##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the quarterly period ended September 30, 2007
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For
the transition period from  to .
 Commission file number: 001-32588
 COVAD COMMUNICATIONS GROUP, INC.
  Delaware
    
    77-0461529(State or other jurisdiction
    
    (I.R.S. Employerof incorporation or organization)
    
    Identification Number)110 Rio Robles 
San Jose, California(Address of principal executive 
offices)
    
    95134(Zip Code)
 (408) 952-6400  (Registrants telephone number, including area code)
 þ o
  o þ o
 o þ




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##### 



COVAD COMMUNICATIONS GROUP, INC.
 For the Quarterly Period Ended September 30, 2007
 TABLE OF CONTENTS
 PagePART I. FINANCIAL INFORMATIONITEM 1.
    
    Financial Statements
    
    
    2Condensed Consolidated Balance Sheets
    
    
    2Condensed Consolidated Statements of Operations
    
    
    3Condensed Consolidated Statements of Cash Flows
    
    
    4Notes to Condensed Consolidated Financial Statements
    
    
    5ITEM 2.
    
    Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    25ITEM 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    45ITEM 4.
    
    Controls and Procedures
    
    
    46PART II. OTHER INFORMATIONITEM 1.
    
    Legal Proceedings
    
    
    47ITEM 1A.
    
    Risk Factors
    
    
    48ITEM 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    62ITEM
3.
    
    Defaults Upon Senior Securities
    
    
    62ITEM 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    62ITEM 5.
    
    Other Information
    
    
    62ITEM 6.
    
    Exhibits
    
    
    63SIGNATURES
    
    
    
    
    64EXHIBIT 10.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  1




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 ITEM 1. Financial Statements
 COVAD COMMUNICATIONS GROUP, INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (All dollar and share amounts are presented in thousands, except par value)
 (Unaudited)
 September 30,
    
    
    December 31,2007
    
    
    2006(Note 1)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    43,576
    
    
    $
    46,279Short-term investments in debt securities
    
    
    12,072
    
    
    
    15,793Restricted cash and cash equivalents
    
    
    8,534
    
    
    
    19,578Accounts receivable, net
    
    
    35,625
    
    
    
    31,151Unbilled revenues
    
    
    2,735
    
    
    
    2,567Inventories
    
    
    2,701
    
    
    
    3,602Prepaid expenses and other current assets
    
    
    4,221
    
    
    
    4,979Total current assets
    
    
    109,464
    
    
    
    123,949Property and equipment, net
    
    
    72,300
    
    
    
    87,586Collocation fees and other intangible assets, net
    
    
    16,604
    
    
    
    22,768Goodwill
    
    
    50,002
    
    
    
    50,002Deferred costs of service activation
    
    
    25,920
    
    
    
    24,268Deferred debt issuance costs, net
    
    
    2,623
    
    
    
    3,823Other long-term assets
    
    
    1,765
    
    
    
    912Total assets
    
    $
    278,678
    
    
    $
    313,308LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    29,580
    
    
    $
    34,189Accrued compensation
    
    
    10,451
    
    
    
    14,539Accrued collocation and network service fees
    
    
    15,643
    
    
    
    15,594Accrued transaction-based taxes
    
    
    7,708
    
    
    
    7,754Collateralized and other customer deposits
    
    
    4,379
    
    
    
    5,585Unearned revenues
    
    
    6,327
    
    
    
    6,528Loan payable to bank
    
    
    6,100
    
    
    
    6,100Other accrued liabilities
    
    
    9,651
    
    
    
    11,381Total current liabilities
    
    
    89,839
    
    
    
    101,670Long-term debt
    
    
    172,461
    
    
    
    167,240Unearned revenues
    
    
    38,859
    
    
    
    39,506Other long-term liabilities
    
    
    3,828
    
    
    
    2,538Total liabilities
    
    
    304,987
    
    
    
    310,954Commitments and contingencies (Notes 5 and 6)Stockholders equity (deficit):Preferred stock, $0.001 par value; 5,000 shares
authorized; no shares issued and outstanding at
September 30, 2007 and December 31, 2006
    
    
    
    
    
    
    Common stock, $0.001 par value; 590,000 shares
authorized; 298,021 shares issued and outstanding at
September 30, 2007 (296,877 shares issued and
outstanding at December 31, 2006)
    
    
    298
    
    
    
    297Common stock  Class B, $0.001 par value; 10,000
shares authorized; no shares issued and outstanding at
September 30, 2007 and December 31, 2006
    
    
    
    
    
    
    Additional paid-in capital
    
    
    1,736,490
    
    
    
    1,734,124Accumulated other comprehensive income (loss)
    
    
    (4
    )
    
    
    3Accumulated deficit
    
    
    (1,763,093
    )
    
    
    (1,732,070
    )Total stockholders equity (deficit)
    
    
    (26,309
    )
    
    
    2,354Total liabilities and stockholders equity (deficit)
    
    $
    278,678
    
    
    $
    313,308
  2




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COVAD COMMUNICATIONS GROUP, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (All dollar and share amounts are presented in thousands, except per share amounts)
 (Unaudited)
 Three months ended September 30,
    
    
    Nine months ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Revenues, net
    
    $
    121,878
    
    
    $
    118,562
    
    
    $
    362,613
    
    
    $
    354,848Operating expenses:Cost of sales (exclusive of depreciation
and amortization)
    
    
    86,950
    
    
    
    83,410
    
    
    
    262,081
    
    
    
    244,149Benefit from federal excise tax adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (19,455
    )Selling, general and administrative
    
    
    25,064
    
    
    
    31,259
    
    
    
    84,853
    
    
    
    98,113Depreciation and amortization of property
and equipment
    
    
    10,137
    
    
    
    8,210
    
    
    
    31,943
    
    
    
    24,938Amortization of collocation fees and
other intangible assets
    
    
    2,322
    
    
    
    2,502
    
    
    
    7,016
    
    
    
    7,538Provision for post-employment benefits
    
    
    66
    
    
    
    186
    
    
    
    1,423
    
    
    
    1,460Total operating expenses
    
    
    124,539
    
    
    
    125,567
    
    
    
    387,316
    
    
    
    356,743Loss from operations
    
    
    (2,661
    )
    
    
    (7,005
    )
    
    
    (24,703
    )
    
    
    (1,895
    )Other income (expense), net:Interest income
    
    
    633
    
    
    
    959
    
    
    
    2,144
    
    
    
    3,063Interest expense
    
    
    (2,856
    )
    
    
    (2,730
    )
    
    
    (8,522
    )
    
    
    (6,784
    )Miscellaneous income (expense), net
    
    
    (20
    )
    
    
    76
    
    
    
    58
    
    
    
    109Other income (expense), net
    
    
    (2,243
    )
    
    
    (1,695
    )
    
    
    (6,320
    )
    
    
    (3,612
    )Net loss
    
    $
    (4,904
    )
    
    $
    (8,700
    )
    
    $
    (31,023
    )
    
    $
    (5,507
    )Basic and diluted net loss per common share
    
    $
    (0.02
    )
    
    $
    (0.03
    )
    
    $
    (0.10
    )
    
    $
    (0.02
    )Weighted-average number of common shares
outstanding used in computing basic and
diluted per share amounts
    
    
    298,013
    
    
    
    295,604
    
    
    
    297,302
    
    
    
    288,435
  3




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COVAD COMMUNICATIONS GROUP, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (All dollar amounts are presented in thousands)
 (Unaudited)
 Nine months ended September 30,2007
    
    
    2006Operating Activities:Net loss
    
    $
    (31,023
    )
    
    $
    (5,507
    )Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Provision for bad debts, net
    
    
    386
    
    
    
    144Benefit from federal excise tax adjustment
    
    
    
    
    
    
    (19,455
    )Depreciation and amortization
    
    
    38,959
    
    
    
    32,476Loss on disposition of property and equipment
    
    
    84
    
    
    
    Stock-based compensation expense
    
    
    1,618
    
    
    
    2,337Amortization of deferred customer incentives
    
    
    506
    
    
    
    569Amortization of deferred debt issuance costs
    
    
    1,200
    
    
    
    1,215Accretion of interest on investments, net
    
    
    (231
    )
    
    
    (138
    )Other non-cash items
    
    
    (300
    )
    
    
    Net changes in operating assets and liabilities, net of assets acquired and liabilities
assumed in acquisition:Accounts receivable
    
    
    (4,860
    )
    
    
    (6,713
    )Unbilled revenues
    
    
    (168
    )
    
    
    (260
    )Inventories
    
    
    901
    
    
    
    1,706Prepaid expenses and other current assets
    
    
    762
    
    
    
    30Deferred costs of service activation
    
    
    (1,652
    )
    
    
    152Other long-term assets
    
    
    (1,382
    )
    
    
    Accounts payable
    
    
    (374
    )
    
    
    7,368Collateralized and other customer deposits
    
    
    (1,206
    )
    
    
    (10,725
    )Redemption of collateralized customer deposit
    
    
    
    
    
    
    (33,538
    )Other liabilities
    
    
    1,653
    
    
    
    (59
    )Unearned revenues
    
    
    (848
    )
    
    
    (2,280
    )Net cash provided by (used in) operating activities
    
    
    4,025
    
    
    
    (32,678
    )Investing Activities:Restricted cash and cash equivalents, net
    
    
    11,044
    
    
    
    (19,171
    )Purchase of short-term investments in debt securities
    
    
    (24,255
    )
    
    
    (18,834
    )Maturities of short-term investments in debt securities
    
    
    28,200
    
    
    
    18,500Purchase of property and equipment
    
    
    (21,003
    )
    
    
    (37,366
    )Proceeds from sale of property and equipment
    
    
    23
    
    
    
    60Payment of collocation fees and purchase of other intangible assets
    
    
    (852
    )
    
    
    (3,056
    )Payment in connection with business and asset acquisitions, net of cash acquired
    
    
    (177
    )
    
    
    (3,187
    )Other long-term assets
    
    
    23
    
    
    
    (511
    )Net cash used in investing activities
    
    
    (6,997
    )
    
    
    (63,565
    )Financing Activities:Proceeds from the issuance of senior secured note, net of issuance costs
    
    
    
    
    
    
    38,457Proceeds from utilization of credit facility
    
    
    18,300
    
    
    
    12,200Principal payments on credit facility
    
    
    (18,300
    )
    
    
    (6,100
    )Principal payment of long-term debt
    
    
    
    
    
    
    (1,031
    )Principal payments under capital lease obligations
    
    
    (780
    )
    
    
    (349
    )Payment of issuance costs related to credit facility
    
    
    
    
    
    
    (651
    )Proceeds from the issuance of common stock, net of issuance costs
    
    
    1,049
    
    
    
    14,695Net cash provided by financing activities
    
    
    269
    
    
    
    57,221Net decrease in cash and cash equivalents
    
    
    (2,703
    )
    
    
    (39,022
    )Cash and cash equivalents at beginning of period
    
    
    46,279
    
    
    
    84,291Cash and cash equivalents at end of period
    
    $
    43,576
    
    
    $
    45,269Supplemental Disclosures of Cash Flow Information:Cash paid during the period for interest
    
    $
    4,052
    
    
    $
    3,956Supplemental Schedule of Non-Cash Investing and Financing Activities:Interest obligation settled with the issuance of additional convertible long-term
notes
    
    $
    5,221
    
    
    $
    2,240Equipment purchased through capital leases
    
    $
    1,467
    
    
    $
    Common stock issued for acquisition of business
    
    $
    
    
    
    $
    16,314Accrued equipment
purchases
    
    $
    3,139
    
    
    $
    6,024
  4




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COVAD COMMUNICATIONS GROUP, INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (All dollar and share amounts are presented in thousands, except per share amounts)
 (Unaudited)
 1. Basis of Presentation and Summary of Significant Accounting Policies
   Long-Term Debt,
   Use of Estimates
  5




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Benefit from federal excise tax adjustment 
   Restricted Cash and Cash Equivalents
 Long-Term Debt.
 6




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Inventories
  Goodwill
   Business Acquisition.
  Collateralized and Other Customer Deposit s
   7




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Revenue Recognition
 Post-Employment Benefits
  Net Loss Per Share
     Three months ended September 30,
    
    Nine months ended September 30,2007
    
    2006
    
    2007
    
    2006Stock options
    
    
    23,213
    
    
    
    23,334
    
    
    
    23,213
    
    
    
    23,334Options under
employee stock
purchase plan
    
    
    800
    
    
    
    911
    
    
    
    800
    
    
    
    911Warrants
    
    
    6,514
    
    
    
    6,514
    
    
    
    6,514
    
    
    
    6,514Common shares
issuable under the
assumed conversion
of convertible
debentures and
notes
    
    
    64,897
    
    
    
    62,089
    
    
    
    64,897
    
    
    
    62,089
 8




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Comprehensive Loss
  Three months ended September 30,
    
    
    Nine months ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net loss
    
    $
    (4,904
    )
    
    $
    (8,700
    )
    
    $
    (31,023
    )
    
    $
    (5,507
    )Unrealized gains
(loss) on
available-for-sale
securities
    
    
    (2
    )
    
    
    1
    
    
    
    (7
    )
    
    
    5Comprehensive loss
    
    $
    (4,906
    )
    
    $
    (8,699
    )
    
    $
    (31,030
    )
    
    $
    (5,502
    )
 Recent Accounting Pronouncements
 The Fair Value Option for Financial Assets and
Financial Liabilities  Including an Amendment of FASB Statement No. 115.
 Fair Value Measurements.
 How Taxes Collected from Customers and Remitted to Governmental Authorities should be presented in
the Income Statement. Disclosure of Accounting Policies.
 Accounting for Uncertainty in
Income Taxes Accounting for Income Taxes.
 9




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Risks and Uncertainties
  
    
    changes in government policy, regulation and enforcement or adverse judicial or
administrative interpretations and rulings or legislative action including, but not limited
to, changes that affect the continued availability of the unbundled network elements of the
local exchange carriers networks and the costs associated therewith;
    
    the Companys dependence on the availability and functionality of the networks of the
incumbent local exchange carriers;
    
    ability to generate cash flows or obtain adequate financing;
    
    recoverability of Companys assets;
    
    events that may trigger change in control provisions;
    
    increased price competition in local and long distance services, including bundled
services, and overall competition within the telecommunications industry; and
    
    adverse determinations in certain litigation matters.
  2. Revenue Recognition
    10




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September 30, 2007
    
    
    December 31, 2006Gross accounts receivable
    
    $
    38,457
    
    
    $
    34,123Allowance for service credits
    
    
    (2,560
    )
    
    
    (2,729
    )Allowance for bad debts
    
    
    (272
    )
    
    
    (243
    )Accounts receivable, net
    
    $
    35,625
    
    
    $
    31,151
 Significant Customers
   11




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Wholesaler Financial Difficulties
   3. Warrants
   12




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4. Post-Employment Benefits
    5. Long-Term Debt
 12% Senior Secured Convertible Notes
  13




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3% Convertible Senior Debentures
  14




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Line of Credit
   6. Commitments and Contingencies
 Litigation
   15




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16




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Other Contingencies
 .
   Indemnification Agreements
   17




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7.  Stock-Based Compensation
     18




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Stock Options
    
    Employee Stock Purchase PlanThree months ended September 30,
    
    Three months ended September 30,2007
    
    2006
    
    2007
    
    2006Expected life of options in years
    
    
    3.5
    
    
    
    3.4
    
    
    
    0.5
    
    
    
    0.5Volatility
    
    
    60.20
    %
    
    
    82.70
    %
    
    
    46.90
    %
    
    
    65.60
    %Risk-free interest rate
    
    
    4.07
    %
    
    
    4.59
    %
    
    
    4.08
    %
    
    
    5.01
    %Expected dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %Stock Options
    
    Employee Stock Purchase PlanNine months ended September 30,
    
    Nine months ended September 30,2007
    
    2006
    
    2007
    
    2006Expected life of options in years
    
    
    3.5
    
    
    
    3.4
    
    
    
    0.5
    
    
    
    0.5Volatility
    
    
    64.33
    %
    
    
    84.50
    %
    
    
    50.63
    %
    
    
    69.8
    %Risk-free interest rate
    
    
    4.53
    %
    
    
    4.80
    %
    
    
    4.79
    %
    
    
    5.00
    %Expected dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
  Number of Shares of
    
    Option Price per
    
    
    Weighted-AverageCommon Stock
    
    Share
    
    
    Exercise PriceBalance as of December 31, 2006
    
    
    23,082
    
    
    $
    0.350 - $149.79
    
    
    
    $4.31Granted
    
    
    4,176
    
    
    $
    0.670 - $  1.360
    
    
    
    $1.13Exercised
    
    
    (213
    )
    
    $
    0.350 - $  1.280
    
    
    
    $0.65Cancelled, expired and forfeited
    
    
    (3,832
    )
    
    $
    0.360 - $63.333
    
    
    
    $8.64Balance as of September 30, 2007
    
    
    23,213
    
    
    $
    0.350 - $149.79
    
    
    
    $3.06
 8. Business Segments
    19




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Total
    
    
    Corporate
    
    
    ConsolidatedAs of and for the three months ended September 30, 2007:
    
    Wholesale
    
    
    Direct
    
    
    Segments
    
    
    Operations
    
    
    TotalRevenues, net
    
    $
    76,614
    
    
    $
    45,264
    
    
    $
    121,878
    
    
    $
    
    
    
    $
    121,878Cost of sales (exclusive of
depreciation and amortization)
    
    
    48,501
    
    
    
    26,224
    
    
    
    74,725
    
    
    
    12,225
    
    
    
    86,950Selling, general and administrative
    
    
    1,908
    
    
    
    5,941
    
    
    
    7,849
    
    
    
    17,215
    
    
    
    25,064Depreciation and amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,459
    
    
    
    12,459Provision for post-employment benefits
    
    
    
    
    
    
    15
    
    
    
    15
    
    
    
    51
    
    
    
    66Income (loss) from operations
    
    
    26,205
    
    
    
    13,084
    
    
    
    39,289
    
    
    
    (41,950
    )
    
    
    (2,661
    )Other income (expense), net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,243
    )
    
    
    (2,243
    )Net income (loss)
    
    $
    26,205
    
    
    $
    13,084
    
    
    $
    39,289
    
    
    $
    (44,193
    )
    
    $
    (4,904
    )Total assets
    
    $
    41,219
    
    
    $
    23,061
    
    
    $
    64,280
    
    
    $
    214,398
    
    
    $
    278,678
 Total
    
    
    Corporate
    
    
    ConsolidatedAs of and for the three months ended September 30, 2006:
    
    Wholesale
    
    
    Direct
    
    
    Segments
    
    
    Operations
    
    
    TotalRevenues, net
    
    $
    78,216
    
    
    $
    40,346
    
    
    $
    118,562
    
    
    $
    
    
    
    $
    118,562Cost of sales (exclusive of
depreciation and amortization)
    
    
    46,535
    
    
    
    23,377
    
    
    
    69,912
    
    
    
    13,498
    
    
    
    83,410Selling, general and administrative
    
    
    1,721
    
    
    
    8,519
    
    
    
    10,240
    
    
    
    21,019
    
    
    
    31,259Depreciation and amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,712
    
    
    
    10,712Provision for post-employment benefits
    
    
    41
    
    
    
    151
    
    
    
    192
    
    
    
    (6
    )
    
    
    186Income (loss) from operations
    
    
    29,919
    
    
    
    8,299
    
    
    
    38,218
    
    
    
    (45,223
    )
    
    
    (7,005
    )Other income (expense), net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,695
    )
    
    
    (1,695
    )Net income (loss)
    
    $
    29,919
    
    
    $
    8,299
    
    
    $
    38,218
    
    
    $
    (46,918
    )
    
    $
    (8,700
    )Total assets
    
    $
    40,514
    
    
    $
    23,451
    
    
    $
    63,965
    
    
    $
    256,600
    
    
    $
    320,565
 20




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Total
    
    
    Corporate
    
    
    ConsolidatedAs of and for the nine months ended September 30, 2007:
    
    Wholesale
    
    
    Direct
    
    
    Segments
    
    
    Operations
    
    
    TotalRevenues, net
    
    $
    229,994
    
    
    $
    132,619
    
    
    $
    362,613
    
    
    $
    
    
    
    $
    362,613Cost of sales (exclusive of
depreciation and amortization)
    
    
    144,440
    
    
    
    79,056
    
    
    
    223,496
    
    
    
    38,585
    
    
    
    262,081Selling, general and administrative
    
    
    5,817
    
    
    
    21,607
    
    
    
    27,424
    
    
    
    57,429
    
    
    
    84,853Depreciation and amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    38,959
    
    
    
    38,959Provision for post-employment benefits
    
    
    435
    
    
    
    490
    
    
    
    925
    
    
    
    498
    
    
    
    1,423Income (loss) from operations
    
    
    79,302
    
    
    
    31,466
    
    
    
    110,768
    
    
    
    (135,471
    )
    
    
    (24,703
    )Other income (expense), net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,320
    )
    
    
    (6,320
    )Net income (loss)
    
    $
    79,302
    
    
    $
    31,466
    
    
    $
    110,768
    
    
    $
    (141,791
    )
    
    $
    (31,023
    )
 Total
    
    
    Corporate
    
    
    ConsolidatedAs of and for the nine months ended September 30, 2006:
    
    Wholesale
    
    
    Direct
    
    
    Segments
    
    
    Operations
    
    
    TotalRevenues, net
    
    $
    238,198
    
    
    $
    116,650
    
    
    $
    354,848
    
    
    $
    
    
    
    $
    354,848Cost of sales (exclusive of depreciation
and amortization)
    
    
    138,481
    
    
    
    69,430
    
    
    
    207,911
    
    
    
    36,238
    
    
    
    244,149Benefit from federal excise tax adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (19,455
    )
    
    
    (19,455
    )Selling, general and administrative
    
    
    6,002
    
    
    
    29,075
    
    
    
    35,077
    
    
    
    63,036
    
    
    
    98,113Depreciation and amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32,476
    
    
    
    32,476Provision for post-employment benefits
    
    
    197
    
    
    
    377
    
    
    
    574
    
    
    
    886
    
    
    
    1,460Income (loss) from operations
    
    
    93,518
    
    
    
    17,768
    
    
    
    111,286
    
    
    
    (113,181
    )
    
    
    (1,895
    )Other income (expense), net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,612
    )
    
    
    (3,612
    )Net income (loss)
    
    $
    93,518
    
    
    $
    17,768
    
    
    $
    111,286
    
    
    $
    (116,793
    )
    
    $
    (5,507
    )
 Total
    
    Corporate
    
    ConsolidatedAs of December 31, 2006:
    
    Wholesale
    
    Direct
    
    Segments
    
    Operations
    
    TotalTotal assets
    
    $
    35,795
    
    
    $
    22,191
    
    
    $
    57,986
    
    
    $
    255,322
    
    
    $
    313,308
 9. Business Acquisition
    21




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Total purchase cost:Cash
    
    $
    3,683Value of common shares issued
    
    
    16,31419,997Acquisition costs
    
    
    327Total purchase cost
    
    $
    20,324Purchase price allocation:Tangible assets acquired
    
    $
    4,918Liabilities assumed
    
    
    (5,662
    )Intangible assets acquired:Customer relationships
    
    
    7,630Non-compete covenant
    
    
    40Goodwill
    
    
    13,398Total purchase consideration
    
    $
    20,324
     10. Related Party Transactions
   22




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##### Table of Contents



11. Income Taxes
  Accounting for Income Taxes.
   23




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12. Subsequent Event
    24




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ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 The following discussion of our financial condition and results of operations should be read
in conjunction with the unaudited condensed consolidated financial statements and the related notes
thereto included elsewhere in this Report on Form 10-Q and the audited consolidated financial
statements and notes thereto and managements discussion and analysis of financial condition and
results of operations for the year ended December 31, 2006 included in our Annual Report on Form
10-K filed with the Securities and Exchange Commission, or SEC, on February 28, 2007. This
discussion contains forward-looking statements, the accuracy of which is subject to risks and
uncertainties. Our actual results could differ materially from those expressed in forward-looking
statements for many reasons including, but not limited to, those discussed herein and in the Risk
Factors section of our Annual Report on Form 10-K , which is contained in Part I, Item 1, Business
- Risk Factors, of that report. We disclaim any obligation to update information contained in any
forward-looking statement. See Forward Looking Statements.
 (All dollar and share amounts are presented in thousands, except per share amounts)
 Overview
 Our Business
      25




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##### Table of Contents



Recent Event
    Our Opportunities and Challenges
  
    
    T-1 access;
    
    business asymmetric DSL, or ADSL;
    
    line-powered voice access service, or LPVA;
    
    VoIP; and
    
    Fixed wireless broadband access.
  26




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##### Table of Contents



Efficient use of cash
 Efficiently deliver broadband Internet access services
 Long-Term Debt
 Respond to Changes in Telecommunications Regulations 
 Enter and maintain acceptable line-sharing terms with the RBOCs
 Expand and diversify our sources of revenue
 New market opportunities
 27




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##### Table of Contents



Critical Accounting Policies and Estimates
  
    
    We recognize revenues when persuasive evidence of our arrangement with the customer exists,
service has been provided to the customer, the price to the customer is fixed or determinable
and collectibility of the sales price is reasonably assured. We recognize up-front fees
associated with service activation, which includes set-up fees and revenue from customer
premises equipment, or CPE, using the straight-line method, over the expected term of the
customer relationship, which ranges from twenty-four to forty-eight months. We include revenue
from sales of CPE and the set-up fees for service activation as up-front fees because neither
is considered a separate unit of accounting. We treat the incremental direct costs of service
activation, which consist principally of CPE, service activation fees paid to other
telecommunications companies and sales commissions, as deferred charges in amounts no greater
than the aggregate up-front fees that are deferred. These deferred incremental direct costs
are amortized to operations using the straight-line method over the expected term of the
customer relationship.
 
    
    We perform ongoing credit evaluations of our customers financial condition and maintain an
allowance for estimated credit losses. In addition, we have billing disputes with some of our
customers. These disputes arise in the ordinary course of business in the telecommunications
industry and we believe that their impact on our accounts receivable and revenues can be
reasonably estimated based on historical experience. In addition, certain customer revenues
are subject to refund if the end-user terminates service within thirty days of service
activation. Accordingly, we maintain allowances, through charges to revenues, based on our
estimate of the ultimate resolution of these disputes and future service cancellations, and
our reported revenue in any period could be different than what is reported if we employed
different assumptions in estimating the outcomes of these items.
 
    
    We state our inventories at the lower of cost or market, determined using the first-in,
first-out method. In assessing the ultimate recoverability of inventories, we are required to
make estimates regarding future customer demand.
 
    
    We record property and equipment and intangible assets at cost, subject to adjustments for
impairment. We depreciate or amortize property and equipment and intangible assets using the
straight-line method over their estimated useful lives. In assessing the recoverability of our
property and equipment and intangible assets, we must make assumptions regarding estimated
future cash flows and other factors to determine the fair value of the respective assets. If
these estimates and assumptions change in the future, we may be required to record additional
impairment charges relating to our property and equipment and intangible assets.
 28




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##### Table of Contents




    
    We record goodwill when the consideration paid for an acquisition exceeds the fair value of
net tangible and intangible assets acquired. We measure and test goodwill for impairment on an
annual basis or more frequently if we believe indicators of impairment exists. The performance
of the test involves a two-step process. The first step compares the fair value of the
reporting unit to its carrying amount, including goodwill. The fair value of the reporting
unit is determined by calculating the market capitalization of the reporting unit as derived
from quoted market prices or other generally accepted valuation methods if quoted market
prices are not available. A potential impairment exists if the fair value of the reporting
unit is lower than its carrying amount. The second step of the process is only performed if a
potential impairment exists, and it involves determining the difference between the fair
values of the reporting units net assets, other than goodwill, to the fair value of the
reporting unit. If the difference is less than the net book value of goodwill, impairment
exists and is recorded.
 
    
    We are a party to a variety of legal proceedings, as either plaintiff or defendant, and are
engaged in other disputes that arise in the ordinary course of business. We are required to
assess the likelihood of any adverse judgments or outcomes to these matters, as well as
potential ranges of probable losses for certain of these matters. The determination of the
liabilities to be recognized, if any, for loss contingencies is made after analysis of each
individual situation based on the facts and circumstances. We also have billing disputes with
our telecommunication vendors that arise in the ordinary course of business. These disputes
are primarily driven by the timing of implementation and interpretation of complex rate
structures and the related agreements with these vendors in various states in which we
operate. Upon receiving an actual credit or a firm commitment to issue the credit by the
vendor, we record the recovery through an adjustment to cost of sales and the related
liability. Estimated recoveries are recorded if there is a legal basis, otherwise such amounts
are recorded when the actual credit or a firm commitment to issue a credit is received from
the vendor. However, it is reasonably possible that the liabilities reflected in our
consolidated balance sheets for loss contingencies and business disputes could change in the
near term due to new facts and circumstances, the effects of which could be material to our
consolidated financial position, results of operations or cash flows.
 
    
    We perform on-going research and analysis of the applicability of transaction-based taxes
to sales of our products and services and purchases of telecommunications circuits from
various carriers. This research and analysis may include discussions with authorities of
jurisdictions in which we do business and transaction-based tax experts to determine the
extent of our transaction-based tax liabilities. In addition, we continue to analyze the
probable applicability of employment-related taxes for certain stock-based compensation
provided to employees in prior periods. It is reasonably possible that our estimates of our
transaction-based and employment-related tax liabilities could change in the near term, the
effects of which could be material to our consolidated financial position and results of
operations.
 
    
    We make market development funds, or MDF, available to certain customers for the
reimbursement of co-branded advertising expenses and other purposes. To the extent that MDF is
used by our customers for co-branded advertising, and the customers provide us with
third-party evidence of such co-branded advertising and we can reasonably estimate the fair
value of our portion of the advertising, such amounts are charged to advertising expense as
incurred. Other MDF activities are recorded as reductions of revenues as incurred. Amounts
payable to customers relating to rebates and customer incentives are recorded as reductions of
revenues based on our estimate of sales incentives that will ultimately be claimed by
customers.
 
    
    We record post-employment benefits which primarily consist of our severance plans. These
plans are primarily designed to provide severance benefits to our eligible employees whose
employment is terminated in connection with reductions in our workforce. We do not accrue for
this employee benefit, other than for individuals that have been notified of termination,
because we cannot reasonably determine the probability or the amount of such payments.
 
    
    We account for income taxes using the liability method, under which deferred tax assets and
liabilities are determined based on differences between the financial reporting and tax bases
of our assets and liabilities. We record a valuation allowance on our deferred tax assets to
arrive at an amount that is more likely than not to be realized. In the future, should we
determine that we are able to realize all or part of our deferred
tax assets, which presently are fully reserved, an adjustment to our deferred tax assets would
increase income in the period in which the determination was made.
 29




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
    
    Effective January 1, 2006, we adopted the provisions of Financial Accounting Standards
Board, or FASB, Statement of Financial Accounting Standards, or SFAS, No. 123R (revised
2004), Share-Based Payment.Accordingly, we account for stock-based awards exchanged for
employee services based on the fair value of the award. We measure the stock-based
compensation cost at the grant-date and recognize such cost over the employee requisite
service period. We estimate the fair value of stock options using a Black-Scholes valuation
model, consistent with the provisions of SFAS No. 123R, SECs Staff Accounting Bulletin, or
SAB, No. 107, including stock-based compensation (determined under a fair value method as
prescribed by SFAS No. 123R). We determine the expected life of the options using historical
data for options exercised, cancelled after vesting and outstanding. We determine the
expected stock price volatility assumption using historical volatility of our common stock
over a period equal to the expected life of the option. These assumptions are consistent with
our estimates prior the adoption of SFAS No. 123R. We determine the forfeiture rate using
historical pre-vesting cancellation data for all options issued after 2001. Determining
assumptions, such as expected term, expected volatility and expected forfeiture rates,
requires significant judgment. Changes in those assumptions could materially impact reported
results in future periods.
 Recent Accounting Pronouncements
 The Fair Value Option for Financial Assets and
Financial Liabilities  Including an Amendment of FASB Statement No. 115.
 Fair Value Measurements.
 How Taxes Collected from Customers and Remitted to Governmental Authorities should be
Presented in the Income Statement. Disclosure of Accounting Policies.
 Accounting for Uncertainty in
Income Taxes. Accounting for Income Taxes.
 30




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Business Segment Information
    Results of Operations For The Three and Nine months Ended September 30, 2007 and 2006
 Revenues, net
  31




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##### Table of Contents



Segment Revenues and Significant Customers
  Three months ended September 30,
    
    Nine months ended September 30,2007
    
    2006
    
    2007
    
    2006Wholesale
    
    $
    76,614
    
    
    $
    78,216
    
    
    $
    229,994
    
    
    $
    238,198Percent of net
revenues
    
    
    62.9
    %
    
    
    66.0
    %
    
    
    63.4
    %
    
    
    67.1
    %Direct
    
    $
    45,264
    
    
    $
    40,346
    
    
    $
    132,619
    
    
    $
    116,650Percent of net
revenues
    
    
    37.1
    %
    
    
    34.0
    %
    
    
    36.6
    %
    
    
    32.9
    %
  32




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Revenue Recognition
 33




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##### Table of Contents



Wholesaler Financial Difficulties
  Operating Expenses
   Three months ended September 30,
    
    Nine months ended September 30,2007
    
    2006
    
    2007
    
    2006Amount
    
    $
    124,539
    
    
    $
    125,567
    
    
    $
    387,316
    
    
    $
    356,743Percent of net revenues
    
    
    102.2
    %
    
    
    105.9
    %
    
    
    106.8
    %
    
    
    100.5
    %
 Cost of Sales (exclusive of depreciation and amortization)
   Three months ended September 30,
    
    Nine months ended September 30,2007
    
    2006
    
    2007
    
    2006Amount
    
    $
    86,950
    
    
    $
    83,410
    
    
    $
    262,081
    
    
    $
    244,149Percent of net revenues
    
    
    71.3
    %
    
    
    70.4
    %
    
    
    72.3
    %
    
    
    68.8
    %
  34




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##### Table of Contents



Three months ended September 30,
    
    
    Nine months ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Wholesale Segment
    
    $
    48,501
    
    
    $
    46,535
    
    
    $
    144,440
    
    
    $
    138,481Direct Segment
    
    
    26,224
    
    
    
    23,377
    
    
    
    79,056
    
    
    
    69,430Corporate Operations
    
    
    12,225
    
    
    
    13,498
    
    
    
    38,585
    
    
    
    36,238Total
    
    $
    86,950
    
    
    $
    83,410
    
    
    $
    262,081
    
    
    $
    244,149
  35




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Benefit from Transaction Tax Adjustment
 Accounting for Contingencies
 36




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##### Table of Contents



Selling, General and Administrative Expenses
   Three months ended September 30,
    
    Nine months ended September 30,2007
    
    2006
    
    2007
    
    2006Amount
    
    $
    25,064
    
    
    $
    31,259
    
    
    $
    84,853
    
    
    $
    98,113Percent of net revenues
    
    
    20.6
    %
    
    
    26.4
    %
    
    
    23.4
    %
    
    
    27.6
    %
    37




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##### Table of Contents



Three months ended September 30,
    
    
    Nine months ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Wholesale Segment
    
    $
    1,908
    
    
    $
    1,721
    
    
    $
    5,817
    
    
    $
    6,002Direct Segment
    
    
    5,941
    
    
    
    8,519
    
    
    
    21,607
    
    
    
    29,075Corporate Operations
    
    
    17,215
    
    
    
    21,019
    
    
    
    57,429
    
    
    
    63,036Total
    
    $
    25,064
    
    
    $
    31,259
    
    
    $
    84,853
    
    
    $
    98,113
   Stock-Based Compensation
  38




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Depreciation and Amortization
    Provision for Post-Employment Benefits
    39




---



##### Table of Contents



Other Expense
 Net Interest Expense
  Income Taxes
  Accounting for Income Taxes.
   Related Party Transactions
   40




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##### Table of Contents



Liquidity, Capital Resources and Contractual Cash Obligations
   Nine months ended September 30,2007
    
    
    2006Net cash provided by (used in):Operating activities
    
    $
    4,025
    
    
    $
    (32,678
    )Investing activities
    
    
    (6,997
    )
    
    
    (63,565
    )Financing activities
    
    
    269
    
    
    
    57,221Total
    
    $
    (2,703
    )
    
    $
    (39,022
    )
 Operating Activities
   41




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##### Table of Contents



Investing Activities
   Financing Activities
  
    
    $38,457 in proceeds, net of transaction and issuance costs, from the sale of a 12%
senior secured convertible note to EarthLink in connection with the agreement for the
expansion of our LPVA services (refer to Note 5, Long-Term Debt,to our consolidated
Financial Statements for a description of the EarthLink transaction);
    
    $13,646 in proceeds from the issuance of our common stock to EarthLink in connection
with the above mentioned agreement and from the exercise of employee stock options; and
    
    $6,100 in proceeds from draws on our credit facility.
   Liquidity
  42




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##### Table of Contents




    
    our continuing ability to obtain access to ILEC facilities, including telephone
lines, remote terminals, interoffice transport and high-capacity circuits, all at
reasonable prices;
    
    rates at which resellers and end-users purchase and pay for our services and the
pricing of such services;
    
    financial condition of our customers;
 43




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##### Table of Contents




    
    levels of marketing required to acquire and retain customers and to attain a
competitive position in the marketplace;
    
    rates at which we invest in engineering, equipment, development and intellectual
property with respect to existing and future technology;
    
    operational costs that we incur to install, maintain and repair end-user lines and
our network as a whole;
    
    pending and any future litigation;
    
    existing and future technology, including any expansion of fixed wireless services;
    
    ability to generate cash flows or obtain adequate financing;
    
    unanticipated opportunities; and
    
    network development schedules and associated costs.
 Contractual Cash Obligations
  2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    Thereafter
    
    
    Total3% convertible senior
debentures
    
    $
    
    
    
    $
    
    
    
    $
    125,000
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    125,00012% senior secured
convertible note
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    47,461
    
    
    
    
    
    
    
    47,461Bank loan
    
    
    6,100
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,100Interest on notes payable
    
    
    2,755
    
    
    
    9,445
    
    
    
    6,477
    
    
    
    5,695
    
    
    
    1,187
    
    
    
    
    
    
    
    25,559Capital leases
    
    
    225
    
    
    
    899
    
    
    
    869
    
    
    
    252
    
    
    
    4
    
    
    
    
    
    
    
    2,249Office leases
    
    
    1,352
    
    
    
    5,115
    
    
    
    3,689
    
    
    
    2,366
    
    
    
    672
    
    
    
    101
    
    
    
    13,295Other operating leases
    
    
    426
    
    
    
    1,323
    
    
    
    764
    
    
    
    451
    
    
    
    196
    
    
    
    57
    
    
    
    3,217Purchase obligations
(network costs)
    
    
    431
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    431$
    11,289
    
    
    $
    16,782
    
    
    $
    136,799
    
    
    $
    8,764
    
    
    $
    49,520
    
    
    $
    158
    
    
    $
    223,312
     44




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##### Table of Contents



Forward-Looking Statements
  
    
    impact of federal, state and local telecommunications regulations, decisions and
related litigation, and our ability to obtain ILEC network elements and facilities at
reasonable rates;
    
    continuing deployment of LPVA and our ability to bundle our data services with the
voice services of EarthLink and other alternative voice providers;
    
    timing of our cash flows;
    
    extent to which customers purchase our services;
    
    relationships with our strategic partners and other potential third parties;
    
    pricing for our services in the future;
    
    plans regarding new financing arrangements;
    
    our ability to increase our revenues and the margins we generate on our service
offerings;
    
    plans to make strategic investments and acquisitions and the effect of such
investments and acquisitions;
    
    estimates and expectations of future operating results, including improvements in
cash flow from operating activities, our selling, general and administrative expenses,
adequacy of our cash reserves, and the number of anticipated installed lines;
    
    plans to increase sales of value-added services, like e-mail, security, web hosting
and fixed wireless;
    
    anticipated capital expenditures;
    
    plans to enter into business arrangements with broadband-related service providers;
    
    feasibility of alternative access solutions, like fixed wireless;
    
    effects of litigation currently pending; and
    
    other statements contained in this Report on Form 10-Q regarding matters that are not
historical facts
   
 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
 (All dollar amounts are presented in thousands)
  45




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Carrying Value
    
    
    Interest RateCash and cash equivalents
    
    $
    43,576
    
    
    
    3.06
    %Short-term investments in debt securities
    
    
    12,072
    
    
    
    0.98
    %Restricted cash and cash equivalents
    
    
    8,534
    
    
    
    0.68
    %$
    64,182
 
 ITEM 4. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures:
  Changes in Internal Controls.
  46




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PART II. OTHER INFORMATION
 
 ITEM 1. Legal Proceedings
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ITEM 1A. Risk Factors
 (All dollar amounts are presented in thousands, except monthly service subscription fees)
 Investing in and holding our common stock involve a degree of risk. Many factors, including
those described below and set forth elsewhere in this report and in other documents we file with
the Securities and Exchange Commission, or SEC, could cause actual results to differ materially
from the results contemplated by the forward-looking statements contained in this report. If any of
these risks materialize, our business, financial condition and results of operations could suffer.
These risks are not the only ones we face. Additional risks that we currently do not know about or
that we currently believe to be immaterial may also impair our business.
 Because the acquisition by Platinum Equity has not yet closed, we cannot be sure that the
transactions contemplated by the Merger Agreement will be consummated, which could have a negative
effect on our financial performance and stock price .
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
    
    the price of our common stock would likely decrease since our current market price
reflects a market assumption that the Merger will be completed;
    
    we may experience difficulties in attracting customers and resellers due to changed
perceptions about our competitive position, our management, or other aspects of our business;
    
    we may not be able to find another buyer willing to pay an equivalent or higher price per
share, in an alternative acquisition transaction, than the price offered by Blackberry;
    
    we would remain liable for significant costs related to the acquisition, such as legal,
accounting and investment banking fees;
    
    activities relating to the acquisition and related uncertainties may lead to a loss of
revenue and market position that we may not be able to regain;
    
    we may not be able to retain key employees or attract new employees in areas of growth or
need; and
    
    we may not be able to maintain effective internal control over financial reporting due to
employee departures.
 We regularly evaluate the strategic value of our business operations and, where appropriate,
invest further in certain business operations, and reduce investment in or divest other business
operations.
  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.
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Charges for network elements are generally outside of our control because they are proposed by the
ILECs and are subject to costly regulatory approval processes.
   Our business will be adversely affected if our interconnection agreements are not renewed or if
they are modified on unfavorable terms.
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We depend on a limited number of customers for the preponderance of our revenues, and we are
highly dependent on sales through our resellers.
   The markets in which we operate are highly competitive, and we may not be able to compete
effectively, especially against established industry competitors with significantly greater
financial resources.
  
    
    develop and adopt new or emerging technologies;
    
    respond to changes in customer requirements more quickly;
    
    devote greater resources to the development, promotion and sale of their products and
services;
    
    form new alliances and rapidly acquire significant market share;
    
    undertake more extensive marketing campaigns;
    
    adopt more aggressive pricing policies; and
    
    devote substantially more resources to developing new services.
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New competitors in the market for VoIP services and improvements in the quality of VoIP service
provided by competitors over the public Internet could increase competition for our VoIP services.
   Failure to complete development, upgrades, testing and introduction of new services, including
VoIP services, could affect our ability to compete in the industry.
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We may need to raise additional capital under difficult financial market conditions.
   
    
    customer disconnection rates that reduce our revenues;
    
    significant price reductions by our competitors;
    
    higher levels of marketing expense required to acquire and retain end-users that purchase
our services from us and from our resellers;
    
    the need to upgrade our systems by investing in our existing and future technology and
infrastructure;
    
    investment opportunities in complementary businesses, acquisitions or other
opportunities;
    
    changes in government regulations and legal actions challenging government
regulations; and
    
    additional risk factors mentioned throughout this section.
   In order to become profitable, we must add end-users and sell additional services to our existing
end-users while minimizing the cost to upgrade and expand our network infrastructure.
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
    
    acquire new end-users at a reasonable cost of acquisition;
    
    efficiently deploy LPVA services under our agreement with EarthLink;
    
    enter into and maintain agreements with the RBOCs or obtain favorable regulatory rulings
that provide us with access to unbundled network elements on terms and conditions that allow
us to profitably sell our consumer services;
    
    upgrade our network to improve reliability and remain competitive;
    
    efficiently expand fixed wireless broadband services;
    
    expand our direct sales capability and infrastructure in a cost-effective manner; and
    
    continue to implement and improve our management information systems, including our
client ordering, provisioning, dispatch, trouble ticketing, customer billing, accounts
receivable, payable tracking, collection, fixed assets, transaction-based taxes and other
management information systems.
  Our end-user disconnection rate reduces our revenue and end-user growth.
  
    
    move to a new location;
    
    are moved off our network when one of our customers acquires, or is acquired by, a
competitor with network facilities;
    
    disconnect because of better offers in the market; or
    
    disconnect because they do not like our service or the service provided by our resellers.
  We may experience decreasing margins on the sale of our services, which may impair our ability to
achieve profitability or positive cash flow.
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If our internal control over financial reporting does not comply with the requirements of the
Sarbanes-Oxley Act, our business, reputation and stock price could be adversely affected.
   Some of our resellers are facing financial difficulties, which makes it more difficult to predict
our revenues.
  The existence of our direct business poses challenges and may cause our resellers to place fewer
orders with us or may cause us to lose resellers.
  
    
    recruit, hire and train additional direct sales teams;
    
    reduce our cost of acquiring new customers;
    
    improve our provisioning, network management and monitoring and billing systems;
    
    manage expanding and increasingly diverse distribution channels;
    
    effectively manage additional vendors; and
    
    continue to enhance our network and improve our services.
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The communications industry is undergoing rapid technological changes and new technologies may be
superior to the technology we use.
  
    
    third parties, including some of our competitors and potential competitors, developing
and providing us with access to new communications and networking technology;
    
    our ability to anticipate or adapt to new technology on a timely basis; and
    
    our ability to adapt to new products and technologies that may be superior to, or may not
be compatible with, our products and technologies.
  A system failure could delay or interrupt service to our customers, which could reduce demand for
our services.
   Our use of fixed broadband wireless technology presents several challenges.
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A breach of network security could delay or interrupt service to our customers, which could reduce
demand for our services.
  Our success depends on our retention of certain key personnel, our ability to hire additional key
personnel and the maintenance of good labor relations.
   We depend on a limited number of third parties for equipment supply, software utilities, service
and installation and if we are unable to obtain these items from these third parties we may not be
able to deliver our services as required.
  
    
    DSLAMs;
    
    CPE, including modems, routers, bridges and other devices;
    
    network routing and switching hardware;
    
    customer support;
    
    installation services;
    
    customized software design and maintenance;
    
    network management software;
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
    
    systems management software;
    
    database management software;
    
    collocation space;
    
    software used in our products;
    
    hosting, email and IP provisioning services;
    
    softswitches, used to provide VoIP services; and
    
    Internet connectivity and Internet protocol services.
   
    
    the possibility that some of our vendors will leave the DSL equipment business or will
stop supporting equipment that we already have installed;
    
    the absence of guaranteed capacity;
    
    the possibility that vendors may become insolvent;
    
    the possibility that vendors will stop supporting software or equipment that we use or
will no longer offer supplemental or replacement parts; and
    
    reduced control over delivery schedules, quality assurance, production yields and costs.
  We use third-party vendors offshore for tasks that were previously done by our employees.
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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.
    We must pay federal, state and local taxes and other surcharges on our services, the applicability
and levels of which are uncertain.
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We are a party to litigation and adverse results of such litigation matters could negatively
impact our financial condition and results of operations.
 Legal
Proceedings.
 Our intellectual property protection may be inadequate to protect our proprietary rights.
    Third parties may claim we infringe their intellectual property rights.
  
    
    be time-consuming, costly and result in litigation;
    
    divert managements time and attention from developing our business;
    
    require us to pay monetary damages or enter into royalty and licensing agreements that we
would not normally find acceptable;
    
    require us to stop selling or to redesign certain of our products; or
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
    
    require us to satisfy indemnification obligations to our customers.
  The price of our common stock may continue to fluctuate significantly.
  
    
    the termination of our recently announced merger with Platinum. The price of our common
stock would likely decrease since our current market price reflects a market assumption that
the Merger will be completed;
    
    state and federal regulatory and legislative actions;
    
    general economic conditions and the condition of the telecommunications industry;
    
    our ability to maintain existing customers and add new customers and recognize revenue
from distressed customers;
    
    our ability to execute our operational plan and reach profitability and cash flow
positive from operations;
    
    our ability to maintain sufficient liquidity to fund our operations;
    
    adverse litigation results;
    
    announcements of new products, services or pricing by our competitors or the emergence of
new competing technologies;
    
    our failure to meet the expectations of investors or of analysts;
    
    the adoption of new, or changes in existing, accounting rules, guidelines and practices,
which may materially impact our financial statements and may materially alter the
expectations of securities analysts or investors;
    
    the level of demand for broadband Internet access services and VoIP telephony services;
    
    departures of key personnel; and
    
    effective internal controls over financial reporting.
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Substantial leverage and debt service obligations may adversely affect our cash flow. (Refer to
Part I, Item 2  Managements Discussion and Analysis of Financial Condition and Results of
Operations  Liquidity, Capital Resources and Contractual Cash Obligations for additional
information)
   
    
    increasing our vulnerability to general adverse economic and industry conditions;
    
    limiting our ability to obtain additional financing;
    
    requiring the dedication of a portion of our expected cash flow from operations to
service our indebtedness, thereby reducing the amount of our expected cash flow available
for other purposes, including capital expenditures;
    
    limiting our flexibility in planning for, or reacting to, changes in our business and the
industry in which we compete; and
    
    placing us at a possible competitive disadvantage relative to less leveraged competitors
and competitors that have better access to capital resources.
 
 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 ITEM 3. Defaults Upon Senior Securities
  
 ITEM 4. Submission of Matters to a Vote of Security Holders
  
 ITEM 5. Other Information
  62




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ITEM 6. Exhibits
 Incorporated by ReferenceExhibit
    
    
    
    
    
    
    
    
    
    ExhibitNumber
    
    Exhibit Description
    
    Form
    
    File No.
    
    Date of First Filing
    
    Number
    
    Filed Herewith2.1
    
    Agreement and Plan of
Merger, dated as of
October 28, 2007, by
and among Covad
Communications Group,
Inc., Blackberry
Holding Corporation and
Blackberry Merger
Corporation.
    
    8-K
    
    001-32588
    
    10/29/07
    
    
    2.14.1
    
    Second Amendment to
Amended and Restated
Stockholder Protection
Rights Agreement, dated
as of October 28, 2007,
by and between Covad
Communications Group,
Inc. and Mellon
Investor Services LLC.
    
    8-K
    
    001-32588
    
    10/29/07
    
    
    4.110.1
    
    Covad Communications
Group, Inc. Form of
Indemnification
Agreement
    
    
    
    
    
    
    
    
    
    
    
    X10.2
    
    Transition Agreement
between Covad
Communications Group,
Inc. and James Kirkland
    
    8-K
    
    001-32588
    
    09/06/07
    
    
    10.110.3
    
    Covad Communications
Group, Inc. 2007 Equity
Incentive Plan, as
amended
    
    8-K
    
    001-32588
    
    09/06/07
    
    
    10.210.4
    
    Covad Communications
Group, Inc. Executive
Severance Plan and
Summary Plan
Description.
    
    8-K
    
    001-32588
    
    09/06/07
    
    
    10.310.5
    
    Change of Control
Agreement between
Charles E. Hoffman and
Covad Communications
Group, Inc.
    
    8-K
    
    001-32588
    
    09/06/07
    
    
    10.410.6
    
    Form of Change in
Control Agreement
    
    8-K
    
    001-32588
    
    09/06/07
    
    
    10.531.1
    
    Certification Pursuant
to Rule 13a-14(a)
    
    
    
    
    
    
    
    
    
    
    
    X31.2
    
    Certification Pursuant
to Rule 13a-14(a)
    
    
    
    
    
    
    
    
    
    
    
    X32.1*
    
    Certification Pursuant
to 18 U.S.C. Section
1350, as Adopted
Pursuant to Section 906
of the Sarbanes-Oxley
Act of 2002
    
    
    
    
    
    
    
    
    
    
    
    X32.2*
    
    Certification Pursuant
to 18 U.S.C. Section
1350, as Adopted
Pursuant to Section 906
of the Sarbanes-Oxley
Act of 2002
    
    
    
    
    
    
    
    
    
    
    
    X
 
 *
    
    These certifications accompany the Registrants Quarterly Report on Form 10-Q and are not
deemed filed with the SEC. 63




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##### Table of Contents



SIGNATURES
  COVAD COMMUNICATIONS GROUP, INC.By:
    
    /s/ CHARLES E. HOFFMAN

Charles E. HoffmanPresident, Chief Executive
Officer and DirectorDate: November 2, 2007Date: November 2, 2007
    
    
    
    By:
    
    /s/ JUSTIN SPENCER

Justin SpencerSenior Vice President and
Chief Financial Officer
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Incorporated by ReferenceExhibit
    
    
    
    
    
    
    
    
    
    ExhibitNumber
    
    Exhibit Description
    
    Form
    
    File No.
    
    Date of First Filing
    
    Number
    
    Filed Herewith2.1
    
    Agreement and Plan of
Merger, dated as of
October 28, 2007, by
and among Covad
Communications Group,
Inc., Blackberry
Holding Corporation and
Blackberry Merger
Corporation.
    
    8-K
    
    001-32588
    
    10/29/07
    
    
    2.14.1
    
    Second Amendment to
Amended and Restated
Stockholder Protection
Rights Agreement, dated
as of October 28, 2007,
by and between Covad
Communications Group,
Inc. and Mellon
Investor Services LLC.
    
    8-K
    
    001-32588
    
    10/29/07
    
    
    4.110.1
    
    Covad Communications
Group, Inc. Form of
Indemnification
Agreement
    
    
    
    
    
    
    
    
    
    
    
    X10.2
    
    Transition Agreement
between Covad
Communications Group,
Inc. and James Kirkland
    
    8-K
    
    001-32588
    
    09/06/07
    
    
    10.110.3
    
    Covad Communications
Group, Inc. 2007 Equity
Incentive Plan, as
amended
    
    8-K
    
    001-32588
    
    09/06/07
    
    
    10.210.4
    
    Covad Communications
Group, Inc. Executive
Severance Plan and
Summary Plan
Description.
    
    8-K
    
    001-32588
    
    09/06/07
    
    
    10.310.5
    
    Change of Control
Agreement between
Charles E. Hoffman and
Covad Communications
Group, Inc.
    
    8-K
    
    001-32588
    
    09/06/07
    
    
    10.410.6
    
    Form of Change in
Control Agreement
    
    8-K
    
    001-32588
    
    09/06/07
    
    
    10.531.1
    
    Certification Pursuant
to Rule 13a-14(a)
    
    
    
    
    
    
    
    
    
    
    
    X31.2
    
    Certification Pursuant
to Rule 13a-14(a)
    
    
    
    
    
    
    
    
    
    
    
    X32.1*
    
    Certification Pursuant
to 18 U.S.C. Section
1350, as Adopted
Pursuant to Section 906
of the Sarbanes-Oxley
Act of 2002
    
    
    
    
    
    
    
    
    
    
    
    X32.2*
    
    Certification Pursuant
to 18 U.S.C. Section
1350, as Adopted
Pursuant to Section 906
of the Sarbanes-Oxley
Act of 2002
    
    
    
    
    
    
    
    
    
    
    
    X
 
 *
    
    These certifications accompany the Registrants Quarterly Report on Form 10-Q and are not
deemed filed with the SEC. 65