,564,058. We expect losses and
negative cash flow to continue at least into 2004. Although we currently have a
plan in place that we believe will ultimately allow us to achieve positive cash
flows from our operating activities without raising additional capital, our
cash reserves are limited and our plan is based on assumptions, which we
believe are reasonable, but some of which are out of our control. If actual
events differ from our assumptions, we may need to raise additional capital on
terms that are less favorable than we desire, which may have a material adverse
effect on our financial condition and could cause significant dilution to our
stockholders. The inability to raise additional capital could also result in a
liquidation or sale of our company.

In the course of preparing our financial statements for the year ended
December 31, 2000, internal control weaknesses were discovered, some of which
continued into 2001 and 2002. The improvements we have made over the last
several quarters to our internal policies and procedures and systems
capabilities have significantly improved controls. However, during our 2002
year-end financial statement close process, we identified some additional
control weaknesses, which are discussed in Part IV, Item 14, Controls and
Procedures in our 2002 Annual Report on Form 10-K.

Recent Developments

On February 20, 2003, the Federal Communications Commission (FCC) issued
a press release announcing the results of its Triennial Review. Based on our
understanding of such press release, the FCCs Triennial Review is a
significant development for us for the following reasons:



| |  |  | The FCC announced that it is phasing out its rule requiring
line-sharing over a three-year period. Line-sharing currently allows us
to provision services using asymmetric DSL (ADSL) technology over the
same telephone line that the local telephone company is using to
provide voice services. The federal rules requiring line-sharing will
be phased out over a
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

15



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##### Table of Contents





| |   |  | three-year period, during which we will be required to transition our
existing line-sharing customers to new arrangements. New line-sharing
customers may be acquired at regulated rates only during the first year of
the transition. During each year of the transition, the FCC-mandated
maximum price for the high-frequency portion of the phone line will
increase incrementally towards the cost of a separate phone line. This
means that, unless we reach agreements with the local telephone companies
that provide us with continued access to line-sharing, we will be required
to purchase a separate telephone line in order to provide services to an
end-user. The cost of a separate phone line is significantly higher than
the cost of a shared line. As of March 31, 2003, we had approximately
211,200 subscriber lines using line-sharing agreements.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The FCC also announced that the local telephone companies would not
be required to allow us to access the packet-switching functions of
fiber-fed telephone lines to provision DSL services. This means that,
unless we reach agreements with the local telephone companies, we will
be unable to provide our most commonly-used services to end-users
served by fiber-fed lines. This is significant for our business because
it preserves a substantial limit on the addressable market for our
services, thereby limiting our growth. In addition, the local telephone
companies are increasing their deployment of fiber-fed remote terminal
architectures. We currently have no lines in service using
packet-switching capabilities of fiber-fed telephone lines.                                                                                                    
|
| |  |  | The FCC announced that, if the state public utilities commissions
deem it appropriate, companies that compete with the local telephone
companies would continue to have access to the local telephone
companies networks in order to provide their services under an
arrangement known as the Unbundled Network Element platform (UNE-P).
Under this arrangement these competitive telecommunications companies
purchase phone lines in order to provide voice and data services. The
continued existence of the UNE-P provides us with the opportunity to
potentially bundle our data services with the voice services of these
companies.                                                                                                                                                                                                                             

The FCC has not yet issued its order in the Triennial Review and it is
uncertain when that order will be released. Without that order, it is difficult
for us to evaluate the full impact of the FCCs decision on our business.
However, based on the FCCs announcement, it appears that at some point we will
be required to purchase a separate telephone line in order to provide services
to an end-user, unless we reach agreements with the local telephone companies
that provide us with continued access to line-sharing. The cost of a separate
phone line is significantly higher than the cost of a shared line. If we are
unable to obtain from the traditional telephone companies reasonable
line-sharing rates substantially below the cost of a separate telephone line,
we may stop selling stand-alone consumer grade services, which would slow the
growth of our revenue and require us to significantly change our business plan.

In addition, one of the traditional telephone companies has notified us
that it claims the decision in the Triennial Review is a change in law that
triggers a renegotiation of our interconnection agreements with it. These
agreements contain the prices and other terms for the telephone lines that we
purchase from this traditional telephone company. It is possible that other
traditional telephone companies will provide us with similar notices.

On September 23, 2002, we announced that we signed a three-year agreement
with AT&T Corp. (AT&T) that provides it with the ability to purchase certain
of our wholesale consumer-grade broadband Internet access services. AT&T began
placing orders for these services in the fourth quarter of 2002. On January 1,
2003, we announced that we amended this agreement and granted AT&T three
warrants to purchase an aggregate of 3,000,000 shares of our common stock at
prices ranging from $0.94 to $5.00 per share. Such warrants were immediately
exercisable, fully vested and non-forfeitable at the date of grant. The
aggregate fair value of such warrants of approximately $2,640 was recorded as a
deferred customer incentive during the three months ended March 31, 2003, and
is being recognized as a reduction of revenues on a straight-line basis over
the three-year term of the agreement because we believe that future revenues
from AT&T will exceed the fair value of the warrants.

Reseller Financial Difficulties

Some of our resellers are experiencing financial difficulties. During the
three months ended March 31, 2003 and 2002, certain of these customers either
(i) were not current in their payments for our services or (ii) were
essentially current in their payments but, subsequent to the end of the
reporting period, their financial condition deteriorated significantly and some
of them filed for bankruptcy protection. Based on this information, we
determined that (i) the collectibility of revenues from these customers was not
reasonably assured or (ii) our ability to retain some or all of the payments
received from some of these customers that filed for bankruptcy protection was
not reasonably assured. Accordingly, we have classified this group of customers
as financially distressed for revenue recognition purposes. Revenues from
financially distressed customers are recognized when cash for services provided
is collected, assuming all other criteria for revenue recognition have been
met, but only after the collection of all previous outstanding accounts
receivable balances. Payments received from financially distressed customers
during a legally defined period prior to their filing of petitions for
bankruptcy protection are recorded in our condensed consolidated balance sheet
caption Unearned revenues if our

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ability to retain these payments is not reasonably assured. Although
WorldCom, Inc (WorldCom) filed for bankruptcy protection during the year
ended December 31, 2002, we have not classified it as a financially distressed
customer based on WorldComs specific facts and circumstances in relation to
the revenue recognition criteria described in Note 2 to our condensed
consolidated financial statements. Therefore, we continued to recognize
revenues from WorldCom on an accrual basis during 2002 and 2003.

In order to limit our exposure to the financial difficulties of certain of
our customers, we have implemented certain policies and taken a series of
actions. We may stop taking new orders from these partners but continue to
install and maintain previously accepted orders. We may terminate our contracts
with those partners who are unresponsive to our collection efforts. While our
goal is to maintain consistent high quality service to end-users, we may also
decide to disconnect some end-users that are purchasing our services from
customers facing financial difficulties and, in some cases, we may attempt to
migrate these end-users to another wholesale partner or to our own Covad Direct
service. Although we have successfully migrated end-users, there can be no
assurance that these migrated end-users will continue to purchase our services.
Even if we are able to migrate end-users, this process requires 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.

Even though we are making progress in reducing the number of financially
distressed customers for which we are not currently recognizing revenue on an
accrual basis, we may be unable to completely restore the remaining customers
to normal revenue producing status and we may encounter future payment problems
with our customers. In addition, in light of the financial position of many of
our resellers, should a particular reseller become subject to reorganization or
bankruptcy proceedings, we may be unable to collect payments owed to us or
retain payments or other consideration (including subscriber lines) already
received by us.

Related Party Transactions

Our former vice-chairman and former interim chief executive officer, Frank
Marshall, who was also a member of our board of directors from October 1997 to
December 2002, was a minority stockholder and former member of the board of
directors of one of our former ISP customers, InternetConnect, which filed for
bankruptcy protection in 2001. We recognized no revenues related to this
customer during the three months ended March 31, 2003 or 2002. On January 3,
2002, we purchased substantially all of the assets of InternetConnect in an
auction supervised by the United States Bankruptcy Court for the Central
District of California. The purchase price for the assets of InternetConnect
was $5,470 in cash. Under the terms of the asset purchase agreement, we may be
required to pay additional cash of up to $1,880 for the assets of
InternetConnect, depending upon the outcome of a previous post-petition
bankruptcy claim filed by us against InternetConnect. That claim is still
unresolved. We did not assume any liabilities or obligations of InternetConnect
or hire any of InternetConnects employees. The tangible assets purchased from
InternetConnect consisted of accounts receivable, refundable deposits and
property and equipment. We also purchased the right, but not the obligation, to
assume InternetConnects customer contracts. However, we did not exercise this
right. Instead, we solicited approximately 9,250 DSL, T-1, VPN and dial-up
customers of InternetConnect, and approximately 6,200 of these customers
executed new contracts with us or our resellers.

We also purchased certain products from a company in which Mr. Marshall
serves as a director. Purchases from this vendor totaled $39 and $39 during the
three months ended March 31, 2003 and 2002, respectively.

A member of our Board of Directors, Richard Jalkut, is the President and
CEO of TelePacific, one of our resellers. We recognized revenues of $207 and
$422 from TelePacific during the three months ended March 31, 2003 and 2002,
respectively.

Results of Operations

Business Segment Information

During the three months ended March 31, 2003 and 2002 we managed our
business segments based upon differences in customers, services and marketing
channels, even though the assets and cash flows from these operations were not
independent of each other. Covad Strategic Partnerships (CSP) focused on
delivering services to enterprise, corporate, small business, small office/home
office (SoHo) and consumer customers primarily through wholesale
relationships with large ISPs, telecommunications carriers and other large
resellers. Covad Broadband Solutions (CBS) focused on small business and SoHo
markets by selling services directly to end-users as well as through
independent authorized sales agents and small ISPs and resellers. We aggregated
and reported all other business operations and activities as Corporate
Operations. These operations and activities were primarily comprised of general
corporate functions to support our revenue producing segments and included
costs and expenses for headquarters facilities and equipment, depreciation and
amortization, network capacity and non-recurring or unusual items not directly
attributable or allocated to

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the segments, gains and losses on our investments, and income and expenses
from our treasury and financing activities. We do not allocate such
operating expenses and other income and expense items to our business
segments because we believe these expenses and other income items are
not directly managed by our business segments.

Our 2002 segment information has been restated to conform to our
organizational structure in 2003.

Reclassifications

Certain balances in our 2002 condensed consolidated financial statements,
including certain operating expenses, have been reclassified to conform to the
presentation in 2003.

Three Months Ended March 31, 2003 and 2002

Revenues, Net

We recorded net revenues of $90,860 for the three months ended March 31,
2003, a decrease of $10,806, or 10.6%, over net revenues of $101,666 for the
three months ended March 31, 2002. The decrease in net revenues is primarily
attributable to an increase in customer incentives and rebates, which we
recorded as reductions of revenues and a decrease in Federal
Universal Service Fund (FUSF) charges billed to our
customers, as further described below, the impact of which was partially offset by
an increase in the number of customers and end-users as a result of various
sales and marketing efforts. In addition, as a result of the developments in
the bankruptcy proceedings of certain of our resellers, as discussed further
below, we recognized revenues of $3,307 during the three months ended March 31,
2002 that were for services provided prior to January 1, 2002. We recognized
similar payments of $34 from certain bankrupt customers as revenues during the
three months ended March 31, 2003. Although we expect our subscriber base to
grow as we introduce new services and continue to execute on our sales and
marketing programs, our revenue growth may continue to be impaired by lower
selling prices and increases in customer incentives and rebates, which we
record as reductions of revenues. For example, recent price
reductions by some of the traditional telephone companies have caused
us to offer lower prices to some of our customers. In addition, if we are unable to obtain from
the traditional telephone companies reasonable line-sharing rates substantially
below the cost of a separate telephone line as a result of the FCCs order in
the Triennial Review, we may stop selling stand-alone consumer grade services.
If we stop selling stand-alone consumer grade services it could significantly
reduce our revenue growth.

Included
in net revenues are FUSF charges billed to our customers aggregating $958 and $2,988 for the three
months ended March 31, 2003 and 2002, respectively. The decrease in FUSF was
primarily driven by the change in the applicability of FUSF to some our
resellers.

We recorded net revenues of $56,449 and $34,411 from our CSP and CBS
business segments, respectively, for the three months ended March 31, 2003, a
decrease of $3,769, or 6.3%, and $7,037, or 17.0%, over net revenues of $60,218
and $41,448, respectively, for the three months ended March 31,
2002. As described above, the
decrease in revenue is primarily attributable to an
increase in customer incentives and rebates, which we recorded as reductions of
revenues and a decrease in FUSF charges billed to our customers, partially offset by an increase in the number of customers and
end-users as a result of various sales and marketing efforts. Net revenues from
our CSP business segment represented 62.1% and 59.2% of total net revenues for
the three months ended March 31, 2003 and 2002, respectively. Net revenues from
our CBS business segment represented 37.9% and 40.8% of total net revenues for
the three months ended March 31, 2003 and 2002, respectively.

We had over 180 resellers as of March 31, 2003, as compared to
approximately 150 as of March 31, 2002. The increase in the number of resellers
occurred primarily in our CBS segment and is attributable to our various sales
and marketing efforts. For the three months ended March 31, 2003 and 2002, our
30 largest customers (11 from CSP and 19 from CBS) collectively comprised 76.1%
and 82.2% of the Companys total net revenues, respectively. As of March 31,
2003 and 2002, receivables from these customers collectively comprised 75.4%
and 73.5%, respectively, of our gross accounts receivable balance.

For the three months ended March 31, 2003, EarthLink, Inc. and AT&T, two
resellers in our CSP business segment, accounted for 21.1% and 11.4% of our
total net revenues. As of March 31, 2003, receivables from these customers
comprised 25.3% and 11.1% of our gross accounts receivable balance. No other
individual customer accounted for more than 10% of our total net revenues
during the three months ended March 31, 2003.

For the three months ended March 31, 2002, Earthlink, Inc. and XO
Communications, two resellers in our CSP business segment, accounted for 20.6%
and 10.7%, respectively, of our total net revenues. As of March 31, 2002,
receivables from Earthlink, Inc. comprised 21.3% of our gross accounts
receivable balance. We began recognizing revenues from XO Communications on a
cash basis

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(as described below) during the fourth quarter of 2001. Therefore, our
contractual receivable from XO Communications of $2,791 as of March 31, 2002
was not recognized in our condensed consolidated balance sheet as of such date.
However, we resumed the recognition of revenues from XO Communications on an
accrual basis during the fourth quarter of 2002.

Some of our resellers are experiencing financial difficulties. During the
three months ended March 31, 2003 and 2002, certain of these customers either
(i) were not current in their payments for our services or (ii) were
essentially current in their payments but, subsequent to the end of the
reporting period, the financial condition of such customers deteriorated
significantly and certain of them have filed for bankruptcy protection. Based
on this information, we determined that (i) the collectibility of revenues from
these customers was not reasonably assured or (ii) our ability to retain some
or all of the payments received from certain of these customers that have filed
for bankruptcy protection was not reasonably assured. Accordingly, we
classified this group of customers as financially distressed for revenue
recognition purposes. Revenues from financially distressed customers that have
not filed for bankruptcy protection are recognized when cash for those services
is collected, assuming all other criteria for revenue recognition have been
met, but only after the collection of all previous outstanding accounts
receivable balances. Payments received from financially distressed customers
during a defined period prior to their filing of petitions for bankruptcy
protection are recorded in the condensed consolidated balance sheet caption
Unearned revenues if our ability to retain these payments is not reasonably
assured.

Some of our customers are currently in bankruptcy proceedings. Revenues
from these customers accounted for approximately 3.1% and 5.6% of our total net
revenues for the three months ended March 31, 2003 and 2002, respectively. As
described above, although WorldCom filed for bankruptcy protection on July 21,
2002, we continued to recognize revenues from WorldCom on an accrual basis
during 2002 and 2003 based on its specific facts and circumstances in relation
to the revenue recognition criteria described in Note 2 to our condensed
consolidated financial statements. Consequently, the disclosures in the
following paragraph related to financially distressed customers exclude amounts
pertaining to WorldCom because we have not presently classified it as a
financially distressed customer for revenue recognition purposes. We continue
to attempt to migrate end-users from some financially distressed customers to
the extent it is legally and operationally feasible.

During the three months ended March 31, 2003 and 2002, we issued billings
to our financially distressed customers aggregating $2,677 and $18,774,
respectively, which were not recognized as revenues or accounts receivable in
our condensed consolidated financial statements. However, we ultimately
recognized net revenues from certain of these customers when cash was collected
aggregating $2,402 and $16,862 during the three months ended March 31, 2003 and
2002, respectively, some of which relates to services provided in prior
periods. Revenues recognized during the three months ended March 31, 2002
include payments totaling $3,307 from certain bankrupt customers that we
received prior to January 1, 2002 and recorded as unearned revenues in our
consolidated balance sheet as of December 31, 2001 because our ability to
retain these payments was not reasonably assured as of that date. However, as a
result of subsequent developments in the bankruptcy proceedings of such
customers, we determined that our ability to retain these payments was
reasonably assured prior to March 31, 2002. Consequently, we recognized these
payments as revenues during the three months then ended. We recognized similar
payments of $34 from certain bankrupt customers as revenues during the three
months ended March 31, 2003. We had contractual receivables from our
financially distressed customers totaling $6,204 as of March 31, 2003 that are
not reflected in our condensed consolidated financial statements. We have made
progress in reducing the number of financially distressed customers in recent
periods. As discussed in the following paragraph, however, there is a high
probability that additional customers will become financially distressed.

Some of our customers, including WorldCom, who were essentially current in
their payments for our services prior to March 31, 2002, or have subsequently
paid all or significant portions of the respective amounts that we recorded as
accounts receivable as of March 31, 2002, have a high risk of becoming
financially distressed. Revenues from these customers accounted for
approximately 25.6% and 23.7% of our total net revenues for the three months
ended March 31, 2003 and 2002, respectively. As of March 31, 2003, receivables
from these customers comprised 31.9% of our gross accounts receivable balance.
If these customers are unable to demonstrate their ability to pay for our
services in a timely manner in periods ending subsequent to March 31, 2003,
revenue from such customers will be recognized when cash is collected, as
described above.

We have billing disputes with some of our customers. These disputes arise
in the ordinary course of business in the telecommunications industry and their
impact on our accounts receivable and revenues can be reasonably estimated
based on historical experience. In addition, certain revenues are
subject to refund if the end-user terminates service within thirty days of
service activation. Accordingly, we maintain allowances, through charges to
revenues, based on our estimate of the ultimate resolution of these disputes
and future service cancellations. These charges to revenues amounted to $671
and $1,260 during the three months ended March 31, 2003 and 2002, respectively.

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During the three months ended March 31, 2003, we changed our estimates of
certain accrued liabilities for customer incentives based on the compilation of
sufficient historical data with which to estimate sales incentives that will
not ultimately be claimed by customers. This change in accounting estimate
increased our revenues by $1,585 and decreased our net loss by $1,850 ($0.01
per share) during the three months ended March 31, 2003.

Network and Product Costs

We recorded network and product costs of $69,024 for the three months
ended March 31, 2003, a decrease of $21,170, or 23.4%, over network and product
costs of $90,194 recorded for the three months ended March 31, 2002. For the
three months ended March 31, 2003, network and product costs were 76.0% of
revenues, a 14.3% improvement from the three months ended March 31, 2002, when
network and product costs were 88.7% of revenues. For the three months ended
March 31, 2003 and 2002, network and product costs were comprised of $39,949
and $47,216, respectively, from our CSP business segment, $17,440 and $19,543,
respectively, from our CBS business segment and, $11,635 and $23,435,
respectively, from our Corporate Operations. The decrease in network and
product costs during the three months ended March 31, 2003 is primarily
attributable to continued efforts to lower network costs by more efficiently
managing our network capacity and a reduction in our workforce within the
operations and engineering groups. In addition, during the three
months ended March 31, 2003, we changed our estimates of certain
liabilities for transaction-based and property taxes based on
settlements reached with various states and local jurisdictions on our
transaction-based taxes and additional compilation of data on the
valuation of our taxable property and equipment. This change in
accounting estimate decreased our network and product costs by
$2,506 and decreased our net loss by $2,506 ($0.01 per share) during
the three months ended March 31, 2003. Network and product costs for the three
months ended March 31, 2003 include a charge of $2,137 for the
probable applicability of employment-related taxes related to certain stock-based compensation
provided to employees in prior periods. Network and product costs
for the three months ended March 31, 2002 include acquisition costs of $3,674
associated with certain of InternetConnects former customers, as described
above. We expect network and product costs to increase in future periods to the
extent we are able to add subscribers and services to our network, but, subject
to the uncertainty noted in the following paragraph, to decrease as a
percentage of revenue if we are able to increase revenue and, accordingly
leverage the economies of scale that we expect.

As discussed in the Overview  Recent Developments section of this
document, there is uncertainty concerning our ability to purchase line-shared
services from the traditional telephone companies as a result of the FCCs
decision in its Triennial Review of the Telecommunications Act of 1996. As a
result, it is possible that the traditional telephone companies could
substantially increase the cost or reduce the availability of line-shared
services, which would substantially increase our overall network cost structure
and might cause us to discontinue our stand-alone consumer grade services for
new and existing customers.

Sales, Marketing, General and Administrative Expenses

We recorded sales, marketing, general and administrative expenses of
$37,379 for the three months ended March 31, 2003, an increase of $175, or
0.5%, over sales, marketing, general and administrative expenses of $37,204
recorded for the three months ended March 31, 2002. Sales, marketing, general
and administrative expenses consist primarily of salaries and related expenses
and our promotional and advertising expenses. For the three months ended March
31, 2003, sales, marketing, general and administrative expenses were 41.1% of
revenues, an increase of 12.3% over the three months ended March 31, 2002, when
sales, marketing, general and administrative expenses were 36.6% of revenues.
For the three months ended March 31, 2003 and 2002, sales, marketing, general
and administrative expenses were comprised of $2,902 and $3,090, respectively,
from our CSP business segment, $8,380 and $7,285, respectively, from our CBS
business segment and, $26,097 and $26,829, respectively, from our Corporate
Operations

The increase in sales, marketing, general and administrative expenses
during the three months ended March 31, 2003 is primarily attributable to a
charge of $3,800 for the potential applicability of employment-related taxes related to
certain stock-based compensation provided to employees in prior periods. The
increase in sales, marketing, general and administrative expenses for the three
months ended March 31, 2003 was partially offset by lower advertising and
transaction-based tax expenses. We expect sales, marketing, general and
administrative expense levels to increase in the near future as we continue our
marketing efforts. However, as discussed in the Overview  Recent
Developments section of this document, there is uncertainty concerning our
ability to purchase line-shared services from the traditional telephone
companies as a result of the FCCs decision in its Triennial Review of the
Telecommunications Act of 1996. As a result, it is possible that the
traditional telephone companies could substantially increase the cost or reduce
the availability of line-shared services, which would substantially increase
our overall network cost structure and might cause us to discontinue our
stand-alone consumer grade services for new and existing customers. If this
occurs, our sales, marketing, general and administrative expense levels may be
curtailed as an element of a new business structure.

Total Operating Expenses

Total operating expenses, which include network and product costs, sales,
marketing, general and administrative expenses, provision for bad
debts or bad
debt recoveries, depreciation and amortization expenses, and
litigation-related expenses were $125,190

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for the three months ended March 31, 2003, a decrease of $32,850, or
20.8%, over operating expenses of $158,040 for the three months ended March 31,
2002. For the three months ended March 31, 2003 and 2002, operating expenses
were comprised of $42,851 and $50,306, respectively, from our CSP business
segment, $25,820 and $26,828, respectively, from our CBS business segment and
$56,321 and $80,906, respectively, from our corporate operations.

Provision for Bad Debts (Bad Debt Recoveries), Net

We recorded net bad debt expenses (recoveries) of $198 and $(73) for the
three months ended March 31, 2003 and 2002, respectively. Bad debt expenses
(recoveries) were 0.1% and 0.1% of net revenues for the three months ended
March 31, 2003 and 2002, respectively. The increase in bad debt expense from
2002 to 2003 is primarily attributable to the fact that we received claims from
certain customers who had previously filed for bankruptcy protection. These
customers alleged that they are entitled to recover amounts paid to us prior to
their bankruptcy filings.

Depreciation and Amortization

We recorded depreciation and amortization expense for property and
equipment in the amount of $14,593 for the three months ended March 31, 2003, a
decrease of $16,260, or 52.3%, over depreciation and amortization expense for
property and equipment of $30,853 recorded for the three months ended March 31,
2002. The decrease from 2002 to 2003 was due principally to asset retirements
and certain assets becoming fully depreciated during 2002 and 2003. We expect
depreciation and amortization to decrease in the future because we anticipate
that our capital expenditures in the near term will be less than historical
amounts and additional assets will become fully depreciated. We believe that
the geographic footprint of our network will remain relatively unchanged and
that near term capital expenditures will be mostly limited to adding capacity
to our network to support new users.

Amortization of intangible assets for the three months ended March 31,
2003 and 2002 was $3,996 and $3,629, respectively. The increase from 2002 to
2003 resulted from the resumption of our network build or augmentation in
selected markets during the latter portion of 2002 and the three months ended
March 31, 2003, which increased collocation fee expenditures and related
amortization expenses. We do not expect to incur significant capital
expenditures for property and equipment in connection with this expansion.

As explained above, we do not allocate depreciation and amortization expense
to our business segments.

Reduction in Force

During the first quarter of 2003, we reduced our workforce by
approximately 70 employees, which represented approximately 5.4% of our total
workforce. The reductions covered employees in the areas of sales and
marketing, operations and corporate functions. In connection with this
reduction, we recorded a charge to operations of $631 during the three months
ended March 31, 2003 relating to employee severance benefits that met the
requirements for accrual and paid severance benefits of approximately $569. We
paid the remainder of the accrued severance benefits in April of 2003. $148 of
the charge to operations was included in our network and product costs, the
remaining $483 was included in our sales, marketing, general and administrative
expenses. $72 and $29 of the cost of the reduction in force related to our CSP
and CBS business segments, respectively. The remaining $530 related to our
Corporate Operations.

Litigation-related Expenses

We recorded a credit to litigation-related expenses of $3,767 for the
three months ended March 31, 2002. The credit represents the non-cash
adjustment for the change in value of the 6,495,844 shares of common stock that
will ultimately be distributed pursuant to the Memorandum of Understanding
(MOU) described in Note 9 to our condensed consolidated financial statements
and in Part II, Item 1, Legal Proceedings. We did not recognize similar
credits for the three months ended March 31, 2003.

Net Interest Income (Expense)

Net interest income (expense) was $(663) and $94 for the three months
ended March 31, 2003 and 2002, respectively. Net interest income (expense)
during the three months ended March 31, 2003 and 2002 consisted principally of
interest expense on our 11% long-term note payable to SBC Communications Inc.
(SBC), less interest income earned on our cash, cash equivalents and
short-term investments balances. We expect future net interest expense to be
limited to accrued interest on our note payable to SBC offset by interest
earned on cash balances. We may, however, seek additional debt financing in the
future if it is available on terms that we believe are favorable. If we seek
additional debt financing, our interest expense would increase.

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Investment Losses

We recorded losses and write-downs on investments for the three months
ended March 31, 2003 in the amount of $216. This included an impairment
write-down of an equity investment of $112 and our equity in the losses of
unconsolidated affiliates of $104. We recorded losses and write-downs on
investments for the three months ended March 31, 2002 in the amount of $48.
This included a net realized loss on short-term investments of $17, our equity
in the losses of unconsolidated affiliates of $391 and a realized gain on the
sale of an investment in an unconsolidated affiliate of $360.

Income Taxes

Because we incurred operating losses during all periods presented, we made
no provision for income taxes in any period presented in the accompanying
condensed consolidated financial statements.

Critical Accounting Policies and Estimates

Our discussion and analysis of financial condition and results of
operations are based upon our condensed consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States for interim financial information, the
instructions to Form 10-Q and Article 10 of Regulation S-X. The preparation of
our condensed consolidated financial statements requires us to make estimates
that affect the reported amounts of assets, liabilities, revenues and expenses,
and related disclosures of contingent assets and liabilities. We base our
accounting estimates on historical experience and other factors that are
believed to be reasonable under the circumstances. However, actual results may
vary from these estimates under different assumptions or conditions. We have
discussed the development and selection of critical accounting policies and
estimates with our audit committee. The following is a summary of our critical
accounting policies and estimates:



| |  |  | We recognize revenues when (i) persuasive evidence of an
arrangement between the customer and us exists, (ii) service has been
provided to the customer, (iii) the price to the customer is fixed or
determinable and (iv) collectibility of the sales price is reasonably
assured. We recognize up-front fees associated with service activation
over the expected term of the customer relationship, which is presently
estimated to be 24 months, using the straight-line method. Similarly,
we treat the incremental direct costs of service activation (which
consist principally of customer premises equipment, service activation
fees paid to other telecommunications companies and sales commissions)
as deferred charges in amounts no greater than the up-front fees that
are deferred, and such incremental direct costs are amortized to
expense using the straight-line method over 24 months.                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | We have concentrations of credit risk with several customers, some
of which were experiencing financial difficulties as of March 31, 2003
and 2002 and were not current in their payments for our services as of
those dates. Accordingly, we recognize revenues from some of these
customers in the period in which cash is collected, but only after the
collection of all previous outstanding accounts receivable balances. We
perform ongoing credit evaluations of our customers financial
condition and maintain an allowance for estimated credit losses. In
addition, we have billing disputes with some of our customers. These
disputes arise in the ordinary course of business in the
telecommunications industry and their impact on our accounts receivable
and revenues can be reasonably estimated based on historical
experience. In addition, certain customer revenues are subject to
refund if the end-user terminates service within thirty days of service
activation. Accordingly, we maintain allowances, through charges to
revenues, based on our estimate of the ultimate resolution of these
disputes and future service cancellations, and our reported revenue in
any period could be different than what is reported if we employed
different assumptions in estimating the outcomes of these items.
|
| |  |  | We state our inventories at the lower of cost or market. In
assessing the ultimate recoverability of inventories, we are required
to make estimates regarding future customer demand.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  |  | Property and equipment and intangible assets are recorded at cost,
subject to adjustments for impairment. Property and equipment and
intangible assets are depreciated or amortized using the straight-line
method over their estimated useful lives. In assessing the
recoverability of our property and equipment and intangible assets, we
must make assumptions regarding estimated future cash flows and other
factors to determine the fair value of the respective assets. If these
estimates and assumptions change in the future, we may be required to
record additional impairment charges relating to our property and
equipment and intangible assets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

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| |  |  | We consummated a plan of reorganization under Chapter 11 of the
United States Bankruptcy Code on December 20, 2001. As of March 31,
2003, we had certain unresolved claims relating to our Chapter 11
bankruptcy proceedings that remain in dispute. Therefore, it is
reasonably possible that such disputed bankruptcy claims could
ultimately be settled for amounts that differ from the aggregate
liability for such claims reflected in our condensed consolidated
balance sheet as of March 31, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | We are a party to a variety of legal proceedings, as either
plaintiff or defendant, and are engaged in other disputes that arise in
the ordinary course of business. We are required to assess the
likelihood of any adverse judgments or outcomes to these matters, as
well as potential ranges of probable losses for certain of these
matters. The determination of the liabilities required, if any, for
loss contingencies is made after careful analysis of each individual
situation based on the facts and circumstances. However, it is
reasonably possible that the liabilities reflected in our condensed
consolidated balance sheets for loss contingencies and business
disputes could change in the near term due to new facts and
circumstances, the effects of which could be material to our
consolidated financial position and results of operations.                                                                                                                                                                                                                                                                                                                                                           
|
| |  |  | We are currently analyzing the applicability of certain
transaction-based taxes to (i) sales of our products and services and
(ii) purchases of telecommunications circuits from various carriers.
This analysis includes discussions with authorities of jurisdictions in
which we do business to determine the extent of our transaction-based
tax liabilities. We believe that these discussions will be concluded
without a material adverse effect to our consolidated financial
position and results of operations. In addition, we are currently
analyzing the probable applicability of employment-related taxes for certain
stock-based compensation provided to employees in prior periods. We
believe that the analysis of the probable applicability of these taxes
and the engagement in discussions with applicable jurisdictions will be
concluded without a material adverse effect to our consolidated financial
position and results of operations. However, it is reasonably possible
that our estimates of our transaction-based and employment-related tax
liabilities could change in the near term, the effects of which could
be material to our consolidated financial position and results of
operations.
|
| |  |  | We make market development funds (MDF) available to certain
customers for the reimbursement of co-branded advertising expenses and
other purposes. To the extent that MDF is used by our customers for
co-branded advertising, and (i) the customers provide us with
third-party evidence of such co-branded advertising and (ii) we can
reasonably estimate the fair value of our portion of the advertising,
such amounts are charged to advertising expense as incurred.
Nonqualified MDF activities are recorded as reductions of revenues as
incurred, and other amounts payable to customers relating to rebates
and customer incentives are recorded as reductions of revenues based on
our estimate of sales incentives that will ultimately be claimed by
customers.                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  |  | We account for income taxes using the liability method, under which
deferred tax assets and liabilities are determined based on differences
between the financial reporting and tax bases of our assets and
liabilities. We record a valuation allowance on our deferred tax assets
to arrive at an amount that is more likely than not to be realized. In
the future, should we determine that we are able to realize all or part
of our deferred tax assets, which presently are fully reserved, an
adjustment to our deferred tax assets would increase income in the
period in which the determination was made.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  |  | We account for stock-based awards to employees using the intrinsic
value method, and non-employees using the fair value method. Under the
intrinsic value method, when the exercise price of our employee stock
options equals or exceeds the market price of the underlying stock on
the date of grant, we do not record compensation expense in our
condensed consolidated statement of operations. We use the intrinsic
value method in accounting for employee stock options because the
alternative fair value accounting requires us to use option valuation
models that were not developed for use in valuing employee stock
options. Rather, such option valuation models were developed for use in
estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. Because our 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 estimates of these valuation
models, we believe such existing models do not necessarily provide a
reliable single measure of the fair value of our employee stock
options.                         

Recent Accounting Pronouncements

In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) number (No.) 148,
Accounting for Stock-Based Compensation  Transition and Disclosure. SFAS No.
148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide
alternative methods of transition for an entity that voluntarily changes to the
fair value method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the

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disclosure provisions of SFAS No. 123 to require prominent disclosure of
the effects of an entitys accounting policy with respect to stock-based
employee compensation on reported results of operations, including per share
amounts, in annual and interim financial statements. The disclosure provisions
of SFAS No. 148 were effective immediately upon issuance in 2002. As of March
31, 2003, we have no immediate plans to adopt the fair value method of
accounting for stock-based employee compensation.

In November 2002, the FASBs Emerging Issues Task Force (EITF) reached a
final consensus on Issue No. 00-21, Accounting for Revenue Arrangements with
Multiple Deliverables, which is effective for revenue arrangements entered
into in fiscal periods beginning after June 15, 2003. Under EITF Issue
No.00-21, revenue arrangements with multiple deliverables are required to be
divided into separate units of accounting under certain circumstances. We will
prospectively adopt EITF Issue No. 00-21 on July 1, 2003, and we do not believe
the adoption of EITF Issue No. 00-21 will have a material effect on our
condensed consolidated financial statements.

In November 2002, the FASB issued Interpretation (FIN) No. 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN No. 45 requires certain
guarantees to be recorded at fair value, which is different from current
practice, which is generally to record a liability only when a loss is probable
and reasonably estimable. FIN No. 45 also requires a guarantor to make
significant new disclosures, even when the likelihood of making any payments
under the guarantee is remote. The disclosure provisions of FIN No. 45 were
effective immediately upon issuance in 2002. We adopted the recognition and
measurement provisions of FIN No. 45 on a prospective basis with respect to
guarantees issued or modified after December 31, 2002. The adoption of the
recognition and measurement provisions of FIN No. 45 had no effect on our
condensed consolidated financial statements as of and for the three months
ended March 31, 2003.

On January 1, 2003, we adopted SFAS No. 146, Accounting for Costs
Associated with an Exit or Disposal Activity. SFAS No. 146 revises the
accounting for exit and disposal activities under EITF Issue No. 94-3,
Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring), by extending the period in which expenses related to
restructuring activities are reported. A commitment to a plan to exit an
activity or dispose of long-lived assets is no longer sufficient to record a
one-time charge for most restructuring activities. Instead, companies record
exit or disposal costs when they are incurred and can be measured at fair
value. In addition, the resultant liabilities are subsequently adjusted for
changes in estimated cash flows. SFAS No. 146 was effective prospectively for
exit or disposal activities initiated after December 31, 2002. Companies may
not restate previously issued financial statements for the effect of the
provisions of SFAS No. 146, and liabilities that a company previously recorded
under EITF Issue No. 94-3 are grandfathered. The adoption of SFAS No. 146 had
no effect on our condensed consolidated financial statements as of and for the
three months ended March 31, 2003.

On January 1, 2003, we adopted SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of SFAS No. 13, and Technical
Corrections. SFAS No. 145 rescinds SFAS No. 4, Reporting Gains and Losses
from Extinguishment of Debt, which required all gains and losses from
extinguishment of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. SFAS No. 145, which is
effective in periods beginning after May 15, 2002, requires that gains or
losses from extinguishment of debt be classified as extraordinary items only if
they meet the criteria of APB Opinion No. 30. The adoption of SFAS No. 145 had
no effect on our condensed consolidated financial statements as of and for the
three months ended March 31, 2003.

On January 1, 2003, we adopted SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying
amount of the long-lived asset. The adoption of SFAS No. 143 had no effect on
our condensed consolidated financial statements as of and for the three months
ended March 31, 2003.

Liquidity and Capital Resources

Our operations have required substantial capital investment for the
procurement, design and construction of our central office collocation
facilities, the design, creation, implementation and maintenance of our
software, the purchase of telecommunications equipment and the design,
development and maintenance of our networks. Capital expenditures were $8,822
for the three months ended March 31, 2003. We expect that in
future periods 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 lower than the current period while incremental, or success-based,
capital expenditures related to the addition of subscribers in existing regions
will increase proportionately in relation to the number of new subscribers that
we add to our network.

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From our inception through March 31, 2003, we financed our operations
primarily through private placements of $220,600 of equity securities,
$1,282,000 in net proceeds raised from the issuance of notes (including our
agreement with SBC for a $50,000 note payable), a $75,000 collateralized
deposit and $719,000 in net proceeds raised from public equity offerings. As of
March 31, 2003, we had an accumulated deficit of $1,564,058 and unrestricted
cash, cash equivalents and short-term investments of $177,398. In addition, we
had stockholders equity as of March 31, 2003 of $50,412.

Net cash used in our operating activities was $19,369 for the three months
ended March 31, 2003. The net cash used in our operating activities during this
period was primarily due to the net loss of $34,722, an increase in accounts
receivable of $2,988, a decrease in other current liabilities of $1,113, a
decrease in collateralized customer deposits of $1,930, a decrease in unearned
revenues of $3,374, offset by depreciation and amortization charges of $18,589,
a decrease in deferred costs of service activation of $3,173, and an increase
in accounts payable of $3,599.

Net cash used in our investing activities was $52,567 for the three months
ended March 31, 2003. The net cash used in our investing activities during this
period was primarily due to purchases of short-term investments of $82,643 and
capital expenditures of $8,822, offset by maturities of short-term investments
of $38,305.

Net cash provided by our financing activities was $203 for the three
months ended March 31, 2003. The net cash provided by our financing activities
during this period was due to proceeds from the issuance of common stock of
$246, offset by principal payments under capital lease obligations of $43.

As of March 31, 2003, we had $24,758 in unrestricted cash and cash
equivalents, and $152,640 in unrestricted short-term investments. We expect to
experience negative cash flow from operating and investing activities into 2004
due to continued development of new services and the addition of new end-users
to our network. 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:



| |  |  | the effect of the FCCs decision in the Triennial Review, our
continuing ability to access line-shared telephone wires and our
ability to obtain access to the traditional telephone companies remote
terminals, all at reasonable prices;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the rate at which resellers and end-users purchase and pay for our services and the pricing of such services;                                                                                                                              
|
| |  |  | the financial condition of our customers;                                                                                                                                                                                                  
|
| |  |  | the level of marketing required to acquire and retain customers and to attain a competitive position in the marketplace;                                                                                                                   
|
| |  |  | the rate at which we invest in engineering, development and
intellectual property with respect to existing and future technology;                                                                                                          
|
| |  |  | the operational costs that we incur to install, maintain and repair end-user lines and our network as a whole;                                                                                                                             
|
| |  |  | pending and any future litigation;                                                                                                                                                                                                         
|
| |  |  | existing and future technology;                                                                                                                                                                                                            
|
| |  |  | unanticipated opportunities;                                                                                                                                                                                                               
|
| |  |  | network development schedules and associated costs; and                                                                                                                                                                                    
|
| |  |  | the number of regions entered, the timing of entry and services offered.                                                                                                                                                                   

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

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Our contractual debt and lease obligations as of December 31, 2002 for the
next five years, and thereafter, were as follows:

|                       |  |      |       |           |  |           |        |            |  |       |       |  |  |   |     |  |  |   |        | 
|---------------------- |  | ---- | ----- | --------- |  | --------- | ------ | ---------- |  | ----- | ----- |  |  | - | --- |  |  | - | ------ | 
|                       |  | 2003 |       | 2004-2005 |  | 2006-2007 |        | Thereafter |  | Total
|                       |  |      |       |           |  |           |        |            |  |      
|Note payable to SBC    |  | $    |      |           |  | $         | 50,000 |            |  | $     |      |  |  | $ |    |  |  | $ | 50,000 | 
|Capital leases         |  |      | 165   |           |  |           |       |            |  |       |      |  |  |   |    |  |  |   | 165    | 
|Office leases          |  |      | 5,424 |           |  |           | 6,112  |            |  |       | 2,450 |  |  |   | 720 |  |  |   | 14,706 | 
|Other operating leases |  |      | 1,451 |           |  |           | 209    |            |  |       | 4     |  |  |   |    |  |  |   | 1,664  | 
|                       |  |      |       |           |  |           |        |            |  |       |       |  |  |   |     |  |  |   |        | 
|                       |  | $    | 7,040 |           |  | $         | 56,321 |            |  | $     | 2,454 |  |  | $ | 720 |  |  | $ | 66,535 | 
|                       |  |      |       |           |  |           |        |            |  |       |       |  |  |   |     |  |  |   |        | 

We lease certain vehicles, equipment and office facilities under various
noncancelable operating leases that expire at various dates through 2009. The
facility leases generally require us to pay operating costs, including property
taxes, insurance and maintenance, and contain scheduled rent increases and
certain other rent escalation clauses. Rent expense is reflected in our
consolidated financial statements on a straight-line basis over the terms of
the respective leases. We are also obligated under a capital equipment lease,
which expires in 2003.

Our 2003 business plan includes discretionary spending that is based on
several assumptions, including growth of our subscriber base with a reasonable
per subscriber profit margin and improvements in productivity. If necessary, we
will curtail this discretionary spending so that we can continue as a going
concern at least through December 31, 2003 using only our unrestricted cash,
cash equivalent and short-term investment balances in existence as of December
31, 2002. Additionally, on February 20, 2003, the FCC announced the results of
the Triennial Review of its rules for network unbundling obligations of
Incumbent Local Exchange Carriers. Among other things, the FCC announced that
it will phase-out its rule requiring line-sharing over a three-year period.
While the FCC has not yet issued its order pursuant to the Triennial Review,
the ultimate impact of the FCCs February 20, 2003 announcement on our
business, which relies on line-sharing to serve our consumer end-users,
will depend on our ability to negotiate fair and reasonable prices
substantially lower than the whole loop cost that will ultimately be permitted
under the FCCs rules. We do not believe the FCCs revised unbundling rules
will have a material adverse effect on our ability to continue as a going
concern at least through December 31, 2003 but our operating results and
financial condition may be adversely affected over time if the new rules result
in substantially higher prices for access to the ILECs telephone lines.

We have in the past described our expectation of attaining cash flow
sufficiency from our operating activities in mid-2004. Subsequent to our
announcement of these expectations, the FCC announced the results of its
Triennial Review, although it has not yet issued its final order. The order,
when issued, may impact our cash flow from operations and the manner in which
we progress towards cash flow sufficiency. In particular, our ability to
continue to sell stand-alone consumer-grade services will likely depend on our
ability to negotiate with the telephone companies fair and reasonable prices
for line-shared services that are substantially lower than the cost of a
separate line. If we cannot reach reasonable terms with the telephone
companies, we may be unable to sell stand-alone consumer-grade services. In
that event, we would be required to, and we believe we can, adjust our business
plan so that we can still reach cash flow sufficiency in the second half of
2004. However, in this event, our growth could be impaired because of our
reduced access to the consumer market.

Nonetheless, adverse business, legal, regulatory or legislative
developments, such as the inability to continue line-sharing, may require us to
raise additional financing, raise our prices or substantially decrease our cost
structure. We also recognize that we may not be able to raise additional
capital, especially under the current capital market conditions. If we are
unable to acquire additional capital on favorable terms or are required to
raise it on terms that are less satisfactory than we desire, it will have a
material adverse effect on our financial condition which could require a sale
or liquidation of our company.

Risk Factors

The following is a summary list of some of the risk factors relating to
our Company. For additional detail regarding these and other risk factors,
please refer to Part I, Item 1, Business  Risk Factors found in our 2002
Annual Report on Form 10-K, which was filed with the SEC on March 20, 2003.

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| |  |  | Our services are subject to government regulation, and changes in
current or future laws or regulations and the methods of enforcing the
law and regulations could adversely affect our business.                                                                                                                                                            
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Charges for unbundled network elements are generally outside of our
control because they are proposed by the traditional telephone
companies and are subject to costly regulatory approval processes.                                                                                                                                                        
|
| |  |  | Our business will suffer if our interconnection agreements are not
renewed or if they are modified on unfavorable terms.                                                                                                                                                                                                                                     
|
| |  |  | We do not currently have access to packet-switching sections of the
ILECs fiber-fed telephone network which limits the addressable market
for our services. We have no guaranties that we will obtain access to
these fiber-fed lines and given additional deployment of fiber-fed
lines by the ILECs, it will further reduce our addressable market.        
|
| |  |  | We are developing the ability to
offer our services over a telephone line that is being used by a
voice provider other than the traditional telephone company. However,
we have not commercially deployed this service and we are
experiencing operational challenges as we work with the traditional telephone companies.                                   
|
| |  |  | We may need to raise additional capital under difficult financial
market conditions in order to maintain our operations.                                                                                                                                                                                                                                     
|
| |  |  | Employees of Qwest Communications
and Verizon Communications have threatened to go on strike in August
of this year. If these labor stoppages occur, they may impair our
ability to provide service to new end-users and perform
maintenance for existing end-users. These events could impair
our revenue growth and increase our network and product costs.
|
| |  |  | In order to become cash flow positive and to achieve profitability,
we must add end-users to our network while minimizing the cost to
expand our network infrastructure.                                                                                                                                                                                     
|
| |  |  | If we do not reduce our end-user disconnection rate our revenue and
end-user growth will decline.                                                                                                                                                                                                                                                            
|
| |  |  | We may experience decreasing margins on the sale of our services,
which may impair our ability to achieve profitability or positive cash
flow.                                                                                                                                                                                                               
|
| |  |  | Our internal controls need to be improved.                                                                                                                                                                                                                                                                                                                   
|
| |  |  | We depend on a limited number of customers for the preponderance of
our revenues, and we are highly dependent on sales through our
resellers.                                                                                                                                                                                                                
|
| |  |  | Some of our resellers are facing financial difficulties, which
makes it more difficult to predict our revenues.                                                                                                                                                                                                                                              
|
| |  |  | Our expanded sales to direct end
users poses operational challenges and the perceived threat may cause
our resellers to place fewer orders with us or may cause us to lose
resellers.                                                                                                                                                                        
|
| |  |  | The markets in which we operate are highly competitive, and we may
not be able to compete effectively, especially against established
industry competitors with significantly greater financial resources.                                                                                                                                                   
|
| |  |  | The broadband communications industry is undergoing rapid
technological changes, and new technologies may be superior to the
technology we use.                                                                                                                                                                                                              
|
| |  |  | A system failure could delay or interrupt service to our customers,
which could reduce demand for our services.                                                                                                                                                                                                                                              
|
| |  |  | Our network security still needs
to be improved and a breach of network security could delay or interrupt service to
our customers, which could reduce demand for our services.                                                                                                                                                                              
|
| |  |  | If we are not able to electronically interface with the traditional
phone companies to order services, our costs will increase.                                                                                                                                                                                                                              
|
| |  |  | 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 a limited number of third parties for equipment supply, service and installation.                                                                                                                                                                                                                                                               
|
| |  |  | Our business is difficult to evaluate because we have a limited operating history.                                                                                                                                                                                                                                                                           
|
| |  |  | 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.                                                                                                                                                                               
|
| |  |  | The unpredictability of our revenues, along with other factors, may
cause the price of our common stock to fluctuate and could cause it to
decline.                                                                                                                                                                                                          

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| |  |  | Future sales or issuances of our common stock may depress our stock
price.                                                                                                                                                                                                                          
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Anti-takeover effects of certain charter and bylaw provisions,
Delaware law, our indebtedness, our Stockholder Protection Rights Plan
and our change in control severance arrangements could prevent a change
in our control, which could inhibit your ability to receive a premium
for your shares.
|
| |  |  | We must comply with federal, state and local tax and other
surcharges on our service, the levels of which are uncertain.                                                                                                                                                                            
|
| |  |  | We are a party to litigation and adverse results of such litigation
matters could negatively impact our financial condition and results of
operations.                                                                                                                                              
|
| |  |  | Our intellectual property protection may be inadequate to protect
our proprietary rights.                                                                                                                                                                                                           

Forward-Looking Statements

We include certain estimates, projections, and other forward-looking
statements in our reports, in presentations to analysts and others, and in
other publicly available material. Future performance cannot be ensured. Actual
results may differ materially from those in forward-looking statements. The
statements contained in this Report on Form 10-Q that are not historical facts
are forward-looking statements (as such term is defined in Section 27A of the
Securities Act and Section 21E of the Exchange Act), which can be identified by
the use of forward-looking terminology such as estimates, projects,
anticipates, expects, intends, believes, or the negative thereof or
other variations thereon or comparable terminology, or by discussions of
strategy that involve risks and uncertainties. Examples of such forward-looking
statements include but are not limited to:



| |  |  | the impact of the FCCs decision in the Triennial Review and our
ability to obtain access to line-sharing at rates that allow us to sell
consumer-grade services;                                                                               
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | expectations regarding the
continuing deployment of local voice services by providers other than
the traditional telephone companies and our ability to bundle our
data services with their voice services;                                     
|
| |  |  | expectations regarding our ability to become cash-flow positive;                                                                                                                                                                                
|
| |  |  | expectations regarding the extent to which customers purchase our services;                                                                                                                                                                     
|
| |  |  | expectations regarding our relationships with our strategic partners and other potential third parties;                                                                                                                                         
|
| |  |  | expectations as to pricing for our services in the future;                                                                                                                                                                                      
|
| |  |  | expectations as to the impact of our service offerings on our margins;                                                                                                                                                                          
|
| |  |  | the possibility that we will increase our revenues;                                                                                                                                                                                             
|
| |  |  | the impact of advertising on brand recognition and operating results;                                                                                                                                                                           
|
| |  |  | plans to make strategic investments and acquisitions and the affect of such investments and acquisitions;                                                                                                                                       
|
| |  |  | estimates and expectations of future operating results, including
expectations regarding when we anticipate operating on a cash flow
positive basis, the adequacy of our cash reserves, our monthly burn
rate and the number of installed lines;
|
| |  |  | plans to develop and commercialize value-added services;                                                                                                                                                                                        
|
| |  |  | our anticipated capital expenditures;                                                                                                                                                                                                           
|
| |  |  | plans to enter into business arrangements with broadband-related service providers;                                                                                                                                                             
|
| |  |  | the effect of regulatory changes;                                                                                                                                                                                                               
|
| |  |  | the effect of litigation currently pending; and                                                                                                                                                                                                 

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| |  |  | other statements contained in this Report on Form 10-Q 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:



| |  |  | adapt our business plan in response to further developments
resulting from the FCCs Triennial Review announcement and future
order;                                                                                                                                                    
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | collect receivables from customers;                                                                                                                                                                                                                                                     
|
| |  |  | retain end-users that are served by customers facing financial difficulties;                                                                                                                                                                                                            
|
| |  |  | successfully market our services to customers;                                                                                                                                                                                                                                          
|
| |  |  | generate customer demand for our services;                                                                                                                                                                                                                                              
|
| |  |  | successfully defend our company against litigation;                                                                                                                                                                                                                                     
|
| |  |  | successfully reduce our operating costs and overhead while continuing to provide good customer service;                                                                                                                                                                                 
|
| |  |  | successfully continue to increase the number of business-grade lines;                                                                                                                                                                                                                   
|
| |  |  | achieve favorable pricing for our services;                                                                                                                                                                                                                                             
|
| |  |  | respond to increasing competition;                                                                                                                                                                                                                                                      
|
| |  |  | manage growth of our operations; and                                                                                                                                                                                                                                                    
|
| |  |  | access regions and negotiate suitable interconnection agreements
with the traditional telephone companies in the areas where we
provide service, all in a timely manner, at
reasonable costs and on satisfactory terms that provide us with
access to line-sharing and remote terminals.

All written and oral forward-looking statements made in connection with
this Report on Form 10-Q 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 document and in our Annual Report
on Form 10-K for the year ended December 31, 2002. We disclaim any obligation
to update information contained in any forward-looking statement.




Item 3.Market Risk

Quantitative and Qualitative Disclosures about Market Risk

Our exposure to financial market risk, including changes in interest 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
investment portfolio or related income would not be significantly impacted by
either a 100 basis point increase or decrease in interest rates due mainly to
the fixed-rate, short-term nature of the substantial majority of our investment
portfolio. In addition, all of our outstanding indebtedness as of March 31,
2003 is fixed-rate debt.




Item 4.Controls and Procedures

The Securities and Exchange Commission defines the term disclosure
controls and procedures to mean a companys controls and other procedures that
are designed to ensure that information required to be disclosed in the reports
that it files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported, within the time periods specified in the
Commissions rules and forms. Our chief executive officer and our chief
financial officer, based on their evaluation of the

29



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effectiveness of our disclosure controls and procedures within 90 days
before the filing date of this quarterly report, have concluded that our
disclosure controls and procedures were effective for this purpose.

There were not any significant changes in our internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

30



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##### Table of Contents






PART II. OTHER INFORMATION




Item 1.Legal Proceedings (all dollar amounts are presented in thousands)

On December 13, 2001, the United States Bankruptcy Court for the District
of Delaware (the Bankruptcy Court) entered an order confirming our
pre-negotiated First Amended Plan of Reorganization, as modified on November
26, 2001 (the Plan). On December 20, 2001 (the Effective Date), the Plan
was consummated and we emerged from bankruptcy. Under our Plan, we settled
several claims against us. These claims include:



| |  |  | The class action lawsuits filed in the United States District Court
for the Northern District of California, provided that this settlement
will not be final unless it is approved by that court. This settlement
is described in more detail below.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The lawsuits filed in the Superior Court of the State of California
for the County of Santa Clara by six purchasers of the convertible
notes that we issued in September 2000.                                                                      
|
| |  |  | Disputed claims made by former shareholders of Laser Link.net.                                                                                                                                                                                      
|
| |  |  | Disputed claims made by GE Capital and its subsidiary, Heller Financial Group.                                                                                                                                                                      

As of March 31, 2003 and 2002, there were approximately $8,331 and $27,200
in unresolved claims related to our Chapter 11 bankruptcy proceedings. As of
March 31, 2003, we have recorded $7,369 for these unresolved claims in our
condensed consolidated balance sheet. However, it is reasonably possible that
our unresolved Chapter 11 bankruptcy claims could ultimately be settled for
amounts that differ from the amounts recorded in our condensed consolidated
balance sheet.

Purchasers of our common stock and purchasers of the convertible notes we
issued in September 2000 have filed complaints on behalf of themselves and
alleged classes of stockholders and holders of convertible notes against us and
certain of our present and former officers and directors. These complaints were
filed in the United States District Court for the Northern District of
California (District Court) in the fourth quarter of 2000. The complaints
have been consolidated and the lead plaintiff has filed its amended
consolidated complaint. The amended consolidated complaint alleges violations
of federal securities laws on behalf of persons who purchased or otherwise
acquired our securities, including common stock and notes, during the period
from April 19, 2000 to May 24, 2001. The relief sought includes monetary
damages and equitable relief. We and the officer and director defendants
entered into a Memorandum of Understanding (MOU) with counsel for the lead
plaintiffs in this litigation that tentatively resolves the litigation. The MOU
sets forth the terms upon which we, the officer and director defendants and the
plaintiffs agree to settle the litigation. Pursuant to the MOU, the plaintiffs
agreed to support and vote in favor of our bankruptcy plan if it provided for
the distribution of $16,500 in cash to be funded by our insurance carriers and
6,495,844 shares of our common stock. The plaintiffs voted in favor of the
Plan. The settlement provided for in the MOU was subject to the approval of the
District Court and, on December 18, 2002, the District Court issued its final
judgment and dismissal order. One class member has filed an appeal pertaining
to the final judgment, but this appeal only relates to the allocation of the
settlement proceeds between the plaintiffs and their attorneys.

In April 1999, we filed a lawsuit against Bell Atlantic (now Verizon) and
its affiliates in the United States District Court for the District of
Columbia. We are pursuing antitrust and other claims in this lawsuit arising
out of Verizons conduct as a supplier of network facilities, including central
office space, transmission facilities and telephone lines. In December 2000, we
also filed a lawsuit against BellSouth Telecommunications and its subsidiaries
in the United States District Court for the Northern District of Georgia. We
are pursuing claims in this lawsuit that are similar to our claims against
Verizon. Both courts dismissed some of our claims based on the ruling of the
Seventh Circuit in Goldwasser v. Ameritech. The court in the Verizon case also
dismissed our remaining claims on other grounds. We voluntarily dismissed our
remaining claims in the BellSouth case so we could pursue certain issues on
appeal. We have appealed these decisions to the United States Court of Appeals
for the Eleventh Circuit and the United States Court of Appeals for the
District of Columbia. On August 2, 2002, the Eleventh Circuit Court of Appeals
reversed the lower courts decision in the BellSouth case and remanded the case
for further proceedings. Both BellSouth and Covad are seeking an appeal of this decision in the
United States Supreme Court. In addition, the United States Supreme Court has
agreed to review a decision from the United States Court of Appeals for the
Second Circuit entitled Verizon Communications v. Law Offices of Curtis Trinko,
which rejected the Goldwasser decision. The Eleventh Circuit relied in part on
the Trinko decision when it reversed the lower courts dismissal of our claims
against BellSouth. The Court of Appeals for the District of Columbia has
indicated that it will not act on our appeal in our case against Verizon until
the Supreme Court issues a decision in the Trinko case. We cannot predict the
outcome of these matters.

31



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On June 11, 2001, Verizon Communications filed a lawsuit against us in the
United States District Court for the Northern District of California. Verizon
is a supplier of telephone lines that we use to provide services to our
customers. In its amended complaint, Verizon claims that we falsified trouble
ticket reports with respect to the phone lines that we ordered and seeks
unspecified monetary damages (characterized as being in the millions) and
injunctive relief. The current complaint asserts causes of action for negligent
and intentional misrepresentation and violations of Californias unfair
competition statute. On November 13, 2002, the District Court entered summary
judgment in favor of the Company and dismissed Verizons claims against the
Company in their entirety. Verizon has appealed the dismissal of its lawsuit.
We believe we have strong defenses to this lawsuit, but litigation is
inherently unpredictable and there is no guarantee we will prevail.

Several stockholders have filed complaints in the United States District
Court for the Southern District of New York, on behalf of themselves and
purported classes of stockholders, against us and several former and current
officers and directors in addition to some of the underwriters in our stock
offerings. These lawsuits are so-called IPO allocation cases, challenging
practices allegedly used by certain underwriters of public equity offerings
during the late 1990s and 2000. On April 19, 2002 the plaintiffs amended their
complaint and removed us as a defendant. Certain directors and officers are
still named in the complaint. The plaintiffs claim that we failed to disclose
the arrangements that some of these underwriters purportedly made with certain
investors. We believe we have strong defenses to these lawsuits and we intend
to contest them vigorously. However, litigation is inherently
unpredictable and there is no guarantee we will prevail.

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. In
September 2000, COVID 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.
The District Court recently dismissed COVIDs lawsuit.

In June 2002, Dhruv Khanna was relieved of his duties as our General
Counsel and Secretary. Shortly thereafter, Mr. Khanna alleged that, over a
period of years, certain current and former directors and officers had breached
their fiduciary duties to the Company by engaging in or approving actions that
constituted waste and self-dealing, that certain current and former directors
and officers had provided false representations to our auditors and that he had
been relieved of his duties in retaliation for his being a purported
whistleblower and because of racial or national origin discrimination. He has
threatened to file a shareholder derivative action against those current and
former directors and officers, as well as a wrongful termination lawsuit. Mr.
Khanna was placed on paid leave while his allegations were being investigated.

Our Board of Directors appointed a special investigative committee, which
initially consisted of Mr. Crandall and Ms. Runtagh, to investigate the
allegations made by Mr. Khanna. Mr. Jalkut was appointed to this committee
shortly after he joined our Board of Directors. This committee retained an
independent law firm to assist in its investigation. Based on this
investigation, the committee concluded that Mr. Khannas allegations were
without merit and that it would not be in the best interests of the Company to
commence litigation based on these allegations. The committee considered, among
other things, that many of Mr. Khannas allegations were not accurate, that
certain allegations challenged business decisions lawfully made by management
or the Board, that the transactions challenged by Mr. Khanna in which any
director had an interest were approved by a majority of disinterested directors
in accordance with Delaware law, that the challenged director and officer
representations to the auditors were true and accurate, and that Mr. Khanna was
not relieved of his duties as a result of retaliation for alleged
whistleblowing or racial or national origin discrimination. Mr. Khanna has
disputed the committees work and the outcome of its investigation.

After the committees findings had been presented and analyzed, we
concluded in January 2003 that it would not be appropriate to continue Mr.
Khanna on paid leave status, and determined that there was no suitable role for
him at the Company. Accordingly, he was terminated as an employee of the
Company. While we believe the contentions of Mr. Khanna referred to above are
without merit, and will be vigorously defended if brought, we are unable to
predict the outcome of any potential lawsuit.

We are also a party to a variety of pending or threatened legal
proceedings as either plaintiff or defendant, or are engaged in business
disputes that arise in the ordinary course of business. 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 do not believe the ultimate outcome of these matters will have a material
impact on our consolidated financial position and results of operations.
However, litigation is inherently unpredictable and there is no guarantee we
will prevail or otherwise not be adversely affected.

We are
subject to state public utility commission, FCC and other regulatory
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 bound by or may otherwise be

32



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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.

In addition, we are engaged in a variety of legal negotiations,
arbitrations and regulatory and court proceedings with multiple telephone
companies. These negotiations, arbitrations and proceedings concern the
telephone companies denial of central office space, the cost and delivery of transmission facilities and telephone lines and
central office spaces, billing issues and other operational issues. Other than
the payment of legal fees and expenses, which are not quantifiable but are
expected to be material, we do not believe that these matters will result in
material liability to us and the potential gains are not quantifiable at this
time. An unfavorable result in any of these negotiations, arbitrations and
proceedings, however, could have a material adverse effect on our consolidated
financial position and results of operations if we are denied or charged higher
rates for transmission lines or central office spaces.




Item 2.Changes in Securities and Use of Proceeds

On January 1, 2003, in conjunction with an amendment to a three-year
Agreement for Broadband Internet Access Services (the Broadband Agreement)
with AT&T Corp., a wholesale customer, we granted AT&T Corp. three warrants to
purchase an aggregate of 3,000,000 shares of the our common stock. We did not
receive any additional purchase price for our issuance of the warrants. The
first warrant is for 1 million shares at $0.94 per share, the second warrant is
for 1 million shares at $3.00 per share and the third warrant is for 1 million
shares at $5.00 per share. These warrants were immediately exercisable, fully
vested and non-forfeitable at the date of grant. The warrants were issued in a
private placement under section 4(2) of the Securities Exchange Act of 1933.

On October 31, 2002, we sold 2,118,657 shares of common stock at $0.544
per share and 319,661 shares of common stock at $1.173 per share to our
employees for an aggregate amount of $1,527,511. On April 30, 2002, we sold
2,135,646 shares of common stock to our employees at $0.544 per share for an
aggregate amount of $1,161,791. All of these sales were made pursuant to the
1998 Employee Stock Purchase Plan.




Item 3.Defaults upon Senior Securities

None.




Item 4.Submission of Matters to a Vote of Security Holders

None.




Item 5.Other Information

None.




Item 6.Exhibits and Reports on Form 8-K

a.     Exhibits:

|        |  |                                                              |  | 
|------- |  | ------------------------------------------------------------ |  | 
|Exhibit |  |                                                              |  | 
|Number  |  | Description                                                 
|        |  |                                                             
|99.1    |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
|        |  | Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  
|       
|99.2    |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
|        |  | Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  

b.     Reports on Form 8-K

We reported the following item on Form 8-K during the quarter ended March
31, 2003:

On January 7, 2003, the Company filed a current report on Form 8-K,
pursuant to Item 5 thereof, reporting that the Company entered into an
amendment to its three-year Agreement for Broadband Internet Access Services
with AT&T Corp.

33



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

|                   |  |  |                                  |                                                                     |  | 
|------------------ |  |  | -------------------------------- | ------------------------------------------------------------------- |  | 
|                   |  |  | COVAD COMMUNICATIONS GROUP, INC.
|                   |  |  |                                  |                                                                     |  | 
|                   |  |  | By:                              | /s/ CHARLES E. HOFFMAN                                              |  | 
|                   |  |  |                                  |                                                                     |  | 
|                   |  |  |                                  | Charles E. HoffmanPresident, Chief Executive Officer and Director   |  | 
|                   |  |  |                                  |                                                                     |  | 
|Date: May 15, 2003 |  |  |                                  |                                                                     |  | 
|                   |  |  |                                  |                                                                     |  | 
|                   |  |  | By:                              | /s/ MARK A. RICHMAN                                                 |  | 
|                   |  |  |                                  |                                                                     |  | 
|                   |  |  |                                  | Mark A. RichmanExecutive Vice President and
Chief Financial Officer |  | 
|                   |  |  |                                  |                                                                     |  | 
|Date: May 15, 2003 |  |  |                                  |                                                                     |  | 

34



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CERTIFICATIONS

I, Charles E. Hoffman, certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Covad
Communications Group, Inc.;                                                                                                                                                                                                                                       
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;                   
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:                                                                                                     



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrants auditors and the
audit committee of registrants board of directors (or persons performing the
equivalent functions):
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to record,
process, summarize and report financial data and have identified for the
registrants auditors any material weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants internal
controls; and                                                                                                                                        



|6. |  | The registrants other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                   |  |  |                                  |                                                                   |  | 
|------------------ |  |  | -------------------------------- | ----------------------------------------------------------------- |  | 
|                   |  |  | COVAD COMMUNICATIONS GROUP, INC.
|                  
|                   |  |  |                                  |                                                                   |  | 
|                   |  |  | By:                              | /s/ CHARLES E. HOFFMAN                                            |  | 
|                   |  |  |                                  |                                                                   |  | 
|                   |  |  |                                  | Charles E. HoffmanPresident, Chief Executive Officer and Director |  | 
|Date: May 15, 2003 |  |  |                                  |                                                                   |  | 

35



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##### Table of Contents



I, Mark A. Richman, certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Covad
Communications Group, Inc.;                                                                                                                                                                                                                                       
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;                   
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:                                                                                                     



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrants auditors and the
audit committee of registrants board of directors (or persons performing the
equivalent functions):
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to record,
process, summarize and report financial data and have identified for the
registrants auditors any material weaknesses in internal controls;
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants internal
controls; and                                                                                                                                    



|6. |  | The registrants other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                   |  |  |                                  |                                                                     |  | 
|------------------ |  |  | -------------------------------- | ------------------------------------------------------------------- |  | 
|                   |  |  | COVAD COMMUNICATIONS GROUP, INC.
|                  
|                   |  |  |                                  |                                                                     |  | 
|                   |  |  | By:                              | /s/ MARK A. RICHMAN                                                 |  | 
|                   |  |  |                                  |                                                                     |  | 
|                   |  |  |                                  | Mark A. RichmanExecutive Vice President and
Chief Financial Officer |  | 
|Date: May 15, 2003 |  |  |                                  |                                                                     |  | 

36



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|        |  |                                                              |  | 
|------- |  | ------------------------------------------------------------ |  | 
|Exhibit |  |                                                              |  | 
|Number  |  | Description                                                 
|        |  |                                                             
|99.1    |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
|        |  | Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  
|       
|99.2    |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
|        |  | Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.