<PAGE>

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

                                 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 June 30, 2001

                       Commission file number: 000-25271

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

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

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

<TABLE>
<S>                                            <C>
                  Delaware                                       77-0461529
        (State or other jurisdiction                          (I.R.S. Employer
      of incorporation or organization)                    Identification Number)
</TABLE>

<TABLE>
<S>                                            <C>
              4250 Burton Drive
           Santa Clara, California                                 95054
  (Address of principal executive offices)                       (Zip Code)
</TABLE>

                                 (408) 987-1000
              (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 [_]

   As of August 10, 2001 there were 177,727,058 shares outstanding of the
Registrant's Common Stock, including Class B Common Stock.

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>

                           COVAD'S CHAPTER 11 FILING

   On August 15, 2001 (the "Petition Date"), Covad Communications Group, Inc.
("Covad") filed a voluntary petition for relief under Chapter 11 of the United
States Bankruptcy Code (the "Bankruptcy Code") with the United States
Bankruptcy Court for the District of Delaware. As of the Petition Date, Covad
commenced operating its business and managing its properties as a debtor in
possession. The Chapter 11 filing is a part of a pre-negotiated plan of
reorganization that, prior to the Petition Date, holders of a majority of the
outstanding face amount or accreted value of Covad's bonds agreed to support.

   Covad's operating subsidiaries did not commence bankruptcy proceedings and
the Company expects them to continue to operate in the ordinary course of
business without any court-imposed restrictions.

   In the near future, Covad expects to file a Disclosure Statement (the
"Disclosure Statement") and a Plan of Reorganization (the "Plan") with the
Bankruptcy Court. The Disclosure Statement will summarize the Plan and contain
information concerning, among other matters, the history, business, results of
operations, management, properties, liabilities and the assets available for
distribution under the Plan as well as the anticipated organization and
operation of reorganized Covad.

   Among other things, the Plan is expected to (1) divide Covad's creditors
into several classes; (2) provide how certain classes of creditors will be
treated and otherwise impaired by the Plan; (3) provide for extinguishment of
all $1.35 billion in aggregate face amount or accreted value of Covad's
outstanding bonds in exchange for a combination of approximately $283.3 million
(of which $13.4 million was paid on August 15, 2001) in cash and convertible
preferred stock with a $100 million liquidation preference which, in general,
would be convertible into approximately 33 million common shares or 15% of the
reorganized Covad's outstanding common stock on a pro forma basis and after
adjustments to reflect certain outstanding options and warrants; (4) provide
that, pursuant to a Memorandum of Understanding dated August 10, 2001, and
subject to court approval and other conditions certain class action securities
plaintiffs shall share in a settlement fund consisting of a cash amount
provided by Covad's insurance carriers plus 3.5% of Covad's fully diluted
outstanding common stock as of August 10, 2001 and (5) provide that holders of
common stock issued prior to the confirmation of the Plan retain their existing
equity interests but would be diluted through the issuance of the preferred
stock (and the common stock issuable upon the conversion thereof) distributable
to the bondholders, common stock issuable to the class action securities
plaintiffs described above and any other securities issued under the Plan.

   While the holders of a majority of the outstanding face amount or accreted
value of Covad's bonds have agreed to support the Plan structure described
above, no assurance can be given that other parties entitled to vote will vote
in favor of the Plan or that Covad's Plan will be fully or timely approved by
all the relevant parties, including the Bankruptcy Court, or not subsequently
modified. Pursuant to the agreements with the bondholders, Covad has placed
approximately $257 million in an escrow account that would be released to the
bondholders if the plan were approved. Our agreements with the bondholders
provide that this escrowed amount would also be released to the bondholders in
certain other events, including: (1) if Covad does not file the Plan by
September 15, 2001; (2) if Covad does not begin soliciting consents to the Plan
by November 15, 2001; or (3) if the Plan is not in effect by January 15, 2002.
This escrowed amount will be returned to Covad in certain events, including if
the bondholders do not vote in favor of the Plan. Moreover, Covad's Chapter 11
proceeding may have an adverse affect on the financial results of the Company.
See "Part I. Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Risk Factors."

   For a more complete description of Covad's Chapter 11 filing, see "Part I.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations--Chapter 11 Reorganization."

                                       2
<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

                                   FORM 10-Q

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                          Page
                                                                          ----
 <C>      <S>                                                             <C>
 PART I.  FINANCIAL INFORMATION

 ITEM 1.  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED).......    4

          CONDENSED CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2001 AND
           DECEMBER 31, 2000............................................    4

          CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE
           AND SIX MONTHS ENDED JUNE 30, 2001 AND 2000..................    5

          CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX
           MONTHS ENDED JUNE 30, 2001 AND 2000..........................    6

          NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS..........    7

 ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
           AND RESULTS OF OPERATIONS....................................   18

 ITEM 3   MARKET RISK...................................................   30

 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.............................................   34

 ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K..............................   34

 SIGNATURE...............................................................  35
</TABLE>

                                       3
<PAGE>

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)

<TABLE>
<CAPTION>
                                                       June 30,    December 31,
                                                         2001          2000
                                                      -----------  ------------
                                                      (Unaudited)  (See Note 1)
                       ASSETS
                       ------
<S>                                                   <C>          <C>
Current assets:
 Cash and cash equivalents........................... $   295,688  $   558,440
 Short-term investments..............................     228,752      311,394
 Restricted cash and investments.....................      27,997       27,748
 Accounts receivable, net of allowances of $12,521
  at June 30, 2001 ($13,864 at
  December 31, 2000).................................      31,119       26,877
 Unbilled revenue....................................       9,629        7,246
 Other receivables...................................       4,899        6,389
 Inventories.........................................      10,626       14,221
 Prepaid expenses and other current assets...........      10,162        5,884
                                                      -----------  -----------
   Total current assets..............................     618,872      958,199
Property and equipment, net..........................     294,274      338,409
Intangible assets, net...............................      58,548       74,888
Restricted investments...............................          --       12,722
Investments in unconsolidated affiliates.............      22,012       30,347
Deferred costs of service activation.................      65,676       52,831
Deferred debt issuance costs.........................      34,066       36,890
Other long-term assets...............................       4,335        7,199
                                                      -----------  -----------
   Total assets...................................... $ 1,097,783  $ 1,511,485
                                                      ===========  ===========

<CAPTION>
        LIABILITIES AND STOCKHOLDERS' DEFICIT
        -------------------------------------
<S>                                                   <C>          <C>
Current liabilities:
 Long-term debt in default, net of discount of
  $9,646 at June 30, 2001............................ $ 1,338,443  $       --
 Current portion of long-term debt...................         --        43,735
 Current portion of capital lease obligations........          25        2,566
 Accounts payable....................................      31,808       72,896
 Accrued collocation and network service fees........      31,026       39,910
 Accrued interest....................................      40,342       38,706
 Accrued market development funds and customer
  incentives.........................................      15,924       13,860
 Accrued restructuring expenses......................       6,137        3,980
 Other accrued liabilities...........................      58,372       64,203
                                                      -----------  -----------
   Total current liabilities.........................   1,522,077      279,856
Long-term debt, net of discount of $10,227 at
 December 31, 2000...................................         --     1,324,704
Long-term portion of capital lease obligations.......         --         3,668
Deferred gain resulting from deconsolidation of
 subsidiary..........................................      55,455          --
Unearned revenue and other...........................      74,999       85,920
                                                      -----------  -----------
   Total liabilities.................................   1,652,531    1,694,148
Commitments and contingencies
Stockholders' deficit:
 Preferred stock, $0.001 par value; 5,000,000 shares
  authorized; no shares issued and outstanding at
  June 30, 2001 and December 31, 2000................         --           --
 Common Stock, $0.001 par value; 590,000,000 shares
  authorized; 175,213,886 shares issued and
  outstanding at June 30, 2001 (171,937,452 shares
  issued and outstanding at December 31, 2000).......         175          172
 Common Stock--Class B, $0.001 par value; 10,000,000
  shares authorized; no shares issued and
  outstanding at June 30, 2001 and December 31,
  2000...............................................         --           --
 Additional paid-in capital..........................   1,510,304    1,509,365
 Deferred stock-based compensation...................        (389)      (3,067)
 Notes receivable from stockholders..................         --          (423)
 Accumulated other comprehensive income (loss).......      (1,575)         556
 Accumulated deficit.................................  (2,063,263)  (1,689,266)
                                                      -----------  -----------
   Total stockholders' deficit.......................    (554,748)    (182,663)
                                                      -----------  -----------
   Total liabilities and stockholders' deficit....... $ 1,097,783  $ 1,511,485
                                                      ===========  ===========
</TABLE>

                            See accompanying notes.

                                       4
<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

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

<TABLE>
<CAPTION>
                            Three months ended June    Six months ended June
                                      30,                       30,
                            ------------------------  ------------------------
                               2001         2000         2001         2000
                            -----------  -----------  -----------  -----------
<S>                         <C>          <C>          <C>          <C>
Revenues, net.............  $    87,099  $    43,244  $   158,344  $    63,994
Operating expenses:
  Network and product
   costs..................      121,444       88,891      256,606      154,899
  Sales, marketing,
   general and
   administrative.........       63,268       64,917      126,095      117,674
  Provision for bad debts
   (bad debt recoveries)..        1,198        1,832       (3,049)       3,628
  Depreciation and
   amortization of
   property and
   equipment..............       33,895       17,204       67,704       29,531
  Amortization of
   intangible assets......        3,969       23,120        7,570       25,567
  Write-off of in-process
   research and
   development costs......          --           --           --         3,726
  Provision for
   restructuring
   expenses...............        2,942          --        17,747          --
  Provision for long-lived
   asset impairment.......        2,230          --         2,230          --
                            -----------  -----------  -----------  -----------
    Total operating
     expenses.............      228,946      195,964      474,903      335,025
                            -----------  -----------  -----------  -----------
Loss from operations......     (141,847)    (152,720)    (316,559)    (271,031)
Other income (expense):
  Interest income.........        7,080       13,081       18,227       26,171
  Realized gain (loss) on
   short-term
   investments............         (460)      13,466        5,837       13,466
  Other than temporary
   losses on short-term
   investments............          --           --        (1,311)         --
  Equity in losses of
   unconsolidated
   affiliates.............       (3,447)      (1,258)      (6,615)      (1,677)
  Gain on disposal of
   investment in
   unconsolidated
   affiliate..............          178          --           178          --
  Interest expense........      (37,487)     (25,590)     (74,246)     (46,960)
  Miscellaneous expense,
   net....................          521          --           492          --
                            -----------  -----------  -----------  -----------
  Other income (expense),
   net....................      (33,615)        (301)     (57,438)      (9,000)
                            -----------  -----------  -----------  -----------
Loss before cumulative
 effect of change in
 accounting principle.....     (175,462)    (153,021)    (373,997)    (280,031)
Cumulative effect of
 change in accounting
 principle................          --           --           --        (9,249)
                            -----------  -----------  -----------  -----------
Net loss..................  $  (175,462) $  (153,021) $  (373,997) $  (289,280)
                            ===========  ===========  ===========  ===========
Basic and diluted net loss
 per common share before
 cumulative effect of
 change in accounting
 principle................  $     (1.01) $     (1.00) $     (2.16) $     (1.87)
                            ===========  ===========  ===========  ===========
Basic and diluted
 cumulative effect of
 accounting change per
 common share.............  $       --   $       --   $       --   $     (0.06)
                            ===========  ===========  ===========  ===========
Basic and diluted net loss
 per common share.........  $     (1.01) $     (1.00) $     (2.16) $     (1.93)
                            ===========  ===========  ===========  ===========
Weighted average common
 shares used in computing
 basic and diluted per
 share amounts............  173,902,805  153,403,000  173,260,179  150,060,000
                            ===========  ===========  ===========  ===========
Pro forma amounts assuming
 the accounting change is
 applied retroactively:
  Net loss................  $  (175,462) $  (153,021) $  (373,997) $  (280,031)
                            ===========  ===========  ===========  ===========
  Basic and diluted net
   loss per common share..  $     (1.01) $     (1.00) $     (2.16) $     (1.87)
                            ===========  ===========  ===========  ===========
</TABLE>

                            See accompanying notes.

                                       5
<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (Amounts in thousands)
                                  (Unaudited)
<TABLE>
<CAPTION>
                                                           Six months ended
                                                               June 30,
                                                          --------------------
                                                            2001       2000
                                                          ---------  ---------
                                                                     Restated
                                                                     (Note 1)
<S>                                                       <C>        <C>
Operating Activities:
Net loss................................................. $(373,997) $(289,280)
Adjustments to reconcile net loss to net cash used in
 operating activities:
 Provision for bad debts (bad debt recoveries)...........    (3,049)     3,628
 Depreciation and amortization...........................    75,274     55,098
 Loss on disposition of equipment........................       355        --
 Provision for restructuring expenses....................    17,747        --
 Provision for long-lived asset impairment...............     2,230        --
 Write-off of in-process research and development
  costs..................................................       --       3,726
 Amortization of deferred stock-based compensation.......     1,365      2,372
 Other stock-based compensation..........................       267      9,089
 Accretion of interest on investments....................    (5,381)   (18,748)
 Accretion of debt discount and amortization of deferred
  debt issuance costs....................................    16,564     13,227
 Realized gain on short-term investments.................    (5,837)   (13,466)
 Other than temporary losses on short-term investments...     1,311        --
 Equity in losses of unconsolidated affiliates...........     6,615      1,677
 Gain on disposal of investment in unconsolidated
  affiliate..............................................      (178)       --
 Change in unrealized gain...............................       (24)       --
 Cumulative effect of change in accounting principle.....       --       9,249
 Net changes in operating assets and liabilities:
   Restricted cash.......................................      (249)      (612)
   Accounts receivable...................................    (4,951)   (15,062)
   Unbilled revenue......................................    (2,383)    (2,136)
   Inventories...........................................     3,371     (8,399)
   Prepaid expenses and other current assets.............    (3,206)   (16,963)
   Deferred costs of service activation..................   (12,845)   (50,196)
   Accounts payable......................................   (39,916)     2,112
   Other current liabilities.............................    (7,237)    23,899
   Unearned revenue and other............................    (9,274)    55,989
                                                          ---------  ---------
Net cash used in operating activities....................  (343,428)  (234,796)
Investing Activities:
Cash acquired through business acquisitions..............       --       4,240
Cash relinquished as a result of deconsolidating a
 subsidiary..............................................    (1,599)       --
Purchase of short-term investments.......................  (413,512)  (271,677)
Maturities of short-term investments.....................   366,508    415,814
Sale of short-term investments...........................   138,122     57,940
Redemption of restricted investments.....................    13,437     13,438
Purchase of property and equipment.......................   (13,028)  (188,438)
Proceeds from sale of property and equipment.............       753        --
Recovery of internal-use software costs..................     2,000     21,500
Payment of collocation fees..............................    (5,406)   (10,294)
Acquisition of investment in unconsolidated affiliates...       --     (22,854)
Proceeds from sale of investment in unconsolidated
 affiliate...............................................     1,223        --
Purchase of other long-term assets.......................       --         956
                                                          ---------  ---------
Net cash provided by investing activities................    88,498     20,625
                                                          ---------  ---------
Financing Activities:
Repurchase of restricted stock...........................      (172)       --
Principal payments on long-term debt.....................    (8,394)       --
Proceeds from issuance of long-term debt, net............       --     413,268
Principal payments under capital lease obligations.......    (1,075)      (142)
Proceeds from common stock issuance......................     1,819     12,647
Payment of short-term borrowings and line of credit......       --      (4,750)
                                                          ---------  ---------
Net cash provided by (used in) financing activities......    (7,822)   421,023
                                                          ---------  ---------
Net increase (decrease) in cash and cash equivalents.....  (262,752)   206,852
Cash and cash equivalents at beginning of period.........   558,440    216,038
                                                          ---------  ---------
Cash and cash equivalents at end of period............... $ 295,688  $ 422,890
                                                          =========  =========
</TABLE>
                            See accompanying notes.

                                       6
<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (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") except the accounts of one subsidiary, BlueStar
Communications Group, Inc. and its subsidiaries, which have been excluded from
the condensed consolidated financial statements effective June 25, 2001 as a
result of the assignments for the benefit of creditors that were executed by
those companies on such date (Note 3). 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 and with 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 considered necessary for a fair presentation of the
condensed consolidated financial statements have been included. Operating
results for the three and six months ended June 30, 2001 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2001.

   The condensed consolidated financial statements have been prepared assuming
the Company will continue as a going concern. The Company has incurred
recurring operating losses and negative cash flows from operating activities,
and it has working capital and stockholders' deficits as of June 30, 2001. In
addition, a number of the Company's ISP customers have experienced financial
difficulties, and certain of them have filed for bankruptcy protection.
Furthermore, several of the Company's stockholders and purchasers of its
convertible notes have filed lawsuits against the Company and certain of its
current and former officers in 2000 alleging violations of federal and state
securities laws. The relief sought in these lawsuits includes rescission of
certain convertible note sales completed by the Company in September 2000 and
unspecified damages. As discussed in Note 6, the Company has signed a
memorandum of understanding to settle one of these actions, but this settlement
is still subject to court approval and other conditions. In addition, the
Company received a notice of default and acceleration claim from a group of its
convertible noteholders who claim that the Company's restatement of its
unaudited interim financial statements for a previously reported quarter in
2000 is a default under the convertible notes indenture. They also claim that
this default cannot be cured and is grounds for acceleration of the entire
amount owed on their convertible notes. Covad has also filed a voluntary
petition to reorganize under Chapter 11 of the U.S. Bankruptcy Code, which is
discussed in more detail in Note 7. Additionally, Covad failed to make a $25.5
million interest payment due under the terms of a senior notes indenture on
August 15, 2001 as a result of its decision to seek reorganization under the
bankruptcy laws through a voluntary Chapter 11 filing. The Chapter 11 filing
also caused a default under substantially all of the Company's debt agreements,
including leases. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. The condensed consolidated financial
statements do not include any adjustments to reflect the possible future
effects on the recoverability and classification of assets or the amounts and
classification of liabilities that might result from the outcome of this
uncertainty.

   The condensed consolidated balance sheet at December 31, 2000 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, 2000. The information included in this report relating to the
three and six

                                       7
<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                                  (Unaudited)

months ended June 30, 2000 has been restated, as more fully explained in Part
II, Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations--Quarterly Financial Information (Unaudited), included in
the Company's Annual Report on Form 10-K for the year ended December 31, 2000.

 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.

 Change in Accounting Estimate

   Effective January 1, 2001, the Company reduced the remaining estimated
useful lives of all long-lived assets, excluding buildings and leasehold
improvements, that previously had estimated useful lives in excess of five
years such that the residual balances and any subsequent additions are now
depreciated or amortized over five years using the straight-line method. This
change in accounting estimate increased the Company's depreciation and
amortization expense and net loss by $3.0 million ($0.02 per share) and by $6.3
million ($0.04 per share) for the three and six months ended June 30, 2001,
respectively.

 Net Loss per Common Share

   Basic net loss per common share is computed by dividing net loss by the
weighted average number of shares of the Company's common stock, after giving
consideration to shares subject to repurchase, outstanding during the period.

   Diluted net loss per common share is determined in the same manner as basic
net loss per share except that the number of shares is increased assuming the
exercise of dilutive stock options and warrants using the treasury stock
method. Diluted net loss per common share in all periods presented is the same
as basic net loss per common share because the Company had net losses during
these periods and the impact of the assumed exercise of outstanding stock
options and warrants and the assumed conversion of the Company's convertible
senior notes is not dilutive.

   The following table presents the calculation of basic and diluted net loss
per common share (amounts in thousands, except share and per share amounts):

<TABLE>
<CAPTION>
                              Three months ended         Six months ended
                                   June 30,                  June 30,
                            ------------------------  ------------------------
                               2001         2000         2001         2000
                            -----------  -----------  -----------  -----------
<S>                         <C>          <C>          <C>          <C>
Net loss..................  $  (175,462) $  (153,021) $  (373,997) $  (289,280)
Basic and diluted:
  Weighted average shares
   of common stock
   outstanding............  174,979,336  157,635,000  174,465,945  154,895,000
  Less weighted average
   shares of common stock
   subject to repurchase..    1,076,531    4,232,000    1,205,766    4,835,000
                            -----------  -----------  -----------  -----------
Weighted average shares
 used in computing basic
 and diluted net loss per
 common share.............  173,902,805  153,403,000  173,260,179  150,060,000
                            ===========  ===========  ===========  ===========
Basic and diluted net loss
 per common share.........  $     (1.01) $     (1.00) $     (2.16) $     (1.93)
                            ===========  ===========  ===========  ===========
</TABLE>

                                       8
<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                                  (Unaudited)


 Comprehensive Loss

   Significant components of the Company's comprehensive loss are as follows
(amounts in thousands):

<TABLE>
<CAPTION>
                                      Three months ended     Six months ended
                                           June 30,              June 30,
                         Cumulative   --------------------  --------------------
                           Amounts      2001       2000       2001       2000
                         -----------  ---------  ---------  ---------  ---------
<S>                      <C>          <C>        <C>        <C>        <C>
Net loss................ $(2,063,263) $(175,462) $(153,021) $(373,997) $(289,280)
Unrealized gains
 (losses) on available-
 for-sale securities....         815        773   (65,383)     (1,457)   (63,977)
Foreign currency
 translation
 adjustment.............      (2,390)        31        --        (674)       --
                         -----------  ---------  ---------  ---------  ---------
Comprehensive loss...... $(2,064,838) $(174,658) $(218,404) $(376,128) $(353,257)
                         ===========  =========  =========  =========  =========
</TABLE>

 New Accounting Pronouncements

   The Company adopted statement of Financial Accounting Standards ("SFAS") No.
133, "Accounting for Derivative Instruments and Hedging Activities," as
amended, on January 1, 2001. SFAS No. 133 standardizes the accounting for
derivatives and hedging activities and requires that all derivatives be
recognized in the statement of financial position as either assets or
liabilities at fair value. Changes in the fair value of derivatives that do not
meet the hedge accounting criteria are required to be reported in operations.
The adoption of SFAS No. 133 had no effect on the Company's condensed
consolidated financial statements as of and for the three and six months ended
June 30, 2001.

   In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations," and SFAS No. 142, "Goodwill and Other Intangibles
Assets." SFAS No. 141 eliminates the pooling-of-interests method of accounting
for business combinations, except for qualifying business combinations that
were initiated prior to July 1, 2001. Under SFAS No. 142, goodwill and
indefinite lived intangible assets are no longer amortized but are reviewed
annually, or more frequently if impairment indicators arise, for impairment.
The Company is required to adopt SFAS No. 142 on January 1, 2002. The Company
has not yet determined the impact, if any, that SFAS Nos. 141 and 142 will have
on its condensed consolidated financial statements.

2. Revenue Recognition and Change in Accounting Principle

   Revenues from recurring DSL service are recognized in the period in which
the service is provided, assuming the collection of such revenues is reasonably
assured and all other criteria for revenue recognition have been met. Revenues
earned for which the customer has not been billed are recorded as "Unbilled
revenue" in the condensed consolidated balance sheet. Amounts billed in advance
of providing service are deferred and recorded as an element of the condensed
consolidated balance sheet caption "Unearned revenue and other." Included in
revenues are Federal Universal Service Fund charges billed to customers
aggregating $3.0 million and $2.6 million for the three months ended June 30,
2001 and 2000, respectively, and $7.1 million and $4.3 million for the six
months ended June 30, 2001 and 2000, respectively.

   The Company has over 250 wholesale customers. For the three and six months
ended June 30, 2001, the Company's 35 largest wholesale customers collectively
comprised 88.0% and 87.4% of the Company's wholesale net revenues, and 72.6%
and 72.0%, respectively, of the Company's total net revenues. As of June 30,
2001, receivables from these customers collectively comprised 80.9% of the
Company's gross accounts receivable balance.

   For the three months ended June 30, 2001, one wholesale customer
individually accounted for 16.7% of the Company's total net revenues. As of
June 30, 2001, receivables from this customer comprised 7.5% of the

                                       9
<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                                  (Unaudited)

Company's gross accounts receivable balance. For the six months ended June 30,
2001, two wholesale customers individually accounted for 16.2% and 10.4%,
respectively, of the Company's total net revenues. As of June 30, 2001,
receivables from these customers comprised 7.5% and 4.1%, respectively, of the
Company's gross accounts receivable balance. The Company had one significant
wholesale customer for the three and six months ended June 30, 2000, that
accounted for 10.2% and 10.0% of the Company's total net revenues,
respectively.

   A number of the Company's Internet service provider ("ISP") customers are
experiencing financial difficulties. During the three and six months ended June
30, 2001, certain of these financially distressed ISP 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 certain of the payments received from the ISP customers who have filed
for bankruptcy protection is uncertain. Revenue related to customers that do
not demonstrate the ability to pay for services in a timely manner, but who
have not filed for bankruptcy protection, is recorded as revenue when cash for
those services is received, 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 revenue and other" if the Company's ability to retain these
payments is uncertain.

   A number of the Company's financially distressed ISP customers have filed
for bankruptcy protection. These ISP customers accounted for approximately 4.4%
and 4.2% for the three and six months ended June 30, 2001, and 25.3% and 25.4%
for the three and six months ended June 30, 2000, of the Company's total net
revenues, respectively. The Company has completed the migration of certain end-
users from certain of these financially distressed ISP customers.

   During the three and six months ended June 30, 2001, the Company issued
billings to its financially distressed customers, including those that have
filed for bankruptcy protection, aggregating $8.0 million and $27.4 million,
respectively. These billings were not recognized as revenues or accounts
receivable in the condensed consolidated financial statements. The
corresponding amount in the first quarter of 2001 was $19.4 million.

   The Company has obtained information indicating that some of its ISP
customers who (i) were essentially current in their payments for the Company's
services prior to June 30, 2001, and (ii) have subsequently paid all or
significant portions of the respective amounts recorded as accounts receivable
by the Company as of June 30, 2001, may become financially distressed. Revenues
from these customers accounted for approximately 15.7% and 15.1% of the
Company's total net revenues for the three months ended June 30, 2001 and 2000,
respectively. For the six months ended June 30, 2001 and 2000 these customers
accounted for approximately 8.7% and 9.3%, respectively, of the Company's total
net revenues. 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
June 30, 2001, revenue from these customers will be recognized on a cash basis
(as described above).

   The Company has billing disputes with certain of its customers. These
disputes arise in the ordinary course of business in the telecommunications
industry and their impact on the Company's revenues can be reasonably estimated
based on historical experience. Accordingly, the Company establishes reserves,
through charges to revenues, based on its estimate of the ultimate resolution
of these disputes.

   During the fourth quarter of 2000, retroactive to January 1, 2000, the
Company changed its method of accounting for up-front fees associated with DSL
service activation and the related incremental direct costs in accordance with
SEC Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in
Financial

                                       10
<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                                  (Unaudited)

Statements." The cumulative effect of the change in accounting principle
resulted in a charge to operations of $9.2 million, which is included in net
loss for the six months ended June 30, 2000. The pro forma amounts presented in
the condensed consolidated statements of operations were calculated assuming
the accounting change was made retroactively to all prior periods presented.
For the three and six months ended June 30, 2001 and 2000, the Company
recognized $3.7 million ($4.7 million in 2000) and $7.9 million ($9.5 million
in 2000), respectively, in revenue that was included in the cumulative effect
adjustment as of January 1, 2000. The effect of that revenue during the three
and six months ended June 30, 2001 and 2000 was to decrease net loss by
$0.9 million ($1.1 million in 2000) and $2.1 million ($2.3 million in 2000),
respectively, during these periods.

3. Restructuring of Operations

   BlueStar Communications Group, Inc. and its subsidiaries (collectively,
"BlueStar"), which were acquired by the Company on September 22, 2000 in a
transaction accounted for as a purchase, provided broadband communications and
Internet services to small and medium sized businesses in smaller cities using
a direct sales model. Continued losses at BlueStar, with no near term
possibility of improvement, caused the Company's Board of Directors, on June
22, 2001, to decide to cease the Company's funding of BlueStar's operations.
Subsequently, on June 25, 2001, BlueStar terminated all of its 365 employees.
However, 59 of BlueStar's former employees were temporarily retained by the
Company for varying periods through July 31, 2001 to assist with the migration
of certain BlueStar end user lines to the Company's network, as described
below. In addition, the Company hired 69 of BlueStar's former employees
subsequent to June 25, 2001.

   On June 24, 2001, the Company and BlueStar entered into a Purchase Agreement
("PA") under which the Company has purchased the right to offer service to
BlueStar's customers, subject to BlueStar's right to seek higher offers. The
amount of consideration to be paid by the Company under the PA is contingent on
the number of end user lines that are successfully migrated from BlueStar to
the Company. However, the maximum amount payable by the Company under the PA is
$5.0 million. To facilitate this migration, the Company and BlueStar entered
into a Migration Agreement on July 12, 2001 that requires the Company to pay
certain amounts contemplated in the PA directly to certain former employees of
BlueStar and certain BlueStar vendors, including the Assignee, as defined
below. Through June 30, 2001, the Company made payments aggregating
approximately $3.7 million in connection with BlueStar's cessation of
operations. Of this amount, approximately $1.3 million represents employee
severance benefits, approximately $2.0 million represents customer acquisition
costs under the PA and approximately $0.4 million represents legal and other
professional fees relating to the liquidation of BlueStar, as described below.
Such (i) severance benefits and professional fees and (ii) customer acquisition
costs have been charged to (i) restructuring expenses and (ii) network and
product costs, respectively, in the Company's condensed consolidated statement
of operations for the three months ended June 30, 2001. Additionally, as of and
for the three months ended June 30, 2001, the Company has accrued certain
estimated direct costs (aggregating approximately $0.7 million) of liquidating
BlueStar, as described below, which consist principally of legal and other
professional fees. The Company will recognize the salary and benefits expenses
(including severance benefits) associated with the former BlueStar employees
that were temporarily retained by the Company, as described above, through
charges to network and product costs as they are incurred in periods ending
subsequent to June 30, 2001.

   On June 25, 2001, BlueStar made an irrevocable assignment for the benefit of
creditors ("ABC") of all its assets to an independent trustee (the "Assignee")
in the State of Tennessee. Immediately thereafter, the Assignee began an
orderly liquidation of BlueStar that is expected to occur over a period of less
than one year. An ABC under Tennessee law is a non-judicial alternative to a
plan of liquidation under Chapter 7 of the United States Bankruptcy Code. As a
result of the ABC, BlueStar's former assets are no longer controlled by

                                       11
<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                                  (Unaudited)

BlueStar or the Company and cannot be used by either BlueStar's or the
Company's Board of Directors to satisfy the liabilities of BlueStar.
Consequently, the liquidation of BlueStar's assets and the discharging of its
liabilities are currently under the sole control of the Assignee. However, on
July 25, 2001, certain creditors of BlueStar filed an involuntary petition for
relief under Chapter 7 of the Bankruptcy Code, and management believes it is
likely this petition will be granted. Nevertheless, the control of BlueStar no
longer rests with the Company. Therefore, it deconsolidated BlueStar effective
June 25, 2001, which resulted in the recording of a deferred gain in the amount
of approximately $55.5 million in the Company's condensed consolidated balance
sheet as of June 30, 2001. Such deferred gain represents the difference between
the carrying values of BlueStar's assets (aggregating approximately $7.9
million) and liabilities (aggregating approximately $63.4 million) as of June
25, 2001. Such deferred gain will be recognized by the Company as an
extraordinary item when the liquidation of BlueStar is complete and its
liabilities have been discharged.

   Under the terms of the acquisition agreement dated September 22, 2000, up to
5.0 million additional common shares of the Company's common stock were to be
issued to BlueStar's former shareholders if BlueStar achieved certain specified
levels of revenues and earnings before interest, taxes, depreciation and
amortization in 2001. However, during April 2001, the Company reached an
agreement with the BlueStar stockholders' representative to resolve this
matter, as well as 800,000 of the Company's common shares that were held in
escrow as of December 31, 2000, by providing the BlueStar stockholders with
3.25 million of the 5.0 million shares, in exchange for a release of claims
against the Company. The 800,000 common shares held in escrow are to be
returned to the Company under this agreement, which was approved by greater
than 80% of BlueStar's stockholders on June 27, 2001. BlueStar's former
stockholders will receive the additional shares of the Company's common stock
subsequent to June 30, 2001. Consequently, the Company recorded a liability in
the amount of approximately $2.2 million through a charge to goodwill during
the three months ended June 30, 2001. However, the Company determined that such
goodwill was impaired based on BlueStar's continued operating losses, as
described above. Therefore, such goodwill balance was written-off through a
charge to operations during the three months ended June 30, 2001.

   During the fourth quarter of 2000, the Company announced a comprehensive
restructuring plan that involves the following steps:

  .  raising revenue by reducing rebates and other incentives that the
     Company provides to customers and correspondingly reducing new line
     addition plans for 2001 to improve margins and reduce subscriber payback
     times;

  .  closing approximately 200 under-performing or not fully built-out
     central offices and holding the size of the Company's network;

  .  reducing the Company's workforce by 638 employees, which represented
     approximately 21% of the Company's workforce;

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

  .  downsizing the Company's international operations and discontinuing
     plans to fund additional international expansion (the Company will
     continue to manage its current international investments);

  .  enhancing productivity in the Company's operations to increase customer
     satisfaction while reducing costs;

  .  restructuring BlueStar to streamline the Company's direct sales and
     marketing channel; and

  .  evaluating and implementing other cost reduction strategies including
     salary freezes and reductions in travel, facilities and advertising
     expenses.

                                       12
<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                                  (Unaudited)


   In connection with this restructuring plan, the Company recorded a charge to
operations of $5.0 million in the fourth quarter of 2000 relating to employee
severance benefits that met the requirements for accrual as of December 31,
2000. During the three months ended June 30, 2001, the Company reduced its
workforce by 150 employees and paid severance benefits of $0.9 million which
were charged against the restructuring liability recorded as of December 31,
2000. For the six months ended June 30, 2001 the total workforce was reduced by
635 employees and the Company paid $3.8 million in severance benefits, which
were charged against the restructuring liability recorded as of December 31,
2000.

   The Company recorded additional restructuring expenses aggregating $14.8
million and $1.0 million during the first and second quarters of 2001,
respectively. These expenses consist principally of collocation and building
lease termination costs that met the requirements for accrual during these
periods. During the three and six months ended June 30, 2001, the Company paid
collocation and building lease termination costs of $2.1 million and
$4.5 million, respectively, which were charged against the restructuring
liabilities recorded during these periods. Management continues to consider
whether additional restructuring is necessary, and additional charges to
operations related to any further restructuring activities may be incurred in
future periods.

4. Long-Term Debt

   As described in Note 6, six purchasers of the convertible notes that the
Company issued on September 19, 2000 have filed complaints against the Company
and two of its former officers in the Superior Court of the State of California
for the County of Santa Clara. The complaints have been consolidated. The
complaints allege fraud, deceit, negligence and violations of state securities
laws. The relief sought includes rescission of the plaintiffs' alleged
purchases of approximately $142 million in aggregate principal amount of
convertible notes and unspecified damages, including punitive damages, and
attorneys' fees. Two of these purchasers allegedly holding $48 million in
aggregate principal amount of the convertible notes have dismissed their
complaints without prejudice. The Company believes the convertible notes were
legally and validly issued.

   In addition, on May 31, 2001, the Company received a notice of default and
acceleration claim from a group of its convertible noteholders who claim that
the Company's restatement of its unaudited interim financial statements for a
previously reported quarter in 2000 is a default under the convertible notes
indenture. They also claim that this default cannot be cured and is grounds for
acceleration of the entire amount owed under their convertible notes
(aggregating approximately $100 million as of June 30, 2001). Management
believes there have been no events of default under the Company's convertible
notes indenture relating to this matter. Additionally, based on the advice of
legal counsel, management believes the probability of the claim asserted by
these convertible noteholders succeeding, if it is litigated, is remote.

   As described in Note 7, on August 15, 2001, Covad filed a voluntary petition
to reorganize under Chapter 11 of the United States Bankruptcy Code. Under the
Plan to be submitted by Covad, all senior notes would be cancelled in exchange
for a cash payment and the issuance of convertible preferred stock.

   On August 15, 2001, due to Covad's Chapter 11 filing on that date, Covad did
not make a $25.5 million interest payment due under the terms of a senior notes
indenture. The filing of this voluntary petition under Chapter 11 resulted in a
default under substantially all of Covad's debt agreements and caused the
Company to classify all of its long-term obligations as current liabilities in
its condensed consolidated balance sheet as of June 30, 2001.

5. Business Segments

   The Company disaggregates its business operations based upon differences in
services and marketing channels, even though the cash flows from these
operations are not largely independent of each other. The

                                       13
<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                                  (Unaudited)

Company's wholesale division ("Wholesale") is a provider of broadband
communications services, which involve DSL technology, to ISP, enterprise and
telecommunications customers. The Covad Integrated Services ("CIS") division is
a provider of Internet access services to corporations and other organizations.
The Covad Business Solutions ("CBS") division is a provider of broadband
communications and Internet services to small and medium-sized businesses in
smaller cities. Corporate operations represent general corporate expenses,
headquarters facilities and equipment, investments, and other non-recurring and
unusual items not allocated to the segments.

   The Company evaluates performance of the segments based on segment operating
results, excluding nonrecurring and unusual items.

   Information about the Company's business segments was as follows (amounts in
thousands):

<TABLE>
<CAPTION>
   As of and for the
   three months ended                                      Total     Corporate  Intercompany Consolidated
     June 30, 2001:       Wholesale     CIS      CBS      Segments   Operations Eliminations    Total
------------------------  ----------  -------  --------  ----------  ---------- ------------ ------------
<S>                       <C>         <C>      <C>       <C>         <C>        <C>          <C>
Domestic revenues from
 unaffiliated customers,
 net ...................  $   71,829  $ 8,908  $  6,362  $   87,099   $    --      $   --     $   87,099
Net loss................  $ (116,503) $(3,973) $(14,749) $ (135,225)  $(40,237)    $   --     $ (175,462)
Assets..................  $1,054,905  $ 2,335  $     --  $1,057,240   $ 40,543     $   --     $1,097,783

<CAPTION>
   As of and for the
   three months ended                                      Total     Corporate  Intercompany Consolidated
     June 30, 2000:       Wholesale     CIS      CBS      Segments   Operations Eliminations    Total
------------------------  ----------  -------  --------  ----------  ---------- ------------ ------------
<S>                       <C>         <C>      <C>       <C>         <C>        <C>          <C>
Domestic revenues from
 unaffiliated customers,
 net....................  $   37,657  $ 5,587  $    --   $   43,244   $    --      $   --     $   43,244
Net income (loss).......  $ (114,300) $   213  $    --   $ (114,087)  $(38,934)    $   --     $ (153,021)
Assets..................  $1,701,402  $ 3,566  $    --   $1,704,968   $ 41,448     $   --     $1,746,416

<CAPTION>
        For the
    six months ended                                       Total     Corporate  Intercompany Consolidated
     June 30, 2001:       Wholesale     CIS      CBS      Segments   Operations Eliminations    Total
------------------------  ----------  -------  --------  ----------  ---------- ------------ ------------
<S>                       <C>         <C>      <C>       <C>         <C>        <C>          <C>
Domestic revenues from
 unaffiliated customers,
 net ...................  $  130,522  $15,845  $ 11,977  $  158,344   $    --      $   --     $  158,344
Net income (loss).......  $ (233,736) $(8,641) $(42,322) $ (284,699)  $(89,298)    $   --     $ (373,997)

<CAPTION>
        For the
    six months ended                                       Total     Corporate  Intercompany Consolidated
     June 30, 2000:       Wholesale     CIS      CBS      Segments   Operations Eliminations    Total
------------------------  ----------  -------  --------  ----------  ---------- ------------ ------------
<S>                       <C>         <C>      <C>       <C>         <C>        <C>          <C>
Domestic revenues from
 unaffiliated customers,
 net ...................  $   57,752  $ 6,242  $    --   $   63,994   $    --      $   --     $   63,994
Income (loss) before
 cumulative effect of
 change in accounting
 principle..............  $ (223,027) $   308  $    --   $ (222,719)  $(57,312)    $   --     $ (280,031)
Net income (loss).......  $ (232,276) $   308  $    --   $ (231,968)  $(57,312)    $   --     $ (289,280)
</TABLE>

6. Legal Proceedings and Other Contingencies

 Legal Proceedings

   Purchasers of the Company's common stock and purchasers of the convertible
notes the Company issued on September 19, 2000 have 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 Northern District of California.
The complaints have been consolidated. The consolidated complaint alleges
violations of federal securities laws on behalf of persons who purchased or
otherwise acquired the Company's securities, including those who purchased
common stock and those who purchased the Company's convertible notes during the
periods from April 19, 2000 to May 24, 2001. The relief sought includes
monetary damages and equitable relief. On August 10, 2001, the Company signed a

                                       14
<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                                  (Unaudited)

memorandum of understanding with the lead plaintiffs in this litigation that
tentatively resolves the litigation. Under this agreement, Covad would
contribute approximately 6.5 million common shares, representing 3 1/2% of the
Company's fully-diluted common stock on August 10, 2001. The Company's
insurance carriers will fund the cash portion of the settlement. Final
settlement is contingent on negotiation and execution of a final agreement and
court approvals. However, management believes that a final settlement agreement
would likely be approved although such approval is not guaranteed.
Consequently, the Company has recorded a liability of approximately $4.0
million in its condensed consolidated balance sheet as of June 30, 2001 through
a charge to sales, marketing and general and administrative expenses for the
three months ended June 30, 2001 in connection with this anticipated
settlement.

   In addition, six purchasers of the convertible notes that the Company issued
on September 19, 2000, have filed complaints against the Company and two former
officers in the Superior Court of the State of California for the County of
Santa Clara. The complaints have been consolidated. The complaints allege fraud
and deceit, negligence and violations of state securities laws. The relief
sought includes rescission of the plaintiffs' alleged purchases of
approximately $142 million in aggregate principal amount of convertible notes
and unspecified damages, including punitive damages and attorneys' fees.
However, the Company believes the convertible notes were legally and validly
issued. Two of these purchasers allegedly holding $48 million in aggregate
principal amount of the convertible notes have dismissed their complaints
without prejudice. Although the Company believes it has strong defenses in
these lawsuits, the ultimate outcome of this litigation cannot presently be
determined.

   Several stockholders have filed complaints, 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 Company's
underwriters in the United States District Court for the Southern District of
New York. 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. Plaintiffs claim that the Company and others
failed to disclose the arrangements that some of the Company's underwriters
purportedly made with certain investors. The Company believes it has strong
defenses to these lawsuits and intends to contest them vigorously. However,
because these lawsuits are at an early stage, the Company is unable to provide
an evaluation of the ultimate outcome of the litigation.

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

   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. The Company also recently filed a lawsuit against BellSouth
Telecommunications and its subsidiaries in the United States District Court for
the Northern District of Georgia. The Company is pursing antitrust and other
claims in this lawsuit arising out of BellSouth's conduct as a supplier of
network facilities, including central office space, transmission facilities and
telephone lines. Both BellSouth and Verizon have asked the courts to dismiss
the Company's cases on the basis of the ruling of the Seventh Circuit in
Goldwasser v. Ameritech, which dismissed a consumer antitrust class action
against Ameritech. The Company opposed the BellSouth and Verizon motions. The
Georgia court recently granted in part BellSouth's motion and dismissed some of
the Company's antitrust claims and breach of contract claims. The Company has
filed a motion seeking to appeal the court's ruling. To date, the District of
Columbia court has not ruled on Bell Atlantic's motion. The Company cannot
predict the outcome of this motion.

                                       15
<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                                  (Unaudited)

   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 resells to its
customers. The Complaint claims that the Company falsified trouble ticket
reports with respect to the phone lines that Covad ordered and seeks
unspecified monetary damages and injunctive relief. The Complaint asserts
causes of action for negligent and intentional misrepresentation and violations
of the Lanham Act. This lawsuit is at an early stage, so the Company is unable
to provide an evaluation of the ultimate outcome.

   In addition, Verizon has separately filed suit against the Company in the
United States District Court for the Eastern District of Virginia, asserting
infringement of a patent issued to it in September 1998 entitled "Variable Rate
and Variable Mode Transmission System." However, on February 18, 2000, the
court issued a summary judgment ruling holding that the Company had not
infringed Verizon's patent. That decision was recently upheld by the United
States Court of Appeals for the Federal Circuit.

   Numerous former shareholders of Laserlink.Net, Inc. have threatened to file
complaints against the Company and two of its former officers and have provided
three draft complaints seeking damages. Their allegations arise out of claims
that the Company failed to timely register shares of the Company that they
received in exchange for their Laserlink.Net shares and thereafter failed to
maintain such registration, that the Company made fraudulent representations in
connection with the acquisition, and that certain shares were not timely
delivered out of escrow. The Company is unable to determine at present the
amount of any liability to the Company that would result were such claims to be
filed. The Company anticipates that other former Laserlink.Net shareholders may
assert claims against it seeking damages based on similar allegations. The
ultimate outcome of these potential matters presently cannot be determined.

   The Company received a letter and a draft complaint seeking damages and
injunctive relief from an attorney who claims to represent an institution
holding some portion of the Company's public debt. The attorney claims that the
client intends to file this complaint against the Company and/or its officers
and directors if the Company does not either demonstrate that it has financing
to take the Company to the point of profitability, or provide a plan to wind
down operations. The Company has had some preliminary discussions with the
attorney representing this institution. Their attorney has informed us that the
institution has sold its position. Based on the claims asserted in the draft
complaint, the Company believes any claim in this regard would be without
merit. However, the outcome of any litigation is inherently uncertain, so the
Company is unable to provide an evaluation of the ultimate outcome.

   Several creditors of BlueStar have threatened to file lawsuits against the
Company to recover amounts owed by BlueStar. It is uncertain whether the
Assignee or Chapter 7 Trustee will assert these claims. See Note 3. The Company
believes that these assertions are without merit and that it would have strong
defenses to any such legal action. However, the facts supporting these
assertions are unclear and the outcome of litigation is inherently uncertain,
so the ultimate outcome of these matters cannot presently be determined.

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

   The Company is also a party to a variety of other legal proceedings, as
either plaintiff or defendant, and is engaged in other business disputes that
arise in the ordinary course of its business. The Company's management believes
these other matters will be resolved without a material adverse effect on the
Company's consolidated financial position and results of operations.

 Other Contingencies

   Covad's voluntary petition to reorganize under Chapter 11 of the Bankruptcy
Code could result in a default under an operating lease of certain vehicles.
This operating lease had future minimum lease payments of

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<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                                  (Unaudited)

approximately $6.9 million remaining as of June 30, 2001 and is secured by two
letters of credit that total $3.0 million. It is possible that this lessor will
attempt to call these letters of credit as a result of Covad's voluntary
petition. If this occurs, the Company expects the bank that issued the letters
of credit to seek reimbursement of this amount from the Company.

   As of June 30, 2001, the Company had disputes with a number of
telecommunications companies concerning the balances owed to them for
collocation fees and certain network services. In the opinion of management,
such disputes will be resolved without a material adverse effect on the
Company's consolidated financial position and results of operations. However,
it is reasonably possible that estimates of the Company's collocation fee and
network service obligations, as recorded in the accompanying condensed
consolidated balance sheets, could change in the near term. In addition, the
Company is engaged in a variety of negotiations, arbitrations and regulatory
proceedings with multiple telephone companies. These negotiations, arbitrations
and regulatory proceedings concern the traditional telephone companies' denial
of physical central office space to the Company in certain central offices, the
cost and delivery of central office space, the delivery of transmission
facilities and telephone lines and other operational issues. An unfavorable
outcome in any of these negotiations, arbitrations and regulatory proceedings
could have a material adverse effect on the Company's consolidated financial
position and results of operations.

   As of June 30, 2001, the Company held a 6% equity interest in Dishnet DSL
Limited ("Dishnet"), a privately held Indian telecommunications company.
Dishnet currently has minimal cash resources and is seeking additional
financing in order to continue as a going concern. Management of the Company
believes (i) it is probable that Dishnet will be able to obtain the financing
necessary for it to continue as a going concern and (ii) the carrying value of
the Company's investment in Dishnet ($14.9 million as of June 30, 2001) is
recoverable.

7. Subsequent Events

   On August 15, 2001, Covad filed a voluntary petition to reorganize under
Chapter 11 of the Bankruptcy Code. Holders of a majority in face amount or
accreted value of Covad's bonds have agreed to support Covad's plan of
reorganization that, if approved by the Bankruptcy Court, would extinguish all
of Covad's bonds and provide all of the bondholders with a combination of cash
and preferred stock. The cash portion would consist of $0.19 on the dollar for
the face amount or the accreted value of both high-yield and convertible bonds.
In addition, Covad would return all of the approximately $26.5 million in
restricted cash and investments reserved for the holders of Covad's 12.5
percent bonds (of which $13.4 million was paid on August 15, 2001). Covad
expects to pay a total of approximately $283.3 million to the bondholders under
the plan of reorganization Covad intends to propose. The preferred stock would
have a $100 million liquidation preference and would be convertible into
approximately 15 percent of the Company outstanding common stock at the
effective date of the plan of reorganization after certain adjustments to
reflect certain outstanding options and warrants at that date. On a pro forma
basis as of August 10, 2001, the preferred stock would be convertible into
approximately 33 million common shares. If the Company secures additional
funding, and subject to certain terms and conditions, it would have the right
to convert the preferred stock to common stock. The preferred stock would also
be convertible at any time at the preferred holders' option into the same
amount of common shares. After the pay out to the bondholders, on a pro forma
basis as of June 30, 2001, the Company would have approximately $250 million in
cash, which the Company expects will fund its operations into the beginning of
2002. Covad plans to submit a plan of reorganization, which would establish its
capital structure upon emergence from the reorganization. This plan will be
subject to court approval after it has been voted on by the bondholders and
other holders of claims against or interests in Covad that are impaired by the
plan. Notably, under the Bankruptcy Code, the Plan may be approved by the
Bankruptcy Court even absent approval of each class of claims or interests
entitled to vote thereon, under certain conditions. If the plan described above
is approved without substantial modification,, Covad would emerge with the
retirement of all of its bond debt. Covad expects this process to be complete
by January 2002.

                                       17
<PAGE>

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,
2000, included in our Annual Report on Form 10-K filed with the SEC on May 24,
2001. This discussion contains forward-looking statements, the accuracy of
which involve risks and uncertainties. Our actual results could differ
materially from those anticipated in the forward-looking statements for many
reasons including, but not limited to, those discussed 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."

Overview

   We are a leading provider of broadband communications services, which we
sell to businesses and consumers directly and indirectly through Internet
service providers ("ISPs"), enterprises, telecommunications carriers and other
customers. These services include a range of high-speed, high-capacity Internet
and network access services using digital subscriber line ("DSL") technology
and related value-added services. We sell our services directly to business and
consumer end-users through our sales force, telephone sales and our website.
Internet service providers purchase our services in order to provide high-speed
Internet access to their business and consumer end-users. Branded virtual
service providers purchase turnkey broadband or dial-up services from us and
sell these services to their existing customers or affiliate groups. Enterprise
customers purchase our services directly or indirectly from us to provide their
employees with high-speed remote access to the enterprise's local area network
("RLAN access"). Other telecommunications carriers purchase our services for
resale to their ISP affiliates, Internet users and enterprise customers.

   We believe we have the largest national DSL network in the United States,
other than those owned by the traditional telephone companies, encompassing
more than 1,700 operational central offices, which pass more than 40 million
homes and businesses in 94 metropolitan statistical areas. As of June 30, 2001,
we had 333,000 DSL based high speed access lines in service, and we have
received orders for our services from more than 250 Internet Service Providers,
enterprise and telecommunications carrier customers, including AT&T
Corporation, XO Communications (formerly NEXTLINK Communications, Inc. and
Concentric Network Corporation), Earthlink, Inc., UUNET Technologies (a
WorldCom company) and Speakeasy.net, a privately owned company. As of June 30,
2001, we also provided dial-up Internet access service to over 340,000
customers through our Covad Integrated Services subsidiary.

   Since our inception, we have generated significant net losses and we
continue to experience negative cash flow. As of June 30, 2001, we had an
accumulated deficit of approximately $2.1 billion. We expect these losses and
negative cash flow to continue at least into 2003, requiring us to obtain
additional capital. Furthermore, a number of our ISP customers have become
financially distressed and certain of them have filed for bankruptcy
protection. In addition, we have limited cash reserves, and it is uncertain
whether we can raise additional capital and continue as a going concern. If we
are unable to acquire additional capital 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 restructuring, sale or
liquidation of the Company.

Chapter 11 Reorganization

   On August 15, 2001 (the "Petition Date"), Covad Communications Group, Inc.
("Covad") filed a voluntary petition for relief under Chapter 11 of the United
States Code (the "Bankruptcy Code") with the United States Bankruptcy Court for
the District of Delaware. As of the Petition Date, Covad commenced operating
its business and managing its properties as a debtor in possession.

                                       18
<PAGE>

   Covad's operating subsidiaries did not commence bankruptcy proceedings and
the Company expects them to continue to operate in the ordinary course of
business without any court-imposed restrictions.

   In the near future, Covad expects to file a Disclosure Statement (the
"Disclosure Statement") and a Plan of Reorganization (the "Plan") with the
Bankruptcy Court. The Disclosure Statement will summarize the Plan and contain
information concerning, among other matters, the history, business, results of
operations, management, properties, liabilities and the assets available for
distribution under the Plan as well as the anticipated organization and
operation of reorganized Covad. The Disclosure Statement will also describe
certain effects of Plan confirmation, certain risk factors associated with the
Plan, the manner in which distributions will be made to our creditors under the
Plan for all amounts that were owed to such parties on the Petition Date and
the confirmation process and voting procedures that holders of claims in
impaired classes must follow for their votes to be counted.

   Prior to the Petition Date, holders of a majority of the face amount or
accreted value of our bonds agreed to support Covad's pre-negotiated Plan that,
if approved by the Bankruptcy Court, would provide that their securities would
be surrendered in exchange for a cash payment of $0.19 on the dollar for the
face amount or the accreted value of their bonds and a pro rata portion of
preferred stock with a $100 million liquidation preference. The preferred stock
would have a $100 million liquidation preference and would be convertible into
approximately 15 percent of our outstanding common stock at the effective date
of the plan of reorganization after certain adjustments to reflect certain
outstanding options and warrants at that date. On a pro forma basis as of
August 10, 2001, the preferred stock would be convertible into approximately 33
million common shares. Under our forthcoming Plan, our existing shareholders
would retain their stock, but would be diluted to the extent of the preferred
stock (and underlying common stock upon the conversion thereof), the common
stock issued to the plaintiffs in the securities litigation and any other stock
issued in the Plan to any other creditor class.

   Upon securing additional funding, and subject to certain terms and
conditions, we would have the right to convert some or all of preferred stock
into common stock, and for each subsequent equal amount of funding, an
equivalent amount of preferred stock to common stock could be converted. The
preferred stock would also be convertible at any time at the preferred holders'
option into the same amount of common shares.

   After the payout to the bondholders, on a pro forma basis as of June 30,
2001, we would have approximately $250 million in cash, which we expect will
fund our operations into the beginning of 2002.

   Once the Plan and Disclosure Statement are filed with the Bankruptcy Court,
they will be subject to a vote by the bondholders and certain other interests
impaired by the Plan as well as court review and confirmation. While we
anticipate filing the Plan and Disclosure Statement substantially as described
herein, we anticipate filing certain amendments to the Plan and/or Disclosure
Statement to, among other things, add and clarify certain terms of the Plan. We
currently expect that our Chapter 11 restructuring proceeding should be
complete by January 2002.

   Pursuant to the agreements with the bondholders, Covad has placed
approximately $275 million in an escrow account that would be released to the
bondholders if the plan were approved. Our agreements with the bondholders
provide that this escrowed amount would also be released to the bondholders in
certain other events, including: (1) if Covad does not file the Plan by
September 15, 2001; (2) if Covad does not begin soliciting consents to the Plan
by November 15, 2001; or (3) if the Plan is not in effect by January 15, 2002.
This escrowed amount will be returned to Covad in certain events, including if
the bondholders do not vote in favor of the Plan.

Nasdaq Delisting

   On July 19, 2001 we received a notification from the Nasdaq Listing
Qualification Panel that we would no longer be listed on the Nasdaq National
Market effective at market opening on July 20, 2001. The Nasdaq Listings
Qualification Panel's decision is based on our failure to meet the requirements
for continued listing. As of July 20, 2001, trading of our common stock began
on the OTC Bulletin Board (OTCBB), a regulated quotation service that displays
real-time quotes, last-sale prices and volume information in over-the-counter
(OTC) equity securities.

                                       19
<PAGE>

   As a consequence of our delisting, it is expected that our stockholders will
find it more difficult to buy or sell shares of, or obtain accurate quotations
as to the market value of our common stock. In addition, our delisting will
make our common stock substantially less attractive as collateral for margin
and borrowings and loan purposes, for investment by financial institutions
under their internal policies or state legal investment laws, or as
consideration in future capital raising transactions.

   Our common stock has also become subject to regulation as a "penny stock."
The Securities and Exchange Commission (the "SEC") has adopted regulations
which generally define "penny stock" to be any equity security that has a
market price or exercise price less than $5.00 per share, subject to certain
exceptions, including listing on the Nasdaq National Market. Since our common
stock is no longer listed on the Nasdaq National Market and no other exception
applies, our common stock may be subject to the SEC's Penny Stock Rules, Rules
15g-1 through Rule 15g-9 under the Exchange Act. For transactions covered by
these rules, broker-dealers must make a special suitability determination for
the purchase of such securities and have received the purchaser's written
consent to the transaction prior to the purchase. Additionally, for any
transaction involving a penny stock, unless exempt, the rules require the
delivery, prior to the transaction, of a risk disclosure document mandated by
the SEC relating to the penny stock market. The broker-dealer must also
disclose the commission payable to both the broker-dealer and the registered
representative, current quotations for the securities and, if the broker-dealer
is the sole market maker, the broker-dealer must disclose this fact and the
broker-dealer's presumed control over the market. Finally, monthly statements
must be sent disclosing recent price information for the penny stock held in
the account and information on the limited market in penny stocks.

   Consequently, the penny stock rules may restrict the ability of broker-
dealers to buy or sell our securities and may affect the ability of holders to
buy or sell our securities in the secondary market and the price at which such
holders can buy or sell any such securities. Rule 15g-9 under the Exchange Act
imposes additional sales practice requirements on broker-dealers who buy or
sell such securities except in transactions exempted from such rule. Such
exempt transactions include those meeting the requirements of Rule 505 or 506
of Regulation D promulgated under the Securities Act and transactions in which
the purchaser is an institutional accredited investor or an established
customer of the broker-dealer.

Other Matters

   On June 25, 2001 we announced that our subsidiary, BlueStar Communications
Group, Inc. and BlueStar's operating subsidiaries, executed Assignments for the
Benefit of Creditors (the "Assignment"). The purpose of the Assignment is to
shut down the BlueStar network, provide an orderly dissolution of BlueStar's
operations and provide for a transition of its customer lines. BlueStar
Communications Group, Inc, our subsidiary, was acquired by us in September 2000
and, through its operating companies, has been engaged in direct sales of high-
speed Internet access and related services. Covad Communications Group, Inc.
and its other operating subsidiaries are unaffected by the BlueStar action and
will continue to operate in the normal course of business. The Assignment
eliminates the cost of maintaining the BlueStar operations. As a result, we
anticipate that this will reduce our operating costs by approximately $75
million over the next year.

   On August 2, 2001, we announced changes in our financial management team. On
an interim basis, our financial matters will be overseen by a quadriad of
finance vice presidents. They are Joseph Le Chevallier, corporate controller,
Christine Morris, treasurer, Mary Kay Runyan, corporate services and Rob
Stamer, financial operations. Our current executive vice president and Chief
Financial Officer, Mark Perry, has resigned and we are currently conducting a
search for a permanent Chief Financial Officer through Egon Zehnder, an
executive search firm.

Results of Operations

 Three Months and Six Months Ended June 30, 2001 and 2000

Revenues, net

   Revenues, net for the three months ended June 30, 2001 were $87.1 million.
This represents an increase of $41.4 million, or 90.6%, when compared to $45.7
million for the three months ended June 30, 2000. Revenues,

                                       20
<PAGE>

net for the six months ended June 30, 2001 were $158.3 million. This represents
an increase of $84.2 million, or 113.6%, when compared to $74.1 million for the
six months ended June 30, 2000. The increase in net revenues is primarily
attributable to a 141% year-over-year growth in the number of subscribers on
our network. Revenues for the three and six months ended June 30, 2000 have
been determined on a pro forma basis as if our subsidiaries, Laserlink.Net,
which is now doing business as Covad Integrated Services ("CIS") and BlueStar
Communications Group, Inc., had been acquired by us on January 1, 2000.

   We have over 250 wholesale customers. For the three and six months ended
June 30, 2001, our 35 largest wholesale customers collectively comprised 88.0%
and 87.4% of our wholesale net revenues, and 72.6% and 72.0%, respectively, of
our total net revenues. As of June 30, 2001, receivables from these customers
collectively comprised 80.9% of our gross accounts receivable balance.

   For the three months ended June 30, 2001, one customer accounted
individually for 16.7%, of our total net revenues. For the six months ended
June 30, 2001, two customers accounted individually for 16.2%, and 10.4%,
respectively, of our total net revenues. As of June 30, 2001, receivables from
these customers comprised 7.5%, and 4.1%, respectively, of the gross accounts
receivable balance. We had one significant customer for the three and six
months ended June 30, 2000, that accounted for 10.2% and 10.0%, respectively,
of our total net revenues.

   Wholesale revenues are derived from broadband communications services sold
primarily to ISP customers and to a lesser extent enterprise and
telecommunications companies. For the three months ended June 30, 2001,
revenues from our wholesale segment were $71.8 million. This represents an
increase of $34.1 million, or 90.4%, when compared to $37.7 million for the
three months ended June 30, 2000. For the six months ended June 30, 2001,
revenues from our wholesale segment were $130.5 million. This represents an
increase of $72.7 million, or 125.6%, when compared to $57.8 million for the
six months ended June 30, 2000. Our subscriber growth was the primarily driver
contributing to the increase. However, due to financial difficulties
experienced by an increasing number of our ISP customers, we did not recognize
revenues of $8.0 million that were billed to these customers during the three
months ended June 30, 2001 and $27.4 million for the six months ended June 30,
2001. The corresponding amount in the first quarter of 2001 was $19.4 million.

   We acquired Laserlink.Net, which is now doing business as CIS, on March 20,
2000. Revenues from CIS are derived from sales of Internet access services to
corporations and other organizations that resell these services to consumer and
business end users. For the three and six months ended June 30, 2001, CIS
revenues were $8.9 million and $15.8 million, respectively. For the three and
six months ended, June 30, 2000, CIS contributed revenue of $5.6 million and
$6.2 million, respectively. CIS revenue comes primarily from two subscriber
services, dial-up and DSL. Revenue growth is expected in the future from
increased subscribers for Virtual Internet Service Provider (VISP) services and
Virtual Broadband Subscriber Provider (VBSP) services.

   We acquired BlueStar (also known as Covad Business Services (CBS)) on
September 22, 2000. On June 25, 2001, BlueStar executed an assignment for the
benefit of its creditors and, from that date we stopped recognizing the results
of BlueStar's operations in our condensed consolidated financial statements.
CBS derived revenue from the sale of broadband communications and Internet
services to small and medium-sized business in smaller markets primarily in the
southeastern United States. CBS revenue for the three and six months ended June
30, 2001 was $6.4 million and $12.0 million, respectively. Revenues for the
three and six months ended June 30, 2001 do not include CBS revenues for June
25 through June 30. BlueStar was not part of our operations during the same
periods in 2000.

   As of June 30, 2001, approximately 51% of our lines were business lines and
49% were consumer lines. Our consumer grade services have lower prices and
significantly lower profit margins than our business grade services. Going
forward we expect the percentage of our revenues which we derive from our
consumer services to increase. The increase in consumer lines may negatively
impact our operating margins.

   Given the perceived uncertainties in the marketplace regarding Covad's
recent bankruptcy filing and the deconsolidation and closure of our BlueStar
subsidiary, we expect little to no growth in revenues during the third quarter
of 2001 in comparison to the second quarter of 2001.

                                       21
<PAGE>

Network and Product Costs

   We recorded network and product costs of $121.4 million for the three months
ended June 30, 2001. This represents an increase of $32.5 million, or 37%, when
compared to $88.9 million for the three months ended June 30, 2000. For the six
months period ended June 30, 2001 we recorded network and product costs of
$256.6 million. This represents an increase of $101.7 million, or 66%, when
compared to $154.9 million for the six months ended June 30, 2000. This
increase is primarily attributable to the increased orders resulting from our
sales and marketing efforts and the expansion of our network to accommodate the
increased traffic. For the three and six months ended June 30, 2001, CIS
network and product costs were included in Covad's consolidated results,
increasing costs by $8.8 million, and $16.6 million, respectively. For the
three and six months ended June 30, 2000, CIS network and product costs were
included in Covad's consolidated results, increasing costs by $2.7 million, and
$2.9 million, respectively. BlueStar contributed $15.7 million and
$34.6 million in network and product costs for the three and six months ended
June 30, 2001, respectively. Beginning on June 25, 2001, we stopped recording
network and product costs associated with BlueStar's operations. BlueStar was
not part of Covad's operations during the same periods in 2000. We expect
network and product costs to increase in future periods due to expected
increased subscribers.

   We continued to execute on several initiatives that were launched during the
first quarter of 2001 to reduce our network and product costs. These
initiatives are focused on improving the efficiency of our consumer service
offering. The three initiatives are line sharing, "access only" and self-
installation. Line sharing allows us to provision DSL service over the same
copper wire that delivers an end users' voice telephone service. Line-shared
loops are leased by us at a significantly lower rate from the incumbent local
exchange carriers (ILECs) than a dedicated second line. For the three months
ended June 30, 2001, substantially all of our consumer orders were provisioned
over line-shared lines. In addition to the lower cost of line-shared lines, the
time to provision and deliver a line-shared order is less than the time
required for a non-line-shared order. "Access only" is another method of
delivering our service, but it limits our service only to the connection of the
end user to the broadband loop via a line-shared-line. Our customer provides
the end user customer premise equipment and any assistance needed for the set
up of the service. For the three months ended, June 30, 2001, over 75% of our
consumer orders were "access only." This means we can maintain a lower
inventory of customer premise equipment, and it also eliminates the cost of a
truck roll to the end user's premise for installation. The third consumer
service initiative launched during the first quarter of 2001 was self-
installation. By providing a self-installation kit to the end user through the
mail, we typically eliminate the cost of a truck roll to the end user's premise
and shorten the amount of time required for service delivery. For the three
months ended June 30, 2001, approximately 90% of our consumer orders were
completed using a self-installation kit.

Sales, Marketing, General and Administrative Expenses

   Sales, marketing, general and administrative expenses consist primarily of
salaries, expenses for the development of our business, the development of
corporate identification, promotional and advertising materials, expenses for
the establishment of our management team and sales commissions. Sales,
marketing, general and administrative expenses were $63.3 million and $64.9
million for the three months ended June 30, 2001 and 2000, and $126.1 million
and $117.7 million for the six months ended June 30, 2001 and 2000,
respectively. This increase in sales, marketing, general and administrative
expense is attributable principally to the increase in resources necessary to
support the growth in subscribers, coupled with accounting and litigation
expenses. In addition, for the three and six months ended June 30, 2001, sales,
marketing and general and administrative expenses include the CIS business
segment expenses of $3.5 million and $6.7 million, respectively. For the three
and six months ended June 30, 2000, sales, marketing and general and
administrative expenses of $2.2 million and $2.5 million from the CIS business
segment were included in our operating results. BlueStar contributed $4.4
million and $11.7 million in sales, marketing, general and administrative
expenses for the three and six months ended June 30, 2001, respectively.
Beginning on June 25, 2001, we stopped recording sales, marketing, general and
administrative expenses associated with BlueStar's operations.

                                       22
<PAGE>

BlueStar was not part of Covad's operations during the same periods in 2000.
Sales, marketing, general and administrative expenses are expected to increase
in line with the expected expansion of our business.

Provision for Bad Debts

   We recorded bad debt expense of $1.2 million for the three months ended June
30, 2001 as compared to $1.8 million for the three months ended June 30, 2000.
For the six months ended June 30, 2001, we recorded a net bad debt recovery of
$3.0 million, as compared to a bad debt expense of $3.6 million for the six
months ended June 30, 2000. The bad debt recovery recorded during the first six
months of 2001 relates to the collection of certain balances from our
financially distressed partners that were reserved in previous periods through
charges to expense.

Depreciation and Amortization

   Depreciation and amortization includes:

  .  depreciation of network costs and related equipment;

  .  depreciation of information systems, furniture and fixtures;

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

  .  amortization of capitalized software costs; and

  .  amortization of intangible assets.

   Depreciation and amortization were approximately $37.9 million and $75.3
million for the three and six months ended June 30, 2001, respectively, and
$40.3 million and $55.1 million for the three and six months ended June 30,
2000, respectively. The increase was due partially to the increase in equipment
and facilities placed in service after the quarter ended June 30, 2000, net of
any subsequent impairment write-downs. In addition, effective January 1, 2001,
we reduced the remaining estimated useful lives of all long-lived assets,
excluding buildings and leasehold improvements, that previously had estimated
useful lives in excess of five years such that the residual balances and any
subsequent additions are now depreciated or amortized over five years using the
straight-line method. This change in accounting estimate increased our
depreciation and amortization expense and net loss by $3.0 million ($0.02 per
share) for the three months ended June 30, 2001 and $6.3 million ($0.04 per
share) for the six months ended June 30, 2001.

Restructuring of Operations

   In connection with the restructuring plan we announced in December 2000, we
recorded a charge to operations of $5.0 million during the fourth quarter of
2000 relating to employee severance benefits that met the requirements for
accrual as of December 31, 2000. During the three months and six months ended
June 30, 2001, we paid severance benefits of approximately $0.9 million and
$3.8 million, respectively, which were charged against the restructuring
liability. No restructuring expenses were recognized during the three and six
months ended June 30, 2000.

   Results of operations for the three months and six months ended June 30,
2001 include restructuring expenses of approximately $1.0 million and $15.8,
respectively, for collocation and building lease termination costs that met the
requirements for accrual during these periods. We continue to consider whether
additional restructuring is necessary, and we may incur additional expenses
related to further restructuring activities in future periods.

                                       23
<PAGE>

   On June 25, 2001, we announced that BlueStar had executed an assignment for
the benefit of its creditors. The expected results from this action are to
reduce costs by approximately $75.0 million over the next twelve months. As
part of this transaction, we have stopped recording BlueStar's assets and
liabilities in our consolidated financial statements, resulting in the
recording of a net deferred gain of $55.5 million in our condensed consolidated
balance sheet as of June 30, 2001. During the three months ended June 30, 2001,
we recognized additional restructuring expenses of $4.4 million consisting
primarily of BlueStar severance benefits, legal and other professional fees.

Long-Lived Asset Impairment

   During the three months ended June 30, 2001, we recorded a charge of $2.2
million relating to the write-off of certain goodwill associated with our
BlueStar subsidiary.

Loss from Operations

   Loss from operations for the three months ended June 30, 2001 was $141.8
million and loss from operations for the three months ended June 30, 2000 was
$152.7 million. Loss from operations for the six months ended June 30, 2001 and
June 30, 2000 were $316.6 million and $271.0 million, respectively. For the
three and six months ended June 30, 2001, loss from operations included losses
of $4.0 million and $8.6 million, respectively, from the CIS business segment.
For the three and six months ended June 30, 2000, loss from operations included
income of $0.2 million and $0.3 million, respectively, from the CIS business
segment. BlueStar contributed losses of $14.7 million and $42.3 million to the
loss from operations for the three and six months ended June 30, 2001,
respectively. Beginning on June 25, 2001, we stopped including BlueStar's
operations in our consolidated operating results due to the assignment for the
benefit of creditors executed by BlueStar on such date. BlueStar was not part
of Covad's operations during the same periods in 2000. We do expect continued
improvement in our loss from operations due to the closure of our BlueStar
subsidiary and our continued efforts to control costs.

Interest Income and Expense, Net

   Interest income and expense, net consists primarily of interest income on
our cash, cash equivalents and short-term investment balances and interest
expense associated with our debt. Net interest expense for the three and six
months ended June 30, 2001, was $30.4 million and $56.0 million, while net
interest expense for the three and six months ended June 30, 2000, was $12.5
million and $20.8 million, respectively. Net interest expense during the period
ending June 30, 2001 consisted primarily of accreted interest expense on our
13.5% senior discount notes due 2008 issued in March 1998, our 12.5% senior
notes due 2009 issued in February 1999, our 12% senior notes due 2010 issued in
January 2000, our 6% senior convertible notes due 2005 issued in September 2000
and capital lease obligations. Net interest expense was partially offset by
interest income earned on cash balances on hand during the period. We expect
net interest expense to decrease in future periods as a result of the voluntary
Chapter 11 filing on August 15, 2001.

Investment Gains and Losses

   We recorded a net loss on investments for the three months ended June 30,
2001 of $3.7 million. This included a net realized loss on short-term
investments and investments in unconsolidated affiliates of $0.3 million and
our equity in the losses of unconsolidated affiliates of $3.4 million. We
recognized a net investment gain for the three months ended June 30, 2000 of
$12.2 million. For the six months ended June 30, 2001, we recorded a net loss
on investments of $1.9 million. This included a realized gain on short-term
investments of $6.0 million, our equity in the losses of unconsolidated
affiliates of $6.6 million and the recognition of other than temporary losses
on short-term investments of $1.3 million. We recognized a net investment gain
of $11.8 million for the six months ended June 30, 2000.


                                       24
<PAGE>

Income Taxes

   We made no provision for income taxes because we operated at a loss during
all periods presented.

New Accounting Pronouncements

   We adopted statement of Financial Accounting Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended, on
January 1, 2001. SFAS No. 133 standardizes the accounting for derivatives and
hedging activities and requires that all derivatives be recognized in the
statement of financial position as either assets or liabilities at fair value.
Changes in the fair value of derivatives that do not meet the hedge accounting
criteria are required to be reported in operations. The adoption of SFAS No.
133 had no effect on our consolidated financial statements as of and for the
three and six months ended June 30, 2001.

   During the fourth quarter of 2000, retroactive to January 1, 2000, we
changed our method of accounting for up-front fees associated with DSL service
activation and the related incremental direct costs in accordance with SEC
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements." The cumulative effect of the change in accounting principle
resulted in a charge to operations of $9.2 million, which is included in net
loss for the six months ended June 30, 2000. For the three months ended June
30, 2001 and 2000, we recognized $3.7 million and $7.9 million, respectively,
in revenue that was included in the cumulative effect adjustment as of January
1, 2000. The effect of that revenue during the three months ended June 30, 2001
and 2000 was to decrease net loss by $.9 million and $2.1 million,
respectively, during these periods. For the six months ended June 30, 2001 and
2000, we recognized $4.7 million and $9.5 million, respectively, in revenue
that was included in the cumulative effect adjustment as of January 1, 2000.
The effect of that revenue during the six months ended June 30, 2001 and 2000
was to decrease net loss by $1.1 million and $2.3 million, respectively, during
these periods.

   In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangibles
Assets". SFAS No. 141 eliminates the pooling-of-interests method of accounting
for business combinations, except for qualifying business combinations that
were initiated prior to July 1, 2001. Under SFAS No. 142, goodwill and
indefinite lived intangible assets are no longer amortized but are reviewed
annually, or more frequently if impairment indicators arise, for impairment.
The company is required to adopt SFAS No. 142 on January 1, 2002. The Company
has not yet determined the impact, if any, that Statements Nos. 141 and 142
will have on its condensed consolidated financial statements.

Liquidity and Capital Resources

   Our operations have required substantial capital investment for the
procurement, design and construction of our central office cages, the design,
creation, implementation and maintenance of our operational support system, the
purchase of telecommunications equipment and the design and development of our
networks. Capital expenditures were approximately $7.7 million for the three
months ended June 30, 2001 and $18.4 million for the six months ended June 30,
2001. We expect that our capital expenditures related to the purchase of
infrastructure equipment necessary for the development and expansion of our
networks and the development of new regions will be less in future periods
while capital expenditures related to the addition of subscribers in existing
regions will increase proportionately to the number of new subscribers that we
add.

   From our inception through June 30, 2001, we financed our operations
primarily through private placements of $220.6 million of equity securities,
$1,231.4 million in net proceeds raised from the issuance of notes, and $719
million in net proceeds raised from public equity offerings. As of June 30,
2001, we had an accumulated deficit of $2,063.3 million, and cash, cash
equivalents, and short-term investments of $524.4 million.

   Net cash used in our operating activities was $343.4 million for the six
months ended June 30, 2001. The net cash used for operating activities during
this period was primarily due to net losses of $374.0 million, decreases in
accounts payable and other current liabilities of $47.1 million, offset by non-
cash expenses of $77.7 million.

                                       25
<PAGE>

   Net cash provided by our investing activities was $88.5 million for the six
months ended June 30, 2001. The net cash provided by investing activities
during this period was primarily due to the net proceeds received from the sale
and maturities of short-term investments, partially offset by the purchase of
short-term investments.

   Net cash used by financing activities for the six months ended June 30, 2001
was $7.8 million, which was primarily due to principal payments on certain
long-term obligations offset by proceeds from the issuance of our common stock.
In light of Covad's recent filing under Chapter 11, Covad did not make its
August 15, 2001 payment on one of its bonds and Covad does not currently plan
to make these payments.

   We expect to experience substantial negative cash flow from operating and
investing activities for at least the next two years due to continued
development of new value-added products and services, commercial deployment of
these products and services and the addition of new end-users to our network.
We may also make investments in and acquisitions of businesses that are
complementary to ours to support the growth of our business. Our future cash
requirements for developing, deploying and enhancing our networks and operating
our business, as well as our revenues, will depend on a number of factors
including:

  .  the rate at which customers 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
     maintain a competitive position in the marketplace;

  .  the rate at which we invest in engineering and 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 litigation;

  .  existing and future technology;

  .  Covad's ability to obtain court approval of Covad's Chapter 11
     restructuring plan;

  .  the regulatory environment for our business;

  .  unanticipated opportunities;

  .  network development schedules and associated costs; and

  .  the number of regions entered, the timing of entry and the 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 debt or equity financing on
favorable terms or at all, in order to finance such an acquisition or
investment.

   We believe that our current cash, cash equivalents and short-term
investments will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures into the second quarter of 2002. If we are
able to obtain court approval of our Chapter 11 restructuring plan and we make
the payments described in that plan to the bondholders, we believe that our
cash, cash equivalents and short term investments will be sufficient to meet
our anticipated cash needs until early 2002. Obtaining additional financing
will be a necessary part of our overall restructuring plan. An adverse judgment
in any of the pending litigation, the continued deterioration of the ability of
our customers to pay for our services or other adverse business, legal,
regulatory or legislative developments would accelerate the time at which we
would need additional capital. If

                                       26
<PAGE>

necessary, we will develop a contingency plan to address any material adverse
developments arising in the securities and noteholder litigation. We also
recognize that we will be required to raise this additional capital at times
and in amounts that are uncertain, especially under the current capital market
conditions. If we are unable to acquire additional capital 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
restructuring, sale or liquidation of the Company.

Risk Factors

   The following is a non-exclusive 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
Annual Report on Form 10-K for the year ended December 31, 2000, filed with the
SEC on May 24, 2001.

  .  Covad's Chapter 11 restructuring Plan may not be timely or fully
     approved by the bankruptcy court which may require us to sell or
     liquidate the Company which would result in our ceasing to be a public
     company and the total loss of value for our current stockholders.

  .  Covad's Chapter 11 restructuring proceeding could be converted into a
     Chapter 7 liquidation proceeding and we could be forced to cease
     operations and liquidate our assets.

  .   The Bankruptcy Court could approve a plan of reorganization other than
      that proposed by Covad.

  .  Our operating subsidiaries may also be forced into bankruptcy
     proceedings.

  .  Covad's Chapter 11 restructuring proceeding may have an adverse effect
     on the financial results of the Company. For example:

    .  we may be unable to attract and retain qualified employees;

    .  our limited management resources will be strained;

    .  our current customers may reduce the number of orders they provide
       us with or disconnect our existing end-users;

    .  prospective customers may be unwilling to enter into agreements to
       purchase our services;

    .  our current vendors may attempt to cancel their contracts with us,
       which would limit our supply of goods and services that we require
       to operate, or they may refuse to ship to us on credit and require
       advance payment; and

    .  prospective vendors may refuse to do business with us or may require
       prepayments by us on terms that are unacceptable.

  .  Even if Covad's Plan is approved by the Bankruptcy Court, we estimate
     that we will need to obtain as much as $200 million in additional
     funding to sustain operations until the time we presently expect to
     become cash flow positive.

  .  If Covad fails to file its plan of reorganization by September 15, 2001
     or fails to begin soliciting consents to its plan of reorganization by
     November 15, 2001, or if its plan of reorganization is not approved by
     January 15, 2002, Covad's agreements with the bondholders provide that
     the $257 million it has placed in escrow for the bondholders will be
     released to the bondholders and they may retain their claims for the
     remaining amounts owed on their bonds. If this occurs, it is probable
     that we will be forced to liquidate the Company.

  .  Covad's Chapter 11 proceeding may make us less attractive to prospective
     investors.

  .  We have been delisted from the Nasdaq National Market and we are now
     regulated as a "penny stock" and subject to the SEC's Penny Stock Rules
     15g-1 through 15g-9 which, among other things, restrict the ability of
     broker-dealers to buy or sell our securities and may affect the ability
     of holders to buy or sell our securities in the secondary market and the
     price at which such holders can buy or sell our securities.

  .  Our delisting by the Nasdaq National Market may result in our stock
     being less attractive to investors.


                                       27
<PAGE>

  .  Our delisting by the Nasdaq National Market may make it more difficult
     for us to raise the additional capital that we need to become cash-flow
     positive.

  .  Our ability to continue as a "going concern" is uncertain.

  .  Our leverage is substantial and may increase, making it more difficult
     to respond to changing business conditions.

  .  Our rapid growth exacerbated weaknesses in our internal controls, which
     the Company is currently addressing.

  .  We must raise additional capital under very difficult market conditions
     in order to continue our growth and maintain current operations.

  .  Our business will suffer in a variety of ways unless economic and
     financial market conditions improve.

  .  The financial uncertainty of the DSL industry is reducing the number of
     orders we receive.

  .  Our failure to manage our growth effectively may hurt our ability to
     achieve profitability and positive cash flow from our operations.

  .  We are dependent on a limited number of customers for the preponderance
     of our revenues, and we are highly dependent on sales through our
     resellers.

  .  We are a party to litigation and adverse results of such litigation
     matters could negatively impact our financial condition and results of
     operations.

  .  We will require a significant amount of cash to service our
     indebtedness, subject to the outcome of Covad's Chapter 11 restructuring
     plan.

  .  Our ability to generate cash depends on many factors beyond our control.

  .  We rely upon distributions from our subsidiaries, excluding BlueStar, to
     service our indebtedness and our indebtedness is effectively
     subordinated to the indebtedness of our subsidiaries.

  .  The price of our common stock may fluctuate significantly, which may
     result in losses for investors.

  .  Future sales or issuance of our common stock may depress our stock
     price.

  .  Anti-takeover effects of certain charter and bylaw provisions, Delaware
     law, our indentures, our Stockholder Protection Rights Agreement and our
     change in control severance arrangements could prevent a change in
     control.

  .  We may experience decreasing margins on the sale of our services, which
     may impair our ability to achieve profitability or positive cash flow.

  .  The markets we face are highly competitive and we may not be able to
     compete effectively, especially against established industry competitors
     with significantly greater financial resources.

  .  Our business is difficult to evaluate because we have a limited
     operating history.

  .  We cannot predict whether we will be successful because our business
     strategy is largely unproven.

  .  We have a history of losses and expect losses in the future.

  .  Our operating results are likely to fluctuate in future periods and may
     fail to meet expectations of securities analysts and investors.

  .  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.


                                       28
<PAGE>

  .  Challenges in obtaining space for our equipment on premises owned by the
     traditional local telephone companies harm our business.

  .  The failure of traditional telephone companies to adequately provide
     transmission facilities and provision telephone wires is likely to
     impair our ability to install lines and adversely affect our growth
     rate.

  .  Challenges in obtaining the overall cooperation of the traditional
     telephone companies harm our business.

  .  Our business will suffer if our interconnection agreements are not
     renewed or if they are modified on unfavorable terms.

  .  Our success depends on our retention of certain key personnel, our
     ability to hire additional personnel and the maintenance of good labor
     relations.

  .  We depend on a limited number of third parties for equipment supply,
     service and installation.

  .  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 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.

  .  A breach of network security could delay or interrupt service to our
     customers.

  .  Interference in the traditional telephone companies copper plant could
     degrade the performance of our services.

  .  Out intellectual property protection may be inadequate to protect our
     proprietary rights.

  .  We must comply with federal and state tax and other surcharges on our
     service, the levels of which are uncertain.

Forward Looking Statements

   The discussions set forth below and elsewhere herein contain certain
statements which are not historical facts and are considered forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended and Section 21E of the Securities Exchange Act of 1934, as amended.
Forward looking statements are identified by the use of such terminology as
"believes," "expects," "may," "should," "anticipates," "plans," "estimates,"
and "intends," or derivations or negatives thereof or comparable terminology.
Accordingly, such statements involve risks (known and unknown) and
uncertainties. Examples of such forward-looking statements include but are not
limited to:

  .  Covad's ability to obtain timely and full Bankruptcy Court approval of
     Covad's Chapter 11 restructuring plan;

  .  our ability to finalize the settlement agreement in the securities
     litigation;

  .  expectations regarding our relationships with our strategic partners;

  .  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 may obtain significantly increased sales
     volumes;

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

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

                                       29
<PAGE>

  .  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 our monthly cash burn rate and the number of
     installed lines;

  .  expectations regarding the time frames, rates, terms and conditions for
     implementing new services;

  .  plans to develop and commercialize value-added services;

  .  projections of the amount of additional capital required to fund our
     business;

  .  our anticipated capital expenditures;

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

  .  expectations regarding the development and commencement of our voice
     services;

  .  our ability to manage relationships with our bondholders;

  .  the effect of regulatory reform and securities and regulatory
     litigation;

  .  the effect of other litigation currently pending; and

  .  other statements contained in this Report on Form 10-Q and in our Annual
     Report on Form 10-K for the year ended December 31, 2000, regarding
     matters that are not historical facts.

   All written and oral forward-looking statements made in connection with this
report on Form 10-Q that are attributable to us or persons acting on our behalf
are based on information available to the Company on the date hereof and
expressly qualified in their entirety by the "Risk Factors" and other
cautionary statements included herein and in our Annual Report on Form 10-K for
the year ended December 31, 2000, filed with the SEC on May 24, 2001. 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 rates
and marketable equity security prices, relates primarily to our investment
portfolio and outstanding debt obligations. We typically do not attempt to
reduce or eliminate our market exposure on our investment securities because a
substantial majority of our investments are in fixed-rate, short-term
securities. We do not have any derivative instruments. The fair value of our
investment portfolio or related income would not be significantly impacted by
either a 100 basis point increase or decrease in interest rates due to the
fixed-rate, short-term nature of the substantial majority of our investment
portfolio. In addition, substantially all of our outstanding indebtedness as of
June 30, 2001, including our 13 1/2% senior discount notes due 2008, our 12
1/2% senior notes due 2009, our 12% senior notes due 2010 and our 6%
convertible notes due 2005 is fixed-rate debt.

                                       30
<PAGE>

                        COVAD COMMUNICATIONS GROUP, INC.

                           PART II. OTHER INFORMATION

Item 1. Legal Proceedings

   Purchasers of the Company's common stock and purchasers of the convertible
notes issued by the Company on September 19, 2000 have 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, Northern District of
California. The complaints have been consolidated. The consolidated complaint
alleges violations of federal securities laws on behalf of persons who
purchased or otherwise acquired the Company's securities, including those who
purchased common stock and those who purchased the Company's convertible notes
during the periods from April 19, 2000 to May 24, 2001. The relief sought
includes monetary damages and equitable relief. On August 13, 2001, the Company
announced it has signed a memorandum of understanding with the lead plaintiffs
in this litigation that tentatively resolves the litigation. Under this
agreement, Covad would contribute shares equal to 3 1/2% of the Company's
fully-diluted common stock on August 10, 2001. The Company's insurance carriers
will fund the cash portion of the settlement. Final settlement is contingent on
negotiation and execution of a final agreement and court approvals.

   In addition, six purchasers of the convertible notes that the Company sold
on September 19, 2000, have filed complaints against the Company and two of its
former officers in the Superior Court of the State of California for the County
of Santa Clara. The complaints have been consolidated. The complaints allege
fraud and deceit, negligence and violations of state securities laws. The
relief sought includes rescission of the plaintiffs' alleged purchases of
approximately $142 million in aggregate principal amount of convertible notes
and unspecified damages, including punitive damages, and attorneys' fees.
However, the Company believes the convertible notes were legally and validly
issued. Two of these purchasers allegedly holding $48 million in aggregate
principal amount of the convertible notes have dismissed their complaints
without prejudice. On June 11, 2001, the four remaining plaintiffs filed a
motion for summary adjudication of particular issues and applications for writs
of attachment of the purchase price of their convertible notes (aggregating
approximately $100 million as of March 31, 2001). On June 21, 2001, defendants
filed a motion for summary adjudication of one of plaintiffs' claims under
state securities laws. On July 20, 2001, the court issued an order denying in
part and granting in part plaintiffs' motion for summary adjudication, denying
plaintiffs' applications for writs of attachment, and denying in part and
granting in part defendants' motion for summary adjudication. Although the
Company believes it has strong defenses in these lawsuits, the ultimate outcome
of this litigation cannot presently be determined.

   Several stockholders have filed complaints, on behalf of themselves and
purported classes of shareholders, against the Company and several former and
current officers and directors in addition to some of the Company's
underwriters in the United States District Court for the Southern District of
New York. 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. Plaintiffs' counsel claim that the Company and
others failed to disclose the arrangements that some of the Company's
underwriters purportedly made with certain investors. The Company believes it
has strong defenses to these lawsuits and intends to contest them vigorously.
However, because these lawsuits are at an early stage, the Company is unable to
provide an evaluation of the ultimate outcome of the litigation.

   In addition, on May 31, 2001, we received a purported notice of default and
acceleration claim from a group of our convertible noteholders who claim that
our restatement of our unaudited interim financial statements for a previously
reported quarter in 2000 is a default under our convertible notes indenture.
These noteholders also claim that this alleged default cannot be cured and is
grounds for acceleration of the entire amount owed on their convertible notes.
We have disputed this notice and we believe that the probability of this claim
succeeding, if it is litigated, is remote.

                                       31
<PAGE>

   The Company received a letter and a draft complaint seeking damages and
injunctive relief from an attorney who claims to represent an institution
holding some portion of our public debt. The attorney claims that the client
intends to file this complaint against the Company and/or its officers and
directors if the Company does not either demonstrate that it has financing to
take the company to the point of profitability, or provide a plan to wind down
operations. We have had some preliminary discussions with the attorney
representing this institution. Their attorney has informed us that the
institution has sold its position. Based on the claims asserted in the draft
complaint, we believe any claim in this regard would be without merit. However,
the outcome of any litigation is inherently uncertain, so we are unable to
provide an evaluation of the ultimate outcome.

   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. We also
recently filed a lawsuit against BellSouth Corporation and its subsidiaries in
the United States District Court for the Northern District of Georgia. We are
pursuing antitrust and other claims in this lawsuit arising out of BellSouth's
conduct as a supplier of network facilities, including central office space,
transmission facilities and telephone lines. Both BellSouth and Verizon have
asked the courts to dismiss Covad's cases on the basis of the ruling of the
Seventh Circuit in Goldwasser v. Ameritech, which dismissed a consumer
antitrust class action against Ameritech. We opposed the BellSouth and Verizon
motions. The Georgia court recently granted in part BellSouth's motion and
dismissed some of the Company's antitrust claims and breach of contract claims.
We have filed a motion seeking to appeal the court's ruling. To date, the
District of Columbia court has not ruled on Bell Atlantic's motion. We cannot
predict the outcome of this motion.

   On June 11, 2001, Verizon Communications filed a lawsuit against us in the
United States District Court for the Northern District of California. Verizon
claims that we falsified trouble ticket reports with respect to the phone lines
that we ordered from Verizon and seeks unspecified monetary damages and
injunctive relief. We believe we have strong defenses to this lawsuit, but
litigation is inherently unpredictable and there is no guarantee we will
prevail.

   In addition, Verizon has separately filed suit against us in the United
States District Court for the Eastern District of Virginia, asserting
infringement of a patent issued to them in September 1998 entitled "Variable
Rate and Variable Mode Transmission System." However, on February 18, 2000 the
court issued a summary judgement ruling holding that we had not infringed
Verizon's patent. That decision was recently upheld by the United States Court
of Appeals for the Federal Circuit.

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

   Numerous former shareholders of Laserlink.Net, Inc. have threatened to file
complaints against the Company and two of its former officers and have provided
three draft complaints seeking damages. Their allegations arise out of claims
that the Company failed to timely register shares of the Company that they
received in exchange for their Laserlink.Net shares and thereafter failed to
maintain such registration, that the Company made fraudulent representations in
connection with the acquisition, and that certain shares were not timely
delivered out of escrow. The Company is unable to determine at present the
amount of any liability to the Company that would result were such claims to be
filed. The Company anticipates that other former Laserlink.Net shareholders may
assert claims against it seeking damages based on similar allegations. The
ultimate outcome of these potential matters presently cannot be determined.

                                       32
<PAGE>

   Several creditors of BlueStar Communications Group, Inc. and its
subsidiaries have threatened to file lawsuits against the Company to recover
amounts owed by BlueStar and its subsidiaries. We believe that these assertions
are without merit and that we would have strong defenses to any such legal
action. However, the facts supporting these assertions are unclear and the
outcome of litigation is inherently uncertain, so the ultimate outcome of these
matters cannot presently be determined.

   We are also a party to a variety of legal proceedings as either plaintiff or
defendant, or are engaged in business disputes that arise in the ordinary
course of business. We do not believe the ultimate outcome of these matters
will have a material impact on our financial position or results of operations.

   Failure to resolve these various legal disputes and controversies without
excessive delay and cost and in a manner that is favorable to us could
significantly harm our business. We are not currently engaged in any other
legal proceedings that we believe could have a material adverse affect on our
business, prospects, operating results and financial condition. We are,
however, subject to state commission, FCC and court decisions as they relate to
the interpretation and implementation of the 1996 Telecommunications Act, the
interpretation of competitive telecommunications company interconnection
agreements in general and our interconnection agreements in particular. In some
cases, we may be deemed to be bound or we may otherwise be significantly
impacted by the results of ongoing proceedings of these bodies or the legal
outcomes of other contested interconnection agreements that are similar to our
agreements. The results of any of these proceedings could harm our business.

   In addition, we are engaged in a variety of negotiations, arbitrations and
regulatory proceedings with multiple traditional telephone companies. These
negotiations, arbitrations and regulatory proceedings concern the traditional
telephone companies' denial of physical central office space to us in certain
central offices, the cost and delivery of central office space, the delivery of
transmission facilities and telephone lines and other operational issues. An
unfavorable outcome in any of these negotiations, arbitrations and regulatory
proceedings could have a material adverse affect on our consolidated financial
position and results of operations.

Item 2. Changes in Securities and Use of Proceeds

     None

Item 3. Defaults upon Senior Securities

   As a result of the commencement of Covad's voluntary petition for relief
under Chapter 11, described above, Covad is currently in default on $1.35
billion in face amount or accreted value of such high yield indebtedness
detailed as follows:

<TABLE>
   <C>             <S>
      $208,700,000 13.5% senior discount notes due 2008
      $215,000,000 12.5% senior notes due 2009
      $425,000,000 12.0% senior notes due 2010
      $500,000,000 6.0% convertible notes due 2005
</TABLE>

   In addition, on August 15, 2001, as a result of its decision to seek
reorganization under the bankruptcy laws through a voluntary Chapter 11 filing,
Covad failed to make a $25.5 million interest payment due under the terms of a
senior notes indenture governing the 12.0% senior notes due 2010. The Chapter
11 filing caused a default under substantially all of the Company's debt
agreements, including leases.

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

     None

                                       33
<PAGE>

Item 5. Other Information

     None

Item 6. Exhibits and Reports on Form 8-K

   a. Exhibits:

<TABLE>
<CAPTION>
 Exhibit
 Number  Description
 ------- -----------
 <C>     <S>
 10.1    Form of Agreement Concerning Voting between Covad Communications
         Group, Inc. and certain holders of any of Covad's 13.5% Senior Notes
         due 2008, 12.5% Senior Notes due 2009, 12% Senior Notes due 2010, and
         6.0% Convertible Notes due 2005.
</TABLE>

   b. Reports on Form 8-K

 No reports on Form 8-K were filed by the Company during the quarter ended June
                                   30, 2001.

                                       34
<PAGE>

                                   SIGNATURE

   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.

                                                /s/ Charles E. Hoffman
Date: August 20, 2001                     By: _________________________________
                                                    Charles E. Hoffman
                                                 President, Chief Executive
                                                    Officer and Director

Date: August 20, 2001                           /s/ Joseph Le Chevallier
                                          By: _________________________________
                                                   Joseph Le Chevallier
                                               Vice President and Controller
                                                 (Chief Accounting Officer)

                                       35