FLAG TELECOM HOLDINGS LTD - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-K
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/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
OR

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission File Number 0-29207

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FLAG TELECOM HOLDINGS LIMITED
(Exact name of registrant as specified in its charter)

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BERMUDA
(State or other jurisdiction of
incorporation or organization)

CEDAR HOUSE
41 CEDAR AVENUE
HAMILTON HM12, BERMUDA
(Address of principal executive office)

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+1-441-296-0909
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$.0006 par value

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /

The aggregate market value of the voting stock held by non-affiliates of the
registrant on March 20, 2002, based upon the closing price of the Common Shares
on The Nasdaq Stock Market for such date, was approximately $35,350,000.

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APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.

The number of outstanding shares of the registrant's Common Shares as of
March 20, 2002 was 134,139,046.

DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents if incorporated by reference and the
Part of the Form 10-K into which the document is incorporated:

None.

A NOTE ABOUT FORWARD-LOOKING STATEMENTS

We have made forward-looking statements in this Form 10-K, including in the
sections entitled "Business" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations", that are based on our
management's beliefs and assumptions and on information currently available to
our management. Forward-looking statements include the information concerning
our possible or assumed results of operations, liquidity and capital resources,
cash flows, business strategies, financing plans, competitive position and
potential growth opportunities. Forward-looking statements include all
statements that are not historical facts and can be identified by the use of
forward-looking terminology such as the words "believes", "expects",
"anticipates", "intends", "plans", "estimates" and similar expressions.

Forward-looking statements involve risks, uncertainties and assumptions.
Actual results may differ materially from those expressed in these
forward-looking statements. You should not put undue reliance on any
forward-looking statements. We do not have any intention or obligation to update
forward-looking statements after we distribute this Form 10-K.

You should understand that many important factors could cause our results to
differ materially from those expressed in these forward-looking statements.
Among the factors that could cause our future results to differ from those
reflected in forward-looking statements are the risks discussed in this
Form 10-K under the heading "Business--Risk Factors" beginning on page 17.
Please read those risk factors carefully.

FLAG TELECOM HOLDINGS LIMITED
TABLE OF CONTENTS

FLAG Telecom Holdings Limited ("FLAG Telecom" or the "Company") is a Bermuda
company with its principal executive offices located at Cedar House, 41 Cedar
Avenue, Hamilton HM12, Bermuda. In addition to the Company, the principal
companies which comprise the FLAG Telecom group of companies are the following
wholly-owned subsidiaries of FLAG Telecom: FLAG Limited, FLAG Atlantic Limited,
FLAG Telecom Ireland Limited, FLAG Asia Limited and FLAG Telecom Global Network
Limited. We refer to these subsidiaries, together with the Company, as the
"Group". In this annual report, the terms "we", "us" and "our" refer to the
Group.

FLAG Telecom is a "foreign private issuer" within the meaning of Rule 3b-4
promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange
Act") and is voluntarily filing periodic reports under the Exchange Act as if it
were a domestic registrant.

PART I

ITEM 1. BUSINESS

INTRODUCTION

Our strategy has not changed in principle since the time of our inception in
1990. We set out to build a global telecommunications network and to leverage
the revenue generating ability of that network by overlaying a range of products
and services focused on serving the needs of other carriers. We have performed
according to our financial plan, built out our systems in a timely manner and on
budget and developed an established base of over 130 customers, many of which
are the world's leading telecommunications and Internet companies. We are highly
focused with a relatively small organization and overhead structure. Our network
is currently operational and is almost complete.

What has changed, quite dramatically, is the economic climate and the
financial challenges imposed on our competitors, customers, potential customers
and us. Overcapacity in some regions, and lower than anticipated demand, have
led to dramatic declines in prices, the unavailability of new capital and a
number of Chapter 11 filings by major competitors. Many of our customers are
limiting their capital commitments to an absolute minimum. In these difficult
market conditions we intend to continue to operate our business conservatively,
with a view to serving our customers, conserving our resources and surviving in
the difficult and fast-changing telecom market.

On February 13, 2002, we announced that we were reviewing our business in
the light of deteriorating market conditions. At that time, we stated that if
there were no improvement in our operating environment, we anticipated that at
some point in 2003 we would not have sufficient liquidity to continue our
operations, unless we were able to raise additional funds, find a strategic
partner, restructure our indebtedness or substantially reduce our cost base in
some other way. On March 7, 2002, we announced that we had retained Credit
Suisse First Boston and The Blackstone Group as strategic and financial advisors
to advise us on financial and strategic alternatives for the long-term
development of the Company. As part of our strategy to conserve capital and to
control costs, these advisors are assisting us in the review of our business and
the evaluation of the most beneficial path for our future, including possible
restructuring of our indebtedness, identifying funding opportunities and working
with potential strategic partners.

With the assistance of our financial advisors, we currently are engaged in
discussions with certain of our lending banks and equipment suppliers regarding
the status of and possible modifications to our existing agreements.
Westdeutsche Landesbank Girozentrale ("WestLB"), the agent bank for our project
financing for our FLAG North Asian Loop, has informed us that it has cancelled
the commitment and terminated the lending facility. We are discussing potential
alternative structures with WestLB and are pursuing other possible financing
structures for financing this system. In addition, as of March 28, 2002, we have
paid all amounts owed to Barclays Bank PLC ("Barclays"), the agent for FLAG
Limited's lending banks, under FLAG Limited's credit agreement. We have also
reached agreement with Barclays, the agent for FLAG Atlantic Limited's lending
banks, under which Barclays has agreed to forbear from exercising certain rights
it may have through April 30, 2002.

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FLAG Telecom has $300 million 11 5/8% Senior Notes and E300 million 11 5/8%
Senior Notes outstanding. We have determined that we will not make the required
interest payments, due March 30, 2002, on these outstanding senior notes.
Failure to pay interest would become an event of default after a 30-day grace
period. After the grace period, the holders of 25% or more of the notes of
either series can accelerate the notes, at which point they would become due and
payable. We do not have sufficient liquidity to pay these two series in full at
this time. We elected not to make this interest payment in order to conserve our
cash and to permit us to enter into discussions with the holders of our
outstanding indebtedness to seek a consensual arrangement under which we would
restructure our outstanding indebtedness.

As a result of our decision not to pay interest on FLAG Telecom's senior
notes, we have reclassified the senior notes from long-term debt to short-term
debt.

If we are unable to negotiate satisfactory arrangements with our lenders and
equipment suppliers, and if FLAG Telecom's senior notes and our equipment
purchase obligations on the FLAG North Asian Loop were to become due and payable
in the near future, we would not have sufficient liquidity to meet all of these
obligations. We cannot assure you that we will be successful in restructuring
our obligations. We may have to seek protection under the insolvency laws either
in conjunction with our restructuring or if we are unable to negotiate a
restructuring. For additional information on these developments, see "Risk
Factors--Risks Relating to our Capital Resources and Liquidity" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources".

Going forward, our operating strategy in the current economic climate is to
preserve capital and reduce costs while, where possible, growing the business
by:

- serving the core backbone needs of large telecoms and Internet companies;

- focusing on regions where we have competitive advantages, such as the
Middle East and Asia, and specializing in hard to reach places with
favorable competitive dynamics; and

- increasing the revenue generating capability of the network by adding
another tier of services, focusing on developing the Internet Protocol
("IP") layer, increasing our Points of Presence ("PoPs") and entering into
new bandwidth intensive markets.

We will continue to operate our business in a focused manner, providing
capacity to traditional carriers, internet service providers and other content
providers and concentrating on geographic regions in which we have a strong
competitive advantage. We have managed our business conservatively and have not
attempted to be all things to all people.

OUR GLOBAL NETWORK

We have developed a global fiber-optic network through our own build and
collaboration with third parties. We set out below the principal features,
geographical reach and status of development of our global network.

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OUR OWN BUILD NETWORK

The following table provides information on the network that we have built
since our inception.

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CAPACITY ACQUIRED FROM OTHER CARRIERS

Where rapid access to a market is required or where it is not economically
feasible to expand our network on our own, we seek to enter into arrangements
with third parties to develop network extensions or to acquire rights to use
their existing networks. Purchasing or leasing capacity from other industry
participants enables us to extend our global network into geographical regions
where we have not constructed our own cable systems at a lower cost than
constructing our own competing capacity. In today's market conditions,
especially given the current difficult capital markets for telecom companies,
purchasing and leasing enables us to access capacity where we might not be able
to construct our own network.

For example, in 2001:

- We announced that we had decided, as a result of our inability to obtain
financing on satisfactory terms, not to proceed with the construction of
the FLAG trans-Pacific system ("FP-1"), that was contemplated to be built
in association with TyCo Telecommunications. Rather than continuing with
the construction of FP-1, we acquired capacity on the Japan-U.S.
consortium cable system and on Asia Global Crossing and Marubeni's jointly
owned PC-1 cable system in order to link FNAL with the west coast of the
U.S.

- We have arrangements in place to use capacity on the U.S. networks of
Level 3 and Global Crossing in order to fulfill our requirements for
carrying traffic across the U.S. We expect to activate wavelengths from
New York to Los Angeles and New York to Miami in 2002.

- We established our FLAG Europe system, an advanced terrestrial fiber-optic
network developed in association with Verizon Communications, Inc. which
links the major European business centers. Interconnection of the FLAG
Europe system with FA-1 and FEA provides seamless connectivity from
European centers to the U.S., the Middle East and Asia. The system went
live on the core ring in the second quarter of 2001.

- We also purchased dark fiber, lit wavelength capacity and co-location
facilities on KPNQwest's pan-European fiber-optic network to extend the
reach of our global network into the major business centers of Europe.

- We acquired capacity into Singapore in order to meet both customer and
regulatory requirements.

In each case, management believed that it was more cost effective to acquire
capacity from third parties than to expand our network independently.

We believe that this flexible approach to expanding our network allows us to
benefit from the assets of our partners, while also reducing the capital
expenditure required to develop the network. It also increases the speed with
which we can add new destinations to our network.

For additional information on our acquisition of capacity from other
carriers, see "Acquiring Backbone Network in Areas Where We Have Not Built
Networks Ourselves" below.

NETWORK OPERATING CENTERS

We monitor our global network on a proactive basis from two network
operating centers which use the latest monitoring technology and provide
24 hours a day, seven days a week coverage. These centers are fully equipped to
detect and handle incidents and quickly re-route traffic in the event of a
fault.

Our network operating centers are located at Heathrow in England and
Fujairah in the United Arab Emirates. The network operating centers, together
with local emergency server facilities, can monitor FEA, FA-1 and FNAL.

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METRO RING SITES AND POINTS OF PRESENCE

A metro ring is a metropolitan fiber ring which connects our PoPs with the
major telehouses in a metropolitan area. A metro ring facilitates traffic
terminating at a customer's site from our major traffic routes. We have
developed metro rings in New York, Paris and London and are finalizing the
configuration of the metro ring in Tokyo. Our New York and European metro rings
went operational in the fourth quarter of 2001.

We currently have 29 PoPs or Virtual Points of Presence ("vPoPs") (as
described below under "Business Strategy") in 14 countries on four continents.
In addition to the PoPs mentioned above, we have 13 other PoPs or vPoPs in the
following locations:

- Brussels, Belgium

- Shanghai, China

- Cairo, Egypt

- Dusseldorf, Germany

- Frankfurt, Germany

- Tehran, Iran

- Milan, Italy

- Amsterdam, Netherlands

- Singapore, Singapore

- Barcelona, Spain

- Madrid, Spain

- San Francisco, California (2)

For additional details regarding metro rings, PoPs and vPoPs, see "Business
Strategy".

BUSINESS STRATEGY

Our goal is to establish FLAG Telecom as a leading independent global
transport and network services provider. We aim to offer an innovative range of
products and services to the international carrier community and content
providers, including Application Service Providers ("ASPs") and Internet Service
Providers ("ISPs"), across our global network. Our network is optimized to
support the next generation of IP services.

An essential part of achieving this goal is the ongoing construction of our
state-of-the-art, technologically advanced network with global reach and a
seamless service capability. Our global network makes it possible for us to
offer one of the widest ranges of destinations available. As well as serving
high volume routes, our network provides connectivity into many hard-to-reach
locations, including the Middle East and Asia Pacific region. Our submarine and
terrestrial cable systems can connect our customers to the majority of the
world's population. Upon completion of the FNAL construction, which is scheduled
for the second half of 2002 if we are able to arrange adequate financing to
replace the WestLB facility, our network will extend to most of the world's
major business centers. We have strong relationships with other network
operators and local providers that enable us to offer end-to-end service
straight to the markets our customers want to serve.

Much of our attention in the period since our initial public offering in
February 2000 has been focused on completing the construction of our global
network to provide seamless service capability and improving our network
services business. In 2001, key construction milestones were met as we:

- brought our FA-1 system fully into commercial service;

- commissioned the eastern, Hong Kong to Tokyo, leg of the FNAL system;

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- progressed the construction of the western leg of the FNAL system;

- commissioned 13 IP PoPs; and

- undertook demand-led capacity upgrades on FA-1 and on the UK-Spain segment
of FEA.

We expect the entire FNAL system to be ready for service in the second half
of 2002 if we are able to arrange adequate financing to replace the WestLB
facility. With the completion of the FNAL system, we will have finished the
construction of all our current major system projects. We started building our
network in 1995 when we closed the financing of our first system, FEA.

As noted above, WestLB, the agent bank for our project financing for FNAL,
has informed us that it has cancelled the commitment and terminated the lending
facility. We are discussing potential alternative structures with WestLB and are
pursuing other possible financing structures for financing FNAL. If we are
unable to arrange alternative financing for FNAL, we will not be able to
complete FNAL and may be required to write off a portion of our investment,
which was approximately $500 million at December 31, 2001, including deferred
financing costs of approximately $3.7 million which would have to be written
off. For additional information on these developments, see "Risk Factors--If We
are Unable to Arrange Alternate Financing for FNAL, We Will Not Be Able to
Complete Construction of the System" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Liquidity and Capital
Resources".

Our network is now operational on all routes. Even though the construction
of the western leg of FNAL is not complete, we have the ability now to take
customer traffic in both directions around the globe. To increase the revenue
generating capability of our global network in a time of declining prices, we
have been moving our focus away from the construction of our global network and
into a phase of leveraging our global network asset by building the volume of
traffic and the value of that traffic on our network.

The principal elements of our business strategy to achieve these objectives
include:

- enhancing the connectivity between our network and other (regional feeder)
networks to enable new customers to readily move their traffic onto our
global network;

- deepening and broadening our relationships with our customers; and

- expanding the range of products and services that we offer our customers.

ENHANCING THE CONNECTIVITY BETWEEN OUR NETWORK AND OTHER (REGIONAL FEEDER)
NETWORKS TO ENABLE NEW CUSTOMERS TO READILY MOVE THEIR TRAFFIC ONTO OUR
GLOBAL NETWORK

We believe that our global network serves the world's major traffic routes.
In order to attract new customers onto our global network and to retain existing
customers, we aim to make it easier for them to access our network. In 2001, we
achieved this by:

- acquiring backbone network in areas where we have not built networks
ourselves;

- building metro rings in major cities so as to provide access in a broader
range of commercial telehouses; and

- extending our network of city PoPs into cities near to our global network.

ACQUIRING BACKBONE NETWORK IN AREAS WHERE WE HAVE NOT BUILT NETWORKS
OURSELVES

We believe that, in order to achieve our goal of being a leading independent
global network services provider, we must offer a global network. Major changes
in market conditions have caused us to shift away from "build" towards "buy" in
most areas in 2001. We had hoped to build out our network infrastructure
independently, believing that owning network infrastructure would offer
significant competitive advantages by securing end-to-end control of capacity
and cost structure, providing access to low unit costs. We still believe that
there are advantages to owning the underlying infrastructure which we operate
end-to-end. However, we acknowledge that the economics of building

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new systems have been altered by the current level of supply and demand, the
state of the capital markets and the ability to purchase capacity over different
systems. We believe we can still achieve our business needs by purchasing
capacity, wavelengths or fiber on existing infrastructure with appropriate
service level guarantees on an end-to-end basis. This has been our primary focus
with respect to new network commitments in 2001.

We set out below the critical achievements we made in 2001, and the business
rationale underlying the decisions we made, to complete our global network
without building networks ourselves:

- FLAG PACIFIC: During 2001, we announced that we had decided, as a result
of our inability to obtain financing on satisfactory terms, not to proceed
with the construction of FP-1 that was contemplated to be built in
association with TyCo Telecommunications. Rather than continuing with the
construction of FP-1, we acquired capacity on the Japan-U.S. consortium
cable system and on Asia Global Crossing and Marubeni's jointly owned PC-1
cable system in order to link FNAL with the west coast of the U.S.

- FLAG SOUTH ASIA: We were originally issued an international facilities
license conditional upon our building a system into Singapore. When we
determined that a system could not be built on acceptable economic terms
as a consequence of other private cable systems that would be available
before our build was complete, we applied successfully to have the
conditions of our license application amended to enable us to satisfy the
condition through our purchasing capacity rather than building our own
system. Now that the high capacity systems are going into service we
expect to utilize, wherever possible, capacity acquired from other
carriers.

- FLAG EUROPE: We require a network in Europe in order to leverage our
terabit systems across the Atlantic and to move traffic originating from
or terminating in Europe onto our FEA system. Given the state of the
European market and the high level of competition, we decided to establish
our FLAG Europe system, a terrestrial fiber-optic network, in association
with Verizon Communications, Inc. We also purchased dark fiber and
co-location facilities on KPNQwest's pan-European fiber optic network to
extend the reach of our global network into the major business centers of
Europe.

- FLAG TRANS-USA: We need capacity across the U.S. because of the
U.S.-centric nature of the Internet, which requires us to provide
connectivity from Asia and Europe to important Internet hubs on both the
east and west coast of the U.S. In addition, having trans-U.S. capacity
enables us to route traffic between Europe and Asia across terabit
systems, rather than being reliant on the FEA system, and provides a
restoration route to improve the resilience of our network. Given that
there was ample supply of network from several different potential
suppliers, matched against our forecast demand, we chose to minimize our
investment by purchasing lit capacity rather than building our own
network. We have arrangements in place to use capacity on the U.S.
networks of Level 3 and Global Crossing in order to fulfill our
requirements for carrying traffic across the U.S.

- FLAG NORTH ASIA: If we are unable to arrange adequate financing we may
not be able to complete the FNAL system. However, in our construction of
the system to date, in some countries we have been able to acquire landing
station sites, backhaul arrangements and co-location facilities partly in
exchange for offering capacity on the system. We believe this has been a
cost effective way in which to build our FNAL system assets.

In this way we expanded our global network to enable us to reach new
customers in important markets and to offer our existing customers a broader
range of destinations. By building our own high capacity global network we are
able to offer low cost bandwidth and IP services to the many regional carriers
and ISPs that do not have their own networks outside their home territory.
Additionally, having an extensive network under the control of our own network
management systems, enables us to offer end-to-end solutions for customers who
otherwise might have to piece together multiple capacity from different
providers.

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This approach is consistent with what we have said previously regarding our
intention to pursue multiple approaches to obtaining city-to-city connectivity
to increase the attractiveness of our global network and to meet increasing
customer demand for connectivity into the major international business centers.
We also, however, intend to develop our own terrestrial networks in key markets
as those markets deregulate and when cost-effective opportunities exist.

BUILDING METRO RINGS IN MAJOR CITIES

Following the completion of the FA-1 cable system, we constructed metro
rings in New York, Paris and London, the three cities in which FA-1 terminates.
These metro rings act as hubs in the critical termination points for our
trans-Atlantic customer traffic. The benefits of metro rings are that they:

- allow us to reach a much larger number of customers directly on our own
network;

- improve the quality of service we provide; and

- offer an alternative to the costly and timely process required for a
customer to build its own connections from telehouses into our global
network.

We have acquired fibers from other providers to connect our major city PoPs
to our landing stations at Long Island, St. Brieuc and Skewjack at which points
the traffic is transferred onto the FA-1 submarine fiber. We are also developing
a metro ring in Tokyo to service traffic in Japan.

EXTENDING OUR NETWORK OF CITY POPS

We look to establish PoPs at locations near to our global network so as to
increase traffic volume on our global network. We currently have 29 PoPs or
vPoPs in 14 countries on four continents. The majority of our PoPs are equipped
to provide Managed Bandwidth Service, with a growing number able to offer IP
services to enable our customers to connect into the major Internet Exchanges.
At most PoPs, our customers are able to install and operate their own equipment
with our co-location service. Through our relationships with local network
providers, we can often set up and manage the local connection from our city
PoPs to our customers' sites. We enter into agreements to acquire terrestrial
capacity to connect our city PoPs to the nearest landing station on our global
network.

We select the locations of our city PoPs to maximize the potential of
attracting local customer traffic onto our global network. We maximize this
potential in two ways:

- Firstly, our city PoPs, which are a physical presence in a location,
form a basis of, and give momentum to, sales and marketing activity in
that region that we would otherwise not be able to achieve.

- Secondly, we choose locations for our city PoPs where we believe there
will be demand for our global network and where we can connect the city
PoP to the main traffic routes on our global network cost efficiently.

DEEPENING AND BROADENING OUR RELATIONSHIPS WITH OUR CUSTOMERS

We believe that we have an established reputation as a leading carrier's
carrier, with telecom operators buying capacity on our global network to extend
their reach. Now we are overlaying our network with a range of value-added
services that will enable carriers, ISPs, ASPs and other content providers
worldwide to take advantage of the next generation of telecom and Internet
services. We will consider ourselves successful as a carrier's carrier if we are
selected to provide that carrier's core network needs and we grow as the carrier
grows. We will consider ourselves successful serving ISPs, ASPs and other
content providers as we increase the number of providers we serve.

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In 2001, we believe that we deepened and broadened our relationships with
our customers by:

- meeting carrier needs for core network;

- expanding our customer base to encompass new types of customers; and

- using our innovative vPoP model to gain deeper access to regulated
markets.

MEETING CARRIER NEEDS FOR CORE NETWORK

Our main target carrier customers are the 50 largest carriers in the world.
Typically these are incumbent Public Telephone Operators ("PTOs") or major
global operators. Our aim is for our carrier customers to use our global network
to meet their core network needs so that our network effectively becomes part of
the backbone of their carrier network. In 2001, we signed over 100 new
contracts, and 88% of those contracts, as measured by contract value, were with
existing customers.

EXPANDING OUR CUSTOMER BASE TO ENCOMPASS NEW PARTICIPANTS

We believe that we are well positioned to serve content providers, such as
broadcasters, who have very high bandwidth demand that requires them to move
vast amounts of digital information quickly between two distant points on the
globe. We have only just begun to target these companies, although early
discussions suggest significant growth potential. For example, we are in
discussions with a company that provides digital television transport services
to broadcasters and film studios and their partners around the world. As these
types of companies migrate from satellite to terrestrial fiber we believe this
is an attractive new market for our global network. Our network is able to
support real-time events (such as the Olympics and the FIFA World Cup) and also
to support film editing and post production. In the latter case, an ability to
leverage post-production facilities around the world to shorten editing cycles
can cut production costs substantially.

USING OUR INNOVATIVE VPOP MODEL TO GAIN DEEPER ACCESS TO REGULATED MARKETS

Like most of our competitors, we are restricted from providing
telecommunications services directly to customers in regulated countries such as
Egypt and China. We believe that our experience in operating in such markets is
a competitive advantage when it comes to forming alliances with incumbent
operators in regulated territories. We have developed a business proposition
which we call the virtual Point of Presence or "vPoP", designed to enable us to
form key relationships with incumbents in regulated territories and help
position us to develop our own networks at such time as the territories
deregulate. The vPoP concept is a revenue-sharing arrangement under which we
collaborate with a local incumbent to provide a city center Point of Presence
connected to the nearest landing point on our global network, and to sell
city-to-city services on an end-to-end basis. Revenues are generated for us and
our local partner both through local customers using the service out of the city
PoP, and from international customers using the service into the city PoP. The
revenues generated are shared in an agreed percentage between the local partner
and ourselves.

In 2001, we announced milestone transactions in Egypt and China which
illustrate the success of our vPoP model. In July 2001 we announced agreements
with EgyNet and Nile on Line, under which each agreed to purchase Managed
Bandwidth Service and Internet connectivity between Cairo and New York to be
carried on our global network. These agreements were made possible as a result
of the establishment of a vPoP in Cairo under the terms of an agreement with
Telecom Egypt to jointly provide network services to the international carrier
community and ISPs supported by service level guarantees. In August 2001, we
announced that we had signed an agreement with China Netcom Corporation, Ltd.
for a vPoP in Shanghai. This cooperation will provide China Netcom's customers
with global reach using our global network and growing network of PoPs worldwide
and will offer our

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customers access to China Netcom's network across China. Several additional
vPoPs are under active discussion at the present time.

EXPANDING THE RANGE OF PRODUCTS AND SERVICES WE OFFER OUR CUSTOMERS

Our core market continues to be based on providing transport services in the
form of bandwidth sales into the carrier's carrier market. Of the customers that
signed new contracts with us in 2001, approximately 60% were either major
incumbents or established global carriers. Revenues from these traditional
carrier service offerings were $138.8 million in 2001, accounting for
approximately 74% of our reported revenues, representing an increase of
approximately 79% over the previous year. We will continue to offer traditional
carrier service offerings, including "lifetime of system" Right of Use ("ROU")
products and services designed to assist carriers in managing their network
capacity needs in a flexible way.

We believe that our Network Services business, which consists of Managed
Bandwidth Services, IP services and co-location services, offers us greater
scope to broaden and expand the products and services that we offer. Our Network
Services revenues in 2001 were $49.5 million, an increase of 129% over the
previous year.

Set forth below is a summary of our existing products and a summary of
certain new products and services that we are developing for future sale.

EXISTING PRODUCTS AND SERVICES

We offer a range of products and services which use a state-of-the-art
SDH-based IP-enabled network infrastructure and are designed to meet the needs
of a wide range of licensed international carriers, ISPs, ASPs and other content
providers. Our current product and service offerings are as follows:

TRADITIONAL CARRIER SERVICE: Our traditional carrier service offerings
include "lifetime of system" ROU products and shorter term leased capacity
products. We offer these products on all routes on our global network. These
services are offered with the option of restoration on alternative systems. We
undertake the responsibility of operating and maintaining the system and the
services on the system. An annual operations and maintenance fee is charged to
customers buying lifetime ROU capacity. For shorter term leases, this fee is
typically included in the annual lease charge.

LEASED CAPACITY SERVICE: We believe our customers are finding it
increasingly difficult to predict their future needs for bandwidth capacity and
we have responded by offering a range of products that help our customers manage
their network capacity in a flexible way. Leasing periods range from a few
months to five years. We also offer a lease-to-buy option that enables our
customers to convert a capacity lease into a lifetime ROU.

Our Network Services business offers a growing range of value-added services
including:

MANAGED BANDWIDTH SERVICE. In 2001, our Managed Bandwidth Service generated
revenues of $34.9 million, approximately 70% of our total Network Services
revenues. Our Managed Bandwidth Service provides customers with a seamless,
full-channel service that packages in-country backhaul with submarine and
terrestrial cable systems to extend service to our city PoPs. Connectivity is
available at speeds of E1, DS3, STM-1, STM-16 and STM-64 throughout Asia,
Europe, North America and the Middle East. The service is backed by a high
quality Service Level Availability Guarantee for service delivery, availability
and restoration. We also offer a range of flexible and competitive commercial
terms for one, two and five-year periods, with a range of billing and currency
options.

IP SERVICES. Our IP network has been designed to maximize efficiency.
Customers are linked to in-country nodes, so that traffic can be routed within a
region or passed to the regional hub for

10

out-region termination. This eliminates the unnecessary use of extra
intermediary router hops, minimizes traffic delivery times, enhances network
resilience through diverse routing options and optimizes bandwidth across the
network as a whole. The network incorporates fault-tolerant, high-capacity
network architecture with built-in redundancies, ensuring high availability, low
latency and virtually zero packet loss. Our IP backbone is based on Juniper
routers. Currently there are two main IP products that we offer:

- OUR GLOBAL IP POINT TO POINT SERVICES ("IP-P") provide global bandwidth
connectivity to carriers, ISPs and other IP network operators. We offer
low absolute delay (latency) connectivity into the key Internet peering
exchanges and also provide a level of flexibility that enables customers
to organize their own presence and peering. Access to our global IP-P
service can be via a local, national or international leased line, which
provides a duplex, dedicated connection between the customer router and an
access router in our IP gateway. Local access circuits are also available,
subject to site survey. Customers using this service arrange their own
presence and peering. The service, which runs on IP and includes latency
guarantees, is designed for customers offering services such as Intranet
backbones, Voice-over-IP services and IP Virtual Private Network
("IPVPN"). IPVPN is a set of facilities or services that a services
provider leases to enterprises to meet their requirements for secure
private networking, as an alternative to each constructing their own
private network infrastructures. It is "virtual" in that the service
provider is able to deploy a single network to support multiple enterprise
customers. IPVPN services are based on IP either transporting customers'
traffic over the public Internet or over a service provider's private IP
network.

- OUR GLOBAL IP TRANSIT SERVICES ("IP-T") provides short-hop Internet access
via public and private peering arrangements with Tier 1 ISPs at speeds
ranging, depending upon the region, from E1 to STM-4. Access is offered at
major cities in Asia, the U.S. and Europe. In the U.S., customers can
access the service from major cities on the east and west coasts, and any
city on our global network can be accessed under a "port-and-pipe"
arrangement. We have peering arrangements at most Internet traffic
exchanges and we are continually enhancing the coverage and depth of our
service.

CO-LOCATION. Our co-location service offers customers who connect directly
to our global network the ability to install and operate their equipment in our
co-location centers. Co-location is available at our PoPs in Amsterdam,
Brussels, Dusseldorf, Frankfurt, Hong Kong, London, Madrid, New York, Paris,
Singapore and Tokyo.

NEW PRODUCTS AND SERVICES WE ARE DEVELOPING FOR FUTURE SALE

We are developing additional products and services which we believe will
enable us both to attract new customers and to create higher value from the
traffic passing through our global network. During 2002, to the extent we have
adequate resources, we expect to launch the following offerings:

OUR FLEXIBLE BANDWIDTH SERVICE will give our customers unrivalled control of
the network capacity they lease from us. Customers will have short turn up times
and the flexibility to turn up, turn down, or turn off capacity to match demand
without the penalty of up-front payment. Eventually, we expect that customers
will be able to reserve and order capacity through a web-based interface.

OUR GIGABIT ETHERNET OFFERING will be a point to point service that will
provide customers with the ability to connect their Local Area Networks ("LANs")
in multiple geographical locations across international boundaries. Customers
will be able to connect through their existing equipment and will enjoy the
benefits of low unit cost, extremely high speed and flexible turn up in small
increments up to 1,000 megabits per second. We expect that Gigabit Ethernet will
be extended through the local loop through partnership arrangements.

11

OUR VIRTUAL NETWORK ACCESS POINT ("VNAP") SERVICE will use advanced IP
technologies (including Layer 2 VPN technology and MPLS tunneling techniques) to
offer customers fast, cost effective secure IP connectivity to the world's major
Internet exchange points. MPLS, or Multi-Protocol Label Switching, is a
collection of standards adopted by the Internet Engineering Task Force designed
to enable traffic engineering on IP networks. Implementation of MPLS in an IP
network is intended to improve scalability, performance, reliability and
efficiency. Our VNAP service will include physical connectivity, routing
equipment at the Network Access Point ("NAP"), co-location and management
services. We believe that this will allow our customer to save time and cost
when compared with securing dedicated connections to the same NAPs.

MARKETING AND SALES

We currently market our network capacity and telecommunications products and
services globally through a sales and marketing force of approximately 120
people in the following locations:

- regional sales offices for North America (New York and Washington, D.C.
area), Europe (London), the Middle East and Africa (Dubai), Asia Pacific
(Hong Kong) and Latin America (Miami);

- local sales offices or other sales presences in Ireland (Dublin), Spain
(Madrid), France (Paris), Netherlands (Amsterdam), Belgium (Brussels),
Germany (Frankfurt), United States (San Francisco), Korea (Seoul), Italy
(Rome), India (New Delhi), Singapore, China (Beijing), Japan (Tokyo),
Greece (Athens), Egypt (Cairo) and Taiwan (Taipei); and

- representatives in Denmark, Morocco, Tunisia, Iran and Hungary.

Each of our regional sales offices is led by a team of senior sales
representatives or advisors who are based locally in that region. Our marketing
and sales team has extensive experience in the telecommunications industry and
the carriers' carrier sector and has very strong ties to the regions in which
our offices are located.

Our regional and local offices are our primary points of customer contact.
The sales representatives in these offices are responsible for promoting sales,
providing customer information, facilitating customer purchases on our network
and ensuring customer satisfaction. To enhance this regional focus to our
marketing and sales efforts, and to address the special needs of our global
customers, we have also adopted a global customer support strategy. This
strategy is designed to provide multiple points of contact and support for our
customers in our organization, at both the regional and senior executive level,
so that we can efficiently and conveniently meet the global telecommunications
needs of these customers. The Company's senior management participate in these
strategic sales relationships.

CURRENT MARKET ENVIRONMENT

The bandwidth market, as a whole, has deteriorated rapidly over the last
year and we do not expect this trend to reverse in 2002. While we have not yet
experienced a slow down in the rate of growth in our core markets in the Middle
East or South East Asia, we have seen the competitive routes such as
trans-Atlantic and intra-European markets being significantly affected. We
anticipate that the competitive routes will remain depressed this year as the
situation of oversupply continues. Our view that the market is unlikely to
recover in 2002 is based on considerations of the capital markets, our customers
and our competitors.

CAPITAL MARKETS

We believe that the public capital markets are effectively closed to
companies in our sector for the foreseeable future. We believe that there has
been a loss of confidence in the international wholesale bandwidth sector. Until
this confidence returns, we do not believe that we will be able to raise

12

additional debt or equity capital to fund our business requirements. We believe
that other participants in our sector are likely to be similarly affected.

CUSTOMERS

We have an established customer base of over 130 customers, many of which
are the world's leading telecommunications and Internet companies. Our principal
customers are international licensed telecommunications companies, emerging
telecommunications companies and ISPs. Our customers have experienced slower
growth in demand than had been expected and this has led to a higher risk of
financial distress or even bankruptcy and some customers are capital constrained
or heavily indebted. We have perceived an overall increase in expectation on
service levels, cost effectiveness and a heightened concern on the part of
certain customers regarding the viability of companies in our industry.

The products and key attributes driving the purchasing decisions of our
customers vary by the type of customer we serve. We believe that the trends
affecting the types of customer we serve are as follows:

- GLOBAL CARRIERS. The market downturn has significantly affected global
carriers. They are now entering a period of focus and consolidation. We
believe that their own network expansion and upgrade will be driven by
short term planning in response to customer demand. We are seeing reduced
demand for long term ROUs over capacity except for higher bandwidth
products such as wavelengths. There is a move towards short term leases,
as opposed to ROUs, for STM-1/STM-4 type of capacities given the market
uncertainty.

- INCUMBENT PUBLIC TELEPHONE OPERATORS AND REGIONAL CARRIERS. These
customers contribute significantly to our revenues. They use us to
supplement existing club system investments, as most are purchasing on
multiple systems to meet resiliency needs. We believe that they continue
to be attracted by our ability to bundle in managed IP services, route
either way round the world and our independent status, as evidenced by our
high level of repeat business. Quality of service, financial security and
price competitiveness are key attributes to win business with these
customers. These customers demand ROUs and leases, but the mix is moving
increasingly towards leases. The typical purchases are at the STM-1 to
STM-4 capacity level delivered into a city telehouse. Incumbent public
telephone operators and regional carriers are seeking flexible drawdown of
capacity and the main demand for Middle East customers is IP transport
into the U.S.

- TIER TWO CARRIERS, ISPS, ASPS AND OTHER CONTENT PROVIDERS. These
customers are demanding high quality of service at low price.
Increasingly, customers in this segment require a high degree of
flexibility in provisioning and may demand a "pay per use" approach. We
are seeing trends towards purchase on demand for these types of customers,
mainly for short term leases. Most services need to be delivered into the
customer premises and the service has to be bundled with very strict
service level agreement terms.

COMPETITION

As a global network services provider, we compete in a wide variety of
geographic markets, in each of which we face, and expect in the future to face,
specific regional competitors. We also compete against a small number of other
companies that have built global networks.

We believe that there is substantial oversupply in many key markets, such as
the trans-Atlantic and intra-European routes. The announcements by 360networks,
Global Crossing and Carrier 1 that they have filed for bankruptcy protection
under Chapter 11 or have gone into liquidation have exacerbated the oversupply
situation by putting further downward pressures on margins as a result of the
need to dispose of assets at distressed prices. Other competitors are
reconsidering their business strategies by

13

either withdrawing from certain markets or being taken private. We anticipate
that assets will be recycled and obtained by competitors at a lower cost
structure than has been achieved by those companies that built the networks
themselves and that this may cause further price erosion. However, we believe
that there is some underestimation of the costs and complexity of managing
services across a global network.

We compete or expect to compete in seven key geographical markets:

- global network services;

- trans-Atlantic services;

- intra-European services;

- Middle Eastern services;

- intra-Asian services;

- Europe-Asia long haul services; and

- trans-Pacific services.

A number of companies have global networks. We have consistently expressed
the view that because of the high cost and complexity of building and operating
global networks this is a market in which there will always be a limited number
of players. Our main competitors in terms of global network operators are
Cable & Wireless, TyCo Telecommunications and WorldCom.

We believe our key competitors in the trans-Atlantic services market are the
TAT-14 consortium system, Cable & Wireless/Apollo, Level 3 and TyCo
Telecommunications. In addition, resellers are putting pressure on margins at
lower levels of capacity, such as at the STM-1 to STM-4 levels. We are aware
that other competitors who are experiencing financial difficulties are trying to
offload excess inventory. Recycling excess inventory onto the market will
exacerbate downward pricing pressure.

The intra-European market has become fiercely competitive as a result of the
large number of pan-European operators. British Telecom, WorldCom, KPNQwest,
Level 3 and Colt have pan-European networks. In spite of consolidation in the
market, price pressure remains intense. This is an extremely competitive market,
although we believe that many competitors are starting to maintain price levels
as pricing approaches the marginal cost of upgrading capacity.

We believe that demand in the Middle East remains high. We believe that our
key competitors in the Middle Eastern market are Sea Me We 3 ("SMW3") consortium
cable system and Teleglobe in the IP sector.

We believe our key competitors in the intra-Asian services market are SMW3,
Asia Pacific Cable Network 2, Asia Global Crossing, the C2C cable network and
the SAFE (South African, France Telecom and Singtel) cable interconnecting with
other cable systems in the region.

In the Europe-Asia long haul market, SMW3 is the primary direct competitor.
However, we expect the strongest competition in the future to come from an
alternative routing from Europe to Asia across the Atlantic Ocean, trans-U.S.,
and across the Pacific Ocean to Japan.

We believe our key competitors on the trans-Pacific route will be Asia
Global Crossing, the Japan-U.S. Cable System, the China-U.S. Cable System and
TyCo Telecommunications.

For our FLAG Network Service business, the competition in most markets is
mainly from the network service companies listed above. However, in wholesale IP
services, further competition will come from the global Tier 1 ISPs such as
Cable & Wireless, UUNet, WorldCom and Genuity.

14

OUR RESPONSE TO THE CURRENT MARKET CONDITIONS

For 2002, in the challenging context of a substantial deterioration of the
telecom sector, slower economic growth and the high pressure on the sector from
distressed assets of insolvent competitors, we intend to continue to manage our
business in a prudent, conservative and focused manner. We intend to serve our
customers, to conserve capital, to reduce costs, to drive revenue and to
leverage our regional advantages in under-serviced areas where we have a strong
geographical presence, like the Middle East and Asia.

On February 13, 2002, we announced that we were reviewing our business in
the light of deteriorating market conditions. We stated then that if there were
no improvement in our operating environment, we anticipated that at some point
in 2003 we would not have sufficient liquidity to continue our operations,
unless we were able to raise additional funds, find a strategic partner,
restructure our indebtedness or substantially reduce our cost base in some other
way. We announced at that time that we had initiated discussions with potential
strategic partners and potential financial advisers.

On March 7, 2002, we announced that we had retained Credit Suisse First
Boston and The Blackstone Group as strategic and financial advisors to advise us
on financial and strategic alternatives for the long-term development of the
Company. As part of our strategy to conserve capital and to control costs, these
advisors are assisting us in the review of our business and the evaluation of
the most beneficial path for our future, including possible restructuring of our
indebtedness, identifying funding opportunities and working with potential
strategic partners. We intend to review our cost base with the aim of making
savings, where operationally possible, by reducing third party costs and capital
expenditures.

With the assistance of our financial advisors, we currently are engaged in
discussions with certain of our lending banks and equipment suppliers regarding
the status of and possible modifications to our existing agreements. WestLB, the
agent bank for our project financing for FNAL, has informed us that it has
cancelled the commitment and terminated the lending facility. We are discussing
potential alternative structures with WestLB and are pursuing other possible
financing structures for financing FNAL. In addition, as of March 28, 2002, we
have paid all amounts owed to Barclays, the agent for FLAG Limited's lending
banks, under FLAG Limited's credit agreement. We have also reached agreement
with Barclays, the agent for FLAG Atlantic Limited's lending banks, under which
Barclays has agreed to forbear from exercising certain rights it may have
through April 30, 2002.

FLAG Telecom has $300 million 11 5/8% senior notes and E300 million 11 5/8%
senior notes outstanding. We have determined that we will not make the required
interest payments, due March 30, 2002, on the outstanding senior notes of FLAG
Telecom. Failure to pay interest would become an event of default after a 30-day
grace period. After the grace period, the holders of 25% or more of the notes of
either series can accelerate the notes, at which point they would become due and
payable. We do not have sufficient liquidity to pay these two series in full at
this time. If we are unable to negotiate a restructuring of these notes, we
would have to file for protection under the bankruptcy laws. We elected not to
make this interest payment in order to conserve our cash and to permit us to
enter into discussions with the holders of our outstanding indebtedness to seek
a consensual arrangement under which we would restructure our outstanding
indebtedness.

As a result of our decision not to pay interest on FLAG Telecom's senior
notes, we have reclassified the senior notes from long-term debt to short-term
debt. Our inability to pay those senior notes in full at this time threatens our
ability to continue as a going concern.

If we are unable to negotiate satisfactory arrangements with our lenders and
equipment suppliers, and if FLAG Telecom's senior notes and our equipment
purchase obligations for FNAL were to become due and payable in the near future,
we would not have sufficient liquidity to meet all of these obligations. We
cannot assure you that we will be successful in restructuring our obligations.
We may

15

have to seek protection under the bankruptcy laws either in conjunction with our
restructuring or if we are unable to negotiate a restructuring. For additional
information on these developments, see "Risk Factors--Risks Relating to our
Capital Resources and Liquidity" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources".

Although there is a great deal of uncertainty facing global economic
recovery and our industry, we remain committed to our originally plotted course.
We believe that we have some unique strengths that underpin this commitment:

- we have cash balances that give us some time to evaluate the most
beneficial path for our future;

- we have strong customer relationships as evidenced by the high proportion
of our repeat business;

- we have a global network that is resilient and reliable;

- we have strong Middle East and Asia coverage where competition is less
intense;

- we have a relatively low overhead structure and our focus on the wholesale
market means we have limited our exposure to the high costs of serving the
enterprise or mass retail market;

- we have a fast moving and flexible approach to customer requirements;

- we have a short development cycle for new product initiatives; and

- we have an international management team and key employees who have the
know-how to run a global company and who come from a traditional
operational telecom background.

EMPLOYEES

At December 31, 2001, we had approximately 345 full-time employees. We
believe that our relations with our employees are good.

REGULATIONS

In the ordinary course of development, construction and operation of our
fiber-optic cable systems and expansion of our network services business, we are
required to obtain and maintain various permits, licenses and other
authorizations in both the U.S. and in other jurisdictions where our cables land
and where we wish to provide services, and we are, or will be, subject to
applicable telecommunications regulations in such jurisdictions.

As of March 20, 2002, Verizon Communications Inc. ("Verizon") holds
24,922,276 shares of our common stock. We may be deemed to be an affiliate of
Verizon under the U.S. Communications Act of 1934, as amended. As an affiliate
of Verizon, our activities are subject to increased regulation by the Federal
Communications Commission (the "FCC"). Specifically, under Section 271 of the
U.S. Communications Act, neither Verizon nor any of its affiliates may provide
or market long distance telecommunications services originating in a
state--referred to as an "in-region state"--in which Verizon is an incumbent
provider of local telephone service until the FCC approves an application of
Verizon to provide long distance services originating in that state. The FA-1
cable system carries trans-Atlantic long distance traffic that originates in New
York, which is a Verizon in-region state. Verizon has obtained the necessary
regulatory approval from the FCC to provide long distance services originating
in New York. As an affiliate of Verizon, we are subject to regulatory
prohibitions on the provision and marketing of trans-Atlantic services via the
FA-1 cable system to prospective customers located in the in-region states for
which Verizon has not obtained necessary regulatory approvals.

We have obtained, or are in the process of obtaining, applicable licenses to
operate our various cable systems. These include the licenses for FA-1, for
which we have obtained a U.S. Landing License, a UK Public Telecommunications
Operator License and a French Article L33.1 License. For FNAL, we

16

have obtained the Fixed Carrier License in Hong Kong and our application for a
Type I Telecommunications License in Taiwan was approved. Our application has
been lodged with the appropriate agency in Taiwan and we are in the process of
obtaining the final operators license with which FLAG Telecom can operate in
Taiwan. In Korea, we recently purchased 49% (the maximum permitted investment we
are entitled to acquire under the current regulatory restrictions) of the
outstanding shares of Seoul Telenet Inc., a local operator. We operate in Korea
through our ownership of Seoul Telenet, which is permitted to operate under its
Facilities Based Telecommunications Business license.

In addition, with the expansion of our Network Services business, we have
acquired, or will apply for, applicable licenses throughout the world to enable
us to operate as we consider necessary in each country. We have been granted
infrastructure licenses in Spain, Italy, The Netherlands, Germany, France,
Switzerland, Ireland, Norway, Sweden, Japan and Singapore and licenses for
resale activities in Belgium and Italy and have applied for applicable,
including infrastructure, licenses in Belgium and the Latin American countries.

RISK FACTORS

RISKS RELATED TO THE CURRENT MARKET ENVIRONMENT

WE ARE BEING ADVERSELY AFFECTED BY PROBLEMS EXPERIENCED BY THE TELECOM
INDUSTRY

The global telecom industry is experiencing significant and well-publicized
problems. A number of industry participants, including Global Crossing,
360networks, Carrier 1 and Viatel, have declared insolvency, and a number of
others, including Williams Communications, have announced that they are
considering insolvency proceedings. Customers, lenders, suppliers and investors
have expressed increasing concern about a large number of industry participants.
Share prices across the sector have declined dramatically over the past year,
and the capital markets generally have closed to industry participants. These
industry-wide factors have affected share prices and the ability to raise
capital, and have led to concern regarding viability of industry participants as
expressed by customers and suppliers. Continued problems experienced by other
industry participants, and continued skepticism about the sector generally, can
be expected to adversely affect our business and our liquidity.

INSOLVENCIES OR FINANCIAL DIFFICULTIES ON THE PART OF OUR CUSTOMERS AND OUR
SUPPLIERS MAY ADVERSELY AFFECT OUR BUSINESS

A number of our customers, who have transferred capacity to us or purchased
capacity from us, are experiencing financial difficulties, and several of them,
including PSINet and Global Crossing, currently are in Chapter 11 proceedings.
Other customers are experiencing financial difficulties. PSINet has brought an
action seeking to recover $23.8 million paid to us shortly before it filed for
bankruptcy protection. We cannot assure you that other customers will not seek
similar relief. In addition, we cannot assure you that other customers will not
seek to avoid obligations to continue to furnish capacity to us that we have
acquired or to pay for long-term purchases of capacity from us. We are dependent
on the capital expenditure and purchase decisions of our customers. Any defaults
in payment or a reduction in purchases by our customers could have a negative
impact on our financial condition, results of operations and liquidity. We
currently own a significant amount of capacity credits on Global Crossing's
network that we have not yet activated. Global Crossing has filed for Chapter 11
and it is not clear whether these credits will be honored.

SUBSTANTIAL EXCESS FIBER CAPACITY CONTINUES TO DRIVE PRICES LOWER

Substantial excess fiber capacity in most markets has driven prices
dramatically lower over the past 18 months. Prices are continuing to fall. We
expect that the insolvency of various industry participants will create further
downward pressure on prices. To the extent that well-financed competitors
acquire distressed assets from insolvent companies, they will be able to offer
capacity at significantly lower

17

marginal costs than the companies that originally built the systems. Continued
price erosion can be expected to have an adverse impact on our results of
operations.

CONTINUING PRICING PRESSURE HAS REQUIRED US TO RECOGNIZE ASSET IMPAIRMENT

Given the high degree of competition in terms of alternative supply, price
erosion and continued lack of demand on the trans-Atlantic route, we have been
reviewing the prospects for demand on that route and we now believe that the
asset value of our FA-1 system is impaired. We determined that the carrying
value of the FA-1 system exceeded its fair value and we have therefore
recognized an impairment charge of $359.0 million in the year ended
December 31, 2001. We derived the fair value based on the present value of
future cash flows expected to be generated by the FA-1 system according to
management's latest demand forecasts. We will continue to review the operating
performance of our systems, and we cannot assure you that continuing pricing
pressure will not require us to recognize further impairments in the future. Any
such impairment could be expected to have a material adverse effect on our
financial condition.

GOVERNMENTAL INVESTIGATIONS WITH RESPECT TO OTHER INDUSTRY PARTICIPANTS MAY
ADVERSELY AFFECT US

The SEC and the Federal Bureau of Investigation are conducting
investigations into the financial reporting of Global Crossing, and the SEC also
is investigating the financial reporting of at least one other industry
participant. In connection with the SEC's Global Crossing investigation, we and
other industry participants have received subpoenas from the SEC requesting
documents relating to our transactions with Global Crossing. It is possible that
the SEC will determine to investigate other industry participants, including us.
We cannot assure you that we will not become the target of an SEC investigation
or that the results of any such investigation would not have a material adverse
effect on our business or financial condition.

THE RECENT FOCUS ON FINANCIAL REPORTING PRINCIPLES MAY RESULT IN CHANGES IN
OUR FINANCIAL REPORTING

As is common in our industry, we have engaged in reciprocal transactions
with other industry participants in which we sell capacity, services or
facilities, by way of leases, ROUs or services agreements, to other
telecommunications companies or service providers at approximately the same time
that we lease or purchase capacity, services or facilities from these same
companies or their affiliates. We believe that we have accounted for such
transactions in accordance with generally accepted accounting principles. We
cannot assure you, however, that the SEC will agree that we accounted for these
transactions in accordance with generally accepted accounting principles, or
that compliance with generally accepted accounting principles produced a fair
presentation of these transactions. We cannot assure you that we will not be
required to record these transactions in a different manner going forward or to
restate our results for financial periods already reported.

RISKS RELATING TO OUR CAPITAL RESOURCES AND LIQUIDITY

WE HAVE SUBSTANTIAL INDEBTEDNESS WHICH MAY AFFECT OUR OPERATING FLEXIBILITY
AND OUR ABILITY TO GROW

As of December 31, 2001, we had the following outstanding indebtedness:

- $430 million 8 1/4% Senior Notes issued by FLAG Limited;

- $300 million 11 5/8% Senior Notes issued by FLAG Telecom;

- E300 million 11 5/8% Senior Notes issued by FLAG Telecom;

- $286.0 million outstanding under FLAG Atlantic's credit and revolving
credit facilities; and

- $55.5 million outstanding under FLAG Limited's credit facility.

18

As of March 28, 2002, we repaid the outstanding amounts under FLAG Limited's
credit facility. In addition, FLAG Asia Limited entered into a credit facility
in August 2001 that was expected to provide up to $170.5 million in external
finance for the construction of the FNAL system. No amounts had been drawn down
under the FNAL credit facility. WestLB, the agent bank for this facility, has
informed us that it has cancelled the commitment and terminated the lending
facility. We are discussing potential alternative structures with WestLB and are
pursuing other possible financing structures for financing FNAL.

We are highly leveraged. We paid interest of $106.0 million in 2001. The
need to make our current debt service payments limits the amount of free cash
flow generated by our business. Our high degree of leverage may limit our
flexibility to adjust to changing market conditions, reduce our ability to
withstand competitive pressures and make us more vulnerable to a downturn in
general economic conditions or our business. We may be unable to make
advantageous purchases of distressed assets or build new connectivity in our key
markets. Our substantial indebtedness may have other important negative
consequences for us, including the following:

- a substantial portion of our cash flow may be required to make principal
and interest payments on our debt, reducing the funds that otherwise would
be available to us for our operations and future business opportunities;
and

- a substantial decrease in our net operating cash flows or an increase in
our expenses could make it difficult for us to meet our debt service
requirements and force us to modify our operations.

WE ELECTED NOT TO PAY INTEREST DUE ON FLAG TELECOM'S SENIOR NOTES

As discussed above, we have determined that we will not make the required
interest payments, due March 30, 2002, on the outstanding senior notes of FLAG
Telecom. Failure to pay interest would become an event of default after a 30-day
grace period. After the grace period, the holders of 25% or more of the notes of
either series can accelerate the notes, at which point they would become due and
payable. We do not have sufficient liquidity to pay these two series in full at
this time. If we are unable to negotiate a restructuring of these notes, we
would have to file for protection under the bankruptcy laws. We elected not to
make this interest payment in order to conserve our cash and to permit us to
enter into discussions with the holders of our outstanding indebtedness to seek
a consensual arrangement under which we would restructure our outstanding
indebtedness. As a result of our decision not to pay interest on FLAG Telecom's
senior notes, we have reclassified the senior notes from long-term debt to
short-term debt.

WE ANTICIPATE THAT WE WILL BE REQUIRED TO RESTRUCTURE OUR INDEBTEDNESS

We are reviewing our business in the light of deteriorating market
conditions. If we are unable to agree to a restructuring with the holders of our
indebtedness and the Group's outstanding debt is accelerated, we will no longer
have sufficient liquidity to meet our capital obligations or to fund our
operations. We cannot provide any assurance that the lenders to the Group will
not declare all of the Group's indebtedness to be immediately due and payable.
Any such action could require us to commence insolvency proceedings. A failure
to restructure our obligations in a timely manner could also result in problems
in attracting and retaining customers. We cannot assure you that we will be
successful in restructuring our obligations. We may have to seek protection
under the bankruptcy laws either in conjunction with our restructuring or if we
are unable to negotiate a restructuring. It is likely that, as a result of any
bankruptcy proceeding, our common shares would have little or no value and our
indebtedness would be worth significantly less than face value.

19

WE MAY BREACH CERTAIN COVENANTS SET FORTH IN THE FLAG ATLANTIC CREDIT
FACILITY

FLAG Atlantic Limited's outstanding indebtedness consists of approximately
$286.0 million of bank debt. The bank syndicate has alleged that we have
breached certain provisions of the credit agreement for FLAG Atlantic Limited's
debt and we are in discussions with them regarding possible breaches of that
agreement. While those discussions continue, the bank syndicate has entered into
a forbearance agreement pursuant to which it has agreed not to take action under
the credit agreement with regard to the defaults under discussion, until
April 30, 2002. We cannot assure you that these discussions will be resolved
favorably to FLAG Atlantic. If not, the bank syndicate could accelerate and
demand payment of the FLAG Atlantic debt, which would constitute a cross default
under FLAG Telecom's bonds.

IF WE ARE UNABLE TO ARRANGE ALTERNATE FINANCING FOR FNAL, WE WILL NOT BE
ABLE TO COMPLETE CONSTRUCTION OF THE SYSTEM

WestLB, the agent bank for our project financing for FNAL, has informed us
that it has cancelled the commitment and terminated the lending facility. We are
discussing potential alternative structures with WestLB and are pursuing other
possible financing structures for financing FNAL. If we are unable to arrange
alternative financing for FNAL, we will not be able to complete FNAL and may be
required to write off a portion of our investment, which was approximately
$500 million at December 31, 2001, including deferred financing costs of
approximately $3.7 million which would have to be written off. A failure to
complete FNAL would have a material adverse effect on our business and our
financial condition.

WE MAY NOT HAVE SUFFICIENT LIQUIDITY TO MEET OUR EQUIPMENT PURCHASE
OBLIGATIONS

We have significant outstanding obligations to suppliers for capital
equipment. In particular, FLAG Telecom has guaranteed the payment by FLAG Asia
Limited of approximately $96.0 million to Alcatel for the full amount of the
construction costs remaining with respect to the build-out of FNAL. Of this
amount, approximately $33.9 million is currently owed to Alcatel. We had planned
to pay a majority of these costs with amounts to be borrowed under the credit
facility that WestLB, the agent bank, has informed us has been terminated. FLAG
Asia Limited may not have sufficient liquidity to make current or future
payments to Alcatel and we cannot assure you that FLAG Telecom will have
sufficient liquidity to meet these guarantee obligations.

RISKS RELATING TO OUR BUSINESS

THERE IS SUBSTANTIAL OVERCAPACITY WHICH IS CONTINUING TO DEPRESS PRICES

Along our global network, we face competition and pricing pressure from
existing competitor cables, planned cables and satellite providers. Slower
growth in demand for bandwidth than was expected is exacerbating the problems
caused by overbuilding in key markets, especially the trans-Atlantic and
European routes. The announcements by 360networks and Global Crossing that they
have filed for bankruptcy protection under Chapter 11 have exacerbated the
oversupply situation by putting further downward pressures on margins as a
result of the need to dispose of so-called distressed assets to achieve some
return on the initial capital investment. Other competitors are retrenching
either, like Level 3, by withdrawing from certain markets, or, like TyCo
Telecommunications by going private. We anticipate that assets will be recycled
and obtained by competitors at a much lower cost structure than has been
achieved by those companies that built the networks themselves. We expect that
these sales could lead to price reductions and reduced operating margins.
Continuing weakness in prices caused by overcapacity can be expected to
adversely affect our results of operations and financial condition.

In addition, if we conclude that the reduction in prices makes it unlikely
that one or more of our systems will be able to generate sufficient excess cash
to repay the indebtedness incurred to finance

20

construction of the system, we may be required to recognize an impairment and to
write down the value of the system.

CUSTOMERS ARE INCREASINGLY DEMANDING SHORTER-TERM ARRANGEMENTS

As prices continue to soften and excess capacity continues to overhang the
market and customers fear that suppliers are financially unstable, customers
have become increasingly unwilling to purchase capacity on an ROU basis over an
extended period of time, typically 15 years. More and more, capacity sales are
structured as short-term arrangements with annual repricing. This shift to
shorter-term arrangements makes it increasingly difficult for us to maintain our
existing customer base and may put greater pressure on our operating margins.

WE ARE REGULARLY DEPENDENT ON THIRD PARTIES FOR THE CRITICAL "LAST MILE"
CONNECTION TO OUR CUSTOMERS

As an independent carrier, we regularly have to rely on established
telephone companies for the "last mile" connection to the individual customer's
network. Our larger competitors, such as the regional Bell companies and the
state PTO companies, have end-to-end connectivity and are not reliant on third
parties for the "last mile". As a result, they may be able to provide service on
a more cost-effective basis than we can. This lack of access, and the cost of
acquiring it, may adversely affect our ability to compete.

WE CANNOT ASSURE THE SUCCESSFUL COMPLETION OF PROJECTS THAT ARE UNDERWAY

We are continuing with our construction of new PoPs, interconnecting our
existing systems and integrating capacity acquired from third parties. The FNAL
system is scheduled for completion in the second half of 2002 if we are able to
arrange adequate financing to replace the terminated WestLB facility. We cannot
assure you that we will complete our projects on time or at all. FLAG Telecom
has issued a performance guarantee in favor of our partner in FNAL, Reach Ltd.,
guaranteeing satisfactory performance of all of FLAG Asia's obligations to
Reach, including completion of FNAL within a specified time frame. If FNAL is
not completed within that time frame, FLAG Telecom could be liable to Reach for
Reach's consequential damages resulting from that failure. We cannot assure you
that FLAG Telecom will have sufficient liquidity to meet this performance
guarantee obligation. We had planned to pay the costs of completing the
construction of FNAL with amounts borrowed under the credit facility that
WestLB, the agent bank, has informed us has been terminated. Any delay in the
completion of the FNAL system, or any other part of our global network which has
not yet entered into commercial service, would have a negative effect on our
results of operations.

Additionally, any delay in the completion of the network would slow our
ability to migrate customer traffic onto our own network from third party
suppliers who are currently providing capacity to us (at a higher cost than our
own network) on a temporary basis and may cause customers on our other systems
to seek another global carrier. Until such migration is completed we continue to
be reliant upon the performance of our third party suppliers, many of whom are
experiencing financial difficulties. Any failure in their performance would have
the effect of delaying the recognition of revenue and increasing costs.
Additionally, failure to complete the FNAL system on time could lead to
penalties to be paid to certain customers due to the delay of the FNAL system.

WE MAY NOT ULTIMATELY REALIZE SUFFICIENT VALUE FROM OUR SYSTEMS

We intend to retain capacity on all our systems for our own account, to
bundle this capacity with our other products and to sell these bundled products.
The future demand for such bundled products, or the prices we can obtain for
these products, may not be sufficient to allow us to fully utilize the retained
capacity or to recover our capital invested in the projects. The overall value
realized from such

21

retained capacity may ultimately not be sufficient to cover the costs allocated
to this capacity on the various cable systems. The trend toward shorter capacity
purchases and continued declining prices makes it increasingly uncertain that we
will be able to recover our costs. If we determine at any time that we are
unlikely to cover the allocated costs, we may be required to recognize an
impairment and to write down the value of the system.

OUR INFRASTRUCTURAL INVESTMENTS AND TECHNOLOGIES COULD BECOME OBSOLETE
BEFORE WE CAN ACHIEVE ADEQUATE UTILIZATION OF THESE ASSETS

The telecommunications industry is subject to rapid and significant changes
in technology. If we do not replace or upgrade technology and equipment that
becomes obsolete, we will be unable to compete effectively because we will not
be able to meet the expectations of our customers. Additionally, in recent
years, the useful economic life of telecommunications equipment has declined
significantly. Although we believe that, for the foreseeable future,
technological changes will not materially affect the use of our fiber-optic
system, we cannot predict the effect of technological changes on our business.
We cannot assure you that technological developments will not render the
infrastructure and technologies in which we invest obsolete before we can
adequately utilize them. If we determine at any time that we are unlikely to
cover the allocated costs, we may be required to recognize an impairment and to
write down the value of the system.

IF WE FAIL TO MAINTAIN CO-OPERATIVE RELATIONSHIPS WITH OUR LANDING PARTIES
AND LOCAL OPERATORS, OUR OPERATIONS MAY BE IMPAIRED

We depend upon a number of different landing parties to provide access to
the origination and termination points at various locations on our global
network. Our ability to offer city-to-city services is dependent on our landing
parties' willingness to provide cost-effective terrestrial services and to agree
to connect other terrestrial networks to our systems. Each of these landing
parties has entered into a construction and maintenance agreement with us and
some of our customers under which each of the landing parties commits to provide
access, to charge reasonable and uniform rates to all customers accessing our
global network through the landing party's landing station and to maintain the
terrestrial portion of our system in the landing party's country. Despite these
commitments, we cannot assure you that the landing parties will perform their
contractual obligations or that there will not be political events or changes in
relation to the landing parties which have adverse effects on us. In addition,
the construction and maintenance agreement restricts our ability to install
further equipment into cable landing facilities without the consent of our
landing parties. We cannot assure you that we will be able to obtain the consent
of our landing parties to proposed future modifications of our landing
facilities that may be advantageous to us or necessary to operate our global
network.

We also depend upon local operators in order to provide telecommunications
services in regulated countries, such as Egypt and China. Such countries
restrict our ability to provide telecommunications services directly to
customers and as a result, we have formed alliances with incumbent operators in
regulated territories. We cannot assure you that we will continue to maintain
cooperative relationships with these local operators in the future.
Additionally, increased restrictions in regulated countries could prohibit us
from working with such local operators.

BECAUSE OUR COMPANY AND OUR INDUSTRY ARE HIGHLY REGULATED, OUR ABILITY TO
COMPETE IN SOME MARKETS IS RESTRICTED

The telecommunications industry is highly regulated. The regulatory
environment varies substantially from country to country and restricts our
ability to compete in some markets. We cannot assure you that we will be able to
obtain the authorizations that we need to implement our business plan and enter
new markets or that these authorizations, if obtained, will not be later
revoked. Regulation of the telecommunications industry is changing rapidly, with
effects on our opportunities,

22

competition and other aspects of our business. Our operations may be subject to
risks such as the imposition of governmental controls and changes in tariffs.

IF ADVERSE FOREIGN ECONOMIC OR POLITICAL EVENTS OCCUR, OUR NETWORK AND
CUSTOMER BASE MAY BE ADVERSELY AFFECTED AND OUR FINANCIAL RESULTS COULD
SUFFER

We derive substantially all of our revenues from international operations.
We have, and expect to have, substantial physical assets in several foreign
jurisdictions along our global network. International operations are subject to
political, economic and other uncertainties, including, risk of war, revolution,
expropriation, renegotiation or modification of existing contracts, labor
disputes and other uncertainties arising out of foreign government sovereignty
over our international operations. Some regions of the world along our routes
have a history of political and economic instability. This instability could
result in new governments or the adoption of new policies that are hostile to
foreign investment.

BECAUSE MANY OF OUR CUSTOMERS DEAL PREDOMINANTLY IN FOREIGN CURRENCIES, WE
MAY BE EXPOSED TO EXCHANGE RATE RISKS

We invoice all capacity sales and maintenance charges in U.S. dollars.
However, we invoice some network services products in local currencies and most
of our customers and many of our prospective customers derive their revenues in
currencies other than U.S. dollars. The obligations of customers with
substantial revenues in foreign currencies may be subject to unpredictable and
indeterminate increases in the event that such currencies devalue relative to
the U.S. dollar. Furthermore, such customers may become subject to exchange
control regulations restricting the conversion of their revenue currencies into
U.S. dollars. In such event, the affected customers may not be able to pay us in
U.S. dollars. As a result of the current global economic uncertainties, we may
experience collection delays or non-payment and we have experienced, and may
continue to experience, deferrals of purchases of our products and services by
our customers.

WE DEPEND ON KEY PERSONNEL

Our business is managed by a number of key personnel who provide expertise
and experience which is critical to our business and the implementation of our
strategy. Competition for senior managers is extremely intense in the unstable
telecom market. If we are unable to retain our senior managers, our activities
could be severely impaired and our ability to carry out our strategy materially
and adversely affected.

OTHER RISKS

THE PRICES OF FLAG TELECOM'S COMMON SHARES CAN BE EXPECTED TO BE VOLATILE

The market price of FLAG Telecom's common shares, like the stock prices of
many publicly traded telecommunications companies, has been, and may continue to
be, highly volatile. The market price of the common shares could be affected by:

- the depth and liquidity of the market for the common shares;

- investor perceptions of our financial condition and results of operations;

- increased price competition;

- quarterly variations in our operating results; and

- changes in general economic conditions of the telecom industry and
volatility in the financial markets.

23

WE ANTICIPATE THAT OUR SHARES WILL BE DELISTED FROM THE NASDAQ NATIONAL
MARKET AND MOVED TO THE SMALL CAP MARKET IN JUNE 2002

Companies listed on the Nasdaq National Market are required to maintain a
minimum per share price of $1.00. Our shares are currently trading far below
this $1.00 requirement. We have been advised by Nasdaq that we will be delisted
from the Nasdaq National Market and moved to the Small Cap Market in June 2002.
Delisting can be expected to reduce the liquidity of FLAG Telecom's common
shares, increase transaction costs of trading in FLAG Telecom's shares and
reduce or eliminate any research coverage. In addition, it is possible that many
of our large, institutional shareholders will not continue to hold FLAG
Telecom's shares after we are delisted from the Nasdaq National Market and moved
to the Small Cap Market.

IF THERE IS ANY CHANGE IN OUR TAX STATUS OR INCOME TAX REGULATIONS OF THE
COUNTRIES WHERE WE OPERATE, OUR FINANCIAL RESULTS COULD BE NEGATIVELY
AFFECTED

We believe that a significant portion of our income will not be subject to
tax by Bermuda, which currently has no corporate income tax, or by other
countries in which we conduct activities or in which our customers are located,
including the United States. However, we base this belief upon the anticipated
nature and conduct of our business, which may change, and upon our understanding
of our position under the tax laws of the various countries in which we have
assets or conduct activities. Our tax position is subject to review and possible
challenge by taxing authorities and to possible changes in law which may have
retroactive effect. We cannot determine in advance the extent to which certain
jurisdictions may require us to pay tax or to make payments in lieu of tax. In
addition, payments due to us from our customers may be subject to withholding
tax or other tax claims in amounts that exceed the taxation that we expect based
on our current and anticipated business practices and current tax regimes.

In addition, the U.S. taxing authorities can be expected to reconsider the
existing tax treaty with Bermuda in the light of the recent publicity given to
the tax avoidance strategies employed by Enron and Global Crossing. We cannot
assure you that the benefits currently enjoyed by Bermuda corporations will
continue to exist in the future.

THE ABILITY OF OUR MAJOR SHAREHOLDERS TO APPOINT MEMBERS OF OUR BOARD OF
DIRECTORS AND CERTAIN PROVISIONS IN OUR BYE-LAWS MAY LIMIT OUR ABILITY TO
ENTER INTO CERTAIN TRANSACTIONS

Our Bye-laws provide that a shareholder is entitled to designate one member
of our board of directors for each 9% of our issued and outstanding common
shares that it holds and also provide that, even if they are not thereby
entitled to designate a director, Verizon International Holdings Ltd. and
Rathburn Limited have the right to designate a director if they own any shares
(although Verizon has exercised its right to designate one, rather than two,
directors, and TGN Holdings Ltd., a greater than 9% shareholder, has irrevocably
waived its right to appoint a director). In addition, our Bye-laws provide that
certain actions required to be approved by our board of directors must be
approved by two-thirds of the votes present and entitled to be cast at a
properly convened meeting of our board. This voting requirement may limit our
ability to take certain actions, even if such actions would be deemed beneficial
by a simple majority of our board.

ITEM 2. PROPERTIES

Our tangible assets include a substantial investment in telecommunications
equipment. Our network and its component assets are the principal properties we
own. Our network includes undersea fiber-optic cable crossing the Atlantic Ocean
(FA-1), in the Far East (FNAL), a route from the UK, via the Mediterranean,
Arabian Sea, Indian Ocean and China Seas Far East (FEA) and a Northern European
terrestrial cable system. Our telecommunications services segment also owns or
leases various

24

cable landing stations and PoPs throughout the world related to its undersea and
terrestrial cable systems.

We maintain our principal executive office at Cedar House, 41 Cedar Avenue,
Hamilton HM12, Bermuda. We also lease corporate office space in London, England
and lease office space in London (network operations center), New York City,
Virginia, San Francisco, Miami, Bangkok, Hong Kong, Taipei, Dubai, Fujairah,
U.A.E. (network operations center), New Delhi, Beijing, Seoul, Tokyo, Singapore,
Madrid, Amsterdam, Frankfurt, Rome, Dublin and Paris. Except as noted, the
properties listed service all business segments to a greater or lesser degree.

ITEM 3. LEGAL PROCEEDINGS

We are currently in litigation proceedings with PSINet, Inc. and its related
affiliates and subsidiaries ("PSINet"). In December 2001, PSINet initiated
Chapter 11 bankruptcy proceedings in the United States Bankruptcy Court in the
Southern District of New York. Pursuant to those proceedings, on December 31,
2001, PSINet commenced litigation against FLAG Atlantic Limited and FLAG
Atlantic USA Limited to recover an alleged preference payment. Prior to PSINet
filing for bankruptcy, we entered into a capacity right of use agreement with
PSINet. In compliance with that agreement, PSINet paid us $23.8 million. PSINet
claims that this payment may be avoided because it was made within 90 days of
PSINet filing for bankruptcy and argues that it is entitled to recover the
amount of the payment, together with interest. We intend to defend this action
vigorously and assert various defenses to the preference claim.

We are involved in a dispute with two former employees, Messrs. Reda and
Jalil, which centers on the lawfulness of the termination of their employment
contracts and the sums payable in that termination. The most significant dispute
between the parties is as to the ex-employees' entitlement to stock options or
damages in lieu. Although Messrs. Reda and Jalil have not made clear what
damages they are claiming, we believe that the amount that they would claim for
wrongful termination would be between $3,000,000 and $4,000,000, plus interest.
We are unable to estimate the amount they would claim with respect to their
allegation that they were entitled to stock options. The Court of Appeal of
Bermuda ruled on this issue in our favor. Messrs. Reda and Jalil have
subsequently appealed to the Privy Council in the United Kingdom. We are of the
opinion that we have good grounds for believing that the ruling of the Court of
Appeal of Bermuda is unlikely to be varied by the Privy Council.

We have received a third-party subpoena from the SEC seeking documents in
connection with the SEC's investigation of Global Crossing. We intend to
cooperate fully with the SEC's request for such documents.

We are also involved in litigation from time to time in the ordinary course
of business. In management's opinion, with the exception of the disputes
described above, the litigation in which we are currently involved, individually
and in the aggregate, is not material to us.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

25

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

PRICE RANGE OF OUR COMMON SHARES

FLAG Telecom's common shares began trading on the Nasdaq National Market and
the London Stock Exchange (LSE) under the symbols "FTHL" and "FTL",
respectively, on February 11, 2000. The number of record holders of the common
shares as of March 20, 2002 was 100 although we believe that there are a larger
number of beneficial owners.

The following table shows the high and low bid price for the common shares
as reported on the Nasdaq Stock Market and the high and low sales prices for the
common shares as reported on the LSE for fiscal quarters since the common shares
began trading on February 11, 2000:

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

(1) Based on the last reported sales price on the Nasdaq National Market.

(2) LSE sales prices are denominated in Sterling.

On March 20, 2002, the last reported sale price on the Nasdaq National
Market was $0.27 and on the LSE was L0.275.

DIVIDEND POLICY

FLAG Telecom has never declared or paid any dividends on the common shares.
The Company's board of directors currently intends to retain any earnings for
use in the operation and expansion of its business and does not anticipate
paying any dividends on the common shares for the foreseeable future. In the
event the Company changes its policy on the payment of dividends, declarations
will be subject to the discretion of the board of directors. The board of
directors will take into account such matters as general business conditions,
the Company's financial results, capital requirements, contractual, legal and
regulatory restrictions on the payment of dividends by the Company or to its
shareholders or by its subsidiaries to the Company and such other factors as the
board of directors may deem relevant. FLAG Telecom's Senior Notes contain
restrictions on the Company's ability to pay dividends and the 8 1/4% Senior
Notes of FLAG Limited restrict the ability of FLAG Limited to pay dividends to
FLAG Telecom. For further discussion regarding the potential funding gap that
could result if FLAG Telecom's subsidiaries are unable to distribute capital to
the Company, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources".

FLAG Telecom is incorporated in Bermuda. Bermuda law does not restrict the
export or import of capital to or from Bermuda in the form of dividends or
otherwise.

26

WITHHOLDING TAX FOR U.S. SHAREHOLDERS

Under current Bermuda law, no income, withholding or other taxes or stamp or
other duties are imposed upon the issue, transfer or sale, or on any payments
made on, common shares of the Company. As there is no withholding tax in
Bermuda, there is necessarily no reciprocal tax treaty between Bermuda and the
United States.

ITEM 6. SELECTED FINANCIAL DATA

The following table presents selected historical financial data of FLAG
Telecom and FLAG Limited for the periods indicated. The financial data for the
periods ended December 31, 1997 and 1998 and for the period from January 1, 1999
to February 26, 1999 are derived from FLAG Limited's audited consolidated
financial statements. The financial data from incorporation to December 31,
1999, and for the periods ended December 31, 2000 and 2001, are derived from
FLAG Telecom's audited consolidated financial statements. We have prepared our
financial statements and related notes included in this annual report in
accordance with accounting principles generally accepted in the United States
("U.S. GAAP").

You should read the selected consolidated financial information in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," FLAG Limited's consolidated financial statements and
notes thereto included elsewhere herein, and FLAG Telecom's consolidated
financial statements and notes thereto included elsewhere herein.

27

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

(1) Certain reclassifications have been made to conform to current year
presentation.

(2) Included in operating expenses for FLAG Telecom for the year ended
December 31, 2001, are the following non-cash compensation expenses:
$0.5 million in operations and maintenance expenses; $0.3 million in sales
and marketing expenses; and $1.2 million in general and administrative
expenses. Included in operating expenses for FLAG Telecom for the year ended
December 31, 2000, are the following non-cash compensation expenses:
$1.8 million in operations and maintenance expenses; $1.2 million in sales
and marketing expenses; and $4.2 million in general and administrative
expenses.

(3) Included in general and administrative expenses for the years ended
December 31, 1997 and 1998 are program management expenses which include
reimbursements to Bell Atlantic Network Systems Company then a shareholder
of FLAG Telecom, for all costs and out-of-pocket expenses incurred by Bell
Atlantic Network Systems Company in performing project management services
for FLAG Limited. In addition, Bell Atlantic Network Systems Company
received a fee equal to 16% of payroll costs and of certain outside
contractor and consultant costs. Bell Atlantic Network Systems Company was a
subsidiary of Bell Atlantic Corporation, a predecessor of Verizon
Communications.

(4) In the year ended December 31, 1998, in connection with FLAG Limited's
issuance of 8 1/4% Senior Notes due 2008 and its entry into its existing
credit facility, FLAG Limited recorded an extraordinary loss of
$59.8 million, representing the write-off of unamortized deferred financing
costs related to its old credit facility.

(5) In the year ended December 31, 1998, in connection with FLAG Limited's
issuance of 8 1/4% Senior Notes due 2008 and its entry into its existing
credit facility, FLAG Limited redeemed its then outstanding preferred stock
at a redemption price of 105% of the liquidation preference. The excess of
the redemption value over the carrying value of the preferred stock on the
date of the redemption of $8.5 million has been reflected as a decrease in
other shareholders' equity.

(6) The net loss per share in 1998, excluding the extraordinary item, was $0.02
and $0.03 for Class A and Class B shares, respectively.

29

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The financial information presented in this report comprises the
consolidated results of FLAG Limited for the accounting periods to February 26,
1999 and the FLAG Telecom consolidated results for the period from incorporation
to December 31, 1999 and for the years ended December 31, 2000 and 2001. You
should read this Management's Discussion and Analysis of Financial Condition and
Results of Operations in conjunction with FLAG Limited's consolidated financial
statements and notes thereto included elsewhere herein and FLAG Telecom's
consolidated financial statements and notes thereto included elsewhere herein.

CRITICAL ACCOUNTING POLICIES

ACCOUNTING FOR ROU AGREEMENTS

It is critical, when looking at our business, that an investor or other user
of the financial statements understands that the cash flows of the business can
vary significantly from the amounts recorded as revenues in our income
statement. When a customer enters into an ROU contract to use capacity on our
global network, that customer typically makes an upfront payment of cash. In
accordance with U.S. accounting practices, we do not recognize that cash as
revenue upfront on the date it is received. Instead, we record the cash as
deferred revenue in the balance sheet. When all the relevant criteria for
revenue recognition are met (generally when the customer circuit has been
activated, the customer has accepted the circuit and the customer becomes liable
for any agreed maintenance charges), we begin to recognize the revenue in the
income statement by amortizing the deferred revenue balance on a straight-line
basis over the term of the relevant agreement. We believe this accounting
treatment is appropriate because, even though the cash for the ROU is received
upfront, we have not earned that revenue in full until the ROU agreement has run
its full term. ROU agreements may have terms for the lifetime of the system,
which tends to be up to 15 years. As a result, the income statement in any
period will reflect as revenues in the period amounts relating to agreements
that were signed, and for which cash was received, in a prior period.

We also sell services and capacity on a short-term lease basis whereby
payments are generally made in installments over the term of the agreement as
opposed to upfront payments. Accordingly, in the case of sales of services and
short term leases there tends to be a closer approximation, in the profile of
cash received and the recognition of revenues in the income statement, than is
the case with right of use agreements.

ACCOUNTING FOR RECIPROCAL TRANSACTIONS

During 2001 we entered into a number of transactions in which we provided
capacity, services or facilities, by way of lease, ROU or services agreement, to
other telecommunications companies and service providers at approximately the
same time that we leased or purchased capacity, services or facilities from
these same companies or their affiliates. We refer to these transactions as
"reciprocal transactions". We enter into these transactions to expand our global
footprint and to provide the necessary capacity to serve our global customers.
In certain instances, these transactions also result in improvement in our cash
position because the payment we receive for the capacity, services or facilities
that we provide exceeds the payment we make for the capacity, services or
facilities that we acquire from the other party to the transaction.

Approximately 14% of GAAP revenues for the year ended December 31, 2001 was
associated with reciprocal transactions entered into with other
telecommunications companies and service providers.

We record amounts receivable from reciprocal transactions at fair value as
deferred revenue. Deferred revenue is amortized into income statement (GAAP)
revenue on a straight-line basis as earned over the shorter of 15 years or the
term of the relevant agreement. We do not recognize any

30

GAAP revenue upfront with respect to reciprocal transactions. Capacity, services
or facilities acquired by us in such transactions are recorded either as
property and equipment, prepayments or other long-term assets, depending upon
when they are brought into service, and are charged as network expense or
depreciated on a straight-line basis over the shorter of 15 years or the term of
the purchase agreement.

The business justification for and accounting treatment of reciprocal
transactions between telecommunications carriers and service providers has
recently been the subject of substantial publicity. We have reviewed our
reciprocal transactions entered into in 2000 and 2001, and concluded that an
appropriate business purpose existed for us to enter into each such transaction.
We have also reviewed our valuations of these transactions and our accounting
treatment of those transactions, and believe the valuations and accounting
treatment are appropriate.

Pursuant to GAAP, we account for reciprocal transactions in accordance with
Accounting Principles Board Opinion No. 29, which addresses "Accounting for
Nonmonetary Transactions." ("APB No. 29"). APB No. 29 states that, in general,
accounting for nonmonetary transactions should be based on the fair value of the
assets or services involved, which is the same basis as that used in monetary
transactions, but excepts from this general rule certain types of "exchanges."
We have analyzed each of our reciprocal transactions, and have determined that
none of those transactions are the types of "exchanges" excluded from the
general accounting treatment specified in APB No. 29. Accordingly, these
transactions have been accounted for at fair value in our financial statements.

Recent testimony by a senior official of the SEC stated that in order to
conclude that a network capacity swap transaction should appropriately be
accounted for as revenue and a capital expenditure at fair value, a company
entering into such a transaction would have to reach the conclusion that:

1. the network capacity received in the exchange will not be sold in the same
line of business as the network capacity given in the exchange,

2. the network capacity received in the exchange is a productive asset that is
dissimilar to the network capacity given up, and

3. the fair values of the assets exchanged are determinable within reasonable
limits.

We concur that these are the critical accounting judgments to be made. As a
matter of policy we only use our network capacity, whether constructed or
acquired, to provide telecommunications services under either service contracts
or operating leases. We do not "sell" network capacity in the ordinary course of
business in reciprocal transactions. Our reciprocal transactions fall into three
categories: services for services, operating leases for operating leases and
operating leases for capital leases. We believe that under an operating lease or
a service contract the earnings process culminates when the service is
delivered. Consequently we recognize such revenues ratably over the contract
term. We also believe that operating leases and capital leases are dissimilar in
nature and consequently are not exchanges of similar productive assets within
the definition of APB No. 29.

We determine fair value by reference to recent cash transactions or quotes
from third parties for equivalent capacity or services.

We are aware, however, that there is a disagreement in the accounting
profession regarding the interpretation of APB No. 29 as applied to certain
reciprocal transactions. If service contracts for service contracts and
operating leases for operating leases were to be deemed to be exchanges of
similar productive assets they would not be recorded at fair value and deferred
revenue would not result. If this alternative interpretation were applied to our
service contract for service contract transactions in the year, the amount
recorded in deferred revenue as at December 31, 2001 and the resulting GAAP
revenue from amortization of deferred revenue for the year ended December 31,
2001, would be reduced by $25.7 million and $6.8 million respectively although,
because we have also

31

accounted for the related network expense at fair value, the reduction to net
operating income would be $0.2 million.

We understand that the SEC is conducting an investigation into the
accounting for and disclosure of reciprocal transactions entered into by Global
Crossing and Qwest. It is uncertain what the outcome of these investigations
will be. One possible outcome will be pronouncements from the SEC setting out
guidance on how reciprocal transactions should be accounted for and disclosed.
If such pronouncements are issued we may be required to adjust, either
prospectively or retrospectively, our accounting for reciprocal transactions.

For additional disclosure concerning our reciprocal transactions and their
impact on our financial statements, see the discussion below on "Financial
Impact of Reciprocal Transactions".

REVENUE RECOGNITION

Our customers generally purchase capacity on our network through agreements
providing for an outright sale of, or the sale of an ROU of, the capacity for
the lifetime of a system. In addition, the customer becomes responsible for
paying the agreed maintenance charges. The Financial Accounting Standards Board
Interpretation No. 43 ("FASB Interpretation No. 43"), requires that sales of
fiber-optic cable capacity be accounted for in the same manner as sales of real
estate with property improvements or integral equipment. In accordance with FASB
Interpretation No. 43, we defer revenue recognition for U.S. GAAP purposes and
we account for capacity contracts as leases. Amounts invoiced to customers
before the requirements of FASB Interpretation No. 43 are satisfied, are
included in deferred revenue and, when the relevant criteria for revenue
recognition are satisfied, are amortized through the income statement on a pro
rata basis evenly over the life time of the system, which generally tends not to
exceed 15 years. This accounting treatment does not affect our cash flows from
customers, who continue to be liable for payments in accordance with the signed
agreements.

Prior to the effectiveness of FASB Interpretation No. 43 on June 30, 1999,
we recognized revenues from capacity transactions on our network cable systems
upon the date the capacity was made available for activation and the customer
became responsible for maintenance charges. During this period we also
considered revenues from operating lease transactions to be incidental. We have
therefore recorded these revenues as reductions of the capacity available for
sale. However, as noted above, the magnitude of these transactions has increased
such that we now recognize revenues from lease transactions over the term of the
leases.

The Network Services business is a growing part of our portfolio, consisting
of Managed Bandwidth Services, IP Services and co-location services. These
services are expected to generate recurring revenues for us. As a result of
extending our range of products and services, we expect the greater part of our
sales to be pursuant to agreements which will require us to recognize revenues
over the relevant term of these agreements. To the extent that we enter into
contracts in the future that satisfy the requirements for sales type lease
accounting, we will recognize revenues without deferral.

We recognize revenues from providing operations and maintenance services in
the period in which we provide these services.

Payments due from purchasers of capacity are generally payable within
30 days; however, we have outstanding receivables greater than 30 days. We have
established an allowance for doubtful accounts based on historical industry
experience with potential uncollectible receivables and our expectations as to
payments. As of December 31, 2001, we had an allowance of $4.1 million.

The majority of revenues from capacity sales agreements and billings of
operations and maintenance services are payable in U.S. dollars. All contracts
for the provision by third parties of restoration are invoiced to us in U.S.
dollars. Some vendor contracts for the provision to the FEA system of operations
and maintenance services are payable in Japanese Yen, British Pounds, Euro,

32

French Francs, Singapore dollars or U.S. dollars. Whenever deemed appropriate,
we have hedged, and may continue to hedge, our exposure to foreign currency
movements.

ACCOUNTING FOR THE CAPITAL COSTS OF OUR GLOBAL NETWORK

We have capitalized direct and indirect expenditures incurred in connection
with the construction of our global network. The construction costs of the FEA,
FA-1 and the FNAL systems are, and will be, amortized over their economic life
from the date they are ready for commercial service or, in the event that we
enter into contracts in the future that satisfy the requirements for sales type
lease accounting, will be written off as cost of sales against revenues from any
such transactions. Capital costs associated with development of the other
elements of our global network will be amortized over their respective economic
lives.

Prior to July 1, 1999, when a system was ready for commercial service we
transferred expenditures to capacity available for sale and charged a proportion
of these expenditures to cost of sales as we recognized revenues from sales of
capacity. In the case of the FEA system, the amount charged as cost of sales was
a function of the allocated costs of construction for each segment and
management's estimate of revenues from future capacity sales. As a result of the
application of FASB Interpretation No. 43, sales on the FEA system do not
satisfy the requirements for sales type lease accounting. The costs of these
segments were reclassified at July 1, 1999 and during the six months ended
December 31, 1999 from capacity available for sale to fixed assets and are being
depreciated over their remaining useful life. Now, as a result of extending our
range of products and services, we expect the greater part of our future revenue
to be under agreements that will be accounted for as operating leases or service
contracts and that will require us to recognize revenues over the relevant term
of the agreements. We therefore reclassified the remaining cost of the FEA from
capacity available for sale to fixed assets in the first quarter of 2000. This
cost is being depreciated over the remaining estimated economic life of the
system.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2001 COMPARED WITH THE YEAR ENDED DECEMBER 31, 2000

Since February 13, 2002, when we announced our preliminary unaudited results
for the year ended December 31, 2001, we have recognized a charge with respect
to an impairment of our FLAG Atlantic-1 system. The impairment charge, which
totals $359.0 million, increased the reported operating loss to $(500.3)
million, giving reported net loss for the year of $(583.0) million and basic and
diluted net loss per share of $(4.36). The background to the impairment charge
is described below under "Operating Expenses". In addition, as a result of our
decision not to pay interest on FLAG Telecom's senior notes, we have
reclassified the senior notes from long-term debt to short-term debt.

REVENUES

We recognized total revenue during the year ended December 31, 2001 of
$188.3 million compared to $99.3 million for the year ended December 31, 2000.
This increase is due to an increase in our Network Services business revenues
and the continued growth in capacity sales and activations on our global
network. During the year we achieved a number of significant milestones in the
construction of our global network bringing parts of our network into commercial
service and thereby permitting the recognition of revenue from presales in the
statement of operations which had previously been deferred. The southern leg of
the FA-1 system entered into commercial service in May 2001 and the full loop
was completed when the northern leg of the system entered into commercial
service in June 2001. With both the full loop of the FA-1 system in commercial
service, the full amount of the presale payments began to be recognized over the
lifetime of the system from June 2001. In addition, revenues in relation to the
agreed maintenance charges on the FA-1 system started to be recognized.

33

The eastern leg of the FNAL system also entered into commercial service in
June 2001. If we are able to arrange adequate financing, as the construction of
the FNAL system progresses and more segments enter into commercial service, the
amount of revenue that can be recognized in the income statement will increase.
Prior to the year ended December 31, 2001, only the FEA system was in commercial
service.

We recognized revenue from the sale of capacity of $80.1 million for the
year ended December 31, 2001 compared to $36.8 million during the year ended
December 31, 2000. The increase is due to the construction milestones achieved
on our global network in 2001 which enabled us to start amortizing deferred
revenue through the income statement over the life time of the system or over
the life of the lease and services agreements.

We recognized revenue from operations and maintenance services of
$58.8 million for the year ended December 31, 2001 compared to $40.9 million for
the year ended December 31, 2000. This increase is a result of the construction
milestones achieved on our global network in the year which enabled us to start
billing the agreed maintenance charges on the systems brought into commercial
service.

We recognized revenue from Network Services of $49.5 million for the year
ended December 31, 2001 compared to $21.6 million for the year ended
December 31, 2000. The Network Services business consists of Managed Bandwidth
Services, IP Services and co-location services. The managed bandwidth product,
which offers customers fully protected international city-to-city circuits
backed by service delivery and availability guarantees, represents approximately
70% of the revenue of Network Services for the year ended December 31, 2001, an
increase from approximately 50% of Network Services revenues in the year ended
December 31, 2000. Our Leased Circuit Services business and our IP services
business, new in the year, represented approximately 14% and 9% respectively of
the revenue of Network Services in the year ended December 31, 2001.

As of December 31, 2001, we had entered into sales transactions with more
than 130 international telecommunication carriers and Internet service providers
compared to 100 as of December 31, 2000.

OPERATING EXPENSES

For the year ended December 31, 2001, we recorded $131.9 million of
depreciation compared to $79.4 million for the year ended December 31, 2000. The
depreciation and amortization charge for the year has increased as construction
milestones on our global network were achieved. As legs of the FA-1 and FNAL
systems entered into commercial service, amounts held within construction in
progress relating to these systems were transferred to property and equipment.
We depreciate property and equipment on a straight line basis over the estimated
useful life of the asset, generally no more than 15 years.

During the year ended December 31, 2001, we incurred $58.2 million in
network expenses compared to $13.0 million for the year ended December 31, 2000.
These costs primarily relate to our utilization of third party capacity,
including backhaul expenses, connection and access charges, restoration charges
and other network procurement costs. Where possible, and as our global network
is completed, we intend to migrate third party capacity onto our global network,
thereby removing the need to incur costs purchasing capacity from third parties.

During the year ended December 31, 2001, we incurred $47.5 million in
operations and maintenance costs compared to $32.3 million for the year ended
December 31, 2000. Operations and maintenance costs relate primarily to the
provision of standby maintenance under maintenance zone agreements as well as
salaries and overhead expenses directly associated with operations and
maintenance activities. The increase in the year reflects the construction
milestones on our global network achieved in the year. As legs of the FA-1 and
FNAL systems were entered into commercial

34

service, we became liable for the contractual commitments under maintenance zone
agreements and started to recognize the salaries and overhead expenses relating
to the operations and maintenance of these systems in the income statement.

During the year ended December 31, 2001, we incurred $17.3 million in sales
and marketing costs compared to $12.7 million incurred during the year ended
December 31, 2000. Sales and marketing costs comprise all sales and marketing
activities that we directly undertake. The increase in sales and marketing costs
is due mainly to the higher personnel costs arising from the increased sales
activity to support our growing range of products and services.

During the year ended December 31, 2001, we incurred $46.4 million of
general and administrative expenses compared to $39.2 million during the year
ended December 31, 2000. The increase in general and administrative costs is
largely due to recruitment of additional staff and increased office related
costs incurred as FLAG expanded its geographical diversity and our global
network was expanded in Europe, the USA and the Far East.

Since February 13, 2002, when we announced our preliminary unaudited results
for the year ended December 31, 2001, we have received third party supplier
analysis that indicates that, with current technology, it is possible to extend
the capacity of the FEA system beyond what we had previously believed to be
possible. Accordingly, at this time, we do not believe that the FEA system is
impaired. However, if we do not decide to invest in the upgrades necessary to
achieve the potential capacity, then it would be likely that we would need to
recognize an impairment charge on FEA at the time the decision not to invest was
made.

Given the high degree of competition in terms of alternative supply, price
erosion and continued lack of demand on the trans-Atlantic route, we have been
reviewing the prospects for demand on that route and we now believe that our
FA-1 system is impaired. We determined that the carrying value of the FA-1
system exceeded its fair value and we have therefore recognized an impairment
charge of $359.0 million in the year. We derived the fair value based on the
present value of future cash flows expected to be generated by the FA-1 system
according to management's latest demand forecasts.

In addition, restructuring and asset impairment charges of $28.2 million
were recorded in the third quarter of 2001. On August 7, 2001 FLAG Telecom
announced that it had decided not to proceed with the FP-1 project in
association with TyCo Telecommunications that had been announced in the second
quarter. The agreement with TyCo Telecommunications was conditional upon our
obtaining financing on satisfactory terms. However, despite substantial efforts
on our part and given the capital market conditions prevailing at the time, the
financing proposal received fell short of expectations. Following the decision
not to proceed with the FP-1 project, certain employment agreements were
terminated and amounts already paid or due in connection with preliminary build
evaluation were written off. The restructuring charge of $1.6 million related to
staff reduction costs. The cash expenditures concerning the workforce reduction
charge had been paid by the end of the year. We had commissioned a marine survey
for the construction of the FP-1 project and entered into other project related
expenditure commitments. Following the decision not to proceed, the residual
value of the costs incurred was $nil and the consequent asset impairment charge
was $26.6 million, comprising $24.0 million in abandoned survey and preliminary
build costs and $2.6 million of other project related costs.

Costs for the year ended December 31, 2001 include $2.0 million in charges
for non-cash compensation expense in respect of stock option awards under our
long-term incentive plan. These charges are required under U.S. accounting
practices and are purely accounting charges having no effect on cash flows.

35

INTEREST EXPENSE, FOREIGN CURRENCY GAIN, AND INTEREST INCOME

Interest expense on borrowings increased to $109.2 million for the year
ended December 31, 2001, from $102.5 million for the year ended December 31,
2000. Interest expense has increased by $6.7 million due to an increase in
borrowings and because, as elements of the construction of our global network
are brought into commercial service, interest on related borrowings can no
longer be capitalized and must be expensed in accordance with U.S. accounting
practices. For additional details, see "Liquidity and Capital Resources".

We experienced a foreign exchange loss of $7.9 million for the year ended
December 31, 2001, as compared to a foreign currency gain of $17.0 million for
the year ended December 31, 2000. The foreign exchange loss of $7.9 million
arose from the translation at the year end of the net Euro denominated
borrowings from Euro to U.S. dollars at the balance sheet exchange rate.

During 2001, we capitalized $16.2 million of interest costs as a component
of construction in progress.

We earned interest income of $43.0 million during the year ended
December 31, 2001, compared to $69.8 million earned during the year ended
December 31, 2000. Interest was earned on:

- cash balances and short term investments held by the collateral trustee
for FLAG Limited's credit facility;

- the restricted cash balances in FLAG Atlantic Limited; and

- the balance of the proceeds from the IPO and high yield funds held by FLAG
Telecom.

PROVISION FOR TAXES

The provision for taxes was $7.4 million for the year ended December 31,
2001, compared to $1.1 million for the year ended December 31, 2000. The
provision for income taxes reflected in the accompanying statement of operations
consists of taxes incurred on the income earned or activities performed by the
Group companies in jurisdictions where they are deemed to have a taxable
presence or are otherwise subject to tax. We believe that a significant portion
of our income will not be subject to tax by Bermuda, which currently has no
corporate income tax, or by other countries in which we conduct activities or in
which our customers are located, including the United States. However, this
belief is based upon the anticipated nature and conduct of our business, which
may change, and upon our understanding of our position under the tax laws of the
various countries in which we have assets or conduct activities, which position
is subject to review and possible challenge by taxing authorities and to
possible changes in law, which may have retroactive effect. The extent to which
certain taxing jurisdictions may require us to pay tax or to make payments in
lieu of tax cannot be determined in advance. In addition, payments due to us
from our customers may be subject to withholding tax or other tax claims in
amounts that exceed the taxation that we anticipate based upon our current and
anticipated business practices and the current tax regime.

We have obtained from the Minister of Finance of Bermuda, under the Exempted
Undertakings Tax Protection Act 1966, an undertaking that, in the event that
Bermuda enacts any legislation imposing tax computed on profits or income or
computed on any capital asset, gain or appreciation, or any tax in the nature of
estate duty or inheritance tax, then the imposition of such tax will not be
applicable to us or to any of our operations, or to the shares, capital or
common stock of FLAG Telecom, until March 28, 2016. This undertaking does not,
however, prevent the imposition of property taxes on any real property or
leasehold interests in Bermuda.

36

As Bermuda does not impose an income tax, the statutory amount of tax is
zero. The provision for income taxes for the year ended December 31, 2001 and
2000, results in an effective tax charge that differs from the Bermuda tax
charge as follows:

FINANCIAL IMPACT OF RECIPROCAL TRANSACTIONS

During 2001 we entered into a number of transactions in which we provided
capacity, services or facilities, by way of leases, ROUs or services agreements,
to other telecommunications companies and service providers at approximately the
same time that we leased or purchased capacity, services or facilities from
these same companies or their affiliates. Our accounting treatment of these
"reciprocal transactions" is discussed above under "Accounting for Reciprocal
Transactions."

Sales made as part of reciprocal transactions totaled $24.8 million in 2000
and $263.5 million in 2001, and were recorded as deferred revenue in those
amounts. GAAP revenues resulting from amortization of this deferred revenue
totaled $nil in 2000 and $27.1 million in 2001, representing 0% and 14.4%,
respectively, of total GAAP revenues for those periods.

Purchases made as part of reciprocal transactions entered into by us totaled
$24.8 million in 2000 and $232.8 million in 2001, and were recorded in those
amounts as property and equipment, prepayments, or other long-term assets.
Amounts recognized as expense or depreciation from reciprocal transactions were
$nil in 2000 and $9.5 million in 2001.

The effect of reciprocal transactions on deferred revenue and other
long-term assets in our balance sheet at December 31, 2001 is set out below:

We are aware that one of our customers, Global Crossing, recently announced
that it has filed for bankruptcy protection under Chapter 11. In the year ended
December 31, 2001, we entered into three transactions with Global Crossing and
its affiliates. For this period, $7.6 million in GAAP revenues was in respect of
transactions with Global Crossing and its affiliates. Cash was received in
connection with

37

these transactions and the last receipt was in October 2001. As at December 31,
2001, Global Crossing and its affiliates did not owe any amounts to us. As at
the same date, $25.9 million, included within "Prepaid expenses and other
assets" represented the unamortized balance for payments for circuits activated
on the networks of Global Crossing and its affiliates. These assets have already
been paid for and are being accounted for as an expense over the 12 month term
of the agreement. It is expected that this balance will be expensed in full
during the year ending December 31, 2002. In addition, as at December 31, 2001,
$42.5 million included within "Other long-term assets" represented capacity
credits that have been purchased on the systems of Global Crossing and its
affiliates. In light of the bankruptcy filing by Global Crossing, there is no
guarantee that we will be able to realize the value of these assets and an
impairment charge may be required.

SUPPLEMENTAL INFORMATION

In previous SEC filings, we have reported certain "pro forma" information
that we identify as EBITDA, Adjusted EBITDA, and cash revenues.

We add any impairment charge to EBITDA for each period on the basis that
impairment represents an acceleration of the deprecation charge. Were we not to
add the impairment charge, EBITDA was $(368.4) million and $2.0 million for 2001
and 2000 respectively.

We compute EBITDA for each period by adding depreciation and amortization to
operating income/(loss) and any impairment charge. EBITDA is not computed in the
same manner as operating loss, which is computed in accordance with U.S. GAAP.
EBITDA for 2001 was $17.2 million, compared to $2.0 million for 2000. We compute
Adjusted EBITDA for each period by adding non-cash stock compensation expense
and the change in deferred revenue to EBITDA. Adjusted EBITDA for 2001 was
$782.8 million, compared to $506.4 million for 2000.

The following table reconciles U.S. GAAP operating loss to EBITDA and
Adjusted EBITDA for 2001 and 2000.

CASH REVENUES

We compute cash revenues for each period by adding the change in deferred
revenue to U.S. GAAP revenues. Deferred revenue will increase as we invoice
amounts receivable as a result of sales of any future services, including
reciprocal transactions and presales of capacity, and will decrease as we
amortize deferred revenue on a straight-line basis as earned over the term of
the relevant agreements. We include the cash received in a reciprocal
transaction in cash revenues, but do not deduct from cash revenues the amount we
pay to the counterparty. The following table reconciles cash revenue for 2001
and 2000 to U.S. GAAP revenue:

38

YEAR ENDED DECEMBER 31, 2000 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1999

ADJUSTED CONSOLIDATED RESULTS

The table below shows the selected statement of operations and cash flow
data in thousands for the year ended December 31, 1999, being a combination of
the results of FLAG Limited for the period from January 1, 1999 to February 26,
1999 and the results of FLAG Telecom for the period from incorporation to
December 31, 1999. These results have been adjusted to eliminate minority
interests. These adjustments will not be reflected in our current and future
financial statements.

We computed EBITDA by adding depreciation and amortization to operating
income/(loss) and any impairment charge. EBITDA is not computed in the same
manner as operating loss, which is computed in accordance with U.S. GAAP. We
compute Adjusted EBITDA by adding non-cash stock compensation expense and the
change in deferred revenue to EBITDA.

39

REVENUES

We recognized total revenue during the year ended December 31, 2000 of
$99.3 million compared to $162.4 million in total revenue for the year ended
December 31, 1999. This reduction is due to the application of FASB
Interpretation No. 43, with effect from July 1, 1999. FASB Interpretation
No. 43 provides that certain sales of capacity should not be recognized as
current revenue if they do not satisfy the requirements for sales type lease
accounting. Revenues from these capacity sales are now deferred and amortized
over the term of the contracts. The change to accounting treatment has no impact
on cash flows. For a more detailed description of FASB Interpretation No. 43,
see "Critical accounting policies--Revenue Recognition" above.

We recognized revenue from the sale of capacity of $36.8 million for the
year ended December 31, 2000, compared to $131.9 million during the year ended
December 31, 1999. This reduction is due to the application of FASB
Interpretation No. 43.

As of December 31, 2000, we had entered into sales transactions with more
than 100 international telecommunication carriers and Internet service providers
compared to 90 as of December 31, 1999.

We recognized revenue from operations and maintenance services of
$40.9 million for the year ended December 31, 2000, compared to $30.6 million
for the year ended December 31, 1999, as a result of the increase in cumulative
capacity sales and activations on the FEA system.

We recognized revenue from Network Services of $21.6 million for the year
ended December 31, 2000. No Network Services revenue was generated for the year
ended December 31, 1999.

OPERATING EXPENSES

For the year ended December 31, 2000, we recorded $79.4 million of
depreciation compared to $61.0 million for depreciation and cost of capacity
sold recorded in the year ended December 31, 1999. The adoption of FASB
Interpretation No. 43 discussed above has meant that the remaining capacity
available for sale has been reclassified to property and equipment on
January 1, 2000 and is being depreciated over the remaining economic life of the
network, rather than being written off as cost of sales.

During the year ended December 31, 2000, we incurred $13.0 million in
network services costs. No network services costs were incurred for the year
ended December 31, 1999. These costs relate primarily to local backhaul,
connection and restoration costs.

During the year ended December 31, 2000, we incurred $32.3 million in
operations and maintenance costs compared to $31.3 million for the year ended
December 31, 1999. Operations and maintenance costs relate primarily to the
provision of standby maintenance under maintenance zone agreements as well as
salaries and overhead expenses directly associated with operations and
maintenance activities. The increase is primarily due to additional costs
arising from increased activity plus use of contracted services.

During the year ended December 31, 2000, we incurred $12.7 million in sales
and marketing costs compared to $11.7 million incurred during the year ended
December 31, 1999. Sales and marketing costs comprise all sales and marketing
activities that we directly undertake. The increase in sales and marketing costs
is due to greater employment and related costs associated with the increased
worldwide sales and marketing activity.

During the year ended December 31,2000, we incurred $39.2 million of general
and administrative expenses compared to $25.8 million during the year ended
December 31, 1999. The increase in general and administrative costs in the year
ended December 31, 2000, is largely due to recruitment and salaries of
additional staff and increased office related costs.

40

Costs for the year ended December 31, 2000 noted above include charges for
non-cash compensation expense in respect of stock option awards under our
long-term incentive plan. These charges are required under U.S. accounting
practices and are purely accounting charges having no effect on cash flows.

INTEREST EXPENSE, FOREIGN CURRENCY GAIN, AND INTEREST INCOME

Interest expense on borrowings increased to $102.5 million for the year
ended December 31, 2000, from $54.8 million for the year ended December 31,
1999. The increase in interest expense of $47.7 million is attributable to
additional borrowings obtained.

The foreign exchange gain of $17.0 million arises from the translation at
the year end of the net Euro denominated borrowings from Euro to U.S. dollars at
the balance sheet exchange rate. On December 20, 2000, we entered into a cross
currency swap to hedge the foreign exchange exposure of our E300 million 11 5/8%
Senior Notes.

During 2000, we capitalized $6.6 million of interest costs as a component of
construction in progress.

We earned interest income of $69.8 million during the year ended
December 31, 2000, compared to $9.0 million earned during the year ended
December 31, 1999. Interest was earned on:

- cash balances and short term investments held by the collateral trustee
for FLAG Limited's credit facility;

- the restricted cash balances in FLAG Atlantic Limited; and

- the balance of the proceeds from the IPO and high yield funds held by FLAG
Telecom.

PROVISION FOR TAXES

The provision for taxes was $1.1 million for the year ended December 31,
2000 compared to $1.7 million for the year ended December 31, 1999. The
provision for income taxes reflected in the accompanying statement of operations
consists of taxes incurred on the income earned or activities performed by Group
companies in certain jurisdictions, where they are deemed to have a taxable
presence or are otherwise subject to tax. as noted above, we believe that a
significant portion of our income will not be subject to tax by Bermuda, which
currently has no corporate income tax, or by other countries in which we conduct
activities or in which our customers are located, including the United States.

As Bermuda does not impose an income tax, the statutory amount of tax is
zero. The provision for income taxes for the year ended December 31, 2000, and
the period from incorporation to December 31, 1999, results in an effective tax
charge that differs from the Bermuda tax charge as follows:

FINANCIAL IMPACT OF RECIPROCAL TRANSACTIONS

During 2000 we entered into transactions in which we provided capacity,
services or facilities, by way of lease, ROUs or services agreement, to other
telecommunications companies and service

41

providers at approximately the same time that we leased or purchased capacity,
services or facilities from these same companies or their affiliates.

Sales made as part of reciprocal transactions totaled $24.8 million in 2000
and $nil in 1999, and were recorded as deferred revenue in those amounts. No
GAAP revenues were recorded in either periods with respect to reciprocal
transactions.

Purchases made as part of reciprocal transactions entered into by us totaled
$24.8 million in 2000 and $nil in 1999, and were recorded as other long-term
assets. No amounts were recognized as expense or depreciation from reciprocal
transactions in either period.

EBITDA

We recognized EBITDA of $2.0 million for the year ended December 31, 2000
compared to $93.6 million for the year ended December 31, 1999. This decrease is
a result of the application of FASB Interpretation No. 43, which stated that,
with effect from July 1, 1999, certain sales of capacity may no longer be
recognized as current revenue because they do not satisfy the requirements for
sales type lease accounting. Revenues from these capacity sales are now deferred
and amortized over the term of the contracts.

ADJUSTED EBITDA

We recognized adjusted EBITDA of $506.4 million for the year ended
December 31, 2000, compared to $128.1 million for the year ended December 31,
1999. This increase includes the effect of the FA-1 presales. Excluding the
effect of FA-1, adjusted EBITDA was $147.7 million for the year, up 15% compared
to 1999.

CASH REVENUES

We recognized cash revenues of $596.4 million for the year ended
December 31, 2000, compared to $188.1 million for the year ended December 31,
1999. This increase includes the effect of the FA-1 presales. Excluding the
effect of FA-1, cash revenues were $237.8 million for the year, up 26% on 1999.

LIQUIDITY AND CAPITAL RESOURCES

We have financed our operations to date through a combination of cash
generated from operations, presale proceeds, equity contributions, bank debt,
the proceeds of debt offerings and the proceeds of our initial public offering.

At December 31, 2001, our available sources of liquidity consisted of:
$424.2 million of unrestricted cash; up to approximately $200.0 million
available for borrowing under our credit agreements; and $321.2 million of
restricted cash, generally available only for specific projects or commitments
under banking agreements. Since December 31, 2001, WestLB has terminated the
FLAG Asia credit facility, we have repaid the FLAG Limited credit facility and
we have used unrestricted cash to make certain payments to Alcatel for equipment
for FNAL. Taking these events into account, proforma as if they had happened as
at December 31, 2001, our available sources of liquidity at December 31, 2001
would have been approximately $474.7 million of unrestricted cash, approximately
$30.0 million available for borrowing under our credit agreements and
$221.2 million of restricted cash.

On February 13, 2001, we announced that we anticipated that our capital
requirements for 2002 would include approximately $475 million to $500 million
for capital expenditures. If we are unable to arrange alternative financing
structures for FNAL, and we elect not to proceed with the remaining construction
of FNAL, our capital requirements for 2002 as at December 31, 2001 would have
decreased by approximately $339 million. In addition, we have received a demand
from PSINet to repay $23.8 million that it paid to us shortly before it filed
for bankruptcy. We are disputing the validity

42

of this claim. Any budgeted capital expenditures for 2002 may depend on our
ability to restructure our outstanding indebtedness.

We are currently reviewing our business in the light of deteriorating market
conditions. We have determined that we will not make the required interest
payments, due March 30, 2002, on the outstanding senior notes of FLAG Telecom.
Failure to pay interest would become an event of default after a 30-day grace
period. After the grace period, the holders of 25% or more of the notes of
either series can accelerate the notes, at which point they would become due and
payable. We do not have sufficient liquidity to pay these two series in full at
this time. If we are unable to negotiate a restructuring of these notes, we
would have to file for protection under the bankruptcy laws. We elected not to
make this interest payment in order to conserve our cash and to permit us to
enter into discussions with the holders of our outstanding indebtedness to seek
a consensual arrangement under which we would restructure our outstanding
indebtedness.

As a result of our decision not to pay interest on FLAG Telecom's senior
notes, we have reclassified the senior notes from long-term debt to short-term
debt.

We have retained Credit Suisse First Boston and The Blackstone Group as
strategic and financial advisors to advise us on financial and strategic
alternatives for our long-term development. As part of our strategy to conserve
capital and to control costs, these advisors are assisting us in the review of
our business and the evaluation of the most beneficial path for our future,
including possible restructuring of our indebtedness, identifying funding
opportunities and working with potential strategic partners.

RESTRICTED CASH

The credit facilities in place at December 31, 2001 in FLAG Limited and FLAG
Atlantic Limited ("the borrowing entities") are ring-fenced and secured by the
assets of the relevant borrowing entities. Under the terms of the credit
facilities, where assets of the borrowing entities are used by Group entities
other than the borrowing entities, intercompany pricing agreements are in place
which fix the rate at which the service is charged. FLAG Telecom owns certain
sales subsidiaries, including FLAG Telecom Ireland Limited ("FTIL") and FLAG
Telecom Global Networks Limited ("FTGNL"), which market the Group's services to
customers. In order to deliver service to their customers FTIL and FTGNL need to
purchase capacity from the borrowing entities and, in this way, cash passes from
the customer to FTIL or FTGNL and then to the borrowing entities.

Funds held by FTIL or FTGNL, until paid over to the borrowing entities as
required, are unrestricted cash. The Group designates funds held by collateral
trustees, in escrow, or legally designated for projects or commitments by bank
agreement, as long term restricted cash. When FTIL or FTGNL make payments to the
borrowing entities, funds pass from unrestricted cash to restricted cash. The
restrictions over the use of the cash in the borrowing entities will only be
lifted when the indebtedness is paid off or when financial covenants that
restrict the borrowing entities making certain payments (including dividends to
the holding company) are complied with.

Much of the Group's cash is restricted at the borrowing entity level and is
not permitted to be transferred to the holding company or the other borrowing
entities. Substantially all cash generated by the operation of our systems
becomes restricted cash. As a result, since the capital markets are effectively
closed to companies in our sector, we are unlikely to be able to generate
additional unrestricted cash until one or more of the borrowing entities have
repaid their outstanding indebtedness. Unrestricted cash at the holding company
level will be required for capital and operating needs.

43

COVENANTS AND IMPAIRMENT

Our operating subsidiaries have incurred indebtedness in connection with the
build-out of our systems. The relevant commercial bank agreements contain
certain financial covenants. Failure to comply with these covenants would not
result in an event of default, but would entitle the lenders to sweep all the
excess cash generated by the relevant operating subsidiary after funding the
system's operations and maintenance costs, amongst other things. At
December 31, 2001, we were in compliance with all of our financial covenants.

FLAG Telecom had $300 million 11 5/8% Senior Notes and E300 million 11 5/8%
Senior Notes outstanding at December 31, 2001, repayable at par in 2010. As
noted above, we have determined that we will not make the required interest
payments, due March 30, 2002, on these senior notes.

Failure to pay principal or interest on the indebtedness of any of our
subsidiaries, or certain other events of default, would result in the
indebtedness in question becoming due and payable. The acceleration of the
maturity of the indebtedness of our subsidiaries also would cause an event of
default on bonds issued by FLAG Telecom that would result in these bonds
becoming due and payable. In the event that there is a change of control of FLAG
Telecom, as defined in the indenture, the bondholders of FLAG Telecom's
$300 million 11 5/8% Senior Notes and E300 million 11 5/8% Senior Notes will
have the right to require the Company to buy back such bonds at a purchase price
equal to 101%.

As of March 28, 2002, we have paid all amounts owed to Barclays, the agent
for FLAG Limited's lending banks, under FLAG Limited's credit agreement. FLAG
Limited also has $430.0 million 8 1/4% Senior Notes outstanding at that date,
repayable at par in 2008. We have reviewed FLAG Limited's business in the light
of deteriorating market conditions, the degree to which it is economic to
upgrade the FEA system and the likelihood that FEA will generate sufficient cash
to repay the Senior Notes at maturity in 2008. The conclusion of this review was
that, at this time, we do not believe that the FEA system is impaired. Since
February 13, 2002, when we announced our preliminary unaudited results for the
year ended December 31, 2001, we have received third party supplier analysis
that indicates that, with current technology, it is possible to extend the
capacity of the FEA system beyond what we had previously believed to be
possible. However, if we do not decide to invest in the upgrades necessary to
achieve the potential capacity, then it would be likely that we would need to
recognize an impairment charge on FEA at the time the decision not to invest was
made.

FLAG Atlantic Limited's outstanding indebtedness consists of approximately
$286.0 million of bank term debt. Under current market conditions on the
Atlantic route, it is possible that we will breach one of the financial
covenants for FLAG Atlantic Limited's debt. We have reached agreement with
Barclays, the agent for FLAG Atlantic Limited's lending banks, under which
Barclays has agreed to forbear from exercising certain rights it may have
through April 30, 2002. Any breach of the financial covenants would not cause an
event of default, but would entitle the banks to increase their sweep of FLAG
Atlantic Limited's excess cash. We do not anticipate that such a breach would
have a material impact on FLAG Atlantic Limited's operations. In the year ended
December 31, 2001, we have recognized an impairment charge of $359.0 million
with respect to our FA-1 system.

CASH SWEEP MECHANISM

As well as intercompany sales, revenues are also invoiced by the borrowing
entities directly to third party customers. When cash is received by a borrowing
entity in connection with all revenues, either directly earned from customers or
through intercompany sales, the cash is retained by the borrowing entity and is
shown in the Group balance sheet as restricted cash. Restricted cash is applied
to pay the costs of the borrowing entity, to meet the additional capital
expenditure requirements of that borrowing entity and to pay debt service of
that borrowing entity.

In FLAG Limited and FLAG Atlantic Limited, a cash sweep mechanism at
December 31, 2001 operated under the terms of the credit facility agreements on
a quarterly basis. Under the cash sweep

44

mechanism, a calculation is done to determine what excess cash flow, if any, the
borrowing entity has generated. If there are funds available as excess cash,
these excess funds are applied, depending upon the applicable rate of cash
sweep, to repay the bank borrowing. As at December 31, 2001, the applicable
rates of cash sweep in FLAG Limited was 50%. The initial applicable rate of cash
sweep in FLAG Atlantic Limited, when it first applies as at March 31, 2002, will
be 75%. There are financial covenants in place in FLAG Atlantic Limited which,
if not complied with, would increase the applicable level of cash sweep to 100%.
Under current market conditions on the Atlantic route, it is likely that we will
breach one of the financial covenants for FLAG Atlantic Limited's debt when they
are measured as at March 31, 2002. For additional information, see the
discussion of "Covenants and Impairment" above.

POTENTIAL USES OF EXCESS CASH

In the event that there is excess cash in the borrowing entity and the cash
sweep is less than 100% that excess cash can, in the case of FLAG Atlantic
Limited, be passed up to FLAG Telecom by way of dividend.

In the case of FLAG Limited, under the terms of the indenture in connection
with the $430 million 8 1/4% Senior Notes due 2008, payments of dividends are
not permitted until it has generated cumulative net income. In addition, under
the terms of the indenture, there is a test, performed annually, to determine
whether FLAG Limited is required to make an excess cash flow offer. As at
December 31, 2001, FLAG Limited was not required to make an excess cash flow
offer under the terms of the indenture. Generally, in an excess cash flow offer
the available funds (the "excess cash" as determined by the definitions in the
indenture) would be spread across all bondholders and applied to repurchase a
fraction of their securities at par. In practice, FLAG Limited may repurchase
its bonds in the open market to satisfy this requirement.

FURTHER DETAILS ON THE GROUP'S INDEBTEDNESS

Further details about the indebtedness of each of our subsidiaries is set
out below:

FLAG TELECOM

On February 16, 2000, we sold 27,964,000 common shares at $24 per share in
our initial public offering. We received $633.7 million in net proceeds from
that offering. On March 17, 2000, we completed our sale of 11 5/8% Senior Notes
due 2010 in the U.S. and Europe, raising net proceeds of $576.6 million.

On December 20, 2000, we entered into a cross currency swap to manage the
foreign exchange exposure of our E300 million 11 5/8% Senior Notes due 2010.
Under the swap agreement we exchanged E300 million for $269.0 million. On
June 20, 2002, we will exchange back the $269.0 million for E300 million.

On January 1, 2001, the Group adopted SFAS No. 133 in its entirety, applying
the necessary accounting treatment for all derivative financial instruments held
within the Group. See Note 12 of the Notes to Consolidated Financial Statements
of FLAG Telecom.

On April 3, 2001, FLAG Telecom entered into an agreement to collaborate in
the development and use of Verizon Communications' city-to-city European
backbone network. We expect to fund our commitments under this agreement from
our existing resources.

On August 7, 2001, FLAG Telecom announced that it had decided not to proceed
with the FP-1 project in association with TyCo Telecommunications that had been
announced in the second quarter. The agreement with TyCo Telecommunications was
conditional upon us obtaining financing on satisfactory terms. However, despite
substantial efforts on our part and given the capital market conditions
prevailing at the time, the financing proposal received fell short of
expectations.

45

FLAG LIMITED

On February 16, 2000, FLAG Limited amended its existing credit facilities to
consist of a $150 million six-year term loan facility ($55.5 million of which
remained outstanding at December 31, 2001 and $93 million of which was
outstanding at December 31, 2000) and a $10 million revolving credit facility
(none of which was outstanding at December 31, 2001 or December 31, 2000).
Dresdner Kleinwort Benson and Barclays Capital acted as joint lead arrangers. As
of March 28, 2002, FLAG Limited repaid all amounts owed under the term loan
facility. The revolving credit facility bore interest at a rate of 225 basis
points over LIBOR for the first six months and thereafter at a rate of between
150 and 250 basis points over LIBOR, depending on the credit rating of the
8 1/4% Senior Notes due 2008 of FLAG Limited. As a consequence of the reductions
in the credit rating announced by Moody's in January 2002, the interest rate for
the revolving credit facility at March 28, 2002 was 225 basis points over LIBOR.
The facility is secured by a pledge by us of all of the capital stock of FLAG
Limited and by assignment of FLAG Limited's contracts and a security interest in
its bank accounts and intangible property. In connection with the February 16,
2000 amendment, FLAG Limited paid fees and expenses to the joint lead arrangers
totaling approximately $3.3 million.

In August 2000, FLAG Limited entered into an interest rate collar
transaction for an initial notional amount of $60.0 million, reducing in
increments to $20.0 million in the final quarter of 2001. The transaction
terminates on April 30, 2002. The collar is comprised of a LIBOR cap at 8% and a
floor of 5.85%. FLAG Limited recognizes the net cash amount received or paid on
interest rate hedging instruments as an adjustment to interest cost on the
related debt.

FLAG ATLANTIC LIMITED

In October 1999, FLAG Atlantic entered into an interest rate collar
transaction for an initial notional amount of $31.0 million, increasing in
increments to $106.0 million in the final quarter of 2001. The transaction
terminated on November 30, 2001. The collar was comprised of a LIBOR cap at 7%
and a floor of 6.27%. FLAG Atlantic recognizes the net cash amount received or
paid on interest rate hedging instruments as an adjustment to interest cost on
the related debt.

In October 2001, FLAG Atlantic entered into an interest rate swap for an
initial notional amount of $260.0 million, reducing in increments to
$99.0 million in the first quarter of 2005. The transaction commenced on
December 31, 2001 and terminates on March 31, 2005. Under the swap agreement,
FLAG Atlantic pays a fixed rate of 3.94% and the swap counterparty pays the
floating rate based on LIBOR.

FLAG Atlantic has a $575.0 million construction/term loan facility (of which
$275.8 million and $62.0 million was outstanding at December 31, 2001 and
December 31, 2000, respectively) and a $25.0 million revolving credit facility
($10.2 million of which was outstanding at December 31, 2001 and none of which
was outstanding at December 31, 2000). The construction loan converted to a term
loan on December 6, 2001 and the remaining commitments were cancelled. These
facilities have a term of 7.5 years and bear interest at LIBOR plus 125 basis
points for that portion of the loans (not to exceed 50% of the outstanding
loans) which are backed by investment grade receivables and LIBOR plus 300 basis
points for the balance of the loans. Commitment fees accrued on the undrawn
balance of the loans at between 37.5 basis points and 75 basis points.

FLAG Atlantic's bank facility is secured by an assignment of all of FLAG
Atlantic's contracts, a security interest in its bank accounts and property and
a pledge of all of the stock in FLAG Atlantic.

In addition to the debt drawn, FLAG Atlantic has a $25.0 million revolving
credit facility available for liquidity purposes. As at December 31, 2001,
$10.2 million had been drawn under the revolving credit facility. Where there is
an event of default or the financial covenants are not met, the amount available
under the revolving credit facility reduces for as long as the event of default
or non-compliance with the financial covenant remains.

46

CASH FLOWS

Total cash provided by operating activities was $692.5 million and that used
in investing activities was $(1,375.7) million, for the year ended December 31,
2001. At December 31, 2001, total cash had decreased to $745.4 million from
$1,292.5 million at December 31, 2000, primarily as a result of further payments
on the construction of the FLAG Telecom network.

Total cash provided by operating activities and used in investing for the
year ended December 31, 2000 were $194.9 million and $(373.0) million,
respectively.

ACCOUNTS RECEIVABLE

The accounts receivable balance at December 31, 2001 of $154.0 million
includes $20.6 million relating to sales contracts payable in accordance with
agreed payment schedules over periods between 30 days and one year from the
balance sheet date. The comparable figure at December 31, 2000 was
$50.6 million.

DISCLOSURES ABOUT CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

The following table provides a summary of our obligations and commitments to
make future payments under contracts, contractual obligations and commercial
commitments as at December 31, 2001:

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

(1) These represent the contractual maturities of the Group's indebtedness.
Actual repayments may differ as a result of actions we take to restructure
our indebtedness.

(2) Many of the commitments renew automatically annually. The expiry is deemed
to be greater than five years unless the Company has already given notice to
terminate the agreement.

47

NEW ACCOUNTING STANDARDS

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141 (SFAS 141), Business Combinations, and
Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and
Other Intangible Assets. SFAS 141 requires the use of the purchase method of
accounting for all business combinations initiated after June 30, 2001.
Additionally, it is likely that more intangible assets will be recognized under
SFAS 141 than its predecessor, APB Opinion (APB) No. 16, although in some
instances previously recognized intangibles will be included as part of
goodwill. SFAS 141 requires that, upon adoption of SFAS 142, companies
reclassify the carrying amounts of certain intangible assets and goodwill based
on the criteria of SFAS 141.

Under SFAS 142, goodwill will no longer be amortized, but will be tested for
impairment on an annual basis and whenever indicators of impairment arise.
Additionally, goodwill on equity method investments will no longer be amortized;
however, it will continue to be tested for impairment in accordance with APB
No. 18, The Equity Method of Accounting for Investments in Common Stock. Under
SFAS 142, intangible assets with indefinite lives will not be amortized. Instead
they will be carried at the lower cost or market value and tested for impairment
at least annually. All other recognized intangible assets will continue to be
amortized over their estimated useful lives.

SFAS 142 is effective for fiscal years beginning after December 15, 2001,
although goodwill on business combinations consummated after July 1, 2001 is not
amortized. Upon adoption, all goodwill and indefinite lived intangible assets
must be tested for impairment and a cumulative effect adjustment to net income
recognized at that time.

The Company adopted SFAS 142 on January 1, 2002 and has not yet determined
the impact that the adoption of SFAS 142 will have on its results of operations,
financial position or cash flow. Had SFAS 142 been in effect from January 1,
2001, amortization of $1,670 would not have been charged.

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143, Accounting for Asset Retirement
Obligations (SFAS 143). SFAS 143 establishes accounting requirements for
retirement obligations associated with tangible long-lived assets, including
(1) the timing of the liability recognition, (2) initial measurement of the
liability, (3) allocation of asset retirement cost to expense, (4) subsequent
measurement of the liability and (5) financial statement disclosures. SFAS 143
requires that the fair value of a liability for an asset retirement obligation
be recognized in the period in which it is incurred if a reasonable estimate of
fair value can be made. The associated asset retirement costs are capitalized as
part of the carrying amount of the long-lived asset and depreciated over the
life of the associated fixed asset. An entity shall measure changes in the
liability for an asset retirement obligation due to passage of time by applying
an interest method of allocation to the amount of the liability at the beginning
of the period. The interest rate used to measure that change shall be the
credit-adjusted risk-free rate that existed when the liability was initially
measured. That amount shall be recognized as an increase in the carrying amount
of the liability and as an expense classified as an operating item in the
statement of income. SFAS 143 is effective for fiscal years beginning after
June 15, 2002, with early application encouraged.

The Company expects to adopt SFAS 143 on January 1, 2003 and has not yet
determined the impact that it will have on its results of operations, its
financial position or its cash flows.

In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets (SFAS 144). SFAS 144 establishes a single
accounting model for long-lived assets to be disposed of by sale consistent with
the fundamental provisions of SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of. While it
supersedes portions of APB Opinion 30, Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a

48

Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, it retains the discontinued operations presentation, yet it
broadens that presentation to include a component of an entity (rather than a
segment of a business). However, discontinued operations are no longer recorded
at net realizable value and future operating losses are no longer recognized
before they occur. SFAS 144 also establishes criteria for determining when an
asset should be treated as held for sale.

SFAS 144 is effective for fiscal years beginning after December 15, 2001 and
interim periods within those fiscal years, with early application encouraged.
The provisions of SFAS 144 are generally to be applied prospectively.

The Company adopted SFAS 144 on January 1, 2002 and does not anticipate that
the adoption of SFAS 144 will have a material impact on its results of
operations, financial position or cash flows.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

CURRENCY RISK

We are exposed to a degree of foreign currency risk in our international
operations. The value of the liability of the E300 million of 11 5/8% Senior
Notes due 2010, as expressed in U.S. dollars on our balance sheet, is dependent
on the U.S. dollar/Euro exchange rate at each balance sheet date. The change in
this liability over a period is reflected in our statement of operations in
accordance with U.S. GAAP.

We have entered into a cross currency swap agreement to manage this aspect
of our foreign exchange exposure arising from the E300 million Senior Notes. The
agreement is for a period of 18 months, after which time we will review the
exposure again and may enter into further transactions if considered
appropriate.

Other than this, we do not believe that we are exposed to significant risk
from movements in foreign currency exchange rates. All capacity and operations
and maintenance revenues are payable in U.S. dollars. All contracts for the
provision by third parties of restoration are invoiced to us in U.S. dollars. We
invoice some network services products in local currencies. Some contracts with
suppliers of services to our network services business are payable in currencies
other than U.S. dollars. Some vendor contracts for the provision of operations
and maintenance services to the FEA cable system and local operating expenses of
our subsidiary companies are payable in currencies other than U.S. dollars. We
enter into forward foreign currency contracts to hedge exposures that are
considered material to our financial position.

On January 1, 1999, 12 of the 15 member countries of the European Union
established fixed conversion rates between their existing sovereign currencies
and a new currency called the "Euro". These countries adopted the Euro as their
common legal currency on that date. The Euro trades on currency exchanges and is
available for non-cash transactions. Until January 1, 2002, the existing
sovereign currencies remained legal tender in these countries. On January 1,
2002, the Euro replaced the sovereign legal currencies of these countries. We
have operations within the European Union including many of the countries that
have adopted the Euro. We continue to evaluate the impact the Euro will have on
our continuing business operations within the overall scope of managing currency
risk. However, we do not expect the introduction of the Euro to have a material
effect on our financial position or competitive position.

49

DERIVATIVE FINANCIAL INSTRUMENTS AS OF DECEMBER 31, 2001

INTEREST RATE RISK

We are exposed to interest rate risk in our financing instruments. Our
long-term financing is provided by fixed rate senior notes and floating rate
bank debt. We use derivative financial instruments for the purpose of reducing
our exposure to fluctuations in interest rates. We do not utilize derivative
financial instruments for trading or other speculative purposes. The
counterparties to these instruments are major financial institutions with high
credit quality. We are exposed to credit loss in the event of non-performance by
these counterparties.

INTEREST RATE DERIVATIVE FINANCIAL INSTRUMENTS AS OF DECEMBER 31, 2001

The three-month LIBOR rate at December 31, 2001 was 1.88125%.

SENIOR NOTES AS OF DECEMBER 31, 2001

50

LONG-TERM DEBT AS OF DECEMBER 31, 2001

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See Pages F-1 through F-56 setting forth the financial statements that are
filed as a part of this Form 10-K.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

51

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth, as of March 20, 2002, the names, ages and
positions of the directors and executive officers of the Company. Additional
biographical information concerning these individuals is provided in the text
following the table.

ANDRES BANDE

Mr. Bande has served as Chairman of the Board and Chief Executive Officer
since January 1998. Before joining us, Mr. Bande was the President of Sprint
International from 1996 to the beginning of 1998. Prior to that, he was
President of Ameritech International Corporation from 1990 to 1996.

EDWARD MCCORMACK

Mr. McCormack has been a member of the Board since October 1999 and has
served as Deputy Chairman of the Board since March 2000. He served as the Chief
Financial Officer from February 1996 to November 2000 and was appointed Chief
Operating Officer in March 2000. Prior to that time, Mr. McCormack spent
17 years with Bechtel, an engineering and construction company. His final
position with Bechtel was Chief Financial Officer of Bechtel Europe, Africa,
Middle East and South West Asia.

MICHEL CAYOUETTE

Mr. Cayouette was appointed Chief Financial Officer in January 2002 when he
joined the Company. Prior to joining us, Mr. Cayouette was the Executive Vice
President and Chief Financial Officer of TIW Asia N.V., a global communications
investment fund, from January 2001 to November 2001. Prior to that, he held
several senior executive positions for Teleglobe Communications Corporation and
Teleglobe Inc., from June 1992 to December 2000.

KEES VAN OPHEM

Mr. van Ophem has served as the General Counsel of the Company since
October 2001. He came to the Company from Carrier 1 in Zurich, a Nasdaq and
Frankfurt Neuer Markt listed company which provides access, internet, bandwidth,
data center and voice outsourcing solutions to large telecommunications users,
where he was co-founder and Executive Vice President, Corporate Services and
General Counsel since March 1998. Carrier 1 filed for bankruptcy in
February 2002. Prior to that, Mr. van Ophem was the General Counsel for
Unisource Carrier Services in Zurich from 1994. Mr. van Ophem was in-house
counsel to Royal PTT Netherlands (KPN) in The Hague and an associate with
various law firms both in the U.S. and Europe.

52

THOMAS BARTLETT

Mr. Bartlett has been a member of our Board since October 2000.
Mr. Bartlett has been President of Verizon Global Solutions Inc., Verizon's
provider of worldwide end-to-end communications solutions since July 2000. From
1995 to July 2000 he was President and Chief Executive Officer of Bell Atlantic
International Wireless.

SOOPAKIJ CHEARAVANONT

Mr. Chearavanont was appointed to the Board in September 2000.
Mr. Chearavanont has been President of Telecom Holding Co., Ltd. since 1999,
President of UBC Group, which operates a pay television business, since 1998 and
Chairman and Chief Executive Officer of Hong Kong Fortune Limited, a real estate
and property investment company since 2000. He has also been a director of
TelecomAsia Corporation Public Co. Ltd. since 1994.

ADNAN OMAR

Mr. Omar was a director of FLAG Limited from April 1994 until the corporate
restructuring in February 1999 and has since been a member of our Board.
Mr. Omar is the President of FLAG Telecom Development Services Company LLC and
has been the Executive Director of Al-Jazirah Transport Holding Company, which
invests in diversified businesses through its subsidiaries and is fully owned by
the Dallah Albaraka Group, since March 1998. From 1990 to March 1998, he was
Technical Director of Al-Jazirah Transport Holding Company. Mr. Omar also serves
on the board of directors of BASAFOJAGU CO., Al-Sham Shipping Co. Syria, Dallah
Transport Co. Saudi Arabia and Dallah Lebanon Tourism & Transport Co.

UMBERTO SILVESTRI

Mr. Silvestri has been a member of the Board of the Company since
October 1999. Mr. Silvestri was the Chairman of STET International Netherlands
from 1997 until December 1999 and was the Chairman of Telecom Italia from 1994
until June 1997.

THEODORE SCHELL

Mr. Schell has been a member of the Board of the Company since July 2001.
Mr. Schell has been the General Partner of Apax Partners, Inc. since 2000. Prior
to that, he was Senior Vice President, Strategic Planning and Corporate
Development of Sprint Corporation since 1990. Mr. Schell is also a Director of
Time Warner Telecom, Upoc, Inc. and Webraska Mobile Technologies. He was
previously a director of Kansas City Board of Trade and Hybrid Network. From
1995 to 1999, Mr. Schell was a director of Iridium, Inc., which filed for
bankruptcy in March 2000.

OSAMA JAMJOOM

Mr. Jamjoom has been a member of our Board since January 2002. Mr. Jamjoom
is the Managing Director of Dallah Telecom, a holding company that manages
Dallah Albarakah Investments in telecommunications, since May 2000. He was the
Acting Managing Director of MUX Co. in Egypt, a Pay-TV platform for Arabic
speakers under the brand name of Arab Radio and Television (ART), from
April 1999 to April 2000. Prior to that, he was Distribution General Manager of
MUX Co. from September 1998. From May 1997 to September 1998, Mr. Jamjoom was
General Manager of Saudi Digital Distribution Co., the distribution arm of MUX
Co. in the Saudi market. Mr. Jamjoom also serves on the Board of MUX Co.,
Mauritius and Multichoice Middle East in Dubai, UAE.

There is no family relationship among any of the above-named officers or any
director of the Company.

53

APPOINTMENT OF DIRECTORS TO OUR BOARD

Pursuant to Section 82 of the Company's Bye-laws, each shareholder holding
at least 9% of the issued and outstanding common shares has the right to
designate one director to the Company's board for each 9% of the issued and
outstanding shares held by such shareholder. Notwithstanding the above, for so
long as either Verizon International Holdings Ltd. and/or Rathburn Limited owns
any amount of the common shares, that shareholder shall have the right to
appoint one director to the Company's board. As a result, Verizon International
Holdings Ltd., which beneficially owns approximately 18.6% of the issued and
outstanding common shares, has the right to designate two directors, and each of
Rathburn Limited, which beneficially owns approximately 15.5% of the issued and
outstanding shares, TGN Holdings Ltd., which beneficially owns approximately
11.2% of the issued and outstanding shares, and K.I.N. (Thailand) Co., Ltd.,
which beneficially owns approximately 10.9% of the issued and outstanding
shares, has the right to designate one director. Pursuant to such rights,
Verizon International Holdings Ltd. has named Mr. Thomas Bartlett as its
designee and waived its rights to designate more than one director. TGN
Holdings Ltd. has waived its right to designate one director. Rathburn Limited
has named Mr. Osama Jamjoom as its designee and K.I.N. (Thailand) Co., Ltd. has
named Mr. Chearavanont as its designee.

Shareholders who appoint directors pursuant to Section 82 of our Bye-laws,
are also entitled to replace their representative on the board. For all other
directors, vacancies on the board are filled in accordance with procedures set
out in the Companies Act 1981 of Bermuda. Under the Company's Bye-laws directors
who are executive officers are not subject to retirement by rotation.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Not applicable.

54

ITEM 11. EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

The table below sets forth information concerning compensation paid to the
CEO and the Company's four (4) most highly compensated executives other than the
CEO for each of fiscal years 1999, 2000 and 2001.

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

(1) Other Annual Compensation includes personal benefits received. In the case
of expatriate executives, this includes a housing allowance and amounts
reimbursed during the fiscal year for the payment of taxes.

(2) All Other Compensation means perquisites and other compensation for the
covered fiscal year such as amounts paid in connection with the resignation
of the officer's employment, insurance premiums paid on behalf of the
registrant during the covered fiscal year with respect to term life
insurance and other professional fees.

(3) In 2001, Mr. Bande was reimbursed $110,316 during the fiscal year for the
payment of taxes.

(4) Mr. van Ophem joined the Company on October 1, 2001, replacing Mr. Stuart
Rubin.

(5) Mr. van Ophem received an annual bonus of $82,850 and a signing on bonus of
$120,000.

(6) Mr. Rubin resigned as General Counsel of the Company in June 2001.

(7) Mr. Rubin's employment with the Company ended on December 31, 2001.

(8) Mr. Rubin received a lump sum compensation payment of $363,167 and other
compensation of $94,269.

(9) Mr. Kawar left the Company on July 31, 2001. He commenced a 12-month
consultancy agreement with the Company on October 1, 2001.

(10) Mr. Kawar received a lump sum compensation payment of $375,000 (of which
$70,000 related to his pro rata bonus). On commencement of his consultancy
agreement, Mr. Kawar received a payment of $400,000. During the period
October to December 2001, he received $75,000 under the terms of the
consultancy agreement. Mr. Kawar received other compensation of $60,309.

As noted in Item 10, on January 14, 2002, Mr. Michel Cayouette was appointed
as Chief Financial Officer, replacing Mr. Larry Bautista. Mr. Cayouette is not
included in the Summary Compensation table above because he received no
compensation from the Company for fiscal year 2001.

55

OPTION GRANTS

The table below sets forth information concerning options granted in 2001 to
the CEO and the Company's four (4) most highly compensated executives other than
the CEO in 2001.

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

(1) The dollar amounts under these columns are the results of calculations
assuming that the market price of the common shares appreciates in value
from the date of grant to the end of the option term at the 5% and 10%
annual appreciation rates set by the SEC for illustrative purposes and are
not intended to forecast future financial performance or possible future
appreciation, if any, in the price of the common shares.

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES

The table below sets forth information concerning exercises of stock options
by the CEO and the Company's four (4) most highly compensated executives other
than the CEO during the last fiscal year, and the fiscal year-end value of such
executives' unexercised options. Amounts in the table are given as of
December 31, 2001. There were no options exercised during the fiscal year ended
December 31, 2001.

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

(1) Options granted during 2001 were granted at an exercise price of $2.75,
$1.14 and $1.44 on April 6, 2001, August 31, 2001 and November 29, 2001
respectively.

(2) An Incentive Stock Option ("ISO") award vests in three equal annual
installments over three years, 33.33% vesting upon the first anniversary of
the date of its grant, 33.33% vesting upon the second anniversary of the
date of its grant and 33.34% vesting upon the third anniversary of the date
of its grant.

(3) The value of unexercised in the money options has been calculated by
determining the difference between the fair market value of a FLAG Telecom
common share at the fiscal year end and the exercise price of the options.

56

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The Compensation Committee of the FLAG Telecom board consists of
Messrs. Bande, Omar and Bartlett. Both Mr. Bande and Mr. Omar hold options of
the Company, whereas Mr. Bande is Chairman and CEO of the Company and Mr. Omar
is the President of FLAG Telecom Development Services Company LLC.

CERTAIN COMPENSATION ARRANGEMENTS

The Company, directly and through one or more of its subsidiaries, is party
to employment agreements with Mr. Andres Bande, Mr. Edward McCormack, Mr. Kees
van Ophem and Mr. Michel Cayouette. Each agreement with the Company provides
that employment shall continue until terminated.

Mr. Bande's employment agreement provides that if the Company terminates the
employee without Cause or the employee terminates his employment for Good Reason
(as each term is defined in the agreement), the Company will pay Mr. Bande
$1,440,000.

Mr. McCormack's employment agreement provides that if the Company terminates
the employee without Cause or notice or for reasons of incapacity, or the
employee terminates his employment within one month of a Change of Control (as
each term is defined in the agreement) or after December 31, 2003, the Company
will pay Mr. McCormack two years' worth of basic salary and a guaranteed bonus
of 100% of two years' basic salary. In addition, Mr. McCormack's unvested stock
options would vest and be exercisable until December 31, 2011 upon the
occurrence of such events.

Mr. van Ophem's employment agreement provides that if the Company terminates
the employee without cause, the Company will pay Mr. van Ophem six-months' worth
of salary. If the Company terminates Mr. van Ophem's employment upon a change of
control during the first 12 months of Mr. van Ophem's employment, the Company
will pay him 12 months' worth of salary.

Mr. Cayouette's employment agreement provides that if the Company terminates
the employee without cause, the Company will pay Mr. Cayouette six-months' worth
of salary and a pro rated bonus unless such termination results from a change of
control. If the Company terminates Mr. Cayouette's employment upon a change of
control, the Company will pay Mr. Cayouette 12 months' worth of salary and a pro
rated bonus.

FLAG Telecom's board is in the process of considering the design and
implementation of a retention program to assure continued employment of the
Company's senior executives during the restructuring of the Group's obligations.

COMPENSATION OF OUTSIDE DIRECTORS

Each director who is not an employee of the Company is paid his reasonable
travel, hotel and incidental expenses in attending and returning from meetings
of the Board or committees or general meetings. In addition, each such director
is paid all expenses properly and reasonably incurred by him in the conduct of
the Company's business or in the discharge of his duties as a director and
non-executive directors are entitled to US$1,500 per day for each day spent
working on one or more matters related to the Company as requested by the Board
or the Chairman.

The Company provides an annual retainer of US$30,000 to each independent
director, in addition to reimbursing travel expenses for attendance at Board
meetings. During 2001, the independent directors who were also members of the
Audit Committee, Mr. Michael Fitzpatrick (who resigned in August 2001),
Mr. Umberto Silvestri, and Mr. Theodore Schell each received an annual retainer
of $30,000 and reimbursements for such travel expenses.

57

On July 31 2001, Mr. Theodore Schell was granted options of 41,667 common
shares with a three year vesting period.

LONG-TERM INCENTIVE PLAN

In 1999, our Board of Directors and our shareholders adopted the FLAG
Limited 1998 Long-Term Incentive Plan (the "Plan"), originally adopted in 1998
by the Board of Directors and shareholders of FLAG Limited. The purpose of the
Plan is to allow us to attract, retain and reward officers, employees,
consultants and certain other individuals and to compensate them in a way that
provides additional incentives and enables such individuals to increase their
ownership interests. Individual awards under the Plan may take the form of:

- incentive stock options ("ISOs") or non-qualified stock options ("NQSOs");

- stock appreciation rights ("SARs");

- restricted or deferred stock;

- dividend equivalents;

- bonus shares and awards in lieu of our obligations to pay cash
compensation; and

- other awards the value of which is based in whole or in part upon the
value of the common shares.

To date, the Company has only distributed ISOs and SARs under the Plan.

The Plan is administered by the Compensation Committee, whose members are
appointed by our Board of Directors. The Committee is empowered to select the
individuals who will receive awards and the terms and conditions of those
awards, including exercise prices for options and other exercisable awards,
vesting and forfeiture conditions (if any), performance conditions, the extent
to which awards may be transferable and periods during which awards will remain
outstanding. Awards may be settled in cash, shares, other awards or other
property, as determined by the Compensation Committee.

The Plan may be amended by the Board of Directors without the consent of our
shareholders, except that any amendment, although effective when made, will be
subject to shareholder approval if required by any Federal or state law or
regulation or by the rules of any stock exchange or automated quotation system
on which our common shares may then be listed or quoted. The number and kind of
shares reserved or deliverable under the Plan and the number and kind of shares
subject to outstanding awards are subject to adjustment in the event of stock
splits, stock dividends and other extraordinary corporate events. All common
shares issued pursuant to the Plan are registered with the SEC on Form S-8. On
June 1, 2001, a subsequent Form S-8 was filed to register 2.5 million common
shares to be issued under the Plan.

The maximum number of common shares that may be subject to awards under the
Plan may not exceed 13,263,791, as of November 27, 2001.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth as of March 20, 2002, the beneficial
ownership of FLAG Telecom's common shares by:

- those persons known by us to own beneficially more than 5% of FLAG
Telecom's outstanding common shares;

- each of the executive officers and directors named elsewhere in this
document and the Company's four most highly compensated executives other
than the CEO; and

- all directors, executive officers and named executives of the Company as a
group.

58

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

* Less than 1%

(1) The amounts and percentages shown are amounts and percentages owned
beneficially as of March 20, 2002, based on information furnished or
publicly disclosed by the persons named. A person is deemed to be the
beneficial owner of common shares if such person, either alone or with
others, has the power to vote or to dispose of such shares. Shares
beneficially owned by a person include shares that the person has the right
to acquire under stock options that were exercisable on March 20, 2002 or
that become exercisable within 60 days after March 20, 2002. All shares
beneficially owned by the individuals Andres Bande, Edward McCormack, Adnan
Omar, and Umberto Silvestri are common shares that the person has the right
to acquire upon the exercise of options.

(2) Verizon Communications Inc. is the ultimate parent of a controlled
subsidiary, Verizon International Holdings Ltd., which directly owns our
common shares. The business address of the direct owner is Verizon
International Holdings Ltd., Cedar House, 41 Cedar Avenue, Hamilton HM12,
Bermuda.

(3) Dallah Albaraka Holding Company (DABHC) is the parent of a wholly-owned
subsidiary, Rathburn Limited, which owns 17,000,000 common shares of the
Company. Dallah Albaraka Securities Holding Ltd., another wholly-owned
subsidiary of DABHC, owns 3,790,157 common shares of the Company. The
business address of Rathburn Limited is Abbot Building, Main Street,
P.O. Box 3186, Road Town, Tortola, BVI. The business address of Dallah
Albaraka Securities Holding Ltd. is P.O. Box 1111, West Wind Building,
Harbour Drive, Grand Cayman, Cayman Islands, B.W.I. Rathburn Limited has
pledged 17,000,000 common shares to Barclays Bank PLC under a security
agreement relating to the obligations of Dallah Albaraka Holding Company.
Dallah Albaraka Securities Holding Ltd. has pledged its 3,790,157 common
shares to UBS AG-London Branch under a security agreement relating to the
obligations of Dallah Albaraka Holding Company.

59

(4) Tyco International Ltd. is the ultimate parent of a wholly-owned subsidiary,
TGN Holdings Ltd., which directly owns our common shares. The business
address of the direct owner is TGN Holdings Ltd., The Zurich Centre, Second
Floor, 90 Pitts Bay Road, Pembroke HM08, Bermuda. TGN Holdings Ltd. acquired
15,000,000 of the Company's common shares in a negotiated purchase from
Verizon International Holdings Ltd. on June 19, 2001.

(5) TelecomAsia Corporation Public Co. Ltd. is the ultimate parent of a
wholly-owned subsidiary, K.I.N. (Thailand) Co., Ltd., which directly owns
our common shares. The business address of the direct owner is K.I.N.
(Thailand) Co., Ltd., c/o Telecom Holding Co., Ltd., 30th Floor, Telecom
Tower, 18 Ratchadaphisak Road, Huai Khwang, Bangkok 10310, Thailand. Verizon
Communications Inc. holds approximately 13.8% of the shares of TelecomAsia
Corporation Public Co. Ltd.

(6) The business address of The Asian Infrastructure Fund is: c/o Caledonian
Bank & Trust Limited, Caledonian House, Mary Street, Georgetown, Grand
Cayman, Cayman Islands.

(7) Marubeni Corporation is the ultimate parent of a wholly-owned subsidiary,
Vectant, Inc., which owns our common shares. The business address of
Vectant, Inc. is 111 West 57th Street, New York, NY 10019.

(8) All shares are subject to options.

(9) The percentage of outstanding shares beneficially owned by FLAG Telecom's
directors and executive officers is calculated on a fully-diluted basis.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

AGREEMENTS WITH VERIZON

Verizon Communications Inc. ("Verizon") is the ultimate parent of a
controlled subsidiary Verizon International Holdings Ltd., which directly owns
18.6% of our common shares. We entered into the following four agreements with
subsidiaries of Verizon throughout 2001:

NETWORK ALLIANCE AGREEMENT

On April 3, 2001, FLAG Telecom Ireland Network Limited ("FTINL"), a
subsidiary of the Company, entered into a Network Alliance Agreement with
Verizon Global Solutions Holdings II Ltd. ("VGS") under which both parties
agreed to create a network alliance to develop a European network. FTINL and its
affiliates will have the right to acquire from VGS capacity on this European
network on an indefeasible right of use ("IRU") basis. FTINL paid VGS
$35.6 million for such IRU over the European network and agreed to pay annual
operating and maintenance fees. The annual operating and maintenance fees
consist of $1.78 million paid in years one up to and including year five of the
IRU, $1.068 million paid in years six to ten, and $712,000 paid in years 11 to
15.

COLLOCATION AGREEMENT

On April 4, 2001, FLAG Atlantic UK Limited and FLAG Atlantic France Sarl,
both subsidiaries of the Company (collectively "FLAG Atlantic"), entered into a
Collocation Agreement with Verizon Global Solutions U.K. Ltd. and Verizon Global
Solutions France SAS (collectively "Verizon UK/ France") under which FLAG
Atlantic agreed to license to Verizon UK/France co-location space in FA-1 PoPs
in both London and Paris. Verizon UK/France agreed to pay approximately
$15,471,000 for the license in the UK and approximately $6,119,000 for the
license in France. The space will be used by VGS to create the London and Paris
PoPs for its European network, which will provide capacity to subsidiaries of
the Company under the Network Alliance Agreement referred to above.

60

RE-SALE AND PURCHASE AGREEMENT

On April 3, 2001, FTINL and FLAG Telecom Global Networks Limited ("FTGNL"),
both subsidiaries of the Company, entered into a Re-Sale and Purchase Agreement
with VGS under which VGS agreed to purchase for $17.6 million approximately 30%
of the dark fiber pairs and co-location facilities located on the KPNQwest
Services UK Limited ("KPNQwest") EuroRings Network. The fiber pairs and
co-location facilities were originally purchased pursuant to a Dark Fibre IRU
and Collocation Facilities Agreement, dated February 28, 2001, among FTINL,
FTGNL and KPNQwest (the "KPNQwest Agreement").

TRI-PARTITE AGREEMENT

On April 3, 2001, FTGNL, KPNQwest and VGS entered into a Tri-Partite
Agreement under which FTGNL assigned all of its rights, title, interest and
obligations under the KPNQwest Agreement to VGS and KPNQwest acknowledged and
consented to such assignment.

MARINE MAINTENANCE SERVICE AGREEMENT WITH TGN

TGN Holdings Ltd. ("TGN") directly owns 11.2% of our common shares. On
June 1, 2001, FLAG Atlantic Limited ("FAL"), a subsidiary of the Company,
entered into a Marine Maintenance Service Agreement with TyCom Contracting
Limited ("TyCom"), an affiliate of TGN, under which TyCom agreed to provide
certain marine maintenance services to FLAG Telecom for our FA-1 undersea fiber-
optic cable systems. FAL agreed to pay $6.9 million per annum for such services.
The earliest date on which we could withdraw from this contract is June 1, 2006.

AGREEMENT WITH ADNAN OMAR

On December 10, 2001, the Company entered into an agreement with Mr. Adnan
Omar, a director on FLAG Telecom's board, pursuant to which Mr. Omar was
appointed President of FLAG Telecom Development Services Company LLC, a
subsidiary of the Company in Egypt. The agreement is for a fixed two year term
under which Mr. Omar is entitled to a monthly payment of US$30,000.

61

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

FINANCIAL STATEMENTS

(a)(1) Financial Statements. See index to Financial Statements on Page F-1.

(a)(2) Financial Statement Schedules. The Financial Statement Schedules
described below are filed as part of this report on pages F-50 to
F-56. All other schedules are omitted because they are not
applicable, not required or the required information is in the
Financial Statements or the Notes thereto.

- Schedule I--Condensed Financial Information of Registrant

- Schedule II--Valuation and Qualifying Accounts

REPORTS ON FORM 8-K

We filed the following Form 8-K Current Reports during the period from
October 1 through December 31, 2001:

EXHIBITS

The following Exhibits are filed as part of this Report as required by
Regulation S-K.

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

* Filed herewith

+ Confidential treatment has been requested with respect to certain portions of
this exhibit. The confidential portions of this exhibit for which
confidential treatment has been requested has been filed separately with the
SEC.

66

FINANCIAL STATEMENTS

F-1

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Shareholders of FLAG Telecom Holdings Limited:

We have audited the accompanying consolidated balance sheets of FLAG Telecom
Holdings Limited, a Bermuda company ("FLAG Telecom"), and subsidiaries as of
December 31, 2001 and 2000, and the related consolidated statements of
operations, comprehensive income, shareholders' equity and cash flows for the
years ended December 31, 2001 and 2000, and the period from incorporation to
December 31, 1999. These financial statements are the responsibility of FLAG
Telecom's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States and all applicable professional and firm auditing
standards, including quality control standards. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of FLAG Telecom and
subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for the years ended December 31, 2001 and 2000,
and the period from incorporation to December 31, 1999, in conformity with
accounting principles generally accepted in the United States.

The accompanying financial statements have been prepared assuming that FLAG
Telecom will continue as a going concern. As discussed in note 1 to the
consolidated financial statements, FLAG Telecom has determined that it will not
make the interest payments on its 11 5/8% senior notes, due on March 30, 2002.
This raises substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also described in
note 1. The consolidated financial statements do not include any adjustments
relating to the recoverability and classification of asset carrying amounts or
the amount and classification of liabilities that might result should FLAG
Telecom be unable to continue as a going concern.

Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedules in Item 14 are presented
for purposes of complying with the Securities and Exchange Commission's rules
and are not part of the basic financial statements. These schedules have been
subjected to the auditing procedures applied in the audits of the basic
financial statements and, in our opinion, fairly state in all material respects
the financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.

Arthur Andersen
Hamilton, Bermuda
March 28, 2002

F-2

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

AS OF DECEMBER 31, 2001 AND 2000

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

The accompanying notes are an integral part of these consolidated financial
statements.

F-3

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000,
AND THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

The accompanying notes are an integral part of these consolidated financial
statements.

F-4

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000,
AND THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS)

The accompanying notes are an integral part of these consolidated financial
statements.

F-5

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000,
AND THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

The accompanying notes are an integral part of these consolidated financial
statements.

F-6

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000,
AND THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS)

F-7

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000,
AND THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS)

The accompanying notes are an integral part of these consolidated financial
statements.

F-8

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

1. BACKGROUND AND ORGANIZATION

FLAG Telecom Holdings Limited ("the Company" or "FLAG Telecom") was
incorporated on February 3, 1999 to serve as the holding company for the FLAG
Telecom group of companies ("the Group"). On February 26, 1999, FLAG Telecom
acquired approximately 66% of FLAG Limited by exchanging 69,709,935 shares of
FLAG Limited common stock for the same number of shares of FLAG Telecom common
stock. The minority shareholder of FLAG Limited exchanged its remaining holding
in FLAG Limited for 36,256,121 shares in FLAG Telecom on January 4, 2000 such
that on that date FLAG Limited became a wholly owned subsidiary of FLAG Telecom.
This acquisition has been accounted for as a recapitalization such that no
goodwill arises and assets and liabilities are reflected at carryover basis.

FLAG Telecom had $300 million 11 5/8% senior notes and E300 million 11 5/8%
senior notes outstanding as at December 31, 2001. We have determined that we
will not make the required interest payments, due March 30, 2002, on these
senior notes. Failure to pay interest would become an event of default after a
30-day grace period. After the grace period, the holders of 25% or more of the
notes of either series can accelerate the notes, at which point they would
become due and payable. We do not have sufficient liquidity to pay these two
series in full at this time. If we are unable to negotiate a restructuring of
these notes, we would have to file for protection under bankruptcy laws. We
elected not to make this interest payment in order to conserve our cash and to
permit us to enter into discussions with the holders of our outstanding
indebtedness to seek a consensual arrangement under which we would restructure
our outstanding indebtedness. As a result of our decision not to pay interest on
FLAG Telecom's senior notes, we have reclassified the senior notes from
long-term debt to short-term debt.

RISKS AND OTHER IMPORTANT FACTORS

The Group's operations and ability to grow may be affected by numerous
factors, including, but not limited to: problems being experienced by the
telecom industry; the insolvency and financial difficulties on the part of
customers and suppliers; excess fiber capacity; pricing pressures requiring the
recognition of an asset impairment; governmental investigations with respect to
other industry participants; the recent focus on financial reporting principles;
the Group's substantial indebtedness; electing not to pay interest due on FLAG
Telecom's senior notes; restructuring of indebtedness; the potential breach of
covenants in the FLAG Atlantic credit facility; an inability to arrange
alternate financing for FNAL; lack of liquidity; substantial overcapacity;
customers demanding shorter-term arrangements; dependence on third parties for
the critical last mile connection to customers; inability to complete projects
underway; failure to realize sufficient value from the FLAG systems;
infrastructural investments and technologies becoming obsolete; maintenance of
cooperative relationships with landing partners and local operators; foreign
regulation; possible international economic and political instability; exposure
to foreign exchange rate risk; dependance on key personnel; volatility of FLAG
Telecom's common shares; the delisting of common shares from the Nasdaq National
Market; changes in tax regulation; and limitations imposed by FLAG Telecom's
Bye-laws. The Group cannot predict which, if any, of these or other factors
might have a significant impact on the telecommunications industry in the
future, nor can it predict what impact, if any, the occurrence of these or other
events might have on the Group's operations.

F-9

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

The Group has devoted substantial resources to the buildout of its network
and expansion of its market offerings. As a result, the Group experienced
operating losses in 2001 and 2000. These losses are expected to continue for
additional periods in the future. There can be no assurance that the Group's
operations will become profitable. The Group's capital requirements for the
continued buildout of its network and growth of its customer base are
substantial. The Group intends to fund its operational and capital requirements
in 2002 using cash on hand, cash flow from operations, and its available credit
facilities. In the event that the Group is unable to maintain sufficient
financing, it would be required to limit or curtail its expansion plans, network
buildout, and marketing programs.

2. SIGNIFICANT ACCOUNTING POLICIES

These financial statements have been prepared in accordance with accounting
principles generally accepted in the United States ("U.S. GAAP") and are
expressed in U.S. Dollars ("Dollars"). The significant accounting policies are
summarized as follows:

a) Basis of Consolidation

The financial statements consolidate the financial statements of FLAG
Telecom and its subsidiary companies after eliminating intercompany transactions
and balances. Investments in which FLAG Telecom has an investment of 20%-50% or
investments in which FLAG Telecom can assert significant influence, but does not
control, are accounted for under the equity method. At December 31, 2001, there
were no equity method investments remaining (see Note 4).

b) Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenue and expenses during the
reporting period. Actual amounts and results could differ from those estimates.

c) Reciprocal Transactions

We enter into transactions in which we provide capacity, services or
facilities, by way of leases, ROUs or service agreements to other
telecommunications companies and service providers at approximately the same
time that we leased or purchased capacity from the same companies or their
affiliates. We term these "reciprocal transactions".

We treat reciprocal transactions as if they were non-monetary transactions
in accordance with APB No. 29. In order to conclude that the reciprocal
transactions should appropriately be accounted for as revenue and a capital
expenditure at fair value, in accordance with APB No. 29, we assess whether:

1. the reciprocal transaction is an "exchange of similar productive assets" as
defined in APB No. 29. We do not hold products or property for sale in the
ordinary course of business so an "exchange" would be the exchange of a
productive asset not held for sale in the ordinary course of business for a
similar productive asset or an equivalent interest in the same or similar
productive asset, and

2. the fair values of the assets exchanged are determinable within reasonable
limits.

F-10

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

Our reciprocal transactions fall into three categories: services for
services, operating leases for operating leases and operating leases for capital
leases. Under the terms of both service contracts and operating leases we do not
exchange an interest in a productive asset but provide a service to, and receive
a service from, our customers. Consequently such transactions are recorded at
fair value. We also consider that operating leases and capital leases are
dissimilar in nature and consequently are not exchanges of similar productive
assets within the definition of APB No. 29.

We determine fair value by reference to recent cash transactions or quotes
from third parties for equivalent capacity or services.

d) Revenue Recognition

CAPACITY

Capacity contracts are accounted for as leases. Capacity contracts that do
not qualify for sales type lease accounting are accounted for as operating
leases and revenue is recognized over the term of the lease. In compliance with
FASB Interpretation No. 43, "Real Estate Sales, an Interpretation of FASB
Statement No. 66," capacity contracts entered into after June 30, 1999, are
deemed not to be sales of real estate and, therefore, are not accounted for as
sales type leases. The Group has recorded only operating leases for capacity
transactions after June 30, 1999 for the periods presented. Until June 30, 1999
revenues from operating lease transactions were considered incidental and
recorded as a reduction of the capacity available for sale, thereafter
recognized over the period of the contract.

Payments received from customers before the relevant criteria for revenue
recognition are satisfied are included in deferred revenue.

In exchange for construction costs incurred, FLAG Limited granted credits to
suppliers toward future capacity. In addition, certain customers have committed
to purchase capacity at a future date under signed capacity credit agreements.
Amounts received under these agreements and the capacity credits granted to
suppliers are recorded at fair value as deferred revenue until the date the
credits are utilized, at which time the deferred revenue is recognized as
earned. Amounts receivable under these capacity agreements are reflected within
accounts receivable in the accompanying balance sheets.

RECIPROCAL TRANSACTIONS

In accordance with U.S. accounting principles, amounts invoiced as part of
reciprocal transactions are recorded at fair value as deferred revenue. We
amortize deferred revenue on a straight-line basis as earned over the term of
the relevant agreement. We have not entered into any reciprocal transactions
that would require us to recognize GAAP revenues upfront.

OPERATIONS AND MAINTENANCE

Standby maintenance and restoration charges are invoiced to customers
separately from capacity sales. Revenues relating to standby maintenance and
restoration are recognized over the period the service is provided. Deferred
revenue also includes amounts invoiced for standby maintenance which are
applicable to future periods.

F-11

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

NETWORK SERVICES REVENUES

Network services revenues are revenues derived from the sale of managed
bandwidth services, Internet Protocol ("IP") and other services. Revenue
associated with short-term leased capacity is recognized as operating lease
revenues unless the criteria under FASB Interpretation No. 43 for sales-type
lease accounting are met. During the periods presented, there were no sales-type
leases recorded.

Revenue from project management services is recognized on a percentage
completion basis as costs are incurred on the project.

e) Direct Costs Related to Revenue

CAPACITY

Costs of the system relating to capacity contracts accounted for as
operating leases are recorded in property and equipment and are depreciated over
the remaining economic life of the network.

RECIPROCAL TRANSACTIONS

Capacity or facilities that we acquire as part of reciprocal transactions
are recorded either as property and equipment, prepaid expenses and other assets
or other long term assets, depending upon when it is anticipated that they will
be brought into service, and are charged as network expense or depreciated on a
straight-line basis over the shorter of 15 years or the term of the purchase
agreement.

OPERATIONS AND MAINTENANCE COSTS

Operations and maintenance costs are expensed over the period to which the
expenditure relates.

NETWORK EXPENSES

Costs relating to the short-term lease of capacity are recognized over the
period of the contract.

The costs of network service products are expensed over the period of the
recognition of the corresponding revenue.

Where network service rebates are received, costs are reduced by the amount
of the rebate received.

f) Commissions

Commissions are capitalized and amortized over the period of the recognition
of the related capacity revenue.

g) Advertising Costs

Advertising costs are expensed as incurred. Such costs are included in sales
and marketing expenses in the accompanying consolidated statements of
operations.

F-12

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

h) Net Income/(Loss) per Common Share

SFAS No. 128 "Earnings per Share" requires dual presentation of basic and
diluted earnings per share on the face of the statements of operations for all
periods presented. Basic earnings per share excludes dilution and is computed by
dividing income available to common stockholders by the weighted-average number
of common shares outstanding for the period. Diluted earnings per share reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of the entity.

i) Cash and Cash Equivalents

The Group considers all short-term investments with original maturities of
90 days or less to be cash equivalents. The carrying amounts reported in the
accompanying consolidated balance sheets approximate to fair value.

j) Goodwill

Goodwill, representing the excess of purchase price over the fair value of
assets acquired and the liabilities assumed relating to the acquisition of FLAG
Atlantic Limited, is amortized on a straight-line basis over a period of
15 years.

k) Restricted Cash

The Group designates funds held by collateral trustees, in escrow or legally
designated for specific projects or commitments by bank agreements, as long term
restricted cash.

l) Capitalized Interest and Financing Costs

Interest costs on qualifying assets are capitalized and amortized over the
useful life.

Costs incurred to obtain financing are capitalized and amortized over the
term of the related borrowings.

m) Construction in Progress

Construction in progress is stated at cost. Capitalized costs include costs
incurred under the construction contract, engineering and consulting fees, legal
fees related to obtaining landing right licenses, interest costs related to
program management, costs for the route surveys, indirect costs associated with
cable systems and points of presence ("PoPs"), long-term capacity lease
purchases, and other costs necessary for developing our global network.
Construction in progress is transferred to property and equipment when placed
into service.

F-13

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

n) Property and Equipment

Property and equipment are stated at cost, net of accumulated depreciation.
Depreciation is provided on a straight-line basis over the estimated useful
lives of the assets as follows:

The estimated useful lives of network assets are determined based on the
estimated period over which they will generate revenue.

o) Impairment of Long-Lived Assets

The Group periodically reviews events and changes in circumstances to
determine whether the recoverability of the carrying value of long-lived assets
should be reassessed. Should events or circumstances indicate that the carrying
value may not be recoverable based on undiscounted future cash flows, an
impairment loss measured by the difference between the fair value and the
carrying value of long-lived assets would be recognized by the Group.

p) Income Taxes

Deferred taxes are determined based on the difference between the tax basis
of an asset or liability and its reported amount in the financial statements. A
deferred tax liability or asset is recorded using the enacted tax rates expected
to apply to taxable income in the period in which the deferred tax liability or
asset is expected to be settled or realized. Future tax benefits attributable to
these differences, if any, are recognizable to the extent that realization of
such benefits is more likely than not.

q) Derivative Financial Instruments

The Group uses derivative financial instruments for the purpose of reducing
its exposure to adverse fluctuations in interest rates, currencies and other
market risks. The Group does not utilize derivative financial instruments for
trading or other speculative purposes. The counterparties to these instruments
are major financial institutions with high credit quality. The Group is exposed
to credit loss in the event of non-performance by these counterparties.

Effective January 1, 2001, the Group adopted Statement of Financial
Accounting Standards No. 133 ("SFAS No. 133"), "Accounting for derivative
Instruments and Hedging Activities", as amended by SFAS No. 137 and 138, which
established accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or a liability
measured at its fair value. The statement also requires that changes in the
derivative's fair value be recognized currently in earnings

F-14

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

unless specific hedge accounting criteria are met. Special accounting for
qualifying hedges allows gains and losses on a derivative to offset related
results on the hedged item in the income statement, and requires that a company
formally document, designate, and assess the effectiveness of transactions that
receive hedge accounting. The following effects were recorded in the
accompanying consolidated financial statements as a result of the adoption of
SFAS No. 133:

- The Group's interest rate collars are accounted for as effective cash flow
hedges and, accordingly, upon adoption of SFAS No. 133 their fair values
were recorded as liabilities in the balance sheet, with the corresponding
effect of adoption recorded directly to accumulated other comprehensive
income.

- The Group's cross currency swap held at January 1, 2001 was not designated
as an accounting hedge; consequently, upon the adoption of SFAS No. 133,
the swap was recorded in the balance sheet at fair value, and the Group's
underlying economically hedged euro-denominated debt was recorded at
current foreign currency rates. The resulting adjustment of $1,291 was
recorded as the cumulative effect of adoption of SFAS No.133.

r) Translation of Foreign Currencies

Transactions in foreign currencies are translated into United States Dollars
at the rate of exchange prevailing at the date of each transaction. Monetary
assets and liabilities denominated in foreign currencies at year-end are
translated into Dollars at the rate of exchange at that date. Foreign exchange
gains or losses are reflected in the accompanying statements of operations.

The statements of operations of overseas subsidiaries are translated into
Dollars at average exchange rates and the year-end net investments in these
companies are translated at year-end exchange rates. Exchange differences
arising from retranslation at year-end exchange rates of the opening net
investments and results for the year are charged or credited directly to the
cumulative translation adjustment in shareholders' equity.

s) Stock Options

As permitted by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock Based Compensation" ("SFAS No. 123"), the Company has
chosen to account for employee stock options under Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25), and,
accordingly, recognizes compensation expense for stock option grants to the
extent that the fair value of the stock exceeds the exercise price of the option
at the measurement date under fixed plan awards. The compensation expense is
charged ratably over the vesting period of the options.

t) Concentration of Credit Risk

Financial instruments that potentially subject the Group to a concentration
of credit risk are accounts receivable. The Group performs ongoing credit
evaluations of its larger customers' financial condition.

See Note 16, Segmental Reporting, for concentrations by geographic areas.

F-15

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

The Company is exposed to credit-related losses in the event of
non-performance by counterparties to financial instruments but does not expect
any counterparties to fail to meet their obligations. The Company deals only
with highly rated counterparties.

u) Reverse Stock Split

The accompanying consolidated financial statements have been retroactively
restated to give effect to the reverse stock split of 6:1 carried out by the
Company on February 11, 2000.

v) Reclassifications

Certain prior year amounts have been reclassified in the consolidated
financial statements to conform to current year presentation.

w) New Accounting Standards

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141 (SFAS 141), Business Combinations, and
Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and
Other Intangible Assets. SFAS 141 requires the use of the purchase method of
accounting for all business combinations initiated after June 30, 2001.
Additionally, it is likely that more intangible assets will be recognized under
SFAS 141 than its predecessor, APB Opinion (APB) No. 16, although in some
instances previously recognized intangibles will be included as part of
goodwill. SFAS 141 requires that, upon adoption of SFAS 142, companies
reclassify the carrying amounts of certain intangible assets and goodwill based
on the criteria of SFAS 141.

Under SFAS 142, goodwill will no longer be amortized, but will be tested for
impairment on an annual basis and whenever indicators of impairment arise.
Additionally, goodwill on equity method investments will no longer be amortized;
however, it will continue to be tested for impairment in accordance with APB
No. 18, The Equity Method of Accounting for Investments in Common Stock. Under
SFAS 142, intangible assets with indefinite lives will not be amortized. Instead
they will be carried at the lower cost or market value and tested for impairment
at least annually. All other recognized intangible assets will continue to be
amortized over their estimated useful lives.

SFAS 142 is effective for fiscal years beginning after December 15, 2001,
although goodwill on business combinations consummated after July 1, 2001 is not
amortized. Upon adoption, all goodwill and indefinite lived intangible assets
must be tested for impairment and a cumulative effect adjustment to net income
recognized at that time.

The Company adopted SFAS 142 on January 1, 2002 and it is not expected to
have a material impact on its results of operations, financial position or cash
flow.

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143, Accounting for Asset Retirement
Obligations (SFAS 143). SFAS 143 establishes accounting requirements for
retirement obligations associated with tangible long-lived assets, including
(1) the timing of the liability recognition, (2) initial measurement of the
liability, (3) allocation of asset retirement cost to expense, (4) subsequent
measurement of the liability and (5) financial statement disclosures. SFAS 143
requires that the fair value of a liability for an asset retirement obligation
be recognized in the period in which it is incurred if a reasonable estimate of
fair value can be made. The

F-16

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset and depreciated over the life of the associated fixed
asset. An entity shall measure changes in the liability for an asset retirement
obligation due to passage of time by applying an interest method of allocation
to the amount of the liability at the beginning of the period. The interest rate
used to measure that change shall be the credit-adjusted risk-free rate that
existed when the liability was initially measured. That amount shall be
recognized as an increase in the carrying amount of the liability and as an
expense classified as an operating item in the statement of income. SFAS 143 is
effective for fiscal years beginning after June 15, 2002, with early application
encouraged.

The Company expects to adopt SFAS 143 on January 1, 2003 and has not yet
determined the impact that it will have on its results of operations, its
financial position or its cash flows.

In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets (SFAS 144). SFAS 144 establishes a single
accounting model for long-lived assets to be disposed of by sale consistent with
the fundamental provisions of SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of. While it
supersedes portions of APB Opinion 30, Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, it
retains the discontinued operations presentation, yet it broadens that
presentation to include a component of an entity (rather than a segment of a
business). However, discontinued operations are no longer recorded at net
realizable value and future operating losses are no longer recognized before
they occur. SFAS 144 also establishes criteria for determining when an asset
should be treated as held for sale.

SFAS 144 is effective for fiscal years beginning after December 15, 2001 and
interim periods within those fiscal years, with early application encouraged.
The provisions of SFAS 144 are generally to be applied prospectively.

The Company adopted SFAS 144 on January 1, 2002 and does not anticipate that
the adoption of SFAS 144 will have a material impact on its results of
operations, financial position or cash flows.

3. RECIPROCAL TRANSACTIONS

During 2001 we entered into a number of transactions in which we provided
capacity, services or facilities, by way of lease, ROUs or services agreement,
to other telecommunications companies and service providers at approximately the
same time that we leased or purchased capacity, services or facilities from
these same companies or their affiliates. Net operating income from reciprocal
transactions was $nil in 2000 and $17.6 million in 2001.

Sales made as part of reciprocal transactions totaled $24.8 million in 2000
and $263.5 million in 2001, and were recorded as deferred revenue in those
amounts. GAAP revenues resulting from amortization of this deferred revenue
totaled $nil in 2000 and $27.1 million in 2001, representing 0% and 14.4%,
respectively, of total GAAP revenues for those periods.

Purchases made as part of reciprocal transactions entered into by us totaled
$24.8 million in 2000 and $232.8 million in 2001, and were recorded in those
amounts as property and equipment,

F-17

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

prepayments, or other long-term assets. Amounts recognized as expense or
depreciation from reciprocal transactions were $nil in 2000 and $9.5 million in
2001.

During 2001, there was one (2000-nil) service contract for service contract
exchange. In respect of this contract, contract value was $32.5 million, GAAP
revenues recognized in the year were $6.8 million and the related network
expense in the year was $6.6 million, giving net operating income of
$0.2 million.

Cash received from sales made as part of reciprocal transactions is included
as a component of "Net cash provided by operating activities" in the cash flow
statement. Cash paid for purchases made as part of reciprocal transactions is
included as a component of "Net cash used in investing activities", where it is
recorded as property and equipment or other long term assets, and as a component
of "Net cash provided by operating activities", where it is recorded as
prepayment.

The effect of reciprocal transactions on deferred revenue and other
long-term assets in our balance sheet at 31 December 2001 is set out below:

4. ASSET IMPAIRMENT AND RESTRUCTURING

FLAG ATLANTIC-1 SYSTEM: Since February 13, 2002, when we announced our
preliminary unaudited results for the year ended December 31, 2001, we have
determined that our FA-1 system is impaired. Given the high level of competition
in terms of alternative supply, price erosion and continued lack of demand on
the trans-Atlantic route, we have been reviewing the prospects for demand on
that route and we now believe that, in accordance with our accounting policy,
our FA-1 system is impaired. We determined that the carrying amount of the FA-1
system exceeded its fair value, and we have therefore recognized an impairment
charge of $359,000 in the year. We determined the fair value of the FA-1 system
based on the present value of future cash flows expected to be generated by the
FA-1 system according to management's latest demand forecasts. The impairment
charge, which is included in

F-18

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

operating loss, reduced the carrying values of Goodwill and Property and
equipment in the balance sheet by $29,793 and $329,207 respectively.

FLAG PACIFIC-1 SYSTEM: Restructuring charges and asset impairment charges
of $28,169 were recorded in the third quarter of 2001. On August 7, 2001 FLAG
Telecom announced that it had decided not to proceed with the FLAG Pacific-1
("FP-1") project in association with TyCo Telecommunications that had been
announced in the second quarter. The agreement in principle with TyCo
Telecommunications was conditional upon FLAG Telecom obtaining financing on
satisfactory terms. However, despite substantial efforts on FLAG Telecom's part
and given the capital market conditions prevailing at the time, the financing
proposal received fell short of expectations. Following this decision three
employment agreements were terminated and amounts already paid or due in
connection with preliminary build evaluation were written off.

The restructuring and asset impairment charges are as follows:

A restructuring charge of $1.6 million related to staff reduction costs. The
cash expenditures concerning the workforce reduction charge had been paid by the
end of the year.

We had commissioned a marine survey for the construction of the FP-1 project
and entered into other project related expenditure commitments. Following the
decision not to proceed, the residual value of the costs incurred was $nil and
the consequent asset impairment charge was $26.6 million, comprising
$24.0 million in abandoned survey and preliminary build costs and $2.6 million
of other project related costs.

5. BUSINESS ACQUISITIONS

On December 6, 2000, FLAG Telecom acquired the remaining 50% equity interest
in FLAG Atlantic Limited from Global TeleSystems Group, Inc. ("GTS") for a cash
consideration of $135 million. The acquisition was accounted for using the
purchase method of accounting, and accordingly, the assets and liabilities
assumed have been recorded at fair value as of the date of acquisition. The
excess of purchase price over the fair value of the assets acquired and the
liabilities assumed had been recorded as goodwill. Following the impairment of
the FLAG Atlantic-1 asset (see Note 4 above) the goodwill was written off in
full in the year ended December 31, 2001.

F-19

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

The following unaudited pro forma condensed combined financial information
of the Group demonstrates the results of operations had the acquisition been
completed at the beginning of the periods presented.

6. ACCOUNTS RECEIVABLE

Accounts receivable consisted of the following:

7. RESTRICTED CASH

The Group designates funds held by collateral trustees, in escrow or legally
designated for specific projects or commitments by bank agreements, as long term
restricted cash. Included in restricted cash as at December 31, 2001 and 2000,
are funds held by collateral trustees totaling $321,195 and $372,808,
respectively. As at December 31, 2001 there was $122,443 restricted for use in
relation to FLAG Atlantic Limited, $137,794 in relation to FLAG Asia Limited and
$60,958 in relation to FLAG Limited. As a consequence of WestLB terminating the
FLAG Asia Limited lending facility, an amount of $100,000, included within
restricted cash as at December 31, 2001, would become unrestricted.

8. CAPITALIZED INTEREST COSTS

Interest costs on qualifying assets are capitalized and amortized over their
useful lives. Total interest capitalized to construction in progress during the
years ended December 31, 2001 and 2000, and the period from incorporation to
December 31, 1999, was $16,150, $6,683 and $1,281, respectively.

F-20

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

9. PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

Following the impairment of the FLAG Atlantic-1 asset (see Note 4 above)
network assets of $329,207 was written off in the year ended December 31, 2001.

F-21

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

10. DEBT

As a result of our decision not to pay interest on FLAG Telecom's 11 5/8%
senior notes, we have reclassified the senior notes from long-term debt to
short-term debt as at December 31, 2001.

The Group's debt comprises the following:

On February 16, 2000, FLAG Limited amended its existing credit facilities to
consist of a $150,000 six-year term loan facility ($55,500 of which remained
outstanding at December 31, 2001 and $93,000 of which was outstanding at
December 31, 2000) and a $10,000 revolving credit facility (none of which was
outstanding at December 31, 2001 or December 31, 2000). Dresdner Kleinwort
Benson and Barclays Capital acted as joint lead arrangers. These facilities bore
interest at a rate of 225 basis points over LIBOR for the first six months and
thereafter at a rate of between 150 and 250 basis points over LIBOR, depending
on the credit rating of the 8 1/4% Senior Notes due 2008 of FLAG Limited. The
current interest rate is 225 basis points over LIBOR. The facilities are secured
by a pledge by us of all of the capital stock of FLAG Limited and by assignment
of FLAG Limited's contracts and a security interest in its bank accounts and
intangible property. In connection with this amendment, FLAG Limited paid fees
and expenses to the joint lead arrangers totaling approximately $3,300.

FLAG Atlantic has a $575,000 construction/term loan facility (of which
$275,823 and $62,000 was outstanding at December 31, 2001 and December 31, 2000,
respectively) and a $25,000 revolving credit facility ($10,175 of which was
outstanding at December 31, 2001 and none of which was outstanding at
December 31, 2000). The construction loan converted to term loans on
December 6, 2001 and the remaining commitments were cancelled. These facilities
have a term of 7.5 years and bear interest at LIBOR plus 125 basis points for
that portion of the loans (not to exceed 50% of the outstanding loans) which are
backed by investment grade receivables and LIBOR plus 300 basis points for the
balance of the loans. Commitment fees accrued on the undrawn balance of the
loans at between 37.5 basis points and 75 basis points.

On January 9, 2001, FLAG Telecom entered into an agreement with Level 3
Communications, Inc. for the development of FNAL, a multi-terabit intra-Asian
submarine cable system. In August, 2001, to finance its share of the
construction costs, FLAG Asia Limited ("FLAG Asia") entered into a $300,000

F-22

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

construction/term loan facility (of which none was outstanding at December 31,
2001). This facility has a term of 6.5 years and bears interest at LIBOR plus
125 basis points for that portion of the loans (not to exceed 50% of the
outstanding loans) which are backed by investment grade receivables and LIBOR
plus 325 basis points for the balance of the loans. In connection with this
facility, FLAG Asia Limited paid external fees and expenses totaling
approximately $5,362. FLAG Asia's bank facility is secured by an assignment of
all of FLAG Asia's contracts, a security interest in its bank accounts and
property and a pledge of all of the capital stock in FLAG Asia. See Note 18
"Post Balance Sheet Event".

FLAG Limited has outstanding $430 million of 8 1/4% Senior Notes with an
effective interest rate at December 31, 2001 of 12.13%. The Senior Notes were
issued in January 1998.

On March 17, 2000 the Group completed the issue of $300 million 11 5/8%
Senior Notes and Euro 300 million 11 5/8% Senior Notes at par in the US and
Europe, raising combined net proceeds of $576,649,000. The effective interest
rates at December 31, 2001 were 16.3% on the US Dollar Notes and 15.8% on the
Euro Notes.

The Credit Facilities and the indentures under which the Senior Notes were
issued impose certain operating and financial restrictions on the respective
borrowers / issuers. Such restrictions will affect, and in many respects
significantly limit or prohibit, among other things, the ability of FLAG
Limited, FLAG Atlantic Limited, FLAG Asia Limited and FLAG Telecom to incur
additional indebtedness, repay indebtedness (including the Senior Notes) prior
to stated maturities, sell assets, make investments, engage in transactions with
shareholders and affiliates, issue capital stock, create liens or engage in
mergers or acquisitions. These restrictions could also limit the ability of each
company to effect future financings, make needed capital expenditures, withstand
a future downturn in its business or the economy in general, or otherwise
conduct necessary corporate activities. In addition, FLAG Limited's Credit
Facility contain financial covenants with respect to maintaining an interest
coverage ratio of 1.7 and maintaining a remaining asset value coverage ratio of
8.5. FLAG Limited was in compliance with these financial covenants throughout
2001 and 2000.

As at December 31, 2001, contractual maturities of the Group's indebtedness
were as follows:

11. SHAREHOLDER'S EQUITY

The authorized capital stock of the Company consists of 300 million Common
Shares, par value $0.0006 per share. One common share has one vote.

F-23

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

On February 26, 1999, FLAG Limited's shareholders other than Bell Atlantic
Network Systems exchanged all their common shares in FLAG Limited for common
shares in FLAG Telecom. Bell Atlantic Network Systems, however, exchanged only a
limited portion of its common shares in FLAG Limited for 3,666,155 common shares
in FLAG Telecom. At the same time, Bell Atlantic Network Systems and FLAG
Telecom entered into an Exchange Agreement and Plan of Reorganization providing
that Bell Atlantic Network System's remaining common shares in FLAG Limited
would be exchanged for common shares in FLAG Telecom in the event that, prior to
February 26, 2002, Bell Atlantic received certain regulatory approvals from the
Federal Communications Commission allowing Bell Atlantic to offer long distance
service. Such regulatory approvals were obtained and Bell Atlantic exchanged its
remaining common shares in FLAG Limited for 36,256,121 common shares in FLAG
Telecom on January 4, 2000.

On February 16, 2000 the Company completed an initial public offering (IPO)
of 27,964,000 common shares at $24 per share. The Company received $633,769 in
net proceeds from that offering.

By ownership of their common shares, the shareholders are entitled to one
vote per share at each meeting of the shareholders and, at any general meeting
or special meeting of all shareholders. Common shareholders are entitled to
receive dividends or distributions declared or paid, pro rata in proportion to
the total number of common shares held.

12. STOCK OPTIONS

In March 1998, FLAG Limited adopted a Long-Term Incentive Plan ("the Plan")
under which options could be granted on up to 4,206,305 shares of common stock
to eligible members of staff. The plan was adopted by the Company in 1999. The
maximum number of common shares that may be subject to awards under the Plan may
not exceed 13,263,791 as of November 27, 2001. Generally, options granted under
this plan vest over periods up to three years from the date of their grant,
subject to meeting certain qualifying criteria. All options vest no later than
eight years and expire ten years after the date of grant.

The following summarizes stock option activity under this plan:

F-24

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

The following table summarizes information about the Plan options
outstanding as December 31, 2001:

The weighted average fair value of options granted during the year was
$1.64, $8.50 and $3.85 per share at December 31, 2001, 2000 and 1999,
respectively. The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the following weighted
average assumptions:

At December 31, 2001, the Company has one stock-based compensation plan
which is described above. The Company applies APB Opinion 25 and related
interpretations in accounting for its plans. The compensation cost that has been
charged against income for its long term incentive plan was $2,007, $7,230 and
$8,800 for 2001, 2000 and 1999 respectively. Had the compensation cost for the
Company's stock-based compensation plan been determined based on the fair value
at the grant dates for awards under the Plan consistent with the method of FASB
Statement 123, the Company's net income and earnings per share would have been
reduced to the pro forma amounts indicated below:

The effects of applying SFAS No. 123 for disclosing compensation cost may
not be representative of the effects on reported net income for future years.

F-25

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

13. FINANCIAL INSTRUMENTS

The notional amounts of interest rate derivatives do not represent amounts
exchanged by the parties and, thus, are not a measure of the Group's exposure
through its use of derivatives. The amounts exchanged are determined by
reference to the notional amounts and the other terms of the derivatives.

F-26

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

The following table presents the carrying amounts and fair values of the
Group's financial instruments as of December 31, 2001 and 2000:

14. TAXES

At the present time, no income, profit, capital or capital gains taxes are
levied in Bermuda. In the event that such taxes are levied in the future, FLAG
Telecom and all its subsidiaries registered in Bermuda have received an
undertaking from the Bermuda Government exempting them from all such taxes until
March 28, 2016.

The provision for income taxes reflected in the accompanying statement of
operations consists of taxes incurred on the income earned or activities
performed by Group companies in certain jurisdictions, where they are deemed to
have a taxable presence or are otherwise subject to tax.

The provision for income taxes, which consists entirely of taxes payable to
foreign governments outside Bermuda, is comprised of the following:

F-27

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

Deferred taxes arise principally because, for tax purposes, in certain
jurisdictions, revenues from capacity sales are deferred and recognized as
taxable income over the estimated life of the appropriate cable system. The
deferred taxes asset/(liability) recorded in the balance sheet comprise the
following:

As Bermuda does not impose an income tax, the statutory amount of tax is
zero. The provision for income taxes for the years ended December 31, 2001 and
2000, and the period from incorporation to December 31, 1999, results in an
effective tax charge that differs from the Bermuda tax charge as follows:

15. RELATED PARTY TRANSACTIONS

AGREEMENTS WITH VERIZON

Verizon Communications Inc. ("Verizon") is the ultimate parent of a
controlled subsidiary Verizon International Holdings Ltd., which directly owns
18.6% of our common shares. We entered into the following four agreements with
subsidiaries of Verizon throughout 2001:

NETWORK ALLIANCE AGREEMENT

On April 3, 2001, FLAG Telecom Ireland Network Limited ("FTINL"), a
subsidiary of the Company, entered into a Network Alliance Agreement with
Verizon Global Solutions Holdings II Ltd. ("VGS") under which both parties
agreed to create a network alliance to develop a European network. FTINL and its
affiliates will have the right to acquire from VGS capacity on this European
network on an indefeasible right of use ("IRU") basis. FTINL paid VGS
$35.6 million for such IRU over the European network and agreed to pay annual
operating and maintenance fees. The annual operating and maintenance fees
consist of $1.78 million paid in years one up to and including year five of the
IRU, $1.068 million paid in years six to ten, and $712,000 paid in years eleven
to fifteen.

F-28

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

COLLOCATION AGREEMENT

On April 4, 2001, FLAG Atlantic UK Limited and FLAG Atlantic France Sarl,
both subsidiaries of the Company (collectively "FLAG Atlantic"), entered into a
Collocation Agreement with Verizon Global Solutions U.K. Ltd. and Verizon Global
Solutions France SAS (collectively "Verizon UK/ France") under which FLAG
Atlantic agreed to license to Verizon UK/France co-location space in FA-1 PoPs
in both London and Paris. Verizon UK/France agreed to pay approximately
$15,471,000 for the license in the UK and approximately $6,119,000 for the
license in France. The space will be used by VGS to create the London and Paris
PoPs for its European network, which will provide capacity to subsidiaries of
the Company under the Network Alliance Agreement referred to above.

RE-SALE AND PURCHASE AGREEMENT

On April 3, 2001, FTINL and FLAG Telecom Global Networks Limited ("FTGNL"),
both subsidiaries of the Company, entered into a Re-Sale and Purchase Agreement
with VGS under which VGS agreed to purchase for $17.6 million approximately 30%
of the dark fiber pairs and co-location facilities located on the KPNQwest
Services UK Limited ("KPNQwest") EuroRings Network. The fiber pairs and
co-location facilities were originally purchased pursuant to a Dark Fibre IRU
and Collocation Facilities Agreement, dated February 28, 2001, among FTINL,
FTGNL and KPNQwest (the "KPNQwest Agreement").

TRI-PARTITE AGREEMENT

On April 3, 2001, FTGNL, KPNQwest and VGS entered into a Tri-Partite
Agreement under which FTGNL assigned all of its rights, title, interest and
obligations under the KPNQwest Agreement to VGS and KPNQwest acknowledged and
consented to such assignment.

MARINE MAINTENANCE SERVICE AGREEMENT WITH TGN

TGN Holdings Ltd. ("TGN") directly owns 11.2% of our common shares. On
June 1, 2001, FLAG Atlantic Limited ("FAL"), a subsidiary of the Company,
entered into a Marine Maintenance Service Agreement with TyCom Contracting
Limited ("TyCom"), an affiliate of TGN, under which TyCom agreed to provide
certain marine maintenance services to FLAG Telecom for our FA-1 undersea fiber-
optic cable systems. FAL agreed to pay $6.9 million per annum for such services.
The earliest date on which we could withdraw from this contract is June 1, 2006.

AGREEMENT WITH ADNAN OMAR

On December 10, 2001, the Company entered into an agreement with Mr. Adnan
Omar, a director on FLAG Telecom's board, pursuant to which Mr. Omar was
appointed President of FLAG Telecom Development Services Company LLC, a
subsidiary of the Company in Egypt. The agreement is for a fixed two year term
under which Mr. Omar is entitled to a monthly payment of US$30,000.

EMPLOYEE SERVICES AGREEMENT WITH BELL ATLANTIC GLOBAL SYSTEMS

In May 1998, FLAG Limited entered into an Employee Services Agreement with
Bell Atlantic Global Systems Company ("BAGS"), an affiliate of one of the
Company's then shareholders, pursuant

F-29

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

to which BAGS employees were seconded to FLAG Limited. The total cost incurred
for this service during the year ended December 31, 2000, and the period from
incorporation to December 31, 1999, was $23 and $298, respectively. These costs
have been expensed in the accompanying statements of operations.

CONSTRUCTION MANAGEMENT SERVICES AGREEMENT WITH FLAG ATLANTIC LIMITED

Effective October 8, 1999, FLAG Telecom Group Services Limited ("FTGSL"), a
100% owned subsidiary of the Company, entered into a construction management
services agreement with FLAG Atlantic Limited (the "Agreement"), which prior to
the acquisition by a subsidiary of all of the equity on December 6, 2000, was a
50:50 joint venture with GTS (See note 4). The Agreement calls for FTGSL to
provide project planning, monitoring, budget reviewing, survey approving,
observation and inspection of installation and commissioning activities,
performance reviews and other related services required to oversee the
construction of the network. Up until December 6, 2000, the Company recorded its
50% share of the profits under the Agreement. After the December 6, 2000
acquisition from GTS, all intercompany revenues in connection with the Agreement
were eliminated on consolidation. Total revenues recognized under the Agreement
during the year ended December 31, 2000 and the period from incorporation to
December 31, 1999 were $6,465 and $1,631 respectively.

16. COMMITMENTS AND CONTINGENCIES

As of December 31, 2001, FLAG Limited was committed under supply contracts
for the FLAG Europe-Asia cable system for final payments totaling $818
representing funds withheld pending the completion of certain outstanding items
under the supply contracts. Provision has been made in full in the Group's
financial statements to cover the anticipated final payments.

During 1997, FLAG Limited entered into an operations contract for the FLAG
Network Operations Center (the "FNOC") with one of the landing parties on the
FLAG Europe-Asia cable system. The terms of the contract require the landing
party to provide a permanent facility in which to locate the FNOC along with
qualified personnel and additional support as required to assist in the
operations of the FNOC. This is an ongoing commitment. In exchange for the
services provided under the contract, FLAG Limited is currently committed to
compensate the landing party with $243 as an annual fixed charge for rent of the
premises where the FNOC is located, subject to review in future years. Costs
incurred by the landing party to provide qualified personnel and additional
support are to be reimbursed by FLAG Limited on a "cost plus" basis.

F-30

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

The Group has entered into lease agreements for the rental of office space.
Rent expense of $6,038, $1,959 and $1,364 was recorded for the years ended
December 31, 2001 and 2000 and the period from incorporation to December 31,
1999, respectively. Estimated future minimum rental payments under the leases
are as follows:

The Group is also committed to make payments under various standby
maintenance agreements for the cable systems currently in use. Estimated future
payments under the standby maintenance agreements are as follows:

The estimated future payments under the standby maintenance agreements are
based on a number of assumptions, including, among other things, the proportion
of the total cable system capacity sold at any point in time and the number of
other cable systems serviced under the agreement.

The Company has capitalized the future minimum lease payments of property
and equipment under leases that qualify as capital leases. At December 31, 2001,
future minimum payments under these capital leases are as follows (in thousands)
and are included in other current liabilities and other deferred liabilities in
the accompanying consolidated balance sheet:

F-31

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

Capital expenditure contracted but not provided for as at December 31, 2001
amounted to approximately $160,089 in relation to the construction of our global
network.

We are currently in litigation proceedings with PSINet, Inc. and its related
affiliates and subsidiaries ("PSINet"). In December 2001, PSINet initiated
Chapter 11 bankruptcy proceedings in the United States Bankruptcy Court in the
Southern District of New York. Pursuant to those proceedings, on December 31,
2001, PSINet commenced litigation against FLAG Atlantic Limited and FLAG
Atlantic USA Limited to recover an alleged preference payment. Prior to PSINet
filing for bankruptcy, we entered into a capacity right of use agreement with
PSINet. In compliance with that agreement, PSINet paid us $23.8 million. PSINet
claims that this payment may be avoided because it was made within 90 days of
PSINet filing for bankruptcy and argues that it is entitled to recover the
amount of the payment, together with interest. We intend to defend this action
vigorously and assert various defenses to the preference claim.

We are involved in a dispute with two former employees, Messrs. Reda and
Jalil, which centers on the lawfulness of the termination of their employment
contracts and the sums payable in that termination. The most significant dispute
between the parties is as to the ex-employees' entitlement to stock options or
damages in lieu. Although Messrs. Reda and Jalil have not made clear what
damages they are claiming, we believe that the amount that they would claim for
wrongful termination would be between $3,000,000 and $4,000,000, plus interest.
We are unable to estimate the amount they would claim with respect to their
allegation that they were entitled to stock options. The Court of Appeal of
Bermuda ruled on this issue in our favor. Messrs. Reda and Jalil have
subsequently appealed to the Privy Council in the United Kingdom. We are of the
opinion that we have good grounds for believing that the ruling of the Court of
Appeal of Bermuda is unlikely to be varied by the Privy Council.

We have received a third-party subpoena from the SEC seeking documents in
connection with the SEC's investigation of Global Crossing. We intend to
cooperate fully with the SEC's request for such documents.

We are also involved in litigation from time to time in the ordinary course
of business. In management's opinion, with the exception of the disputes
described above, the litigation in which we are currently involved, individually
and in the aggregate, is not material to us.

17. SEGMENT REPORTING

On a segmental basis, FLAG Telecom has historically reported its results in
its two primary operational areas: Capacity and Operations and Network Services.
The decision to report under these two segments was made on the basis that they
are managed and evaluated separately and that each segment possesses different
economic characteristics requiring different marketing strategies. This
rationale is currently under review and we may choose to adopt a different
segmental analysis in future reporting periods. Our sales and marketing
functions are structured as geographical sales teams selling the full range of
the products and services to their customer base, on our global network,
supported by corporate functions. As such it is increasingly difficult to
separate our activities into the two primary operational areas identified.

F-32

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

The accounting policies adopted for each segment are the same as those
described in the summary of significant accounting policies. Management
evaluates performance based on operating contribution, where segment revenues
are reduced by those costs that are allocable to the segments.

Details of the financial results of the two business segments for the year
ended December 31, 2001 and 2000 are summarized below, reconciled to the totals
for the Group as a whole. Substantially all the revenues and operating results
in 1999 and earlier periods arose from Capacity and Operations. There was no
Network Service revenue recognized in 1999.

The following table presents selected items for December 31, 2001, by
segment are as follows:

The following table presents selected items for December 31, 2000, by
segment are as follows:

No individual customer accounted for greater than 10% of revenues.

The revenue generated by geographic location of customers is as follows:

F-33

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

18. POST BALANCE SHEET EVENT

As at December 31, 2001, we had a lending facility with WestLB, the agent
bank for our project financing for FNAL. Since December 31, 2001, WestLB have
informed us that it has cancelled the commitment and terminated the lending
facility. We are discussing potential alternative structures with WestLB and are
pursuing other possible financing structures for financing FNAL. If we are
unable to arrange alternative financing for FNAL, we will not be able to
complete FNAL and may be required to write off a portion of our investment,
which was approximately $500 million at December 31, 2001 (including deferred
financing costs of approximately $3.7 million which would have to be written
off).

As at December 31, 2001, $42.5 million included within "Other long-term
assets" represented capacity credits that have been purchased on the systems of
Global Crossing and its affiliates. In light of the bankruptcy protection filing
by Global Crossing, there is no guarantee that we will be able to realize the
value of these assets and an impairment charge may be required.

F-34

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Shareholders of FLAG Limited:

We have audited the accompanying consolidated statements of operations,
comprehensive income, shareholders' equity and cash flows of FLAG Limited (a
Bermuda company) and subsidiaries for the period from January 1, 1999 to
February 26, 1999. These financial statements are the responsibility of FLAG
Limited's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the consolidated statements of operations, comprehensive
income, shareholders' equity and cash flows referred to above present fairly, in
all material respects, the results of operations and cash flows for FLAG Limited
and subsidiaries for the period from January 1, 1999 to February 26, 1999 in
conformity with accounting principles generally accepted in the United States.

Arthur Andersen & Co.
Hamilton, Bermuda
December 30, 1999

F-35

FLAG LIMITED

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE PERIOD FROM JANUARY 1, 1999 TO FEBRUARY 26, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

The accompanying notes are an integral part of these financial statements.

F-36

FLAG LIMITED

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE PERIOD FROM JANUARY 1, 1999 TO FEBRUARY 26, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS)

The accompanying notes are an integral part of these financial statements.

F-37

FLAG LIMITED

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

FOR THE PERIOD FROM JANUARY 1, 1999 TO FEBRUARY 26, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT NUMBERS OF SHARES)

The accompanying notes are an integral part of these financial statements.

F-38

FLAG LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE PERIOD FROM JANUARY 1, 1999 TO FEBRUARY 26, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS)

The accompanying notes are an integral part of these financial statements.

F-39

FLAG LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE PERIOD FROM JANUARY 1, 1999 TO FEBRUARY 26, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

1. BACKGROUND

The Company is a facilities-based provider of telecommunications capacity to
licensed international carriers through its ownership of the world's longest
independent, privately-owned digital fiber-optic undersea cable system, the FLAG
Europe-Asia cable system. The FLAG Europe-Asia cable system links the
telecommunications markets of Western Europe and Japan through the Middle East,
India, Southeast Asia and China (the "FLAG Route"), along a route which adjoins
countries with approximately 70% of the world's population. The FLAG Europe-Asia
cable system was constructed to address the growing demand for high performance,
secure and cost-effective digital communications for voice, data and video along
the FLAG Route. The Company provides capacity on the FLAG Europe-Asia cable
system at market-based prices to licensed international carriers. The FLAG
Europe-Asia cable system, which was placed in commercial service on
November 22, 1997, cost approximately $1.6 billion to construct, and consists of
over 28,000 kilometers of fiber-optic cable.

On February 26, 1999, the Company was part of a reorganization whereby FLAG
Telecom Holdings Limited ("FTHL"), a Bermuda company, became the holding company
for the FLAG Telecom group of companies. Pursuant to this reorganization, all of
the Class A common shares of the Company were converted to Class B common shares
and the shareholders of the Company transferred to FTHL 418,259,688 Class B
common shares in exchange for an equal number of shares in FTHL. As a result of
this reorganization, FTHL held 65.79% of the share capital of the Company with
the balance of 34.21% being held by Bell Atlantic Network Systems Company.

2. SIGNIFICANT ACCOUNTING POLICIES

These financial statements have been prepared in accordance with accounting
principles generally accepted in the United States and are expressed in U.S.
Dollars ("Dollars"). The preparation of financial statements in conformity with
U.S. generally accepted accounting principles ("U.S. GAAP") requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

The significant accounting policies are summarized as follows:

a) Basis of Consolidation

The financial statements consolidate the financial statements of the Company
and its subsidiary companies after eliminating intercompany transactions and
balances.

b) Sales and Cost of Sales Recognition

Revenues are recognized upon the date the risks and rewards of ownership are
transferred to the purchaser, which is the date the capacity is made available
for activation and the customer becomes responsible for standby maintenance and
repairs.

Because substantially all receivables under agreements qualifying as
sales-type leases are receivable within 75 days of the date the risks and
rewards of ownership are transferred to the customer, the accounts receivable
balance in the accompanying balance sheets, representing the gross future
minimum lease payments due, approximates the present value of future minimum
lease payments. Amounts billed

F-40

FLAG LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE PERIOD FROM JANUARY 1, 1999 TO FEBRUARY 26, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

to customers for maintenance and repair services are invoiced separately from
capacity lease payments. There are no guaranteed or unguaranteed residual values
accruing to the benefit of the Company. The Company has no minimum lease
payments due in 1999 and no minimum lease payments for all subsequent years.

As of December 31, 1998, in exchange for construction costs incurred, the
Company had granted credits to suppliers toward future capacity. In addition,
certain customers have committed to purchase capacity at a future date under
signed capacity credit agreements. Such amounts received or receivable under
these agreements and the capacity credits granted to suppliers are recorded as
deferred revenue until the date the credits are utilized, at which time the
deferred revenue is recognized as earned. Amounts receivable under these
capacity agreements are reflected within accounts receivable in the accompanying
balance sheets. Deferred revenue also includes amounts invoiced for standby
maintenance which are applicable to future periods.

For certain customers, the Company has granted price protection credits
entitling them to additional capacity if the Company lowers its prices prior to
December 31, 1999. In the period that it becomes probable that the Company will
lower its list prices, the Company records a provision for expected cost of
sales for the additional units of capacity granted.

The cost of the FLAG Europe-Asia cable system relating to capacity sold is
recognized as cost of sales upon recognition of revenues. The amount charged to
cost of sales is based on the ratio of capacity sales recognized as revenues in
the period to total expected revenues over the entire life of the FLAG
Europe-Asia cable system multiplied by the total construction costs. This
calculation of cost of sales matches costs with the relative sales value of each
sale to total expected revenues.

Management's estimate of total expected revenues over the life of the FLAG
Europe-Asia cable system may change due to a number of factors affecting
estimated future revenues including changes in management's estimate of the
units of capacity to be sold and changes in the expected sales value per unit of
capacity to be sold. Additionally, the cost per unit will decrease in the event
the Company elects to upgrade the capacity of the FLAG Europe-Asia cable system
in the future to increase the units of capacity available for sale. Changes in
management's estimate of total expected revenues over the life of the FLAG
Europe-Asia cable system will result in adjustments to the calculations of cost
of sales. These adjustments will be recorded on a prospective basis over future
periods commencing with the period management revises its estimate. As the
revenue from operating lease transactions is incidental, such transactions are
recorded as a reduction of capacity available for resale and no depreciation is
recorded.

Standby maintenance charges are invoiced separately from capacity sales.
Revenue relating to standby maintenance is recognized over the period in which
the service is provided.

c) Commissions

Commissions for purchase commitments are recognized as an expense upon
recognition of the related revenues.

d) Capacity Available for Sale and Construction in Progress

Capacity available for sale is recorded at the lower of cost or fair value
less cost to sell and is charged to cost of sales as capacity is sold.
Construction in progress is transferred to capacity available for sale at the
date it is completed and placed into commercial operation. Construction in
progress

F-41

FLAG LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE PERIOD FROM JANUARY 1, 1999 TO FEBRUARY 26, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

includes direct and indirect expenditures which are stated at cost and includes
the accumulated work in progress for construction of the FLAG Europe-Asia cable
system. Capitalized costs include costs incurred under the construction
contract, engineering and consulting fees, legal fees related to obtaining
landing right licenses, costs related to program management, costs for the route
surveys, interest and other costs necessary for developing the FLAG Europe-Asia
cable system.

e) Capitalized Financing Costs

Costs incurred by the Company to obtain financing for the FLAG Europe-Asia
cable system have been capitalized and are being amortized over the term of the
related borrowings. Capitalized costs relating to existing financings are
written off when a refinancing occurs.

f) Fixed Assets

Fixed assets are stated at cost, net of accumulated depreciation.
Depreciation is provided on a straight-line basis over the estimated useful
lives of the assets as follows:

Computer equipment.......................................... 33 1/3% per annum
Fixtures and fittings....................................... 20% per annum
Leasehold improvement....................................... remaining lease term
Motor vehicles.............................................. 20% per annum

g) Interest Rate Derivatives

The Company uses derivative financial instruments for the purpose of
reducing its exposure to adverse fluctuations in interest rates. The Company
does not utilize derivative financial instruments for trading or other
speculative purposes. The counterparties to these instruments are major
financial institutions with high credit quality. The Company is exposed to
credit loss in the event of nonperformance by these counterparties.

At the end of March 1998, the Company entered into two interest rate swap
agreements to manage the Company's exposure to interest rate fluctuations on the
$370,000 bank credit facility undertaken on January 30, 1998 (the "New Credit
Facility"). Under the swap agreements, the Company pays a fixed rate of 5.60% on
a notional amount of $60,000, a fixed rate of 5.79% on a notional amount of
$100,000, and the counterparty pays the floating rate based on LIBOR. The swap
agreements terminate in January and July 2000, respectively, unless extended by
an additional one year and six months, respectively, at the option of the
counterparty.

The 8 1/4% Senior Notes arising on the refinancing undertaken on
January 30, 1998 (the "Senior Notes") accrue interest at the rate of 8 1/4% per
annum paid semi-annually on January 30 and July 30 of each year, commencing on
July 30, 1998 (see Note 3. "Long-term Debt"). Interest is expensed as it
accrues. The Senior Notes are redeemable at the Company's option, in whole or in
part, at any time on or after January 30, 2003, at specified option prices. In
the event of any equity offering before January 31, 2001, the Company may use
all or a portion of the net proceeds therefrom to redeem up to 33 1/3% of the
original principal amount of the Senior Notes at a redemption price of 108.25%
plus accrued and unpaid interest. If the Company has excess cash flow, as
defined, for any fiscal year commencing in 2001, the Company is required,
subject to certain exceptions and limitations, to make an offer to purchase the
Senior Notes at specified prices. Upon a change in control, the note holders

F-42

FLAG LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE PERIOD FROM JANUARY 1, 1999 TO FEBRUARY 26, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

may require the Company to purchase all or any portion of the outstanding notes
at a price equal to 101% of the principal amount plus accrued but unpaid
interest.

For interest rate derivatives to qualify for hedge accounting, the debt
instrument being hedged must expose the Company to interest rate risk and, at
the inception of the derivative instrument and throughout the period the
derivative is held, there must be a high correlation of changes in the market
value of the derivative and interest expense of the hedged item. Gains and
losses on interest rate derivatives and other derivative instruments which do
not meet this criteria would be recorded in the statement of operations.

If an interest rate derivative instrument were to terminate or be replaced
by another instrument and no longer qualify as a hedge instrument, then it would
be marked to market and carried on the balance sheet at fair value.

h) Translation of Foreign Currencies

Transactions in foreign currencies are translated into Dollars at the rate
of exchange prevailing at the date of each transaction. Monetary assets and
liabilities denominated in foreign currencies at year end are translated into
Dollars at the rate of exchange at that date. Foreign exchange gains or losses
are reflected in the accompanying statements of operations.

The statements of operations of overseas subsidiary undertakings are
translated into United States Dollars at average exchange rates and the year-end
net investments in these companies are translated at year-end exchange rates.
Exchange differences arising from retranslation at year-end exchange rates of
the opening net investments and results for the year are charged or credited
directly to the cumulative translation adjustment in shareholders' equity.

i) Stock Option Plan

The Company accounts for stock option grants in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB No. 25") and accordingly, recognizes compensation expense for stock option
grants to the extent that the fair value of the stock exceeds the exercise price
of the option at the measurement date.

j) Income Taxes

Deferred taxes are determined based on the difference between the tax basis
of an asset or liability and its reported amount in the financial statements. A
deferred tax liability or asset is recorded using the enacted tax rates expected
to apply to taxable income in the period in which the deferred tax liability or
asset is expected to be settled or realized. Future tax benefits attributable to
these differences, if any, are recognizable to the extent that realization of
such benefits is more likely than not.

k) Net Income per Common Share

In February 1999, the shareholders of all Class A common shares in the
Company converted their shares into Class B common shares of equivalent value.
Basic net income per Class B common share in 1999 is based on dividing the net
income by the number of Class B common shares outstanding for the period as if
the exchange had occurred on January 1, 1999.

F-43

FLAG LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE PERIOD FROM JANUARY 1, 1999 TO FEBRUARY 26, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

l) Pending Accounting Standards

The Financial Accounting Standards Board has also recently issued Statement
of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"), which is effective for periods beginning
after June 15, 2000. This pronouncement requires the recognition of all
derivative instruments on the balance sheet at fair-value. Any subsequent
changes in fair-value are then recognized in earnings unless the derivative
qualifies for treatment as a hedge. Management has not yet assessed the impact
of the adoption of SFAS 133 on the Company's financial position or results of
operations, although it may lead to increased volatility in the Company's
earnings and comprehensive income.

The Financial Accounting Standards Board has recently issued Interpretation
No. 43, "Real Estate Sales, an interpretation of FASB Statement No. 66." This
interpretation clarifies that sales of real estate with property improvements or
integral equipment that cannot be removed and used separately from the real
estate without incurring significant costs should be accounted for under FASB
Statement No. 66, "Accounting for Sales of Real Estate" ("FAS 66"). The
provisions of this Interpretation are effective for all sales of real estate
with property improvements or integral equipment entered into after June 30,
1999. It is expected that the provisions of this pronouncement will affect
timing of the Company's recognition of revenues and costs associated with future
sales of capacity.

3. SHAREHOLDERS' EQUITY

a) Class A Common Shares

In February 1999, the shareholders of all Class A common shares in the
Company converted their shares into Class B common shares of equivalent value.
132,000,000 Class A shares were converted to 69,937,597 Class B shares.

As of December 31, 1998, 132,000,000 Class A common shares were issued and
outstanding.

By ownership of their Class A common shares, the Class A shareholders were
entitled to one vote per share at any meeting of Class A shareholders and, at
any general meeting or special meeting of all shareholders, to a vote
representing 11% of the total voting interests of the Company, multiplied by the
percentage of Class A common shares held. Class A shareholders were entitled to
receive 11% of any dividends or distributions declared, paid pro rata in
proportion to the number of Class A common shares held, prior to the payment of
any dividends or distributions to the Class B shareholders.

b) Class B Common Shares

The authorized Class B common shares capital of the Company consists of
1,000,000,000 shares with a par value of $.0001 per share. The following number
of shares were issued and outstanding.

By ownership of their Class B common shares, the Class B shareholders are
entitled to one vote per share at each meeting of Class B shareholders and, at
any general meeting or special meeting of all shareholders, to a vote
representing 89% of the total voting interests of the Company, multiplied by the

F-44

FLAG LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE PERIOD FROM JANUARY 1, 1999 TO FEBRUARY 26, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

percentage of Class B common shares held. Class B shareholders are entitled to
receive dividends or distributions declared or paid, pro rata in proportion to
the total number of Class B common shares held, after taking into account the
rights of Class A shareholders to such dividends and distributions.

4. STOCK OPTIONS

In March, 1998, the Company adopted a Long-Term Incentive Plan under which
the Company may grant up to 25,237,831 shares of common stock to eligible
members of staff. During the year ended December 31, 1998, options to purchase
14,146,239 Class B common shares were granted under the plan. No options were
granted under the plan from January 1, 1999 to February 26, 1999. Generally, the
options vest and are exercisable on the third and fourth anniversaries of their
grant, subject to meeting certain qualifying criteria. All options vest no later
than eight years and expire ten years after the date of grant. The options can
vest, and are exercisable, earlier on the commencement of an initial public
offering of equity in the Company. All of the options were granted at an
exercise price of $1.07 per share. No options had vested. Since the Company
accounts for employee options in accordance with APB No. 25, the Company has not
recognized compensation expense with respect to the options granted since the
exercise price did not exceed management's estimated fair value of the shares on
the date of the grant (the measurement date).

Had the compensation for the Company's Long Term Incentive Plan (see above
in this Note 4) been determined in accordance with SFAS 123, the Company's net
loss and earnings per share would have been reduced to the pro forma amounts
indicated below:

The effects of applying SFAS 123 for disclosing compensation cost may not be
representative of the effects on reported net income for future years.

The weighted average fair value of options granted during 1998 was $0.61 per
share. The fair value of each option grant is estimated on the date of grant
using the Black Scholes option-pricing model using the following weighted
average assumptions.

Dividend yield.............................................. 0.0%
Expected volatility......................................... 0.59
Risk-free interest rate..................................... 6.0%
Expected lives of the options............................... 5.0 years

The weighted average remaining contractual life of all options is
9.31 years.

F-45

FLAG LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE PERIOD FROM JANUARY 1, 1999 TO FEBRUARY 26, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

5. BASIC AND DILUTED INCOME (LOSS) PER COMMON SHARE

In February 1999, the shareholders of all Class A common shares in the
Company converted their shares into Class B common shares of equivalent value.
Basic net income per Class B common share in 1999 is based on dividing the net
income by the number of Class B common shares outstanding for the period as if
the exchange had occurred on January 1, 1999. The basic net loss per Class A and
Class B common share in 1998 is based on dividing net loss applicable to
Class A and Class B shareholders by the weighted average number of common shares
outstanding during the period.

No stock options were granted during the period from January 1, 1999 to
February 26, 1999. The stock options granted during 1998, discussed in Note 4,
did not have a dilutive effect on 1999 net income per common share or 1998 net
loss per common share.

6. TAXES

At the present time, no income, profit, capital or capital gains taxes are
levied in Bermuda. In the event that such taxes are levied, the Company has
received an undertaking from the Bermuda Government exempting it from all such
taxes until March 28, 2016.

The provision for income taxes reflected in the accompanying statement of
operations consists of taxes incurred on income derived from capacity sales and
standby maintenance revenues from customers in certain jurisdictions along the
FLAG Europe-Asia cable system where the Company is deemed to have a taxable
presence or is otherwise subject to tax.

Income tax expense, which consists entirely of taxes payable to foreign
governments, is comprised of the following:

Deferred taxes arise principally because, for tax purposes, in certain
jurisdictions, revenues from capacity sales are deferred and recognized as
taxable income over the estimated life of the FLAG Europe-Asia cable system.

F-46

FLAG LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE PERIOD FROM JANUARY 1, 1999 TO FEBRUARY 26, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

Since Bermuda does not impose an income tax, the difference between reported
tax expense in the accompanying statements of operations and tax as computed at
statutory rates, is attributable to the provisions for foreign taxes shown
above.

7. RELATED PARTY TRANSACTIONS

The Company and certain of its Shareholders or affiliates thereof have
entered into agreements for the development, construction, operation, financing
and marketing of the FLAG Europe-Asia cable system.

a) Program Management Services Agreement

Under the terms of a Program Management Services Agreement, Bell Atlantic
Network Systems Company ("BANS"), then a Shareholder of the Company, managed all
aspects of the planning and construction of the FLAG Europe-Asia cable system.
The Company reimbursed BANS for all related costs and out-of-pocket expenses
plus a fee equal to 16% of payroll costs and certain outside contractor and
consultant costs.

Effective May 14, 1998, the Company entered into a Termination and Release
Agreement providing for the termination of the Program Management Services
Agreement with BANS. In June 1998, the Company made a final payment to BANS to
settle all outstanding liabilities under the Program Management Services
Agreement.

b) Marketing Services Agreement

The Company and BANS, entered into a Marketing Services Agreement pursuant
to which BANS was responsible for marketing the assignable capacity of the FLAG
Europe-Asia cable system. BANS invoiced the Company for commissions at the rate
of 3% of the commitments obtained.

Effective May 21, 1998, under a Marketing Transition Agreement the Company
and BANS agreed to terminate the Marketing Services Agreement. Under the
Marketing Transition Agreement, the Company agreed to pay certain of BANS'
closing down expenses and certain commissions in connection with their
pre-termination and post-termination activities. The Company will pay BANS
commissions accrued under the Marketing Services Agreement but remaining unpaid
and up to $3,000 in commissions resulting from certain sales. Also under the
Marketing Transition Agreement the Company has agreed to pay BANS or its
affiliate a 50% commission where BANS or its affiliate secures the sale of four
whole DS-3s (which equates to 84 whole MIUs) on the FLAG Europe-Asia cable
system. The Company will accrue a liability for the commissions in the period it
becomes probable that BANS or its affiliate will obtain the sales and that the
amount of the commissions can be reasonably estimated.

c) Employee Services Agreement

In May 1998, the Company entered into an Employee Services Agreement with
Bell Atlantic Global Systems Company ("BAGS"), an affiliate of BANS, pursuant to
which BAGS seconds certain employees to the Company.

The total costs incurred for this service during the year ended
December 31, 2000, and the period from incorporation to December 31, 1999, was
$23 and $298 respectively.

F-47

FLAG LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE PERIOD FROM JANUARY 1, 1999 TO FEBRUARY 26, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

8. COMMITMENTS AND CONTINGENCIES

As of February 26, 1999, the Company was committed under the Contract for a
final payment totaling $132,725. FLAG Limited is currently holding discussions
with Tyco and KDD Submarine Cable Systems Inc. regarding the final payment.
Provision has been made in the Company's financial statements to cover the
anticipated final payment.

During the year, the Company signed agreements with two new landing parties.
The Company reached formal agreements with the Saudi Telecom Company and the
Jordan Telecommunications Company to add landing points in Jeddah and Aqaba
respectively. The estimated cost to construct these landing points is
approximately $53 million and is being funded through the Company's cash flow
and contributions from one of the landing parties. The landing stations are
expected to enter service in July 1999.

During 1997 the Company entered into an operations contract for the FLAG
Network Operations Center (the "FNOC") with one of the landing parties on the
FLAG Europe-Asia cable system. The terms of the contract require the landing
party to provide a permanent facility in which to locate the FNOC along with
qualified personnel and additional support as required to assist in the
operations of the FNOC. In exchange for the services provided under the
contract, the Company is committed to compensate the landing party an annual
fixed charge for rent of the premises where the FNOC is located equal to $200
for the first year of the contract increasing in 5% increments for the following
three years. Costs incurred by the landing party to provide qualified personnel
and additional support are to be reimbursed by the Company on a cost plus basis.

The Company has entered into lease agreements for the rental of office
space. Estimated future minimum rental payments under the leases are for the
period February 27, 1999 to December 31, 1999 and for the years ended
December 2000, 2001, 2002 and 2003 and thereafter are as follows:

Remainder of 1999........................................... $ 963
2000........................................................ 824
2001........................................................ 537
2002........................................................ 549
2003........................................................ 549
Thereafter.................................................. 2,910

The Company is also committed to make quarterly payments under standby
maintenance agreements for the period commencing October 8, 1997 and continuing
through December 31, 2007. Estimated future payments under the standby
maintenance agreements are for the period February 27, 1999 to December 31, 1999
and for the years ended December 2000, 2001, 2002 and 2003 and thereafter are as
follows:

Remainder of 1999........................................... $18,694
2000........................................................ 24,546
2001........................................................ 25,105
2002........................................................ 25,197
2003........................................................ 8,820
Thereafter.................................................. 35,280

F-48

FLAG LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE PERIOD FROM JANUARY 1, 1999 TO FEBRUARY 26, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

The estimate future payments under the standby maintenance agreements are
based on a number of assumptions, including, among other things, the proportion
of the total FLAG Europe-Asia cable system capacity sold at any point in time
and the number of other cable systems serviced under the agreement.

The Company is subject to legal proceedings and claims in the ordinary
course of business. Based on consultations with legal counsel, management does
not believe that any of these proceedings or claims will have a material effect
on the Company's financial position or results of operations.

9. SUBSEQUENT EVENTS

On February 26, 1999, the Company was part of a reorganization whereby FLAG
Telecom Holdings Limited, a Bermuda company, became the holding company for the
FLAG Telecom group of companies. As a result of this reorganization, the Company
became a majority-owned subsidiary of FLAG Telecom Holdings Limited.

F-49

FLAG TELECOM HOLDINGS LIMITED

SCHEDULE I

CONDENSED FINANCIAL INFORMATION OF REGISTRANT

INDEX

F-50

FLAG TELECOM HOLDINGS LIMITED

CONDENSED BALANCE SHEETS

AS OF DECEMBER 31, 2001 AND 2000

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

The accompanying notes are an integral part of these condensed financial
statements.

F-51

FLAG TELECOM HOLDINGS LIMITED

CONDENSED STATEMENTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

The accompanying notes are an integral part of these condensed financial
statements.

F-52

FLAG TELECOM HOLDINGS LIMITED

CONDENSED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000 AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS)

The accompanying notes are an integral part of these condensed financial
statements.

F-53

FLAG TELECOM HOLDINGS LIMITED

CONDENSED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS)

The accompanying notes are an integral part of these condensed financial
statements.

F-54

FLAG TELECOM HOLDINGS LIMITED AND SUBSIDIARIES

NOTES TO THE CONDENSED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000, AND THE PERIOD FROM
INCORPORATION TO DECEMBER 31, 1999

(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

1. BACKGROUND AND ORGANIZATION

FLAG Telecom Holdings Limited ("the Company" or "FLAG Telecom") was
incorporated on February 3, 1999 to serve as the holding company for the FLAG
Telecom group of companies. On February 26, 1999, FLAG Telecom acquired
approximately 66% of FLAG Limited by exchanging 69,709,935 shares of FLAG
Limited common stock for the same number of shares of FLAG Telecom common stock.
The minority shareholder of FLAG Limited exchanged its remaining shareholding in
FLAG Limited for 36,256,121 shares in FLAG Telecom on January 4, 2000 such that
on that date FLAG Limited became a wholly owned subsidiary of FLAG Telecom.

FLAG Telecom is an leading global network services provider and independent
carrier's carrier providing a range of products and services to the
international carrier community, Application Service Providers (ASPs) and
Internet Service Providers ("ISPs") across a global network platform. Leveraging
this network, FLAG Telecom's network services business markets a range of
managed bandwidth and value-added services targeted at carriers, ISPs, ASPs and
other content providers worldwide.

2. DEBT

As a result of our decision not to pay interest on FLAG Telecom's 11 5/8%
Senior Notes, we have reclassified those Senior Notes from long-term to
short-term debt as at December 31, 2001.

The Company's debt comprises the following:

On March 17, 2000 the Company completed the issue of $300,000 11 5/8% Senior
Notes and Euro 300,000 11 5/8% Senior Notes at par in the US and Europe, raising
combined net proceeds of $576,649. The effective interest rates at December 31,
2000 were 16.3% on the Dollar Notes and 15.8% on the Euro Notes.

The indentures under which the Senior Notes were issued impose certain
operating and financial restrictions. Such restrictions will affect, and in many
respects significantly limit or prohibit, among other things, the ability of the
Company to incur additional indebtedness, sell assets, make investments, engage
in transactions with shareholders and affiliates, issue capital stock, create
liens or engage in mergers or acquisitions. These restrictions could also limit
the ability of the company to effect future financings, make needed capital
expenditures, withstand a future downturn in its business or the economy in
general, or otherwise conduct necessary corporate activities.

3. EQUITY METHOD INVESTMENTS

A dividend received during 2000 from FLAG Limited of $30,000 is reflected
within equity method investments in the accompanying balance sheet.

F-55

FLAG TELECOM HOLDINGS LIMITED

SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS

(EXPRESSED IN THOUSANDS OF DOLLARS)

F-56

SIGNATURES

Pursuant to the requirements of Section 13 and 15(d) of the Securities
Exchange Act 1934, FLAG Telecom Holdings Limited has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of New York, the State of New York, on the 28th day of March, 2002.

FLAG TELECOM HOLDINGS LIMITED

By: /s/ KEES VAN OPHEM
-----------------------------------------
Kees van Ophem
SECRETARY

Know All Men By These Presents, that each person whose signature appears
below constitutes and appoints Kees van Ophem, his attorney-in-fact, each with
the power of substitution for him in any and all capacities, to sign any
amendments to this Report on Form 10-K and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact, or his substitute or substitutes, may do or cause to be done
by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:

EXHIBIT INDEX

The following Exhibits are filed as part of this Report as required by
Regulation S-K.

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

* Filed herewith

+ Confidential treatment has been requested with respect to certain portions
of this exhibit. The confidential portions of this exhibit for which
confidential treatment has been requested has been filed separately with the
SEC.