##### Table of Contents



UNITED STATES SECURITIES AND
    EXCHANGE COMMISSIONWashington, DC
    20549
   Form 10-K
  þ

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934For the Fiscal Year Ended
    December 31, 2006   Commission file number
    001-32588
   Covad Communications Group,
    Inc.
   Incorporated in
    Delaware

I.R.S. Employer Identification
    No.:
    77-0461529   110 Rio
    Robles, San Jose, California 95134(408) 952-6400
  Securities registered pursuant to Section 12(b) of the
    Act:
    None
  Securities registered pursuant to Section 12(g) of the
    Act:
    Common Stock, par value $0.001 per share
    Stock Purchase Rights Pursuant To Rights Agreement
  o þ
  o þ
  þ o
  Regulation S-K Form 10-K Form 10-K.  Yes þ o
  Rule 12b-2
  o þ o
  Rule 12b-2 o þ
    þ o




---



##### 



COVAD
    COMMUNICATIONS GROUP, INC.
    For the Fiscal Year Ended December 31, 2006
  
  TABLE OF
    CONTENTS
  PagePART IITEM 1.

Business


2ITEM 1A.

Risk
    Factors


16ITEM 1B.

Unresolved Staff
    Comments


28ITEM 2.

Properties


28ITEM 3.

Legal
    Proceedings


28ITEM 4.

Submission of
    Matters to a Vote of Security Holders


29PART IIITEM 5.

Market for
    Registrants Common Equity, Related Stockholder Matters and
    Issuer Purchases of Equity Securities


29ITEM 6.

Selected Financial
    Data


31ITEM 7.

Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations


32ITEM 7A.

Quantitative and
    Qualitative Disclosures About Market Risk


52ITEM 8.

Financial
    Statements and Supplementary Data


54ITEM 9.

Changes in and
    Disagreements with Accountants on Accounting and Financial
    Disclosure


99ITEM 9A.

Controls and
    Procedures


99ITEM 9B.

Other
    Information


100PART IIIITEM 10.

Directors,
    Executive Officers and Corporate Governance


100ITEM 11.

Executive
    Compensation


100ITEM 12.

Security Ownership
    of Certain Beneficial Owners and Management and Related
    Stockholder Matters


100ITEM 13.

Certain
    Relationships and Related Transactions, and Director
    Independence


100ITEM 14.

Principal
    Accounting Fees and Services


100PART IVITEM 15.

Exhibits, Financial
    Statement Schedules


100SIGNATURES


104EXHIBIT 21.1EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2   1




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##### Table of Contents



PART I  ITEM 1.
    Business  The following discussion contains forward-looking statements,
    including statements regarding our growth rates, cash needs, the
    adequacy of our cash reserves, relationships with customers and
    vendors, market opportunities, legislative and regulatory
    proceedings, operating and capital expenditures, expense
    reductions and operating results. Each of these statements
    involves risks and uncertainties. As a result, actual results
    could differ materially from those anticipated in the
    forward-looking statements as a result of certain factors
    including, but not limited to, those discussed in Part I,
    Item 1A.  Risk Factors and elsewhere
    in this Report.
  We disclaim any obligation to update information contained in
    any forward-looking statement. See Part II,
    Item 7.  Managements Discussion and
    Analysis of Financial Condition and Results of
    Operations  Forward-Looking Statements.
  (All
    dollar and share amounts are presented in thousands, except per
    share amounts)
  Overview
         2




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
    direct sales of bundled services, which includes VoIP and data
    communications services, to small and medium-sized businesses;
    higher-bandwidth services, like our T-1 services;
    fixed wireless broadband services; and
    LPVA service.      Industry
    Background
        Our
    Service Offerings
     3




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##### Table of Contents



Risk
    Factors  We may experience decreasing margins on the
    sale of our services, which may impair our ability to achieve
    profitability or positive cash flow for a discussion of
    some of the risks associated with our ability to sustain current
    price levels in the future.
  TeleSpeed
    TeleSoho
      TeleXtend
    TeleSurfer
     4




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Fixed
    Broadband Wireless
    Voice
    over Internet Protocol for Businesses
        Voice
    over Internet Protocol for Consumers
     5




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##### Table of Contents



Asynchronous
    Transfer Mode, or ATM, Network Services
  DS-3 DS-3
  Broadband
    Internet Access Service
    Value-Added
    Services
    Email and Web Hosting: easy-to-use
  Installation Services:
  Sales and
    Marketing
  Wholesale
         6




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Direct
          Network
    Architecture and Technology
    Consistent and Scalable Performance
  Intelligent
    End-to-End
    Network Management
  Flexibility
  Network Operations Centers end-to-end
 7




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Nationwide Broadband Access and Internet
    Connectivity
  Private Metropolitan Network
  Central Office Spaces
  Telephone Lines
  Fixed Wireless Connections point-to-point
  DSL Modems, Telecommunications Equipment and
    On-Site
    Connection on-site
  Competition
   8




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
    RBOCs (Verizon, Qwest and AT&T);
    cable television companies providing broadband and VoIP, such as
    Comcast Corporation, Cox Communications, Time Warner, Inc. and
    Charter Communications;
    competitive telecommunications companies, such as MegaPath and
    XO Communications;
    interexchange carriers including Sprint and Level 3
    Communications;
    VoIP service providers, such as M5 Networks, PingTone and
    cBeyond;
    telephone equipment providers offering VoIP services, such as
    Nortel, Avaya, Cisco and Lucent;
    Internet service providers, such as EarthLink and Speakeasy.net;
    online service providers, including companies such as AOL,
    Google and MSN, a subsidiary of Microsoft Corp.; and
    wireless and satellite service providers such as AT&T,
    Sprint, Verizon Wireless,
    T-Mobile,
    StarBand Communications Inc., DirecTV, EchoStar Communications
    Corporation, Globalstar, Lockheed, NextLink (a subsidiary of XO
    Holdings), StarBand Communications and Teledesic.  Interconnection
    Agreements with the Regional Bell Operating Companies
      
    prices we pay to lease access, both for stand-alone and
    line-shared lines;
    special conditioning on certain of these lines to enable the
    transmission of digital signals;
    prices and terms of central office space for our equipment;
    prices we pay and access we have to data transport facilities
    connecting our facilities in different central offices and
    network points of presence;
    interfaces that we can use to place orders, report network
    problems and monitor responses to our requests;
    dispute resolution processes we use to resolve
    disagreements; and
    terms of the interconnection agreement, its transferability to
    successors, its liability limits and other general aspects of
    the relationships.     9




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Government
    Regulation
  Overview
  Recent Developments
  
    If certain criteria are met, ILECs can stop providing new
    transport services between the telephone companies central
    offices at regulated rates, which are usually lower than
    commercially available rates. These criteria are based on the
    number of business lines served by the connected central offices
    and the number of alternative providers collocated in the
    central offices. This rule went into effect on March 11,
    2005. For existing transport services where the criteria are
    met, ILECs are required to continue to provide the services with
    a price increase of 15% for either twelve or eighteen months
    after the order went into effect. The twelve and eighteen month
    periods expired on March 11, 2006 and September 11,
    2006, at which time commercially available rates prevailed. We
    currently purchase interoffice transport from the ILECs in order
    to carry traffic over our network. This change increased our
    data transport costs by approximately $4,260 in 2006 and we
    expect it will increase our data transport costs in 2007 by
    approximately $5,000.
    In addition, ILECs are no longer required to provide new
    high-capacity unbundled
    DS-1 and
    DS-3 lines
    at regulated rates in locations where certain criteria are met.
    These criteria are based on the number of business lines served
    by the central office and the number of alternative providers
    collocated in the central office. This rule went into effect on
    March 11, 2005. For existing high-capacity
    DS-1 and
    DS-3 lines
    where the criteria are met, ILECs are required to continue to
    provide the lines for a twelve month transition period with a
    price increase of 15%. The transition period expired on
    March 11, 2006, at which time commercially available rates
    prevailed. We use
    DS-1 lines
    to provide business-grade services to our end-users. This change
    increased our cost to purchase
    DS-1 lines
    by approximately $503 in 2006.
    ILECs are no longer required to provide new dark fiber lines at
    regulated rates. As of March 11, 2006, commercially
    available rates for these services prevail. In certain areas, we
    purchase dark fiber to transport data traffic within our
    network. Currently we purchase our dark fiber from non-ILEC
    providers. However, if we are unable to purchase dark fiber from
    non-ILEC providers in the future, we expect this change will
    increase our cost to purchase dark fiber lines. At this time we
    cannot reliably quantify the aggregate amount of these
    increases, if any.
    Competitive telecommunications carriers, including our
    resellers, can no longer purchase voice services from the ILECs
    under an arrangement known as the Unbundled Network Element
    Platform, or UNE-P, for new customers at regulated rates. The
    existence of UNE-P had allowed us to bundle our data services
    with the voice services of competitive telecommunications
    providers through line-splitting arrangements. We currently
    bundle services in this manner only with competitive
    telecommunications providers that have agreements with the ILECs
    to allow them continued access to UNE-P or similar resold
    services. As discussed above, we have deployed an alternative
    method of delivering residential voice services with our LPVA
    service, which enables our strategic reseller, EarthLink, to
    offer local and long distance voice services to its customers
    (bundled with our data services) in competition with the local
    telephone companies. 10




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
    Our line-shared customers as of October 2, 2003 were
    grandfathered indefinitely at current rates, terms and
    conditions. These line-shared customers provided approximately
    $68,758, $68,755 and $89,857, or 14.5%, 15.5% and 20.9%, of our
    revenues for 2006, 2005 and 2004, respectively.
    For line-shared customers acquired from October 3, 2003 to
    October 2, 2004, the FCC-mandated maximum price for the
    high-frequency portion of the telephone line was 25% of the cost
    of a separate telephone line during the first year, 50% of the
    cost of a separate telephone line from October 3, 2004 to
    October 2, 2005, and 75% of the cost of a separate
    telephone line from October 3, 2005 to October 2,
    2006. After October 2, 2006, we were required to transition
    these customers to new arrangements, which could include
    continued provision of services pursuant to commercial
    agreements.
    As of October 3, 2004, we could no longer acquire new
    line-shared customers at regulated rates under Section 251
    of the Telecommunications Act of 1996.       11




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Federal and State VoIP Regulation 
 12




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Other Federal Regulation 
  rights-of-way.
    Other State Regulation 
 13




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Local Government Regulation
    Risk
    Factors  Our services are subject to government
    regulation, and changes in current or future laws or regulations
    could adversely affect our business Risk Factors 
    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.
  Significant
    Customers
    
    AT&T accounted for 14.3%, 16.3% and 13.8% of our total net
    revenues for 2006, 2005 and 2004, respectively; and
    EarthLink accounted for 11.1%, 14.6%, and 16.9% of our total net
    revenues for 2006, 2005 and 2004, respectively. 14




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Intellectual
    Property
          Employees
    Available
    Information
  www.covad.com Form 10-K, Form 10-Q, Form 8-K, 1-800-SEC-0330. www.sec.gov
 15




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ITEM 1A.
    Risk
    Factors  (All
    dollar and share amounts are presented in thousands, except per
    share amounts)
  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.
  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 network elements are generally outside of our control
    because they are proposed by the ILECs and are subject to costly
    regulatory approval processes.
   16




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Our
    business will be adversely affected if our interconnection
    agreements are not renewed or if they are modified on
    unfavorable terms.
        We
    depend on a limited number of customers for the preponderance of
    our revenues, and we are highly dependent on sales through our
    resellers.
     17




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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.      video-on-demand,
  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.
   18




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Failure
    to complete development, upgrades, testing and introduction of
    new services, including VoIP services, could affect our ability
    to compete in the industry.
    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.   19




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In
    order to become cash flow positive and to achieve profitability,
    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.
    
    acquire new end-users;
    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;
    enhance, improve and increase sales of our VoIP 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;
    disconnect because of better offers in the market; or
    disconnect because they do not like our service or the service
    provided by our resellers. 20




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We may
    experience decreasing margins on the sale of our services, which
    may impair our ability to achieve profitability or positive cash
    flow.
    If our
    internal controls over financial reporting do 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 VoIP provisioning, network management and monitoring
    and billing systems;
    manage expanding and increasingly diverse distribution channels; 21




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
    effectively manage additional vendors; and
    continue to enhance our network and improve our VoIP services.    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, to develop and provide 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.
    IP-based
  Our
    use of fixed broadband wireless technology presents several
    challenges.
   22




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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; 23




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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 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.
        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.
   24




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We
    must pay federal, state and local taxes and other surcharges on
    our services, the applicability and levels of which are
    uncertain.
     25




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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
    require us to satisfy indemnification obligations to our
    customers.    The
    price of our common stock may continue to fluctuate
    significantly.
   26




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##### Table of Contents




    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.    Substantial
    leverage and debt service obligations may adversely affect our
    cash flow. (Refer to Part II, Item 7 
    Managements Discussion and Analysis of Financial
    Condition and Results of Operations  Liquidity and
    Capital Resources 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. 27




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ITEM 1B.
    Unresolved
    Staff Comments    ITEM 2.
    Properties      ITEM 3.
    Legal
    Proceedings       28




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ITEM 4.
    Submission
    of Matters to a Vote of Security Holders    PART II   ITEM 5.
    Market
    for Registrants Common Equity, Related Stockholder Matters
    and Issuer Purchases of Equity Securities  (Share
    amounts are presented in thousands)
  Market
    Price Information and Dividend Policy for Our Common
    Stock
   29




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High


LowFiscal Year Ended
    December 31, 2005First Quarter

$
2.26


$
1.20Second Quarter

$
1.49


$
1.07Third Quarter

$
1.50


$
1.06Fourth Quarter

$
1.10


$
0.67Fiscal Year Ended
    December 31, 2006First Quarter

$
2.13


$
0.87Second Quarter

$
2.59


$
1.75Third Quarter

$
2.05


$
1.35Fourth Quarter

$
1.53


$
1.08         Number ofsecuritiesremainingavailableWeighted-


for futureNumber of


average


issuancesecurities to be


exercise


under equityissued upon


price of


compensationexercise of


outstanding


plans (excludingoutstanding


options,


securitiesoptions, warrants


warrants and


reflectedand rights


rights


in column (a))Plan Category

(a)


(b)


(c)Equity compensation plans approved
    by security holders(1)


23,038


$
4.30



21,350Equity compensation plans not
    approved by security holders(2)


44



9.83



Total


23,082


$
4.31



21,350     (1)
    
    1997 Stock Plan and 2003 ESPP. Securities available for future
    issuance under the Companys 2003 ESPP are included in
    column (c) but are not included in columns (a)
    and (b) because amount and price of securities purchased in
    an offering period are determined at the end of such offering
    period. The Companys next offering period ends in June
    2007.(2)
    
    These plans consist of the Laser Link 1997 Stock Plan, the
    BlueStar 2000 Stock Incentive Plan, and the GoBeam 2000 Employee
    and Consultant Equity Incentive Plan, all of which were assumed
    by the Company in connection with the acquisitions of each
    company. 30




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ITEM 6.
    Selected
    Financial Data  Managements Discussion and Analysis of Financial
    Condition and Results of Operations Financial Statements and
    Supplementary Data Form 10-K.
  For the Year Ended December 31,2006


2005


2004


2003


2002(All dollar and share amounts are presented in thousands,except per share amounts)Consolidated Statement of
    Operations Data:Revenues, net

$
474,304


$
443,179


$
429,197


$
388,851


$
383,496Cost of sales (exclusive of
    depreciation and amortization)


328,474



311,139



266,172



288,122



298,336Benefit from federal exercise tax
    adjustment


(19,455
)














Selling, general and administrative


127,129



158,552



146,241



140,081



150,373Depreciation and amortization


44,825



67,241



77,410



73,884



127,088Provision for restructuring and
    post-employment benefits


1,597



3,640



1,409



1,235



Loss from operations


(8,517
)


(97,964
)


(60,000
)


(114,570
)


(180,992
)Interest expense


9,562



5,005



4,927



5,526



5,581Gain on sale of equity securities






28,844











Gain on deconsolidation of
    subsidiary






53,963











Net loss

$
(13,949
)

$
(15,722
)

$
(60,761
)

$
(112,302
)

$
(184,828
)Basic and diluted per share
    amounts:Net loss

$
(0.05
)

$
(0.06
)

$
(0.24
)

$
(0.50
)

$
(0.84
)Weighted-average common shares
    used in computing basic and diluted per share amounts


290,262



265,240



249,187



224,950



219,744   As of December 31,2006


2005


2004


2003


2002Consolidated Balance Sheet
    Data:Cash, cash equivalents and
    short-term investments

$
62,072


$
96,501


$
150,996


$
114,345


$
202,492Property and equipment, net

$
87,586


$
71,663


$
78,707


$
94,279


$
108,737Total assets

$
313,308


$
300,581


$
385,225


$
334,711


$
442,161Long-term obligations, including
    capital leases

$
168,801


$
125,206


$
125,734


$
50,000


$
50,165Total stockholders equity
    (deficit)

$
2,354


$
(20,169
)

$
(8,635
)

$
(5,553
)

$
82,299   As of and for the Year Ended December 31,2006


2005


2004


2003


2002Other Operating and Financial
    DataCollocation facilities


2,048



2,052



2,052



1,819



1,802Homes and businesses passed
    (approximately)


57,000,000



57,000,000



50,000,000



46,000,000



46,000,000Lines in service


519,000



567,200



533,200



517,000



381,000Capital expenditures for property
    and equipment

$
46,964


$
42,397


$
38,743


$
44,142


$
22,782Capital expenditures for
    collocation fees and purchases of other intangibles assets

$
3,236


$
3,582


$
7,900


$
14,889


$
3,782  31




---



##### Table of Contents



ITEM 7.
    Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations  (All dollar and share amounts are presented in thousands,
    except per share amounts)
  The following discussion of our financial condition and
    results of operations should be read in conjunction with the
    consolidated financial statements and the related notes thereto
    included elsewhere in this Annual Report on
    Form 10-K.
    This discussion contains forward-looking statements, the
    accuracy of which involves risks and uncertainties. Our actual
    results could differ materially from those anticipated in the
    forward-looking statements for many reasons including, but not
    limited to, those discussed in Part I,
    Item 1A.  Risk Factors and elsewhere
    in this Annual Report on
    Form 10-K.
    We disclaim any obligation to update information contained in
    any forward-looking statement. See  Forward-Looking
    Statements.
  Overview
  Our
    Business
            Regulatory
    Environment
  Business  Government
    Regulation,
 32




---



##### Table of Contents



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.        Efficient use of cash
  Efficiently deliver broadband Internet access services to
    consumers
  Long-Term Debt and Credit
 33




---



##### Table of Contents



Arrangements
  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
  
    Covad ClearEdge Integrated Access  an integrated
    voice and data T-1 line that targets customers who have a
    premises-based PBX or key telephone system;
    Covad ClearEdge Office  a hosted VoIP and broadband
    offering designed for very small businesses; and
    Fixed wireless Broadband  through our acquisition of
    NextWeb, Inc., or NextWeb, we plan to leverage wireless
    broadband technology, expand our market reach and reduce our
    dependence on the ILECs and other carriers.      Critical
    Accounting Policies and Estimates
   34




---



##### Table of Contents




    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 over the expected term of the customer relationship,
    which is presently estimated to be twenty-four to forty-eight
    months using the straight-line method. Similarly, we treat the
    incremental direct costs of service activation, which consist
    principally of customer premises equipment, or CPE, service
    activation fees paid to other telecommunications companies and
    sales commissions, as deferred charges in amounts no greater
    than the up-front fees that are deferred, and such incremental
    direct costs are amortized to expense using the straight-line
    method over a range of twenty-four to forty-eight months.
    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.
    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. 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. 35




---



##### Table of Contents




    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.
    Effective January 1, 2006, we adopted the provisions of
    Financial Accounting Standards Board, or FASB, Statement of
    Financial Accounting Standards, or SFAS, No. 123 (revised
    2004), Share-Based Payment, or
    SFAS 123R. 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. Prior to January 1, 2006, we accounted for
    stock-based compensation under the recognition and measurement
    provisions of Accounting Principles Board Opinion No. 25,
    or APB 25, and related Interpretations, and provided the
    required pro-forma disclosures prescribed by
    SFAS No. 123, Accounting for Stock-Based
    Compensation,as amended by SFAS No. 148,
    Accounting for Stock-Based Compensation 
    Transition and Disclosures.In accordance with
    APB 25, we did not recognize compensation cost for awards
    that had an exercise price equal to, or greater than, the market
    value of the underlying common stock on the date of grant. We
    elected to adopt the modified prospective transition method as
    provided by SFAS 123R. Under this transition method,
    compensation cost recognized in our consolidated statement of
    operations includes (i) compensation cost for all
    shared-based payments granted prior to, but not yet vested as of
    December 31, 2005, based on the grant-date fair value
    estimated in accordance with the original provisions of
    SFAS 123, and (ii) compensation cost for all
    share-based payments granted subsequent to December 31,
    2005, based on the grant-date fair value estimated in accordance
    with the provisions of SFAS 123R. The results for prior
    periods have not been restated. We currently do not recognize
    and do not expect to recognize in the near future, any tax
    benefit related to employee stock-based compensation cost as a
    result of the full valuation allowance on our net deferred tax
    assets and because of our net operating loss carryforwards. We
    capitalize stock-based compensation as part of the cost of our
    network when we perform major build or enhancement projects. We
    estimate the fair value of stock options using a Black-Scholes
    valuation model, consistent with the provisions of
    SFAS 123R, SECs Staff Accounting
    Bulletin No. 107, or SAB 107, and our prior
    period pro-forma disclosures of net earnings, including
    stock-based compensation (determined under a fair value method
    as prescribed by SFAS 123). We determine the expected life
    of the options using historical data for options exercised,
    cancelled after vesting 36




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##### Table of Contents



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 123R. We determine the forfeiture rate
    using historical pre-vesting cancellation data for all options
    issued after 2001. Prior to the adoption of SFAS 123R, we
    accounted for forfeitures upon occurrence.  Recent
    Accounting Pronouncements
  Fair Value Measurements.
  Considering
    the Effects of Prior Year Misstatements when Quantifying
    Misstatements in Current Year Financial Statement.
  No. 06-3, How Taxes Collected from Customers and Remitted to
    Governmental Authorities should be Presented in the Income
    Statement. 06-3 Disclosure of Accounting
    Policies. 06-3 06-3
  Accounting for Uncertainty in Income Taxes Accounting for Income Taxes.
 37




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##### Table of Contents



Business
    Segment Information
        Results
    of Operations for 2006, 2005 and 2004
  Revenues,
    net
   38




---



##### Table of Contents



dial-up
    Segment
    Revenues and Significant Customers
    Year Ended December 31,2006


2005


2004Wholesale

$
315,321


$
314,205


$
309,899Percent of net revenues


66.5
%


70.9
%


72.2
%Direct

$
158,983


$
128,974


$
119,298Percent of net revenues


33.5
%


29.1
%


27.8
%     dial-up
 39




---



##### Table of Contents



Revenue
    Recognition
    Wholesaler
    Financial Difficulties
     40




---



##### Table of Contents



Operating
    Expenses
      Year Ended December 31,2006


2005


2004Amount


482,821


$
541,143


$
489,197Percent of net revenues


101.8
%


122.1
%


114.0
%   Cost of
    sales (exclusive of depreciation and amortization)
      Year Ended December 31,2006


2005


2004Amount

$
328,474


$
311,139


$
266,172Percent of net revenues


69.3
%


70.2
%


62.0
%      41




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##### Table of Contents



Year Ended December 31,2006


2005


2004Wholesale Segment

$
186,142


$
193,721


$
177,115Direct Segment


94,484



81,521



57,141Corporate Operations


47,848



35,897



31,916Total

$
328,474


$
311,139


$
266,172    42




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##### Table of Contents



Benefit
    from Federal Excise Tax Adjustment
  Accounting for
    Contingencies
  2006-50 2006-50
  Selling,
    General and Administrative Expenses
   43




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##### Table of Contents



Year Ended December 31,2006


2005


2004Amount

$
127,129


$
158,552


$
146,241Percent of net revenues


26.8
%


35.8
%


34.1
%           Year Ended December 31,2006


2005


2004Wholesale Segment

$
7,742


$
8,353


$
9,048Direct Segment


36,183



49,938



36,859Corporate Operations


83,204



100,261



100,334Total

$
127,129


$
158,552


$
146,241    44




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##### Table of Contents



Stock-Based
    Compensation
  Stock-Based Compensation,
  Provision
    for Bad Debts (Bad Debt Recoveries)
    Depreciation
    and Amortization
     45




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##### Table of Contents



Provision
    for Restructuring and Post-Employment Benefits
    Other
    Income (Expense)
  Net
    Interest Expense
    Gain on
    Deconsolidation of Subsidiary
  Other Restructuring
    Activities
  Gain on
    Sale of Equity Securities
    Income
    Taxes
   46




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##### Table of Contents



Business Acquisitions, Asset Acquisitions and Equity
    Investments,
  Business
    Acquisitions, Asset Acquisitions and Equity Investments,
  Restructuring and Post-Employment Benefits,
  Business Acquisitions, Asset
    Acquisitions and Equity Investments,
      Related
    Party Transactions
     47




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##### Table of Contents



Liquidity,
    Capital Resources and Contractual Cash Obligations
      Year Ended December 31,2006


2005


2004Net cash provided by (used in):Operating activities

$
(24,654
)

$
(40,732
)

$
3,676Investing activities


(71,825
)


4,611



(29,780
)Financing activities


58,467



2,906



78,234Total

$
(38,012
)

$
(33,215
)

$
52,130   Operating
    Activities
       48




---



##### Table of Contents



Investing
    Activities
        Financing
    Activities
  Long-Term
    Debt and Credit Arrangements,
     49




---



##### Table of Contents



Liquidity
           50




---



##### 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;
    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;
    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 notes










42,240







42,240Bank loan


6,100















6,100Interest on notes payable


11,391



14,669



6,125







32,185Capital leases


617



764



180







1,561Office leases


5,231



8,612



2,835



23



16,701Other operating leases


1,295



1,682



425



26



3,428Purchase obligations


5,845















5,845$
30,479


$
150,727


$
51,805


$
49


$
233,060       Forward-Looking
    Statements
   51




---



##### Table of Contents



Form 10-K
  
    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;
    margins on our service offerings;
    possibilities that we will increase our revenues;
    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 VoIP 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-K
    regarding matters that are not historical facts    Form 10-K Form 10-K.
  ITEM 7A.
    Quantitative
    and Qualitative Disclosures About Market Risk  (All
    dollar amounts are presented in thousands)
   52




---



##### Table of Contents



Carrying Value


Interest RateCash and cash equivalents

$
46,279



2.73
%Short-term investments in debt
    securities


15,793



1.05
%Restricted cash and cash
    equivalents


19,578



1.15
%$
81,650  53




---



##### Table of Contents



ITEM 8.  Financial
    Statements and Supplementary Data



FINANCIAL
    STATEMENTS



INDEX



(a) The following documents are filed as part of this
    Form 10-K:



(1) Financial Statements.  The following
    Financial Statements of Covad Communications Group, Inc. and
    Report of Independent Registered Public Accounting Firms are
    filed as part of this report. PageReport of
    PricewaterhouseCoopers LLP, Independent Registered Public
    Accounting Firm


55Consolidated
    Balance Sheets


57Consolidated
    Statements of Operations


58Consolidated
    Statements of Stockholders Equity (Deficit)


59Consolidated
    Statements of Cash Flows


60Notes to
    Consolidated Financial Statements


61  54




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##### Table of Contents



Report of
    Independent Registered Public Accounting Firm       Consolidated
    financial statements
      Internal
    control over financial reporting
  Control and Procedures, Internal Control 
    Integrated Framework Internal Control  Integrated
    Framework
   55




---



##### Table of Contents



Control and
    Procedures,
  PricewaterhouseCoopers
    LLP
    56




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  CONSOLIDATED BALANCE SHEETS
  December 31,2006


2005(All dollar and share amounts are presented in thousands,
    except par value)ASSETSCurrent assets:Cash and cash equivalents

$
46,279


$
84,291Short-term investments in debt
    securities


15,793



12,210Restricted cash and cash equivalents


19,578



5,503Accounts receivable, net


31,151



28,074Unbilled revenues


2,567



3,326Inventories


3,602



5,245Prepaid expenses and other current
    assets


4,979



2,400Total current assets


123,949



141,049Property and equipment, net


87,586



71,663Collocation fees and other
    intangible assets, net


22,768



20,715Goodwill


50,002



36,626Deferred costs of service activation


24,268



25,456Deferred debt issuance costs, net


3,823



3,223Other long-term assets


912



1,849Total assets

$
313,308


$
300,581LIABILITIES AND
    STOCKHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable

$
34,189


$
23,331Accrued compensation


14,539



16,277Accrued collocation and network
    service fees


15,594



14,583Accrued transaction-based taxes


7,754



30,159Collateralized and other customer
    deposits


5,585



33,230Unearned revenues


6,528



6,500Loan payable to bank


6,100



Other accrued liabilities


11,381



9,137Total current liabilities


101,670



133,217Long-term debt


167,240



125,000Collateralized and other long-term
    customer deposits






16,912Unearned revenues


39,506



43,758Other long-term liabilities


2,538



1,863Total liabilities


310,954



320,750Commitments and contingencies
    (Notes 7, 8, 9 and 10)Stockholders equity
    (deficit):Preferred stock, $0.001 par
    value; 5,000 shares authorized; no shares issued and
    outstanding at December 31, 2006 and 2005






Common stock, $0.001 par
    value; 590,000 shares authorized; 296,877 shares
    issued and outstanding at December 31, 2006
    (268,353 shares issued and outstanding at December 31,
    2005)


297



268Common stock 
    Class B, $0.001 par value; 10,000 shares
    authorized; no shares issued and outstanding at
    December 31, 2006 and 2005






Additional paid-in capital


1,734,124



1,697,686Deferred stock-based compensation






(5
)Accumulated other comprehensive
    income


3



3Accumulated deficit


(1,732,070
)


(1,718,121
)Total stockholders equity
    (deficit)


2,354



(20,169
)Total liabilities and
    stockholders equity (deficit)

$
313,308


$
300,581    57




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##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
 CONSOLIDATED STATEMENTS OF OPERATIONS  Year Ended December 31,2006


2005


2004(All dollar and share amounts are presented in thousands,
    exceptper share amounts)Revenues, net

$
474,304


$
443,179


$
429,197Operating expenses:Cost of sales (exclusive of
    depreciation and amortization)


328,474



311,139



266,172Benefit from federal excise tax
    adjustment


(19,455
)






Selling, general and administrative


127,129



158,552



146,241Provision for bad debts (bad debt
    recoveries), net


251



571



(2,035
)Depreciation and amortization of
    property and equipment


34,876



49,813



56,825Amortization of collocation fees
    and other intangible assets


9,949



17,428



20,585Provision for restructuring and
    post-employment benefits


1,597



3,640



1,409Total operating expenses


482,821



541,143



489,197Loss from operations


(8,517
)


(97,964
)


(60,000
)Other income (expense):Interest income


3,938



4,142



2,668Gain on sale of equity securities






28,844



Gain on deconsolidation of
    subsidiary






53,963



Interest expense


(9,562
)


(5,005
)


(4,927
)Miscellaneous income, net


192



298



1,498Other income (expense), net


(5,432
)


82,242



(761
)Net loss

$
(13,949
)

$
(15,722
)

$
(60,761
)Basic and diluted net loss per
    share

$
(0.05
)

$
(0.06
)

$
(0.24
)Weighted-average number of common
    shares outstanding used in computing basic and diluted per share
    amounts


290,262



265,240



249,187    58




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  CONSOLIDATED STATEMENTS OF STOCKHOLDERS
    EQUITY (DEFICIT)
  AccumulatedOther





TotalAdditional


Deferred


Comprehensive





StockholdersPreferred Stock


Common Stock


Paid-In


Stock-Based


Income


Accumulated


EquityShares


Amount


Shares


Amount


Capital


Compensation


(Loss)


Deficit


(Deficit)(All dollar and share amounts are presented in thousands)Balances at December 31,
    2003





$




230,163


$
230


$
1,651,267


$
(14,459
)

$
(953
)

$
(1,641,638
)

$
(5,553
)Net loss






























(60,761
)


(60,761
)Unrealized losses on
    available-for-sale
    securities


























(32
)






(32
)Comprehensive loss


































(60,793
)Issuance of common stock for ESPP










5,316



5



4,722















4,727Issuance of common stock upon
    exercise of options










1,951



2



2,149















2,151Issuance of common stock for
    bankruptcy filing related transactions










6,496



7



6,944















6,951Issuance of common stock as a
    result of business acquisition expenses










834



1



1,780















1,781Issuance of common stock to vendors










8







13















13Issuance of common stock for
    business acquisition










18,724



19



39,345















39,364Issuance of restricted stock










189







660



(660
)










Amortization (reversal) of
    stock-based compensation


















(11,456
)


14,180











2,724Balances at December 31,
    2004










263,681



264



1,695,424



(939
)


(985
)


(1,702,399
)


(8,635
)Net loss






























(15,722
)


(15,722
)Unrealized gains on
    available-for-sale
    securities


























26







26Foreign currency translation
    adjustment


























962







962Comprehensive loss


































(14,734
)Issuance of common stock for ESPP










3,898



3



3,384















3,387Issuance of common stock upon
    exercise of options










774



1



620















621Amortization (reversal) of
    stock-based compensation


















(1,742
)


934











(808
)Balances at December 31,
    2005










268,353



268



1,697,686



(5
)


3



(1,718,121
)


(20,169
)Net loss






























(13,949
)


(13,949
)Comprehensive loss


































(13,949
)Issuance of common stock for ESPP










3,048



3



2,761















2,764Issuance of common stock upon
    exercise of options










3,275



3



3,741















3,744Issuance of common stock for
    business acquisition










15,361



16



16,298















16,314Issuance of common stock to
    EarthLink related to purchase agreements










6,135



6



9,594















9,600Issuance of common stock as a
    result of business acquisition expenses










705



1



749















750Stock-based compensation


















3,295



5











3,300Balances at December 31,
    2006





$




296,877


$
297


$
1,734,124


$



$
3


$
(1,732,070
)

$
2,354    59




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  CONSOLIDATED STATEMENTS OF CASH FLOWS
  Year Ended December 31,2006


2005


2004(All dollar amounts arepresented in thousands)Operating Activities:Net loss

$
(13,949
)

$
(15,722
)

$
(60,761
)Adjustments to reconcile net loss
    to net cash provided by (used in) operating activities:Provision for bad debts (bad debt
    recoveries), net


251



571



(2,035
)Benefit from federal excise tax
    adjustment


(19,455
)






Depreciation and amortization


44,825



67,241



77,410Loss on disposition of property and
    equipment


2



53



669Stock-based compensation expense
    (reversal)


3,300



(808
)


2,737Amortization of deferred customer
    incentives


759



1,419



1,749Amortization of deferred debt
    issuance costs


1,680



1,008



809Accretion of interest on
    investments, net


(199
)


(408
)


(716
)Gain on sale of equity securities






(28,844
)


Gain on deconsolidation of
    subsidiary






(53,963
)


Net changes in operating assets and
    liabilities, net of assets acquired and liabilities assumed in
    purchase acquisition:Accounts receivable


(2,830
)


1,396



1,055Unbilled revenues


759



499



1,302Inventories


1,644



(616
)


730Prepaid expenses and other current
    assets


(2,097
)


1,364



741Deferred costs of service activation


1,188



4,696



1,334Accounts payable


9,754



2,576



4,407Collateralized and other customer
    deposits


(11,019
)


(2,208
)


(7,908
)Redemption of collateralized
    customer deposit


(33,538
)






Other current liabilities


(1,067
)


(13,306
)


(12,059
)Unearned revenues


(4,662
)


(5,680
)


(5,788
)Net cash provided by (used in)
    operating activities


(24,654
)


(40,732
)


3,676Investing Activities:Restricted cash and cash
    equivalents, net


(14,075
)


(2,970
)


359Purchase of short-term investments
    in debt securities


(27,284
)


(43,835
)


(144,105
)Maturities of short-term
    investments in debt securities


23,900



65,548



160,268Proceeds from the sale of equity
    securities






29,807



Purchase of property and equipment


(46,964
)


(42,397
)


(38,743
)Proceeds from sale of property and
    equipment


60



141



115Payment of collocation fees and
    purchase of other intangible assets


(3,236
)


(3,582
)


(7,900
)Payment in connection with business
    acquisition, net of cash acquired


(3,187
)






(366
)Payment in connection with assets
    purchase


(1,183
)






Decrease in other long-term assets


144



1,899



592Net cash provided by (used in)
    investing activities


(71,825
)


4,611



(29,780
)Financing Activities:Proceeds from the issuance of
    senior unsecured convertible debentures, net of issuance costs


38,457







119,961Proceeds from utilization of credit
    facility


18,300







Principal payments on credit
    facility


(12,200
)






Principal payments of long-term debt


(1,031
)






(50,000
)Principal payments under capital
    lease obligations


(517
)


(1,102
)


(386
)Payment of issuance cost related to
    credit facility


(651
)






Proceeds from the issuance of
    common stock, net of issuance costs


16,109



4,008



8,659Net cash provided by financing
    activities


58,467



2,906



78,234Net increase (decrease) in cash and
    cash equivalents


(38,012
)


(33,215
)


52,130Cash and cash equivalents at
    beginning of year


84,291



117,506



65,376Cash and cash equivalents at end of
    year

$
46,279


$
84,291


$
117,506Supplemental Disclosures of Cash
    Flow Information:Cash paid during the year for
    interest

$
4,038


$
3,831


$
8,535Supplemental Schedule of
    Non-Cash Investing and Financing Activities:Interest obligation settled with
    the issuance of additional convertible long-term notes

$
2,240


$



$
Equipment purchased through capital
    leases

$
1,139


$
573


$
959Common stock issued in settlement
    of claims related to bankruptcy

$



$



$
6,951Common stock issued for acquisition
    of business

$
16,314


$



$
39,364Common stock issued as a result of
    business acquisition expenses

$
750


$



$
1,781    60




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
 Years Ended December 31, 2006, 2005 and 2004
 (All dollar and share amounts are presented in thousands,
    except per share amounts)
  1.
    Nature of
    Operations and Summary of Significant Accounting
    Policies  Organization,
    Business and Basis of Presentation
  Organization
    and Business
      Long-Term Debt and Credit
    Arrangements,
  Basis of
    Presentation
   61




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Summary
    of Significant Accounting Policies
  Use of
    Estimates
    Cash
    Equivalents and Short-Term Investments
  available-for-sale available-for-sale available-for-sale
    December 31, 2006Gross


GrossAmortized


Unrealized


UnrealizedCost


Gains


Losses


Fair ValueCommercial paper

$
6,380


$



$



$
6,380Corporate debentures/bonds


9,412



2



(1
)


9,413Total
    available-for-sale
    securities

$
15,792


$
2


$
(1
)

$
15,793   December 31, 2005Gross


GrossAmortized


Unrealized


UnrealizedCost


Gains


Losses


Fair ValueU.S. Government agency
    securities

$
6,486


$



$
(5
)

$
6,481Agency discount note


497











497Commercial paper


5,231



1







5,232Total
    available-for-sale
    securities

$
12,214


$
1


$
(5
)

$
12,210   available-for-sale
 62




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   available-for-sale
  Year EndedDecember 31,2006


2005


2004Total gains

$



$
28,844


$
   Restricted
    Cash and Cash Equivalents
  Long-Term Debt and Credit Arrangements.
  Other
    Investments
      Concentrations
    of Credit Risk, Significant Customers and Key
    Suppliers
    Revenue Recognition,
   63




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Related
    Parties
      Inventories
  first-in,
  Property
    and Equipment
    Leasehold improvements

5 years or the term of the
    lease, whichever is lessComputer equipment

2 to 5 yearsComputer software

3 to 5 yearsFurniture and fixtures

2 to 5 yearsNetworks and communication
    equipment

2 to 5 years    64




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Collocation
    Fees and Other Intangible Assets
        2007

$
9,1762008

$
7,3062009

$
4,3512010

$
1,4802011

$
455   Changes
    in Accounting Estimates
      2006-50
 65




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  2006-50
    Impairment
    of Long-lived Assets
      Advertising
    Costs
      Market
    Development Funds
   66




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Legal
    Costs
    Income
    Taxes
    Fair
    Values of Financial Instruments
    Cash, Cash Equivalents, Short-Term Investments and Restricted
    Cash and Cash Equivalents
  Borrowings
  Foreign
    Currency
    Net Loss
    per Share
     67




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Year Ended December 31,2006


2005


2004Weighted-average shares of common
    stock outstanding


290,262



265,261



249,295Less weighted-average shares of
    common stock subject to repurchase






21



108Weighted-average common shares
    used in computing basic and dilutive net loss per share amounts


290,262



265,240



249,187     Year Ended December 31,2006


2005


2004Stock options


23,082



24,973



22,997Options under employee stock
    purchase plan










4,441Warrants


6,514



6,514



6,514Common shares issuable under the
    assumed conversion of convertible debentures and notes


62,089



39,380



39,380   Comprehensive
    Loss
    Cumulative


Year Ended December 31,Amounts


2006


2005


2004Net loss

$
(1,732,070
)

$
(13,949
)

$
(15,722
)

$
(60,761
)Unrealized gains (losses) on
    available-for-sale
    securities


3







29,832



(32
)Realized gains on equity
    securities previously included in unrealized gains (losses)










(29,806
)


Foreign currency translation
    adjustment










962



Comprehensive loss

$
(1,732,067
)

$
(13,949
)

$
(14,734
)

$
(60,793
)  68




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Goodwill
      Business Acquisitions, Asset Acquisition and Equity
    Investments.
  Business Acquisitions, Asset Acquisition and Equity
    Investments.
  Collateralized
    and Other Customer Deposits
  10-year
   69




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Post-Employment
    Benefits
    Recent
    Accounting Pronouncements
  Fair Value
    Measurements.
  Considering the Effects
    of Prior Year Misstatements when Quantifying Misstatements in
    Current Year Financial Statement.
  No. 06-3, How Taxes Collected from Customers and Remitted to
    Governmental Authorities should be Presented in the Income
    Statement. 06-3
 70




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Disclosure of Accounting Policies. 06-3 06-3
  Accounting for Uncertainty in Income Taxes Accounting for Income Taxes.
  Risks and
    Uncertainties
    
    changes in government policy, regulation and enforcement or
    adverse judicial or administrative interpretations and rulings
    or legislative action relating to regulations, enforcement and
    pricing, 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;
    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   71




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
            December 31,2006


2005Gross accounts receivable

$
34,123


$
31,398Allowance for service credits


(2,729
)


(2,838
)Allowance for bad debts


(243
)


(486
)Accounts receivable, net

$
31,151


$
28,074     December 31,2006


2005


2004Allowance for service
    credits:Balance at beginning of period

$
2,838


$
1,405


$
2,124Provision


4,536



9,333



4,914Write-offs


(4,645
)


(7,330
)


(5,136
)Recoveries






(570
)


(497
)Balance at end of period

$
2,729


$
2,838


$
1,405  72




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  December 31,2006


2005


2004Allowance for bad
    debts:Balance at beginning of period

$
486


$
161


$
2,750Provision


173



800



487Write-offs


(416
)


(329
)


(1,051
)Recoveries






(146
)


(2,025
)Balance at end of period

$
243


$
486


$
161   Significant
    Customers
      Wholesaler
    Financial Difficulties
     73




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    3.
    Restructuring
    and Post-Employment Benefits  Reduction
    in Force
    Other
    Restructuring Activities
       74




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   4.
    Property
    and Equipment    December 31,2006


2005Leasehold improvements

$
10,952


$
10,880Computer equipment


51,066



50,797Computer software


60,789



57,362Furniture and fixtures


16,866



16,268Network and communication equipment


442,914



403,071582,587



538,378Less accumulated depreciation and
    amortization


495,001



466,715Property and equipment, net

$
87,586


$
71,663   5.
    Collocation
    Fees and Other Intangibles Assets    December 31,2006


2005Collocation fees

$
100,458


$
97,243Customer lists


19,241



10,470119,699



107,713Less accumulated amortization:Collocation fees


87,104



80,548Customer lists


9,827



6,450Collocation fees and other
    intangibles assets, net

$
22,768


$
20,715   6.  Business
    Acquisition, Asset Acquisitions and Equity Investments
  Acquisition
    of DataFlos Assets
        Acquisition
    of NextWeb
   75




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
            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    76




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
           Acquisition
    of GoBeam
       77




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Total purchase cost:Value of common shares issued

$
38,910Value of assumed GoBeam options
    and warrants


45439,364Acquisition costs


473Total purchase cost

$
39,837Purchase price allocation:Tangible net liabilities acquired

$
(4,479
)Intangible assets acquired:Customer relationships


6,600Internal use software


1,090Goodwill


36,626Total purchase consideration

$
39,837             Year Ended December 31,2004Revenue

$
432,148Net loss

$
(68,331
)Basic and diluted net loss per
    share

$
(0.27
)    78




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Unconsolidated
    Investments in Affiliates
    Ownership





InvestmentPercentage


Method of


Carrying ValueEntity Name

Date of Investment(s)


2006


2005


Accounting


2006


2005ACCA Networks Co., Ltd.


August 2000











Equity







Certive Corporation


November 1999; May 2000



0.01
%


0.01
%


Equity







   ACCA
    Networks Co., Ltd.
    paid-up
  Certive
    Corporation
   79




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   7.
    Long-Term
    Debt and Credit Arrangements  12% Senior
    Secured Convertible Notes
      Form S-3
      3% Convertible
    Senior Debentures
   80




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Line
    of Credit
       81




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   8.
    Capital
    Leases    9.  Operating
    Leases, Commitments and Purchase Obligations
  Operating
    Leases
    Gross Lease


Less Sublease


Net LeasePayments


Payments


PaymentsYear ending December 31, 2007

$
6,526


$
30


$
6,4962008


6,080







6,0802009


4,215







4,2152010


2,586







2,5862011


674







674Thereafter


49







49Total

$
20,130


$
30


$
20,100   Commitments
             82




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Purchase
    Obligations
      Year ending December 31, 2007

$
5,845     10.
    Contingencies  Litigation
     83




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
             Other
    Contingencies
   84




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        Indemnification
    Agreements
      11.
    Stockholders
    Equity  Common
    Stock
   85




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Outstanding options


23,082Options available for grant


15,361Employee stock purchase plan


5,989Convertible debentures


62,089Outstanding warrants


6,514Total


113,035   Stockholder
    Protection Rights Plan
    Warrants
     86




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
       12.
    Income
    Taxes      Year Ended December 31,2006


2005


2004Federal benefit at statutory rate

$
(4,882
)

$
(5,503
)

$
(21,266
)State benefit, net of federal
    benefit


(697
)


(786
)


(3,038
)Net operating losses with no
    current benefits


4,143



5,931



22,290Deferred variable stock-based
    compensation


1,000



(364
)


1,099Other


436



722



915Income tax expense (benefit)

$



$



$
     December 31,2006


2005Deferred tax assets:Net operating loss carryforwards

$
392,458


$
368,863Capital loss carryforwards


11,700



10,163Deferred and unearned revenue


11,205



31,610Unconsolidated investments in
    affiliates


2,030



2,030Depreciation and amortization


33,365



41,655Other


2,555



11,229Total deferred tax assets


453,313



465,550Deferred tax liabilities


(3,420
)


(1,821
)Net deferred tax assets


449,893



463,729Valuation allowance


(449,893
)


(463,729
)Net deferred taxes

$



$
    87




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Share-Based
    Payment. Accounting for Stock Issued to Employees.
               88




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   13.
    Stock-Based
    Compensation  Impact
    of adopting SFAS 123R
  Accounting for Stock-Based Compensation, Accounting for
    Stock-Based Compensation  Transition and
    Disclosures.
        Valuation
    Assumptions
  Share-Based Payment
 89




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        Stock Options


Employee Stock Purchase Plan2006


2005


2004


2006


2005


2004Stock OptionsExpected life of options in years


3.4



4.0



4.0



0.5



0.5



0.5Volatility


83.06
%


91.07
%


123.70
%


68.76
%


91.07
%


123.70
%Risk-free interest rate


4.78
%


4.34
%


3.27
%


5.00
%


4.35
%


2.61
%Expected dividend yield


0.00
%


0.00
%


0.00
%


0.00
%


0.00
%


0.00
%   Equity
    Incentive Programs
    2003
    Employee Stock Purchase Plan
       90




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Stock
    Option Plans
    out-of-the-money
       91




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Number of Shares of


Option Price per


Weighted-AverageCommon Stock


Share


Exercise PriceBalance as of December 31,
    2003


21,677


$
0.001 - $149.79


$
5.76Granted


6,867


$
1.460 - $  3.51


$
2.81Exercised


(1,951
)

$
0.001 - $  3.72


$
1.10Cancelled, expired and forfeited


(3,596
)

$
0.001 - $149.79


$
8.49Balance as of December 31,
    2004


22,997


$
0.001 - $149.79


$
5.35Granted and assumed


7,162


$
0.730 - $  1.69


$
1.42Exercised


(774
)

$
0.296 - $  2.16


$
0.80Cancelled, expired and forfeited


(4,412
)

$
0.022 - $149.79


$
5.89Balance as of December 31,
    2005


24,973


$
0.001 - $149.79


$
4.96Granted


5,528


$
1.180 - $  2.51


$
1.52Exercised


(3,275
)

$
0.296 - $  2.52


$
1.14Cancelled, expired and forfeited


(4,144
)

$
0.001 - $149.79


$
6.99Balance as of December 31,
    2006


23,082


$
0.350 - $149.79


$
4.31     Options Outstanding


Options ExercisableWeighted-











Weighted-Average











AverageRemaining











RemainingRange of

Number


Contractual


Weighted-


Aggregate


Number


Contractual


Weighted-


AggregateExercise

of


Term


Average


Intrinsic


of


Term


Average


IntrinsicPrices

Shares


(in years)


Exercise Price


Value


Shares


(in years)


Exercise Price


Value$0.35 - $  0.56


788






$
0.55







788






$
0.55$0.57 - $  0.84


2,560







0.83







2,449







0.83$0.86 - $  1.24


3,318







1.18







1,260







1.16$1.26 - $  1.28


2,515







1.28







2,309







1.28$1.29 - $  1.52


2,086







1.39







921







1.38$1.54 - $  1.54


2,696







1.54







2,695







1.54$1.56 - $  2.40


2,479







1.98







1,373







2.02$2.41 - $  2.56


1,601







2.53







1,381







2.55$2.63 - $  3.34


2,786







3.33







2,785







3.33$3.51 - $149.79


2,253







28.64







2,253







28.64$0.35 - $149.79


23,082



4.72


$
4.31


$
3,049



18,214



4.10


$
5.07


$
2,530   in-the-money
   92




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Stock OptionsWeighted-AverageGrant-DateNumber of Shares


Fair ValueNon-vested at December 31,
    2005


2,240


$
0.43Awards granted


5,528



0.97Awards vested


(1,750
)


0.97Awards cancelled, expired and
    forfeited


(1,150
)


0.68Non-vested at December 31,
    2006


4,868


$
0.91   Prior
    to adopting SFAS 123R
    2005


2004Basic:Net loss, as reported

$
(15,722
)

$
(60,761
)Stock-based employee compensation
    expense (reversal) included in the determination of net income
    (loss), as reported


(808
)


2,724Stock-based employee compensation
    expense that would have been included in the determination of
    net loss if the fair value method had been applied to all awards


(19,767
)


(21,593
)Net loss, pro-forma

$
(36,297
)

$
(79,630
)Weighted-average number of common
    shares outstanding used in the computations of basic and diluted
    loss per share


265,240



249,187Basic and diluted net loss per
    common share:As reported

$
(0.06
)

$
(0.24
)Pro forma

$
(0.14
)

$
(0.32
)   Defined
    Contribution Plan
     93




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   14.
    Business
    Segments         94




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Total


Corporate


ConsolidatedWholesale


Direct


Segments


Operations


TotalAs of and for the year ended
    December 31, 2006:Revenue, net

$
315,321


$
158,983


$
474,304


$



$
474,304Cost of sales (exclusive of
    depreciation and amortization)


186,142



94,484



280,626



47,848



328,474Benefit from federal exercise tax
    adjustment














(19,455
)


(19,455
)Selling, general and administrative


7,742



36,183



43,925



83,204



127,129Provision for bad debts














251



251Depreciation and amortization














34,876



34,876Amortization of intangible assets














9,949



9,949Provision for restructuring and
    post-employment benefits


232



479



711



886



1,597Total operating expenses


194,116



131,146



325,262



157,559



482,821Income (loss) from operations


121,205



27,837



149,042



(157,559
)


(8,517
)Interest income














3,938



3,938Interest expense














(9,562
)


(9,562
)Miscellaneous income, net














192



192Total other income, net














(5,432
)


(5,432
)Net income (loss)

$
121,205


$
27,837


$
149,042


$
(162,991
)

$
(13,949
)Assets

$
35,795


$
22,191


$
57,986


$
255,322


$
313,308Capital expenditures for property
    and equipment













$
46,964


$
46,964Payment of collocation fees and
    purchase of other intangible assets













$
3,236


$
3,236   95




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Total


Corporate


ConsolidatedWholesale


Direct


Segments


Operations


TotalAs of and for the year ended
    December 31, 2005:Revenue, net

$
314,205


$
128,974


$
443,179


$



$
443,179Cost of sales (exclusive of
    depreciation and amortization)


193,721



81,521



275,242



35,897



311,139Selling, general and administrative


8,353



49,938



58,291



100,261



158,552Provision for bad debts














571



571Depreciation and amortization














49,813



49,813Amortization of intangible assets














17,428



17,428Provision for restructuring and
    post-employment benefits


285



397



682



2,958



3,640Total operating expenses


202,359



131,856



334,215



206,928



541,143Income (loss) from operations


111,846



(2,882
)


108,964



(206,928
)


(97,964
)Interest income














4,142



4,142Gain on sale of equity securities














28,844



28,844Gain on deconsolidation of
    subsidiary














53,963



53,963Interest expense














(5,005
)


(5,005
)Miscellaneous income, net














298



298Total other income, net














82,242



82,242Net income (loss)

$
111,846


$
(2,882
)

$
108,964


$
(124,686
)

$
(15,722
)Assets

$
38,725


$
19,395


$
58,120


$
242,461


$
300,581Capital expenditures for property
    and equipment

$



$



$



$
42,397


$
42,397Payment of collocation fees and
    purchase of other intangible assets

$



$



$



$
3,582


$
3,582   96




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Total


Corporate


ConsolidatedWholesale


Direct


Segments


Operations


TotalAs of and for the year ended
    December 31, 2004:Revenue, net

$
309,899


$
119,298


$
429,197


$



$
429,197Cost of sales (exclusive of
    depreciation and amortization)


177,115



57,141



234,256



31,916



266,172Selling, general and administrative


9,048



36,859



45,907



100,334



146,241Provision for bad debt recoveries














(2,035
)


(2,035
)Depreciation and amortization














56,825



56,825Amortization of intangible assets














20,585



20,585Provision for restructuring and
    post-employment benefits


374



281



655



754



1,409Total operating expenses


186,537



94,281



280,818



208,379



489,197Income (loss) from operations


123,362



25,017



148,379



(208,379
)


(60,000
)Interest income














2,668



2,668Interest expense














(4,927
)


(4,927
)Miscellaneous income, net














1,498



1,498Total other expense, net














(761
)


(761
)Net income (loss)

$
123,362


$
25,017


$
148,379


$
(209,140
)

$
(60,761
)Assets

$
47,994


$
18,707


$
66,701


$
318,524


$
385,225Capital expenditures for property
    and equipment

$



$



$



$
38,743


$
38,743Payment of collocation fees and
    purchase of other intangible assets

$



$



$



$
7,900


$
7,900    97




---



##### Table of Contents



COVAD
    COMMUNICATIONS GROUP, INC.
  SUPPLEMENTARY
    DATA
  Selected
    Quarterly Financial Information (Unaudited)
  (All dollar and share amounts are presented in thousands,
    except per share amounts)
    Three Months EndedMarch 31


June 30


September 30


December 312006:Revenues, net

$
117,751


$
118,535


$
118,562


$
119,456Gross profit (exclusive of
    depreciation and amortization)

$
37,814


$
37,733


$
35,152


$
35,131Depreciation and amortization

$
11,048


$
10,716


$
10,712


$
12,349Net income (loss)

$
(9,280
)

$
12,473


$
(8,700
)

$
(8,442
)Earnings (loss) per common share:Basic

$
(0.03
)

$
0.04


$
(0.03
)

$
(0.03
)Diluted

$
(0.03
)

$
0.04


$
(0.03
)

$
(0.03
)2005:Revenues, net

$
107,718


$
109,741


$
112,069


$
113,651Gross profit (exclusive of
    depreciation and amortization)

$
34,969


$
33,501


$
27,572


$
35,998Depreciation and amortization

$
19,149


$
17,626


$
16,038


$
14,428Net income (loss)

$
34,374


$
(16,403
)

$
(15,805
)

$
(17,888
)Earnings (loss) per common share:Basic

$
0.13


$
(0.06
)

$
(0.06
)

$
(0.07
)Diluted

$
0.11


$
(0.06
)

$
(0.06
)

$
(0.07
)     2006-50 2006-50
  Other
    Restructuring Activities ACCA Networks Co., Ltd.
 98




---



##### Table of Contents



ITEM 9.
    Changes
    in and Disagreements with Accountants on Accounting and
    Financial Disclosure    ITEM 9A.
    Controls
    and Procedures  Evaluation
    of Disclosure Controls and Procedures:
      Managements
    Report on Internal Control over Financial Reporting:
  Rule 13a-15(f)
  Internal Control 
    Integrated Framework.
  Internal Control  Integrated
    Framework.
  Financial
    Statements and Supplementary Data.
  Changes
    in Internal Control over Financial Reporting:
   99




---



##### Table of Contents



ITEM 9B.
    Other
    Information    PART III  ITEM 10.
    Directors,
    Executive Officers and Corporate Governance   ITEM 11.  Executive
    Compensation



Information regarding director and executive compensation in the
    2007 Proxy Statement is hereby incorporated by reference.  ITEM 12.
    Security
    Ownership of Certain Beneficial Owners and Management and
    Related Stockholder Matters    ITEM 13.
    Certain
    Relationships and Related Transactions, and Director
    Independence    ITEM 14.
    Principal
    Accounting Fees and Services    PART IV  ITEM 15.
    Exhibits,
    Financial Statement Schedules  Form 10-K:
  Financial Statements.
              Financial Statement
    Schedules. conditions
  Exhibits. Form 10-K.
 100




---



##### Table of Contents



EXHIBIT INDEX
  Incorporated by ReferenceExhibit







Date of

Exhibit

FiledNumber

Exhibit Description

Form

File No.

First Filing

Number

Herewith2
.1

Plan: First Amended Plan of
    Reorganization, as Modified, of Covad Communications Group, Inc.
    dated November 26, 2001

8-K

000-25271

12/28/01


2
.12
.2

Order Pursuant to
    Section 1129 of the Bankruptcy Code Confirming the
    Debtors First Amended Chapter 11 Plan of
    Reorganization, as Modified

8-K

000-25271

12/28/01


99
.122
.3

Agreement and Plan of Merger,
    dated as of March 2, 2004, among Covad Communications
    Group, Inc., Covad Communications Investment Corp., GoBeam, Inc.
    and Eduardo Briceno, as Representative

8-K

000-25271

5/17/04


2
.12
.4

Agreement and Plan of Merger,
    dated as of October 4, 2005, among Covad Communications
    Group, Inc., Windtalker Acquisition Corp., NextWeb, Inc. and
    Ghia Griarte as Representative.

8-K

000-25271

10/7/05


2
.13
.1

Amended and Restated Certificate
    of Incorporation

S-1/A

333-38688

7/17/00


3
.23
.2

Certificate of Amendment of
    Certificate of Incorporation of the Registrant filed on
    July 14, 2000

S-1/A

333-38688

7/17/00


3
.53
.3

Certificate of Amendment of
    Certificate of Incorporation of the Registrant filed on
    December 20, 2001

10-K

000-25271

3/29/02


3
.33
.4

Amended and Restated Bylaws, as
    currently in effect

8-K

001-32588

11/2/05


3
.14
.1

12% Senior Secured
    Convertible Note due 2011, dated as of March 29, 2006,
    entered into by Covad Communications Group, Inc. and Covad
    Communications Company for the benefit of EarthLink, Inc.

8-K

001-32588

4/4/06


99
.14
.2

Registration Rights Agreement,
    dated as of March 29, 2006, by and between Covad
    Communications Group, Inc. and EarthLink, Inc.

8-K

001-32588

4/4/06


99
.34
.3

Indenture, dated as of
    March 10, 2004 between the Registrant and The Bank of New
    York, as Trustee

10-Q

000-25271

5/17/04


4
.14
.4

Resale Registration Rights
    Agreement, dated as of March 10, 2004 among the Registrant
    and Banc of America Securities LLC

10-Q

000-25271

5/17/04


4
.24
.5

Form of Debenture for the
    Registrants 3% Convertible Senior Debentures due 2024

10-Q

000-25271

5/17/04


4
.34
.6

Stockholder Protection Rights
    Agreement dated February 15, 2000

8-A

000-25271

2/22/00


4
.14
.7

Amended and Restated Stockholder
    Protection Rights Agreement, dated as of November 1, 2001

8-K

000-25271

12/14/01


4
.14
.8

Amendment to Amended and Restated
    Stockholder Protection Rights Agreement, dated as of
    March 29, 2006, by and between Covad Communications Group,
    Inc. and Mellon Investor Services

8-K

001-32588

4/4/06


99
.510
.1

Form of Indemnification Agreement
    entered into between the Registrant and each of the
    Registrants executive officers and directors

S-1

333-63899

9/21/98


10
.110
.2

1998 Employee Stock Purchase Plan
    and related agreements

10-K

000-25271

3/29/02


10
.2 101




---



##### Table of Contents



Incorporated by ReferenceExhibit







Date of

Exhibit

FiledNumber

Exhibit Description

Form

File No.

First Filing

Number

Herewith10
.3

1997 Stock Plan and related option
    agreement, as currently in effect

10-K

000-25271

3/29/02


10
.310
.4

Resale Agreement dated as of
    November 12, 2001 by and among SBC Communications Inc.,
    Covad Communications Group, Inc., Covad Communications Company,
    DIECA Communications Company and Laser Link.net, Inc.

8-K

000-25271

11/14/01


10
.110
.5

Form of Warrant to Purchase Common
    Stock Issued by the Registrant on September 3, 2002 to
    America Online, Inc.

8-K

000-25271

9/5/02


99
.110
.6

Form of Warrant to Purchase Common
    Stock Issued by the Registrant on January 1, 2003 to
    AT&T Corp.

8-K

000-25271

1/7/03


99
.110
.7

Covad Communications Group, Inc.,
    2003 Employee Stock Purchase Plan, as amended

8-K

001-32588

12/8/05


99
.110
.8

Covad Communications Group, Inc.
    Executive Severance Plan and Summary Plan Description

8-K

000-25271

10/6/04


10
.110
.9

Letter Agreement between Covad
    Communications and Charles Hoffman dated May 29, 2001

10-K

000-25271

2/27/04


10
.4110
.10

Lease Agreement for 110 Rio
    Robles, San Jose, California, between Covad Communications
    and CarrAmerica Realty Corporation dated August 6, 2003

10-K

000-25271

2/27/04


10
.4210
.11

First Amendment to Lease by and
    between Covad Communications Company and CarrAmerica Realty
    Operating Partnership, L.P. dated July 27, 2005

8-K

001-32588

8/1/05


10
.110
.12

Change in Control Agreement
    between Covad Communications Group, Inc. and Charles E. Hoffman

8-K

000-25271

10/6/04


10
.210
.13

Change in Control Agreement
    between Covad Communications Group, Inc. and James A. Kirkland

8-K

000-25271

10/6/04


10
.510
.14

Change in Control Agreement
    between Covad Communications Group, Inc. and David McMorrow

8-K

000-25271

10/6/04


10
.710
.15

Change in Control Agreement
    between Covad Communications Group, Inc. and Chris Dunn

8-K

001-32588

11/2/05


10
.110
.16

Indemnification Agreement between
    Covad Communications Group, Inc. and Chris Dunn

8-K

001-32588

11/2/05


10
.210
.17

Transition Agreement between Covad
    Communications Group, Inc. and Andrew Lockwood

8-K

001-32588

12/15/05


10
.210
.18

Covad Communications 2006 Bonus
    Plan

8-K

001-32588

3/8/06


10
.110
.19

Purchase Agreement, dated as of
    March 15, 2006, by and among Covad Communications Group,
    Inc., Covad Communications Company and EarthLink, Inc.

8-K

001-32588

3/17/06


99
.110
.20

Security Agreement, dated as of
    March 29, 2006, by and among Covad Communications Group,
    Inc., Covad Communications Company and EarthLink, Inc.

8-K

001-32588

4/4/06


99
.210
.21

Agreement for XGDSL Services,
    dated as of March 29, 2006, by and between Covad
    Communications Company and EarthLink, Inc.

8-K

001-32588

4/4/06


99
.4 102




---



##### Table of Contents



Incorporated by ReferenceExhibit







Date of

Exhibit

FiledNumber

Exhibit Description

Form

File No.

First Filing

Number

Herewith10
.22

Loan and Security Agreement, dated
    as of April 13, 2006, between Covad Communications Group,
    Inc., Covad Communications Company and Silicon Valley Bank

8-K

001-32588

4/18/06


10
.110
.23

Indemnification Agreement between
    Covad Communications Group, Inc. and Robert Neumeister

8-K

001-32588

4/26/06


10
.110
.24

Change in Control Agreement
    between Covad Communications Group, Inc. and Patrick Bennett

8-K

001-32588

8/1/06


10
.110
.25

Indemnification Agreement between
    Covad Communications Group, Inc. and Diana Leonard

8-K

001-32588

12/12/06


10
.110
.26

Covad Communications 2007
    Executive Short Term Incentive Plan

8-K

001-32588

1/9/07


10
.121
.1

Subsidiaries of the Registrant











X23
.1

Consent of PricewaterhouseCoopers
    LLP, Independent Registered Public Accounting Firm











X24
.1

Power of Attorney (incorporated in
    the signature page herein)











X31
.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 Annual
    Report on
    Form 10-K
    and are not deemed filed with the SEC. 103




---



##### Table of Contents



SIGNATURES      By:
    /s/  Christopher
    Dunn  Christopher Dunn
 Senior Vice President and
 Chief Financial Officer
    Signature

Title/s/  Charles
    E. Hoffman(Charles
    E. Hoffman)

Chief Executive Officer and
    Director
    (Principal Executive Officer)/s/  Christopher
    Dunn(Christopher
    Dunn)

Senior Vice President and Chief
    Financial Officer
    (Principal Financial and Accounting Officer)/s/  Charles
    McMinn(Charles
    McMinn)

Chairman of the Board of Directors/s/  L.
    Dale Crandall(L.
    Dale Crandall)

Director/s/  Diana
    Einterz Leonard(Diana
    Einterz Leonard)

Director/s/  Robert
    M. Neumeister, Jr.(Robert
    M. Neumeister, Jr.)

Director/s/  Larry
    Irving(Larry
    Irving)

Director/s/  Daniel
    Lynch(Daniel
    Lynch)

Director/s/  Richard
    A. Jalkut(Richard
    Jalkut)

Director  104




---



##### Table of Contents



EXHIBIT INDEX
 Incorporated by ReferenceExhibit







Date of

Exhibit

FiledNumber

Exhibit Description

Form

File No.

First Filing

Number

Herewith2
.1

Plan: First Amended Plan of
    Reorganization, as Modified, of Covad Communications Group, Inc.
    dated November 26, 2001

8-K

000-25271

12/28/01


2
.12
.2

Order Pursuant to
    Section 1129 of the Bankruptcy Code Confirming the
    Debtors First Amended Chapter 11 Plan of
    Reorganization, as Modified

8-K

000-25271

12/28/01


99
.122
.3

Agreement and Plan of Merger,
    dated as of March 2, 2004, among Covad Communications
    Group, Inc., Covad Communications Investment Corp., GoBeam, Inc.
    and Eduardo Briceno, as Representative

8-K

000-25271

5/17/04


2
.12
.4

Agreement and Plan of Merger,
    dated as of October 4, 2005, among Covad Communications
    Group, Inc., Windtalker Acquisition Corp., NextWeb, Inc. and
    Ghia Griarte as Representative

8-K

000-25271

10/7/05


2
.13
.1

Amended and Restated Certificate
    of Incorporation

S-1/A

333-38688

7/17/00


3
.23
.2

Certificate of Amendment of
    Certificate of Incorporation of the Registrant filed on
    July 14, 2000

S-1/A

333-38688

7/17/00


3
.53
.3

Certificate of Amendment of
    Certificate of Incorporation of the Registrant filed on
    December 20, 2001

10-K

000-25271

3/29/02


3
.33
.4

Amended and Restated Bylaws, as
    currently in effect

8-K

001-32588

11/2/05


3
.14
.1

12% Senior Secured
    Convertible Note due 2011, dated as of March 29, 2006,
    entered into by Covad Communications Group, Inc. and Covad
    Communications Company for the benefit of EarthLink, Inc.

8-K

001-32588

4/4/06


99
.14
.2

Registration Rights Agreement,
    dated as of March 29, 2006, by and between Covad
    Communications Group, Inc. and EarthLink, Inc.

8-K

001-32588

4/4/06


99
.34
.3

Indenture, dated as of
    March 10, 2004 between the Registrant and The Bank of New
    York, as Trustee

10-Q

000-25271

5/17/04


4
.14
.4

Resale Registration Rights
    Agreement, dated as of March 10, 2004 among the Registrant
    and Banc of America Securities LLC

10-Q

000-25271

5/17/04


4
.24
.5

Form of Debenture for the
    Registrants 3% Convertible Senior Debentures due 2024

10-Q

000-25271

5/17/04


4
.34
.6

Stockholder Protection Rights
    Agreement dated February 15, 2000

8-A

000-25271

2/22/00


4
.14
.7

Amended and Restated Stockholder
    Protection Rights Agreement, dated as of November 1, 2001

8-K

000-25271

12/14/01


4
.14
.8

Amendment to Amended and Restated
    Stockholder Protection Rights Agreement, dated as of
    March 29, 2006, by and between Covad Communications Group,
    Inc. and Mellon Investor Services

8-K

001-32588

4/4/06


99
.510
.1

Form of Indemnification Agreement
    entered into between the Registrant and each of the
    Registrants executive officers and directors

S-1

333-63899

9/21/98


10
.110
.2

1998 Employee Stock Purchase Plan
    and related agreements

10-K

000-25271

3/29/02


10
.210
.3

1997 Stock Plan and related option
    agreement, as currently in effect

10-K

000-25271

3/29/02


10
.3




---



##### Table of Contents



Incorporated by ReferenceExhibit







Date of

Exhibit

FiledNumber

Exhibit Description

Form

File No.

First Filing

Number

Herewith10
.4

Resale Agreement dated as of
    November 12, 2001 by and among SBC Communications Inc.,
    Covad Communications Group, Inc., Covad Communications Company,
    DIECA Communications Company and Laser Link.net, Inc.

8-K

000-25271

11/14/01


10
.1Form of Warrant to Purchase Common10
.5

Stock Issued by the Registrant on
    September 3, 2002 to America Online, Inc.

8-K

000-25271

9/5/02


99
.110
.6

Form of Warrant to Purchase Common
    Stock Issued by the Registrant on January 1, 2003 to
    AT&T Corp.

8-K

000-25271

1/7/03


99
.110
.7

Covad Communications Group, Inc.,
    2003 Employee Stock Purchase Plan, as amended

8-K

001-32588

12/8/05


99
.110
.8

Covad Communications Group, Inc.
    Executive Severance Plan and Summary Plan Description

8-K

000-25271

10/6/04


10
.110
.9

Letter Agreement between Covad
    Communications and Charles Hoffman dated May 29, 2001

10-K

000-25271

2/27/04


10
.4110
.10

Lease Agreement for 110 Rio
    Robles, San Jose, California, between Covad Communications
    and CarrAmerica Realty Corporation dated August 6, 2003

10-K

000-25271

2/27/04


10
.4210
.11

First Amendment to Lease by and
    between Covad Communications Company and CarrAmerica Realty
    Operating Partnership, L.P. dated July 27, 2005

8-K

001-32588

8/1/05


10
.110
.12

Change in Control Agreement
    between Covad Communications Group, Inc. and Charles E. Hoffman

8-K

000-25271

10/6/04


10
.210
.13

Change in Control Agreement
    between Covad Communications Group, Inc. and James A. Kirkland

8-K

000-25271

10/6/04


10
.510
.14

Change in Control Agreement
    between Covad Communications Group, Inc. and David McMorrow

8-K

000-25271

10/6/04


10
.710
.15

Change in Control Agreement
    between Covad Communications Group, Inc. and Chris Dunn

8-K

001-32588

11/2/05


10
.110
.16

Indemnification Agreement between
    Covad Communications Group, Inc. and Chris Dunn

8-K

001-32588

11/2/05


10
.210
.17

Transition Agreement between Covad
    Communications Group, Inc. and Andrew Lockwood

8-K

001-32588

12/15/05


10
.210
.18

Covad Communications 2006 Bonus
    Plan

8-K

001-32588

3/8/06


10
.110
.19

Purchase Agreement, dated as of
    March 15, 2006, by and among Covad Communications Group,
    Inc., Covad Communications Company and EarthLink, Inc.

8-K

001-32588

3/17/06


99
.110
.20

Security Agreement, dated as of
    March 29, 2006, by and among Covad Communications Group,
    Inc., Covad Communications Company and EarthLink, Inc.

8-K

001-32588

4/4/06


99
.210
.21

Agreement for XGDSL Services,
    dated as of March 29, 2006, by and between Covad
    Communications Company and EarthLink, Inc.

8-K

001-32588

4/4/06


99
.410
.22

Loan and Security Agreement, dated
    as of April 13, 2006, between Covad Communications Group,
    Inc., Covad Communications Company and Silicon Valley Bank

8-K

001-32588

4/18/06


10
.110
.23

Indemnification Agreement between
    Covad Communications Group, Inc. and Robert Neumeister

8-K

001-32588

4/26/06


10
.1




---



##### Table of Contents



Incorporated by ReferenceExhibit







Date of

Exhibit

FiledNumber

Exhibit Description

Form

File No.

First Filing

Number

Herewith10
.24

Change in Control Agreement
    between Covad Communications Group, Inc. and Patrick Bennett

8-K

001-32588

8/1/06


10
.110
.25

Indemnification Agreement between
    Covad Communications Group, Inc. and Diana Leonard

8-K

001-32588

12/12/06


10
.110
.26

Covad Communications 2007
    Executive Short Term Incentive Plan

8-K

001-32588

1/9/07


10
.121
.1

Subsidiaries of the Registrant23
.1

Consent of PricewaterhouseCoopers
    LLP, Independent Registered Public Accounting Firm











X24
.1

Power of Attorney (incorporated in
    the signature page herein)











X31
.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 Annual
    Report on
    Form 10-K
    and are not deemed filed with the SEC.