FLAG TELECOM GROUP LTD - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003

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

COMMISSION FILE NO.: 000-29207

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

BERMUDA
(State or Other Jurisdiction of Incorporation or Organization)

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

+1 441 296 0909
(Registrant's Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and 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 / / No /X/

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes / / No /X/

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

2,000,000 common shares (par value $1.00 per share) of FLAG Telecom Group
Limited were outstanding as of March 31, 2003.

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FLAG TELECOM GROUP LIMITED
(SUCCESSOR TO FLAG TELECOM HOLDINGS LIMITED)
FORM 10-Q
INDEX

PART I
FINANCIAL INFORMATION

1.A ITEM 1. FINANCIAL STATEMENTS.

FLAG TELECOM GROUP LIMITED
(SUCCESSOR TO FLAG TELECOM HOLDINGS LIMITED)
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2003 AND DECEMBER 31, 2002
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

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

1

1.B

FLAG TELECOM GROUP LIMITED
(SUCCESSOR TO FLAG TELECOM HOLDINGS LIMITED)
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED
MARCH 31, 2003 AND 2002
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

Per share and share information--see Note 6

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

2

1.C

FLAG TELECOM GROUP LIMITED
(SUCCESSOR TO FLAG TELECOM HOLDINGS LIMITED)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
FOR THE THREE MONTHS ENDED
MARCH 31, 2003 AND 2002
(EXPRESSED IN THOUSANDS OF DOLLARS)

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

3

1.D

FLAG TELECOM GROUP LIMITED
(SUCCESSOR TO FLAG TELECOM HOLDINGS LIMITED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2003 AND 2002
(EXPRESSED IN THOUSANDS OF DOLLARS)

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

4

1.E NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

1. BASIS OF PRESENTATION

These consolidated financial statements contain information relating to FLAG
Telecom Group Limited, a Bermuda corporation (together with its subsidiaries,
"FLAG Telecom", "Successor" or the "Company"), which is the successor entity of
FLAG Telecom Holdings Limited ("Predecessor") which, on October 9, 2002 (the
"Effective Date"), transferred substantially all of its assets, at fair value,
to the Company, as a result of transactions contemplated by a Plan of
Reorganization (the "Plan") of Predecessor and certain of its subsidiaries under
chapter 11 of the United States Bankruptcy Code and related Bermuda Schemes of
Arrangement. Predecessor is now in liquidation under Bermuda law.

The accompanying unaudited consolidated financial statements are expressed
in U.S. Dollars ("Dollars") and have been prepared in accordance with accounting
principles generally accepted in the United States ("U.S. GAAP") for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation 8-X. Accordingly, they do not include all of the information required
by U.S. GAAP for complete financial statements.

In the opinion of management, the accompanying unaudited consolidated
financial statements reflect all normal, recurring adjustments necessary for a
fair presentation of the results of operations for the three months ended
March 31, 2003 and 2002, the balance sheet as of March 31, 2003, and the cash
flows for the three months ended March 31, 2003 and 2002.

Our comparative financial statements have been restated. The restatements
related to guidance issued by the SEC relating to accounting for reciprocal
transactions, adjustments for other revenue recognition matters to comply with
SAB 101, and other adjustments arising from a re-audit of Predecessor's 2000 and
2001 financial statements. Certain other reclassifications and audit adjustments
have been made to conform to current year presentation. These are more fully
explained in Note 3.

The balance sheet at December 31, 2002 has been derived from the audited
financial statements at that date but does not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements. The accompanying unaudited consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements for the year ended December 31, 2002. In addition, Predecessor's
results of operations for the quarter ended March 31, 2002 are not comparable to
the Company's results of operations for the quarter ended March 31, 2003 due to
the adoption of fresh start accounting upon emergence from bankruptcy.

The preparation of financial statements in conformity with 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, as well as the reported
amounts of revenue and expenses during the reporting period. Actual amounts and
results could differ from those estimates. The results of operations for any
interim period are not necessarily indicative of results for the full year.

5

1.E NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

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:

2.1 BASIS OF CONSOLIDATION

The financial statements consolidate the financial statements of FLAG
Telecom and its subsidiary companies after eliminating intercompany transactions
and balances and recording minority interests. Investments in which FLAG has an
investment of 20%-50% or investments in which FLAG can exert significant
influence, but does not control, are accounted for under the equity method.
However, the Company has a 49% interest in Seoul Telenet Inc which is accounted
for under the principles of consolidation. The Company consolidates Seoul
Telenet Inc as it exercises control over the operations despite having an
investment of 49%.

2.2 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 contingencies at the date of the financial statements, as well as
the reported amounts of revenue and expenses during the reporting period. The
most critical estimates include accounts receivable reserves, impairment
charges, useful lives of fixed assets, asset retirement obligations and
performance obligations under long term contracts. Actual amounts and results
could differ from those estimates.

2.3 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. The Company has
recorded only operating leases for capacity transactions for the periods
presented.

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

In exchange for construction costs incurred, the Company granted credits to
suppliers toward future capacity. In addition, certain customers have committed
to purchase capacity from the Company 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 FOR CAPACITY

Historically, in accordance with U.S. GAAP, amounts invoiced as part of
reciprocal transactions for capacity were recorded at fair value as deferred
revenue. Predecessor amortized deferred revenue on a straight-line basis as
earned over the term of the relevant agreement. During the periods presented,
the

6

1.E NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

2.3 REVENUE RECOGNITION (CONTINUED)
Company was not a party to any reciprocal transaction that would require it to
recognize revenues up-front. Predecessor and Successor (collectively, "we" or
"us") adopted the guidance issued by the AICPA--SEC Regulations committee on
August 2, 2002 (the "AICPA Guidance"), applied this retrospectively and restated
the comparative period financial statements. The adoption of the AICPA Guidance
resulted in a change to our accounting policy for reciprocal transactions for
capacity and, consequently, they are no longer capitalized. See Note 3.

OPERATIONS AND MAINTENANCE

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

NETWORK REVENUES

Network revenues are revenues derived from the lease of managed bandwidth
services and Internet Protocol ("IP") services. Revenue associated with leased
capacity is recognized as operating lease revenue unless the criteria under FASB
Interpretation No. 43 for sales-type lease accounting are met. During the
periods presented, we did not record any sales-type leases.

2.4 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 FOR CAPACITY

Historically, we recorded capacity acquired as part of reciprocal
transactions for capacity either as property and equipment, prepaid expenses and
other assets or other long-term assets, depending upon when we anticipated that
they would be brought into service, and were charged as network expenses or
depreciated on a straight-line basis over the shorter of 15 years or the term of
the purchase agreement.

As discussed in Note 3, we adopted the AICPA Guidance issued on August 2,
2002, applied this retrospectively and restated the comparative period financial
statements.

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.

7

1.E NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

2.5 COMMISSIONS

Third party commissions are capitalized and amortized over the period of the
recognition of the related capacity revenue. Internal sales commissions are
expensed as incurred.

2.6 ADVERTISING COSTS

Advertising costs are expensed as incurred. Such costs are included in
selling, general and administrative expenses in the accompanying consolidated
statements of operations.

2.7 PENSIONS

All eligible employees of FLAG Telecom are covered by a non-contributory
defined contribution pension plan.

2.8 INCOME TAXES

Income taxes are accounted for under the liability method. 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. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period in
which the change is enacted. Future tax benefits attributable to these
differences, if any, are recognizable to the extent that realization of such
benefits is more likely than not. Valuation allowance is applied to deferred tax
assets in order to recognize them at fair value at the balance sheet date.

2.9 NET LOSS PER COMMON SHARE

Basic net loss per common share is computed by dividing net loss applicable
to common shareholders by the weighted average number of common shares
outstanding during the period. Diluted net loss per common share is computed by
dividing net loss by the weighted average number of common shares and common
share equivalents outstanding during the period.

2.10 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, program
management costs, costs for the route surveys, indirect costs associated with
cable systems and points of presence ("PoPs"), long-term capacity lease
purchases, and other costs incurred in the development of our global network.
Construction in progress is transferred to property and equipment when placed
into service.

2.11 PROPERTY AND EQUIPMENT

Property and equipment are stated at cost, net of accumulated depreciation.
In accordance with fresh start accounting, the book value of property and
equipment was adjusted to its fair value and

8

1.E NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

2.11 PROPERTY AND EQUIPMENT (CONTINUED)
amortized over its remaining estimated useful life. Depreciation is taken on a
straight-line basis over the estimated useful lives of the property and
equipment as follows:

Computer equipment....................... 3 years
Fixtures and fittings.................... 5 years
Leasehold improvements................... Remaining lease term
Motor vehicles........................... 5 years
Network assets........................... 15 years or remaining useful lives

The estimated useful lives of network assets are determined based on the
estimated period over which they will generate revenue, ranging from 10 to
14 years.

2.12 IMPAIRMENT OF LONG LIVED ASSETS

On January 1, 2002, we adopted Statement of Financial Accounting Standards
No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived
Assets". We periodically review 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 us.

Under the testing for impairment, estimates of future cash flows are used to
test the recoverability of a long-lived asset, and are based on the existing
service potential of the asset. These estimates exclude cash flows associated
with future capital expenditures that would increase the service potential of
the long-lived asset.

2.13 CASH AND CASH EQUIVALENTS

We consider 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 are approximate to fair value.

2.14 RESTRICTED CASH

We designate funds held by collateral trustees, in escrow on deposit or
legally designated for specific projects or commitments by bank agreements, as
restricted cash.

2.15 DERIVATIVE FINANCIAL INSTRUMENTS

Prior to the commencement of its chapter 11 proceedings, Predecessor had
been using derivative financial instruments for the purpose of reducing its
exposure to adverse fluctuations in interest rates, currencies and other market
risks. Predecessor did not utilize derivative financial instruments for trading
or other speculative purposes. The counter-parties to these instruments are
major financial institutions with high credit quality. Predecessor was exposed
to credit loss in the event of non-performance by these counter-parties.

FLAG Telecom records all derivative instruments on the balance sheet at fair
value. Changes in a derivative's fair value are recognized in earnings unless
specific hedge criteria are met. If the derivative

9

1.E NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

2.15 DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
is designated as a fair value hedge, the changes in the fair value of the
derivative and of the hedged item attributable to the hedged risk are recognized
as a charge or credit to earnings. If the derivative is designated as a cash
flow hedge, the effective portions of changes in the fair value of the
derivative are recorded in other comprehensive income (loss) and are recognized
in the consolidated statement of earnings when the hedged item affects earnings
and the cash flows are classified consistent with the underlying hedged item.
For purchased foreign currency options the entire change in fair value is
included in the measurement of hedge effectiveness for cash flow hedges.
Ineffective portions of changes in the fair value of cash flow hedges are
recognized as a charge or credit to earnings.

FLAG Telecom designates and assigns derivatives as hedges of forecasted
transactions, specific assets or specific liabilities. When hedged assets or
liabilities are sold or extinguished or the forecasted transactions being hedged
are no longer expected to occur, the Company recognizes the gain or loss on the
designated hedging financial instruments.

2.16 CAPITALIZED INTEREST AND FINANCING COSTS

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

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

2.17 TRANSLATION OF FOREIGN CURRENCIES

Transactions in foreign currencies are translated into Dollars at the rate
of exchange at the date of each transaction. Monetary assets and liabilities
denominated in foreign currencies at period-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 period-end net investments in these
companies are translated at period-end exchange rates. Exchange differences
arising from retranslation at period-end exchange rates of the opening net
investments and results for the period are charged or credited directly to the
cumulative translation adjustment in shareholders' equity.

2.18 STOCK OPTIONS

As permitted by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock Based Compensation" ("SFAS No. 123"), we account for
employee stock options under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"), and, accordingly,
recognize 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.

2.19 CONCENTRATION OF CREDIT RISK

Financial instruments that potentially subject FLAG Telecom to a
concentration of credit risk are accounts receivable. FLAG Telecom performs
ongoing credit evaluations of its larger customers' financial condition.
Geographical risk is mitigated by the fact that revenues are not concentrated in
one part of the world. See Note 5, "Segment Reporting", for revenue by
geographic areas.

10

1.E NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

2.19 CONCENTRATION OF CREDIT RISK (CONTINUED)
FLAG Telecom is exposed to credit-related losses in the event of
non-performance by counter parties to financial instruments but does not expect
any counter parties to fail to meet their obligations. FLAG Telecom deals only
with highly rated counter parties.

2.20 ALLOWANCE FOR DOUBTFUL ACCOUNTS

FLAG Telecom maintains an allowance for doubtful accounts. 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 our experience with potential uncollectable
receivables and our expectations as to payments. This allowance could require
adjustments based on changing circumstances, including changes in the economy or
in the particular circumstances of individual customers.

2.21 REPAIRS AND MAINTENANCE COSTS

Expenditures for repairs, replacement and maintenance are expensed as
incurred. Such costs include routine maintenance and repair work to office
buildings and equipment.

2.22 ASSET RETIREMENT OBLIGATIONS

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.

The Company measures 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 is the credit-adjusted risk-free rate that existed
when the liability was initially measured. That amount is 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.

2.23 RECLASSIFICATIONS

In addition to the restatements discussed in Note 3, certain prior year
amounts have been reclassified in the consolidated financial statements to
conform to current year presentation.

11

1.E NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

3. RESTATEMENTS OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

The Company has recorded certain restatement adjustments to its previously
issued 2002 financial statements. The effects of the adjustments on the
quarterly financial statements are as follows:

12

1.E NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

3. RESTATEMENTS OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS (CONTINUED)
RECIPROCAL TRANSACTIONS REVERSALS

We have entered into transactions in which we provide capacity, services or
facilities, by way of leases, right of use ("ROU") or service agreements to
other telecommunications companies and service providers at approximately the
same time that we lease or purchase capacity from the same companies or their
affiliates. We call these transactions "reciprocal transactions".

Historically, we treated reciprocal transactions as if they were
non-monetary transactions in accordance with Accounting Principles Board Opinion
No. 29 "Accounting for Non-monetary Transactions" ("APB No. 29"). In order to
determine whether our reciprocal transactions should be accounted for as revenue
and a capital expenditure at fair value as deferred revenue and deferred costs,
in accordance with APB No. 29, we assessed whether:

- the reciprocal transaction was 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

- the fair values of the assets exchanged were determinable within
reasonable limits.

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, these transactions were
recorded at fair value as deferred revenue on a straight-line basis over the
term of the relevant agreement. We also considered that operating leases and
capital leases were dissimilar in nature and consequently were not exchanges of
similar productive assets within the definition of APB No. 29.

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

In August 2002, the staff of the Securities and Exchange Commission (the
"SEC") indicated that the SEC staff had concluded that all non-monetary exchange
transactions for telecommunications capacity should be accounted for as an
exchange of assets, irrespective of whether the transaction involved the lease
of assets. The conclusion was based on the SEC staff's view that the right to
use an asset (that is, a lease), is in fact an asset and not a service contract,
irrespective of whether such asset is characterized as an asset on the balance
sheet. This conclusion requires that non-monetary exchange transactions for
telecommunications capacity involving the exchange of one or more operating
leases be recognized based on the carrying value of the assets exchanged, rather
than at fair value, resulting in no recognition of revenue for the transactions.
Prior to the SEC's communication on this issue, Predecessor's accounting for
these transactions, which resulted in Predecessor recognizing revenue, had been
consistent with guidance for these types of transactions. The SEC indicated that
it expects affected companies to retroactively apply this guidance to historical
non-monetary exchange capacity transactions that occurred in prior years and, if
appropriate, restate their financial statements. The total impact of these
adjustments has been a reduction in total assets of $224.9 million as at
March 31, 2002.

13

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

3. RESTATEMENTS OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS (CONTINUED)

As reported in our Annual Report on Form 10-K, the Company restated its
results as a result of audits and re-audits for the years ended 2002, 2001 and
2000. As a result, certain of these adjustments impacted the quarter ended
March 31, 2002. These adjustments are summarized below.

ADJUSTMENTS TO OPENING RETAINED EARNINGS

The accounting for sales of capacity has evolved over the last few years as
the interpretation and application of certain pronouncements by the SEC and
accounting standard setting bodies have been clarified. To take account of these
developments and to be consistent with current industry practice, the accounting
for certain sales transactions has been re-stated as follows:

- A contract signed in September 1998, but related to a customer commitment
in an earlier period was treated as a sales type lease because the
customer had a fixed period to commit to draw down the capacity and to
start paying maintenance charges for certain specifically identified
capacity on our network, otherwise the customer would lose the capacity
with no refund. On re-evaluation of the contract the Company has accounted
for these capacity sales as operating leases as and when drawn down.

- A contract, which was signed in September 1999, was treated as a sales
type lease contract because the customer had committed to the purchase in
an earlier period and some capacity had been activated prior to June 1999.
On re-evaluation of the contract and taking account of the criteria stated
in FIN 43 and SFAS 66 for the "transfer of title" for capacity contracts
entered into after June 1999, the Company has accounted for the contract
as an operating lease.

- The Company had entered into a contract in August 1998, which involved the
sale of capacity and the customer having a "rent free" period from paying
standby operations and maintenance charges. The entire contract was
treated as a sales type lease contract and the Company set up a provision
for costs to be incurred during the free maintenance period. Subsequently
the Company also recognised capacity credits as revenues in 2001. On
re-evaluation of the terms and components of the contract adjustments have
been made to revenues in 1998, 1999, 2000 and 2001.

OTHER ADJUSTMENTS TO THE THREE MONTHS ENDED MARCH 31, 2002

- The Company also adjusted the revenues for the years 2000 and 2001, upon
further analysis of the deliveries of capacity to the customers, in
compliance with the current revenue recognition policy.

- In December 2001, the Company accrued for an upgrade on the FA-1 system,
which was committed to be purchased. Upon further analysis by management,
the accruals and related assets have been reversed to reflect the fact
that the work had not been undertaken by the supplier in 2001.

- The Company identified additional fixed assets for which depreciation had
to be charged in the three months to March 31, 2002.

- Adjustments to cash and expense accounts to reflect payments made to
suppliers but not posted to the accounts payable ledger in the three
months to March 31, 2002.

- Correction of book keeping and accounting errors.

The total impact of all adjustments in the three months to March 31, 2002 is
to decrease previously reported net income in the three months to March 31, 2002
by $6.3 million. This reflects a

14

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

3. RESTATEMENTS OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS (CONTINUED)
reduction in reported net income of $10.8 million with respect to reciprocal
transactions reversals, partially offset by an increase in net income of
$4.5 million as a result of other adjustments.

4. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

EMERGING ISSUES TASK FORCE ISSUE NO. 00-21, REVENUE ARRANGEMENTS WITH
MULTIPLE DELIVERABLES--EITF 00-21

In November 2002, the EITF reached a consensus on Issue No. 00-21, "Revenue
Arrangements with Multiple Deliverables." EITF Issue No. 00-21 provides guidance
on how to account for arrangements that involve the delivery or performance of
multiple products, services and/or rights to use assets. The provisions of EITF
Issue No. 00-21 will apply to revenue arrangements entered into in fiscal
periods beginning after June 15, 2003. FLAG Telecom is currently evaluating the
effect that the adoption of EITF Issue No. 00-21 will have on its results of
operations and financial condition.

5. SEGMENT REPORTING

Predecessor has historically reported its segmental disclosures in its two
primary operational areas: Capacity and Operations and Network Services. The
Company has changed the way it manages its business. Although our sales and
marketing function is structured geographically, we sell the full range of our
products and services across the global network. The Company evaluates the
performance of one segment, the global network. The prior period segment
disclosures have been restated.

Revenue analyzed by geographical location of customers is as follows:

6. EARNINGS PER SHARE

Basic net loss per common share is computed by dividing net loss applicable
to common shareholders by the weighted average number of common shares
outstanding during the period. Diluted net loss per common share is computed by
dividing net loss by the weighted average number of common shares and common
share equivalents outstanding during the period. For the three month

15

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

6. EARNINGS PER SHARE (CONTINUED)
periods ended March 31, 2003 and 2002 presented, no potentially dilutive
securities have been included in the calculation of diluted net loss per share
amounts as the effect would be anti-dilutive.

* The pro forma information has been provided to disclose the impact of the
share structure of the Company assuming the shares had been outstanding in
the comparative period.

7. STOCK-BASED COMPENSATION

At March 31, 2003, the Company had one stock-based employee compensation
plan, which is more fully described in Note 17 in Company's Notes to
Consolidated Financial Statements on its Annual Report on Form 10-K for the year
ended December 31, 2002. The Company accounts for this plan under the
recognition and measurement principles of APB Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES, and related interpretations and adopted the
disclosure only provisions of SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION. Accordingly, no compensation cost has been recognized for its
stock-based compensation plan under the fair value method as described in
SFAS 123. The Company has issued restricted stock at a price determined by the
Compensation Committee of the Board of Directors subject to the Company's right
to repurchase such stock in specified circumstances prior to the expiration of a
restricted period within these plans.

In accordance with SFAS No. 148, ACCOUNTING FOR STOCK-BASED
COMPENSATION--TRANSITION AND DISCLOSURE, the following table illustrates the
assumptions used and the effect on net income (loss) and earnings per share if
the Company had applied the fair value recognition provisions of SFAS No. 123
for all employee stock options granted using the Black-Scholes option pricing
model prescribed by SFAS No. 123.

16

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

8. RESTRUCTURING COSTS

Upon emergence from bankruptcy, the Company instigated a plan for a number
of office closures, employee relocations and further employment terminations,
the details of which were finalized during 2002 and the first quarter of 2003.
The employees affected were in Sales (4), Operations (17) and Finance and
Administration (14). The Successor expects to incur $4.9 million in costs as
part of the plan, of which $2.3 million of one-time termination costs had been
incurred by December 31, 2002. A further $2.4 million of one-time termination
costs and $0.2 million of other associated costs were incurred in the first
quarter of 2003.

The last planned office closure occurred in April 2003 and the last related
employee termination is expected in August 2003.

The following summarizes the activity for the restructuring costs incurred
by the Company

9. LEGAL PROCEEDINGS

LOFTIN ACTION--CLASS ACTION LAWSUIT

Five class action complaints against Predecessor and some of its past and
present officers, brought by certain of Predecessor's shareholders on behalf of
a proposed class of those who purchased Predecessor's stock between
February 16, 2000 and February 13, 2002 (the "Class Period"), were filed in the
United States District Court for the Southern District of New York, beginning in
April 2002. A sixth action was filed in the same court against certain past and
present officers and directors of Predecessor, Salomon Smith Barney, Inc. and
Verizon Communications, Inc. All these actions have now been consolidated by
order of the Court (the "Loftin action").

The consolidated amended complaint (the "Complaint") was filed by the
plaintiffs on March 20, 2003 and asserts claims under sections 11, 12(a)(2) and
15 of the Securities Act and sections 10(b) and 20(a) of the Exchange Act, as
well as Rule 10b-5. More specifically, the Complaint alleges, among other
things, that the defendants: knew but failed to tell the market about the glut
of capacity and falling bandwidth prices that allegedly existed at the time of
the initial public offering and throughout the Class Period; engaged in, or
caused Predecessor to engage in, transactions with competitors whereby they
would sell each other cable that neither needed, for the sole purpose of
increasing revenue; and accounted for, or caused Predecessor to account for,
these transactions improperly and to overstate revenue. The Complaint does not
name Predecessor as a defendant, but it does name FLAG Telecom. The Plan
provides that we shall have no liability for any claims relating to the period
prior to the Plan's Effective Date. The claims asserted in the Complaint relate
solely to that period. The amount of damages sought from the defendants is not
specified.

As the Company, per the Plan, have no liability for any claims relating to
the period prior to the Effective Date, we believe there is no potential
liability for us and therefore no reserves have been established. There is a
contingent liability, on the part of the Company, of $3.25 million for a defense
fund in case the Directors' & Officers' Liability policy ("D&O policy") is
invalidated or attempted to

17

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

9. LEGAL PROCEEDINGS (CONTINUED)
be by the insurance company. No provision for these liabilities has been made in
our financial statements.

Predecessor and the insurers under the D&O policy have executed an interim
funding agreement by which the insurers are willing to advance reasonable and
necessary costs and expenses in connection with the above matters. In the
meantime, the insurers have confirmed the existence of the D&O policies.

OTHER

We are also involved in litigation from time to time in the ordinary course
of business. In management's opinion the litigation in which we are currently
involved, individually and in the aggregate, is not material to our company.

10. INDEBTEDNESS

Upon our emergence from chapter 11 proceedings, our company and our
subsidiaries entered into various financing agreements. Our debt instruments are
described below:

THE SERIES A NOTES

On the Effective Date, we issued Series A Notes in the original principal
amount of $45 million, which are due and payable on October 1, 2005, and bear
simple interest on this amount, less any principal repayments made, at the
following rates: 6.67% per annum for the first 12 months after the Effective
Date; 7.33% per annum for months 13 through 24 after the Effective Date; and 8%
per annum for months 25 through 36 after the Effective Date.

At any time up until April 2004, we have the right, in our sole and absolute
discretion, provided that no default or event of default has occurred or is
continuing, to redeem all of the Series A Notes by paying the sum of
$30 million, plus accrued but unpaid interest. Such discount redemption must be
done via Board resolution with 30 days prior notice to the trustee and can only
be done in a situation where there is no default. Each subsequent month, the
repayment sum increases by $0.833 million until October 1, 2005 whereby the
total sum would be $45 million.

In the event of a liquidation event or Change of Control (defined below),
the original principal amount of $45 million will be payable in full plus
accrued but unpaid interest, less any principal repayments made. "Change of
Control" is defined to mean, in summary: (i) when any person or group becomes
the beneficial holder of more than 50% of our voting stock; and (ii) when we
consolidate or merge with or into any other person or sell all or substantially
all of our assets.

To secure payment of the Series A Notes a lien was granted on substantially
all of the assets of our company and certain of our subsidiaries in favor of The
Bank of New York, as Trustee to the Indenture (the "Indenture"). Such lien ranks
PARI PASSU in priority and right of payment with the Series B Note and the
Series C Note.

THE SERIES B NOTE

We issued the Series B Note on the Effective Date. The Series B Note has an
original principal amount of $4 million, is due and payable on October 1, 2004
and bears simple interest on this amount, less any principal repayments made, at
the following rates: 10% per annum until October 1, 2003; and 11% thereafter.
Unlike the Series A Notes, the Series B Note is not redeemable at a discount.

18

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

10. INDEBTEDNESS (CONTINUED)
We may issue senior secured debt obligations equal and ratable to the
Series B Note upon payment by us of $15 million of the original principal amount
of the Series A Notes.

In the event of a liquidation or Change of Control, the original principal
amount of $4 million plus a $2 million premium is payable in full plus accrued
but unpaid interest, less any principal repayments made.

The Series B Note is cross-defaulted with both the Series A Notes and the
Series C Note. The Series B Note is secured by liens on the same assets as the
Series A Notes and ranks PARI PASSU in priority and right of payment with the
Series A Notes and the Series C Note. Upon the payment by us of $5 million of
the original principal amount of the Series A Notes, the Series B Note lien will
be cancelled and released.

THE SERIES C NOTE

We issued the Series C Note on the Effective Date. The Series C Note has an
original principal amount of $1.25 million, is due and payable on October 1,
2004 and has the same material terms and conditions as the Series B Note.

In the event of a liquidation or Change of Control, the original principal
amount of $1.25 million is payable in full plus accrued but unpaid interest,
less any principal repayments made. The Series C Note is cross-defaulted with
both the Series A Notes and the Series B Note. The Series C Note is secured by
liens on the same assets as the Series A Notes and ranks PARI PASSU in priority
and right of payment with the Series A Notes and the Series B Note. Upon the
payment by us of $5 million of the original principal amount of the Series A
Notes, the Series C Note lien will be cancelled and released.

We may issue senior secured debt obligations equal and ratable to the
Series C Note upon the payment by us of $15 million of the original principal
amount of the Series A Notes.

INDENTURE FOR SERIES A, B AND C NOTES

The Series A Notes, the Series B Note and the Series C Note are each
governed by an Indenture, dated as of October 9, 2002, between FLAG Telecom and
The Bank of New York, as indenture trustee. We are prohibited from retiring any
debt prior to its scheduled maturity, other than the Series A, B and C Notes,
non-recourse debt, and intercompany debt. Therefore, we cannot retire the FNAL
Note (see below) without the consent of the Series A, B and C Noteholders.
However, the FNAL Note and other indebtedness does not prevent us from
repurchasing the Series A, B and C Notes.

Furthermore, any payment of dividends would be restricted by the terms of an
Indenture between FLAG Telecom and the Bank of New York, as Indenture Trustee,
dated October 9, 2002. The Indenture governs that any dividend or distribution
paid pursuant to the provisions of the Security and Pledge Agreement, also with
the Bank of New York, as Collateral Trustee, dated October 9, 2002, shall be
paid to the Bank of New York and such dividend or distribution paid will be used
to redeem the Series A, B & C Notes pro rata. Any and all dividends and interest
paid or payable in case in respect of any Security Collateral (i.e. Pledged
Stock, Pledged Notes, additional shares of Capital Stock and additional
indebtedness from time to time) in connection with a partial or total
liquidation or dissolution or in connection with a reduction of capital surplus
or paid-in-surplus, and cash paid, payable or otherwise distributed in respect
of principal of, or redemption of, or in exchange for, any Security Collateral,
shall be forthwith delivered to the Collateral Trustee to be held as Security
Collateral.

19

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

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

10. INDEBTEDNESS (CONTINUED)
Pursuant to the terms of the Indenture, each of our subsidiaries other than
FLAG Telecom Korea Limited, Seoul Telenet, Inc. and FLAG Telecom Switzerland
Network AG has granted a guarantee of the full and punctual payment of
principal, premium and interest of each of the Series A, B and C Notes and all
other obligations of the Company under the Notes.

We also entered into a Security and Pledge Agreement, dated as of
October 9, 2002, with The Bank of New York, as collateral trustee, under which
we have pledged and granted a security interest in substantially all of our
current and future assets to secure the payment of all the Series A Notes, the
Series B Note and the Series C Note.

OTHER INDEBTEDNESS

In addition to the notes described above, we, and/or certain of our
subsidiaries, issued several promissory notes to trade creditors in connection
with the Plan. In particular, on May 16, 2002, FLAG Asia Limited issued a
promissory note (the "FNAL Note") to a trade creditor in the principal amount of
$27.4million. The FNAL Note is secured by certain assets of FLAG Asia Limited,
including one fiber pair and related equipment and rights on FNAL, and
guaranteed by FLAG Telecom. The guarantee issued by FLAG Telecom to the holder
and the collateral agent of the FNAL Note provides that, for the term of the
FNAL Note, FLAG Telecom will guarantee the payment and performance of the FNAL
Note until the date on which the note is paid in full. As a result, FLAG Telecom
is obligated fully and to the same extent as FLAG Asia Limited for the full
amount of the FNAL Note until it is paid in full. The FNAL Note bears an
interest rate of 7% per annum payable quarterly in arrears commencing on the
Effective Date. Of the principal amount, $6 million is due and payable on
September 30, 2003, $6.9 million is due and payable on September 30, 2004 and
the remaining principal is due and payable on September 30, 2005.

In the event of a liquidation event or Change of Control (defined below),
the original principal amount of $27.4 million will be payable in full plus
accrued but unpaid interest, less any principal repayments made. "Change of
Control" is defined to mean, in summary: (i) when any person becomes the
beneficial holder of 100% of FLAG Asia Limited's issued capital stock; and
(ii) when FLAG Asia Limited consolidates or merges with or into any other person
or sell all or substantially all of our assets.

On the Effective Date, we also issued a promissory note to another trade
creditor in the principal amount of $2.4 million with an 18-month term and 7%
interest.

Also on the Effective Date, FLAG Asia Limited issued an unsecured promissory
note to another trade creditor in the principal amount of $1 million with an
18 month term and 7% interest payable monthly, maturing on March 25, 2004.

On the Effective Date, we also issued an unsecured note to another trade
creditor of $3.42 million, repayable in 12 equal monthly installments. This note
is not interest bearing.

20

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

FORWARD-LOOKING STATEMENTS

We have made forward-looking statements, within the meaning of Section 27A
of the Securities Act of 1933 ("Securities Act") and Section 21E of the Exchange
Act, in this report 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 report.

You should understand that many important factors could cause our results to
differ materially from those expressed in these forward-looking statements.
Factors that could cause our future results to differ from those reflected in
forward-looking statements include, but are not limited, to:

- the uncertainty caused by significant oversupply in the industry;

- certain companies refusing to pay certain operations and management
charges;

- lack of availabilities for additional financing for telecommunications
companies such as ours;

- the significant problems being experienced by the telecom industry;

- the financial difficulties being experienced by customers and suppliers;
and

- tax and regulatory changes and conditions.

A detailed explanation of these risk factors is incorporated by reference to our
Annual Report on Form 10-K for the year ended December 31, 2002, which is filed
with the Securities and Exchange Commission on July 3, 2003. Please read those
risk factors carefully. We cannot predict which, if any, of these or other
factors might have a significant impact on the telecommunications industry in
the future, nor can we predict what impact, if any, the occurrence of these or
other events might have on our operations.

INTRODUCTION

We are a multinational corporate organization made up of multiple corporate
entities. We operate a global telecommunications network comprised of advanced
fiber-optic cable systems and interfaces that are owned by, leased to, or
otherwise available to our company. Over our global network, we offer a variety
of telecommunications products and services, internet protocol ("IP") transit,
IP point-to-point, leased capacity services, managed bandwidth services,
co-location services and long-term rights of use in capacity. We are a
"carrier's carrier", meaning that our target customer base is the international
wholesale broadband market, consisting of established carriers or major public
telephone operator incumbents, including application service providers ("ASPs")
and internet service providers ("ISPs"), alternate carriers and other bandwidth
intensive users (such as broadcasters), rather than individual
telecommunications consumers

21

CRITICAL ACCOUNTING POLICIES

Please refer to the Annual Report for our critical accounting policies. We
have made no material changes to the critical accounting policies described in
our Annual Report on Form 10-K.

RESULTS OF OPERATIONS

Total revenue for the quarter ended March 31, 2003 decreased 41.4% to
$31.3 million as compared to $53.5 million for the quarter ended March 31, 2002.
This decrease is primarily due to the write off of all deferred revenue as part
of fresh start accounting. Consequently revenues in the three months to
March 2003 reflect only services performed or products sold and ready for
service since October 9, 2002 along with amortization of performance obligations
under long-term contracts. We only recognize revenues from the date that a
system is ready for commercial service and revenues are recognized in the income
statement on a pro rata basis evenly over the life of the contract, which
generally tends to be over the life of the cable system, with a maximum of
15 years. Additionally, upon emergence from chapter 11 we began to amortize
performance obligations under long-term contracts within revenues. In the
quarter ended March 31, 2003, we have amortized $3.5 million to the income
statement. These performance obligations under long-term contracts arose upon
the adoption of fresh start accounting.

Revenue recognized from the sale of capacity decreased by 87.0% to
$2.9 million for the quarter ended March 31, 2003, as compared to $22.4 million
for the quarter ended March 31, 2002. The decrease was due to the write off of
all deferred revenue at fresh start. Capacity revenues in the quarter ended
March 31, 2003 only include capacity IRU /ROU (lifetime of cable system)
contracts entered into subsequent to October 9, 2002.

Revenue recognized from operations and maintenance decreased by 42.5% to
$11.6 million for the quarter ended March 31, 2003, as compared to
$20.2 million for the quarter ended March 31, 2002. This decrease is due to
writing off deferred revenue on prepaid operations and maintenance ("O&M")
contracts at fresh start. Additionally, an overall price reduction of
approximately 15% on our FLAG Europe-Asia ("FEA") O&M for 2003 has resulted in
reduced revenue in the quarter to March 31, 2003 of $1.2 million.

Revenue recognized from our network services activities increased by 22.1%
to $13.3 million for the quarter ended March 31, 2003, as compared to
$10.9 million for the quarter ended March 31, 2002. The network services
activities consist of IP Transit, managed bandwidth services, vPoP and
co-location services. Further demand has resulted in a steady increase in all
network revenues compared to March 2002.

22

OPERATING EXPENSES

During the quarter ended March 31, 2003, operations and maintenance costs
decreased by 21.0% to $16.5 million, as compared to $20.9 million for the
quarter ended March 31, 2002. Operations and maintenance costs relate primarily
to the provision of standby maintenance under maintenance zone agreements as
well as salaries and overheads directly associated with operations and
maintenance activities. This decrease partly reflects the renegotiation of
contracts and rationalization in our marine cable operations, landing stations,
terrestrial cable operations, PoPs and vendor maintenance and support.

During the quarter ended March 31, 2003, network expenses decreased by 65.4%
to $5.6 million, as compared to $16.1 million for the quarter ended March 31,
2002. These costs relate primarily to the utilization of third party capacity,
including local backhaul costs, connection and access fees, restoration charges
and other network procurement costs. This decrease reflects the, migration from
temporary Atlantic facilities onto our own network which took place during the
third quarter of 2002.

During the quarter ended March 31, 2003, selling, general and administrative
expenses decreased by 10.5% to $12.8 million, as compared to $14.3 million for
the quarter ended March 31, 2002. This decrease reflects lower personnel and
related costs due to the downsizing of personnel and office closures during the
latter half of 2002 and first quarter of 2003.

For the quarter ended March 31, 2003, we recorded $7.9 million in respect of
depreciation compared to $44.3 million for the quarter ended March 31, 2002. The
depreciation charge decreased as a result of asset impairments of $2.0 billion
in 2002 related to our cable systems. We depreciate property and equipment on a
straight-line basis over the estimated useful life of the asset, generally no
more than 15 years.

For the quarter ended March 31, 2003, we recorded $0.5 million in respect of
bad debt expense compared to $6.5 million for the quarter ended March 31, 2002.
The expense in the quarter to March 31, 2002 included $4.3 million related to
high-risk customers holding capacity on FA-1 who subsequently became insolvent.

RESTRUCTURING COSTS

Upon emergence from bankruptcy, the Company instigated a plan for a number
of office closures, employee relocations and further employment terminations,
the details of which were finalized during 2002 and the first quarter of 2003.
The employees affected were in Sales (4), Operations (17) and Finance and
Administration (14). The Successor incurred $4.9 million in costs as part of the
plan, of which $2.3 million of one-time termination costs had been incurred by
December 31, 2002. A further $2.4 million of employee-related benefits and
$0.2 million of other associated costs were incurred and paid in 2003.

23

The last planned office closure occurred in April 2003 and the last related
employee termination is expected in August 2003.

The following summarizes the activity for the restructuring costs incurred
by the Company

INTEREST EXPENSE AND INTEREST INCOME

Interest expense on borrowings for the quarter ended March 31, 2003 was
$3.1 million, compared to $40.1 million during the quarter ended March 31, 2002.
The decrease in interest expense for these periods was attributable to reduction
and restructuring of our debt as a result of chapter 11 proceedings.

Foreign exchange loss for the quarter ended March 31, 2003 was
$0.3 million. The loss resulted from the weakening of the US dollar. We
recognized a foreign exchange gain of $2.0 million for the quarter ended
March 31, 2002 comprised of a net loss of $0.4 million arising from the
translation of Euro denominated cash balances into US dollars at the balance
sheet exchange rate and a net gain of $2.4 million arising on foreign currency
swaps.

Interest income of $0.3 million was earned during the quarter ended
March 31, 2003, compared to $4.0 million earned during the quarter ended
March 31, 2002, reflecting the reduced cash balances. The interest income was
earned on cash balances, short-term investments and restricted cash.

PROVISION FOR TAXES

The provision for taxes was a charge of $0.3 million for the quarter ended
March 31, 2003, compared to a credit of $2.2 million for the quarter ended
March 31, 2002.

The provision for income tax charges / (credits) consists of taxes payable /
(receivable) relating to the income earned / (losses) incurred or activities
performed by us and our subsidiaries in certain 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 certain other
countries in which either we conduct activities or in which our customers are
located. 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, or upon the location of our customers. Our tax 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

24

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.

NET LOSS AND LOSS PER COMMON SHARE

For the quarter ended March 31, 2003, we recorded a net loss of
$13.8 million, compared to a net loss of $80.4 million for the quarter ended
March 31, 2002.

Basic and diluted loss per common share was $6.89 for the quarter ended
March 31, 2003, compared to basic and diluted loss per common share of $0.60 for
the quarter ended March 31, 2002. These amounts are not comparable due to the
change in the share structure as part of the restructuring plan.

LIQUIDITY AND CAPITAL RESOURCES

For a description of our restructuring, see Note 1 to the financial
statements included in Item 1.

RESTRICTED CASH

The Group designates funds held by collateral trustees, in escrow or legally
designated for specific projects or commitments by bank agreements, as
restricted cash. Restricted cash as at March 31, 2003 totals $9.3 million and
represents amounts held in escrow accounts and commitments by bank agreements.
As part of the Plan, all amounts previously restricted became unrestricted at
the Effective Date.

As at March 31, 2003, the Company currently had cash and cash equivalents of
$100.4 million based on our latest financial projections. We do not expect our
cash balance to change significantly by the end of 2003.

We believe that, based on current market conditions, current financial
conditions and our latest financial projections, this cash balance is sufficient
to enable us to continue to meet in full our financial obligations as they fall
due in the foreseeable future.

CASH FLOWS

Cash used in operating activities was $19.4 million, cash used in financing
activities was $0.2 million and cash used in investing activities was
$6.3 million during the quarter ended March 31, 2003. At March 31, 2003, total
cash, excluding restricted cash, had decreased to $100.4 million from
$125.8 million at December 31, 2002, primarily as a result of payments made to
reduce our trade creditors balance by $13.3 million and payments made for
construction costs in the three months to March 31, 2003.

ASSETS

Our primary asset is the net book value of the FLAG Telecom global network,
including construction in progress recorded in property and equipment totaling
$294.7 million at March 31, 2003, compared to $300.6 million at December 31,
2002. The increase of $1.7 million (excluding depreciation charged in the three
months ended March 31, 2003 of $7.8 million) is mainly attributed to an overall
increase in network capacity.

Our other property and equipment consist primarily of office furniture,
leasehold improvements and computer equipment that had net book values of
$10.8 million and $12.6 million as of March 31, 2003 and December 31, 2002,
respectively.

As of March 31, 2003, we had net current assets of $116.9 million, compared
to net current assets of $130.1 million, at December 31, 2002.

25

ACCOUNTS RECEIVABLE

The accounts receivable balance at March 31, 2003 was $76.4 million compared
to $81.9 million at December 31, 2002. The balance at March 31, 2003 includes
$3.3 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 in comparison to $0.7 million at December 31, 2002.

The net allowance for doubtful accounts at March 31, 2003 was
$11.0 million, compared to $10.4 million at December 31, 2002.

We are aware that one of our customers, Global Crossing, has announced that
it has filed for bankruptcy protection under chapter 11. As at March 31, 2003,
Global Crossing and its affiliates owed us $0.2 million ($0.2 million at
December 31, 2002). This has been provided for in full. Global Crossing has
$24.7 million of credits to be used on our system, subject to certain provisions
under a governing agreement, which cannot be offset against any monies owing to
us.

Other customers have credits totaling $26.3 million to be used on our
fiber-optic system, subject to certain provisions under our agreements with
these customers.

INFLATION

In management's view, inflation in operating, maintenance and general and
administrative costs will not have a material effect on our financial position
in the short-term.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

CURRENCY RISK

We do not believe that our operations are exposed to significant risk from
movements in foreign currency exchange rates. The foreign exchange gain in 2002
resulted from the translation of Euro and sterling-denominated cash balances and
the retranslation of Euro-denominated debt.

All capacity and operations and maintenance revenues are payable in Dollars.
All contracts for the provision by third parties of restoration are invoiced to
us in Dollars. We invoice some network services business products in local
currencies. Some contracts with suppliers of services to our network services
business are payable in currencies other than Dollars. Some vendor contracts for
the provision to the FEA cable system of operations and maintenance services and
local operating expenses of our subsidiary companies are payable in currencies
other than Dollars. When deemed necessary, we enter into forward foreign
currency contracts to hedge exposures that are considered material to our
financial position.

INTEREST RATE RISK

Historically we have been exposed to interest rate risk on bank debt
incurred by FLAG Limited and FLAG Atlantic Limited, and interest rate swaps
transactions were entered to manage this risk. FLAG Limited's bank debt was
repaid in full in March 2002, and FLAG Atlantic Limited's debt was redeemed
pursuant to the Plan.

Commodity price risk is not material to our company.

ITEM 4. CONTROLS AND PROCEDURES

CHANGES IN INTERNAL CONTROLS

As discussed in our Annual Report Form 10-K, during 2002, management became
aware of certain deficiencies and weaknesses in our Internal Controls. To
address the deficiencies and weaknesses identified, we have implemented and
continue to implement changes required to our processes,

26

procedures, systems and personnel. We have also taken corrective actions with
regard to our internal controls, which include, among other things:

- Adopting of a Code of Business Conduct and Ethics;

- Establishing an internal audit department;

- Restructuring the finance department with an emphasis on accountability;

- Increasing supervisory and management review procedures during the month
end closing process;

- Establishing new processes and procedures for various activities including
disbursements, revenues assurance and capital projects approvals;

- Centralizing several critical functions including the accounts payable,
billing and credit control functions.

- Performing accounting reconciliation activities (including bank
reconciliations) on a more regular basis;

- Implementing a centralized purchase order system;

- Revising the approval authority matrix signatories and limits;

During the external audit and re-audit of our financial statements for 2002,
2001 and 2000, our independent auditors, Ernst & Young, LLP, also noted
deficiencies and weaknesses in our Internal Controls. They have advised the
Audit Committee that these Internal Control deficiencies constitute reportable
conditions and collectively, a material weakness as defined in Statement on
Auditing Standards No. 60. The specific reportable conditions noted by our
independent auditors are related to:

1. Bank reconciliations: Reconciliations of bank accounts were either
infrequent, not timely, or both. Reconciling items were not always
investigated and appropriate action was not always taken;

2. Accounts payable: Purchase orders were not routinely matched to
invoices and invoices were not always posted to the accounts payable
ledger despite payment being authorized and made; and

3. Financial statements close process: The closing process was protracted
and difficult due to the significant resources dedicated towards the
re-audit of 2001 and 2000, and the consequences of the chapter 11 process
and restructuring activities.

Our independent auditors also identified a significant number of audit
adjustments, which impacted prior years. All these adjustments have been
approved and posted by management.

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Within the 90-day period prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operations of our disclosure controls and
procedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934. As a
result of this review and evaluation, which was concluded in the course of
preparing our financial statements for the quarter ended March 31, 2003 and in
connection with the audit and re-audit of our financial statements for 2002,
2001 and 2000 by our independent auditors, Ernst & Young, LLP, management
determined that, despite the fact that improvements had been made, the
corrective actions and changes being made to the internal controls had not yet
been fully implemented and tested.

27

Following this review and evaluation, we have also performed additional
substantive procedures, including a review of specific balance sheet and
operating expense accounts as well as a review of the application of our revenue
recognition policy. We believe the corrective actions we have taken and the
additional substantive procedures we have performed, provide us with reasonable
assurance that the deficiencies and weaknesses identified did not result in
material misstatements in our consolidated financial statements contained in
this Quarterly Report on Form 10-Q.

Notwithstanding management's conclusions, the effectiveness of a system of
disclosure controls and procedures is subject to certain inherent limitations,
including cost limitations, judgments used in decision making, assumptions
regarding the likelihood of future events, soundness of internal controls and
fraud. Due to such inherent limitations, there can be no assurance that any
system of disclosure controls and procedures will be successful in preventing
all errors or fraud, or in making all material information known in a timely
manner to the appropriate management.

28

PART II
OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

LOFTIN ACTION--CLASS ACTION LAWSUIT

Five class action complaints against Predecessor and some of its past and
present officers, brought by certain of Predecessor's shareholders on behalf of
a proposed class of those who purchased Predecessor's stock between
February 16, 2000 and February 13, 2002 (the "Class Period"), were filed in the
United States District Court for the Southern District of New York, beginning in
April 2002. A sixth action was filed in the same court against certain past and
present officers and directors of Predecessor, Salomon Smith Barney, Inc. and
Verizon Communications, Inc. All these actions have now been consolidated by
order of the Court (the "Loftin action").

The consolidated amended complaint (the "Complaint") was filed by the
plaintiffs on March 20, 2003 and asserts claims under sections 11, 12(a)(2) and
15 of the Securities Act and sections 10(b) and 20(a) of the Exchange Act, as
well as Rule 10b-5. More specifically, the Complaint alleges, among other
things, that the defendants: knew but failed to tell the market about the glut
of capacity and falling bandwidth prices that allegedly existed at the time of
the initial public offering and throughout the Class Period; engaged in, or
caused Predecessor to engage in, transactions with competitors whereby they
would sell each other cable that neither needed, for the sole purpose of
increasing revenue; and accounted for, or caused Predecessor to account for,
these transactions improperly and to overstate revenue. The Complaint does not
name Predecessor as a defendant, but it does name FLAG Telecom. The Plan
provides that we shall have no liability for any claims relating to the period
prior to the Plan's Effective Date. The claims asserted in the Complaint relate
solely to that period. The amount of damages sought from the defendants is not
specified.

As the Company, per the Plan, have no liability for any claims relating to
the period prior to the Effective Date, we believe there is no potential
liability for us and therefore no reserves have been established. There is a
contingent liability, on the part of the Company, of $3.25 million for a defense
fund in case the Directors' & Officers' Liability policy ("D&O policy") is
invalidated or attempted to be by the insurance company. No provision for these
liabilities has been made in our financial statements.

Predecessor and the insurers under the D&O policy have executed an interim
funding agreement by which the insurers are willing to advance reasonable and
necessary costs and expenses in connection with the above matters. In the
meantime, the insurers have confirmed the existence of the D&O policies.

OTHER

We are also involved in litigation from time to time in the ordinary course
of business. In management's opinion the litigation in which we are currently
involved, individually and in the aggregate, is not material to our company.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

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ITEM 4. OTHER INFORMATION

Not applicable.

ITEM 5. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

2.1 Third Amended and Restated Disclosure Statement and Third Amended and
Restated Joint Plan of Reorganization of the Company (incorporated by
reference to Exhibit 2.1 filed with the Company's Current Report on
Form 8-K dated August 8, 2002 and filed with the Commission on
August 13, 2002).

3.1 Memorandum of Association of FLAG Telecom Group Limited (incorporated by
reference to Exhibit 4.1 filed with the Company's Current Report on
Form 8-K dated October 9, 2002 and filed with the Commission on
October 15, 2002).

3.2 Bye-laws of FLAG Telecom Group Limited (incorporated by reference to
Exhibit 4.2 filed with the Company's Current Report on Form 8-K dated
October 9, 2002 and filed with the Commission on October 15, 2002).

4.1 Indenture between the Registrant and The Bank of New York, as indenture
trustee, dated October 9, 2002 (incorporated herein by reference to the
Registrant's Post Effective Amendment No. 1 to its Application for
Qualification of Indenture under the Trust Indenture Act of 1939 on
Form T-3/A, filed on October 11, 2002).

5.1 FNAL Note and FNAL Guarantee and FNAL Security Agreement (incorporated
by reference to Exhibits 10.28, 10.29 and 10.30 filed with the Company's
Annual Report on Form 10-K for the year ended December 31, 2002 and filed
with the Commission on July 3, 2003).

99.1* Certification of the Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.

99.2* Certification of the Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.

99.3 Risk Factors Affecting Future Financial Performance (incorporated by
reference to the Company's Annual Report on Form 10-K for the year ended
December 31, 2002 and filed with the Commission on July 3, 2003).

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

* Filed herewith.

(b) Reports on Form 8-K.

The Company filed the following Form 8-K Current Reports during the period
from January 1, 2003 through March 31, 2003:

Feb 24, 2003 Announcing that Patrick Gallagher was appointed the Company's
Chief Executive Officer.

II-2

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized this 3rd day of July 2003.

FLAG TELECOM GROUP LIMITED

By: /s/ MICHEL CAYOUETTE
---------------------------------------
Michel Cayouette
CHIEF FINANCIAL OFFICER

By: /s/ KEES VAN OPHEM
---------------------------------------
Kees van Ophem
GENERAL COUNSEL AND ASSISTANT SECRETARY

S-1

CERTIFICATIONS

I, Patrick Gallagher, certify that:

1. I have reviewed this quarterly report on Form 10-Q of FLAG Telecom Group
Limited;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

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

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

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

Date: July 3, 2003

/s/ PATRICK GALLAGHER
------------------------------------------------
Name: Patrick Gallagher
Title: Chief Executive Officer

C-1

I, Michel Cayouette, certify that:

1. I have reviewed this quarterly report on Form 10-Q of FLAG Telecom Group
Limited;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

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

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

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

Date: July 3, 2003

/s/ MICHEL CAYOUETTE
------------------------------------------------
Name: Michel Cayouette
Title: Chief Financial Officer

C-2