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 JUNE 30, 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
(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)

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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 August 14, 2003.

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FLAG TELECOM GROUP LIMITED
FORM 10-Q
INDEX

PART I
FINANCIAL INFORMATION

1.A ITEM 1. FINANCIAL STATEMENTS.

FLAG TELECOM GROUP LIMITED
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 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
CONSOLIDATED STATEMENTS OF OPERATIONS
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)

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

2

1.C

FLAG TELECOM GROUP LIMITED
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(EXPRESSED IN THOUSANDS OF DOLLARS)

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

3

1.D

FLAG TELECOM GROUP LIMITED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(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 S-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 and six months
ended June 30, 2003 and 2002, the balance sheets as of June 30, 2003 and
December 31, 2002, and the cash flows for the six months ended June 30, 2003 and
2002.

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 three months and six months ended June 30, 2002
are not comparable to the Company's results for the three months and six months
ended June 30, 2003 due to the adoption of fresh start accounting upon emergence
from bankruptcy.

2. SIGNIFICANT ACCOUNTING POLICIES

These financial statements have been prepared in accordance with U.S. GAAP
and are expressed in Dollars. The significant accounting policies of the Company
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

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

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

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. The
results of operations for any interim period are not necessarily indicative of
results for the full year.

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.

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.

PERFORMANCE OBLIGATIONS

As part of fresh start accounting, deferred revenue balances were written
off and a performance obligations reserve was created to cover future expenses
resulting from sale activity recognized prior to restatement, and for which
benefit was also received prior to restatement. This reserve will be amortized
in line with the relevant cost incursion associated with the performance of
contracts.

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.

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

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

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.

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 related to
program management, costs for the route surveys, indirect costs

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

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

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 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
Cable systems............................... 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

8

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

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

trading or other speculative purposes. The counter-parties to these instruments
were 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 does not currently use derivative 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 in effect at the beginning of the month. 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 non U.S. 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

Accounts receivable potentially subject FLAG Telecom to a concentration of
credit risk. FLAG Telecom performs ongoing credit evaluations of the financial
condition of its larger customers. Geographical risk is mitigated by the fact
that revenues are not concentrated in one part of the world. See Note 4,
"Segment Reporting", for concentrations by geographic areas.

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 in
financial instruments only with counter-parties having highly rated credit
histories.

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

9

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

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

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

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

3. 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.

4. SEGMENT REPORTING

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.

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

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

Revenue analyzed by geographical location of customers, based on the
location of the parent company, is as follows:

5. 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 and six
month periods ended June 30, 2003 and 2002 presented, no potentially dilutive
securities have been included in the calculation of diluted net loss per share
amounts, as the effects would be anti-dilutive.

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* 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 entire period.

6. STOCK-BASED COMPENSATION

At June 30, 2003, the Company had one stock-based employee compensation
plan, which is more fully described in Note 17 in the Notes to Consolidated
Financial Statements contained in the Company's 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

11

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

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

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.

The stock-based employee compensation plan of Predecessor was cancelled on
April 11, 2002 after the commencement of chapter 11 activities.

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.

7. RESTRUCTURING COSTS

Upon emergence from bankruptcy, the Company initiated 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 three months of 2003.
The employees affected were in Sales (4), Operations (17) and Finance and
Administration (14). The Company expects to incur $4.1 million in costs as part
of the Plan, of which $3.3 million had been incurred by June 30, 2003.

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

12

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

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

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

8. 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 of Predecessor 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.

A Motion to Dismiss was filed by the defendants, including FLAG Telecom, on
July 7, 2003.

As the Company, per the Plan, has 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. 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. Based on the likelihood of this
event occurring, no provision for these liabilities has been made in our
financial statements.

13

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

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

INJUNCTIVE RELIEF--FNAL NOTE

On August 7, 2003, the Company and certain of its subsidiaries commenced an
action for injunctive and declaratory relief (the "Action") in the United States
Bankruptcy Court for the Southern District of New York naming Kensington
International Ltd. ("Kensington"), Springfield Associates, LLC ("Springfield"),
Wilmington Trust Company, and The Bank of New York as defendants. Kensington and
Springfield allege to be the holders of the FNAL Note (defined below) issued by
FLAG Asia Limited, a subsidiary of the Company. The Company is a guarantor of
the FNAL Note. By letter dated August 4, 2003 and addressed to FLAG Asia
Limited, Kensington and Springfield alleged that a default occurred arising from
an alleged failure of a subsidiary of the Company to further perfect the
interests in the collateral that secures the FNAL Note in Taiwan. Further, the
letter declared that the alleged default caused an acceleration of the
indebtedness underlying the FNAL Note. In the Action, the Company and certain of
its subsidiaries seek a prompt entry of an order declaring that FLAG Asia
Limited has not defaulted on the FNAL Note. The Action further seeks to enjoin
the defendants from accelerating the amounts owed on the FNAL Note, as well as
certain other senior secured notes issued under that certain Indenture, dated as
of October 9, 2002 among the Company, certain subsidiaries of the Company that
are guarantors thereto, and The Bank of New York, as trustee (the "Indenture").
As previously announced, the Company intends to redeem the notes issued under
the Indenture on August 25, 2002 at a discount of $35.25 million plus accrued
interest.

Management believes that the alleged default under the FNAL Note is without
merit and the likelihood of the allegation being upheld is remote. Consequently,
no provision has been made. In arriving at its opinion, management has consulted
external counsel.

A hearing on the matter is currently scheduled for August 21, 2003 and a
judgment is expected on August 22, 2003.

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.

9. 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 1, 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

14

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

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

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 (as 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; or (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 under the Indenture governing the Series A Notes,
the Series B Note and the Series C Note. 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.

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.

15

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

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

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 the Indenture. Under the terms of the Indenture 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 or redeeming the Series A, B and C Notes.

Furthermore, any payment of dividends are restricted by the Indenture. 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 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.

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 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.

On July 25, 2003, the Company notified the Bank of New York, the trustee
under the Company's Indenture dated October 9, 2002, of our election to redeem
all three series of Notes issued by the Company under the Indenture on
August 25, 2003. As permitted under Sections 3.05, 4.03 and 5.03 of the
Indenture, we intend to redeem the Notes, which have a combined face value of
$50.25 million, for a discounted redemption value of $35.25 million and will pay
all accrued but unpaid interest.

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
$27.4 million. The FNAL Note is secured by certain assets of FLAG Asia Limited,
including one fiber pair and related equipment and rights of FNAL, and
guaranteed by FLAG Telecom. The guarantee issued by FLAG Telecom 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.

16

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

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

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; or
(ii) when FLAG Asia Limited consolidates or merges with or into any other person
or sells all or substantially all of its assets.

On August 7, 2003, the Company and certain of its subsidiaries commenced an
action for injunctive and declaratory relief. Refer to Note 8 for further
details.

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 25 March, 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.

10. POST BALANCE SHEET EVENT

On July 25, 2003, the Company notified the Bank of New York, the trustee
under the Company's Indenture dated October 9, 2002, of our election to redeem
all three series of Notes issued by the Company under the Indenture on
August 25, 2003. As permitted under the Indenture, we will redeem the Notes,
which have a combined face value of $50.25 million, for a discounted redemption
value of $35.25 million and will pay all accrued but unpaid interest.

On August 7, 2003, the Company and certain of its subsidiaries commenced an
action for injunctive and declaratory relief. Refer to Note 8 for further
details.

17

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;

- 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.

For a detailed explanation of these risk factors and others, see
Exhibit 99.1 attached hereto. 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.

CRITICAL ACCOUNTING POLICIES

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

18

RESULTS OF OPERATIONS

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 three months and six months ended June 30, 2002 are not comparable to the
Company's results for the three months and six months ended June 30, 2003 due to
the adoption of fresh start accounting upon emergence from bankruptcy.

REVENUES

TOTAL REVENUE

Total revenue for the three months ended June 30, 2003 decreased 46.6% to
$33.5 million as compared to $62.8 million for the three months ended June 30,
2002. Total revenue for the six months ended June 30, 2003 decreased 44.2% to
$64.8 million as compared to $116.3 million for the six months ended June 30,
2002. These decreases are primarily due to the write off of all deferred revenue
as part of fresh start accounting. Consequently, revenues as of June 30, 2003
reflect only services performed or products sold and ready for service related
to contracts entered into subsequent to October 9, 2002, along with the
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. Included within total revenue for the
three months and six months ended June 30, 2003 is $23.1 million and
$48.0 million, respectively, related to contracts entered into prior to
December 31, 2002. Additionally, we have signed new contracts to the value of
$36.8 million and $78.9 million in the three months and six months ended
June 30, 2003, respectively. We have started to recognize revenue on new
contracts with a value of $9.5 million and $29.6 million in the three months and
six months ended June 30, 2003, respectively.

CAPACITY REVENUE

Revenue recognized from the sale of capacity decreased by 91.8% to
$2.5 million for the three months ended June 30, 2003, as compared to
$30.6 million for the three months ended June 30, 2002. Revenue recognized from
the sale of capacity decreased by 94.8% to $2.6 million for the six months ended
June 30, 2003, as compared to $50.4 million for the six months ended June 30,
2002. These decreases are primarily due to the write off of all deferred revenue
as part of fresh start accounting. Capacity revenues in the three months and six
months ended June 30, 2003 only include revenues from contracts entered into
subsequent to October 9, 2002. Capacity revenues consist of leases and ROU
contracts.

19

OPERATIONS AND MAINTENANCE REVENUE

Revenue recognized from operations and maintenance decreased by 17.7% to
$16.4 million for the three months ended June 30, 2003, as compared to
$20.0 million for the three months ended June 30, 2002. Revenue recognized from
operations and maintenance decreased by 27.8% to $30.8 million for the six
months ended June 30, 2003, as compared to $42.7 million for the six months
ended June 30, 2002. These decreases are primarily due to the write off of
deferred revenue on prepaid operations and maintenance ("O&M") contracts as part
of fresh start accounting, along with price reductions reflecting general market
conditions.

NETWORK SERVICES REVENUE

Revenue recognized from our network services activities decreased by 9.2% to
$11.1 million for the three months ended June 30, 2003, as compared to
$12.3 million for the three months ended June 30, 2002. Revenue recognized from
our network services activities increased by 5.5% to $24.4 million for the six
months ended June 30, 2003, as compared to $23.2 million for the six months
ended June 30, 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 services revenue in the six months
ended June 30, 2003 compared to the six months ended June 30, 2002. This was
partially offset by the conversion of a lease contract to a ROU contract in the
second quarter of 2003 which led to a $1.1 million reduction in network services
revenue for the three months ended June 30, 2003.

AMORTIZATION OF PERFORMANCE OBLIGATIONS UNDER LONG-TERM CONTRACTS

Upon emergence from chapter 11 we began to amortize performance obligations
under long-term contracts within revenues. In the three months and six months
ended June 30, 2003, we have amortized $3.5 million and $7.0 million to the
income statement, respectively. These performance obligations under long-term
contracts arose upon the adoption of fresh start accounting. As part of fresh
start accounting, deferred revenue balances were written off and a performance
obligations reserve was created to cover future expenses resulting from sale
activity recognized prior to restatement, and for which the benefit, except for
ongoing O&M payments, was also received prior to restatement. This reserve will
be amortized in line with the relevant cost incursion associated with
performance of contracts.

OPERATING EXPENSES

Included within our operating expenses for the three months and six months
ended June 30, 2003 are recurring fixed costs of $18 million and $33 million,
respectively.

20

OPERATIONS AND MAINTENANCE

During the three months ended June 30, 2003, operations and maintenance
costs decreased by 16.6% to $19.6 million, as compared to $23.4 million for the
three months ended June 30, 2002. During the six months ended June 30, 2003,
operations and maintenance costs decreased by 18.7% to $36.0 million, as
compared to $44.3 million for the six months ended June 30, 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. These decreases partly
reflect the renegotiation of contracts and rationalization in our marine cable
operations, landing stations, terrestrial cable operations, PoPs and vendor
maintenance and support, along with reductions in certain fixed costs related
primarily to marine costs on fixed contracts. We incurred increased costs of
$2.4 million in the three months ended June 30, 2003 as a direct result of
repairs to the FEA cable after the earthquake in Algeria during May 2003.

NETWORK EXPENSES

During the three months ended June 30, 2003, network expenses decreased by
38.1% to $6.5 million, as compared to $10.5 million for the three months ended
June 30, 2002. During the six months ended June 30, 2003, network expenses
decreased by 54.6% to $12.1 million, as compared to $26.6 million for the six
months ended June 30, 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. These decreases
reflect the migration from temporary Atlantic facilities onto our own network
which took place during the third quarter of 2002 and other measures taken to
improve the efficiency of network utilization.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

During the three months ended June 30, 2003, selling, general and
administrative expenses decreased by 23.9% to $16.1 million, as compared to
$21.1 million for the three months ended June 30, 2002. During the six months
ended June 30, 2003, selling, general and administrative expenses decreased by
20.6% to $28.8 million, as compared to $36.3 million for the six months ended
June 30, 2002. These decreases reflect 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. Included within selling, general and administrative
expenses are certain fixed costs which primarily relate to salaries, office rent
and insurance costs. Our total headcount has decreased from 387 at June 30, 2002
to 239 at June 30, 2003. Selling, general and administrative expenses increased
in the three months ended June 30, 2003 primarily as a result of additional
legal and professional fees incurred related to reorganization issues.

BAD DEBT EXPENSE

For the three months ended June 30, 2003, we recorded $8.6 million in
respect of bad debt expense compared to $4.1 million for the three months ended
June 30, 2002. For the six months ended June 30, 2003, we recorded $9.2 million
in respect of bad debt expense compared to $10.6 million for the six months
ended June 30, 2002. The bad debt expense in the six months ended June 30, 2003
was primarily a result of provisions taken against specific credit concerns as
well as certain customer disputes.

DEPRECIATION

For the three months ended June 30, 2003, we recorded $8.1 million in
respect of depreciation compared to $39.9 million for the three months ended
June 30, 2002. For the six months ended June 30, 2003, we recorded
$15.9 million in respect of depreciation compared to $84.3 million for the six
months ended June 30, 2002. The depreciation charge decreased as a result of
asset impairments

21

totaling $0.5 billion in the second quarter of 2002 and $1.4 billion as part of
fresh start accounting. We depreciate property and equipment on a straight-line
basis over the estimated useful life of the asset, generally no more than
15 years.

IMPAIRMENT OF LONG-LIVED ASSETS

The FEA system consists of approximately 28,000 kilometers of undersea
fiber-optic cable with a 580 kilometer dual land crossing in Egypt and a 450
kilometer dual land crossing in Thailand, linking Western Europe and Japan via
the Middle East, India, Southeast Asia and China.

The FNAL system provides a 12,500 kilometer city-to-city service between the
high traffic centers of Hong Kong, Seoul, Tokyo and Taipei, over infrastructure
co-built and co-owned with Reach.

Following the adoption of SFAS 144, we prepared DCF models for each of the
cable systems, including a review of the estimation of the cost of capital.
Given the high level of competition in terms of alternative supply, lower than
generally expected demand for the trans-Atlantic route, significant over-supply
for the trans-Atlantic route, we have reviewed the revenue opportunities on this
route and have recognized an impairment charge of $327.9 million in respect of
the FEA system in the second quarter of 2002.

Given the high level of competition in terms of alternative supply and
higher than expected price erosion on various routes connecting Hong Kong, we
have reviewed the revenue opportunities on this route and have recognized an
impairment charge of $225.0 million in respect of the FNAL system in the second
quarter of 2002. See Note 2.12.

REORGANIZATION COSTS

During the three months ended June 30, 2002 we incurred reorganization costs
of $33.3 million arising from the application of SOP 90-7, as referred to in
Basis of Preparation and Forward-Looking Statements above. Specifically, these
costs relate to professional fees ($3.6 million), retainers ($2.2 million),
capitalized finance cost ($18.2 million) and underwriter's discount
($12.3 million) paid during the three months ended June 30, 2002, net of
interest received of $3.0 million.

RESTRUCTURING COSTS

Upon emergence from bankruptcy, the Company initiated 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 $4.1 million in costs as part of the
Plan, of which $3.3 million had been incurred by June 30, 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

22

INTEREST EXPENSE

Interest expense on borrowings for the three months ended June 30, 2003 was
$1.4 million, compared to $0.8 million during the three months ended June 30,
2002. Interest expense on borrowings for the six months ended June 30, 2003 was
$4.5 million, compared to $40.9 million during the six months ended June 30,
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 GAINS/LOSSES

Foreign exchange gain for the three months and six months ended June 30,
2003 was $0.9 million and $0.6 million, respectively. The gain resulted
predominantly from appreciation in value on our Euro bank accounts in the three
months ended June 30, 2003, which was partially offset by the weakening of the
US dollar against operating expenses in foreign currencies in the six months
ended June 30, 2003. We recognized a foreign exchange loss of $30.7 million and
$27.8 million for the three months and six months ended June 30, 2002,
respectively, arising predominantly from the translation of Euro denominated
debt.

INTEREST INCOME

Interest income of $0.1 million and $0.4 million was earned during the three
months and six months ended June 30, 2003, respectively, compared to $nil and
$4.0 million earned during the three months and six months ended June 30, 2002,
respectively, reflecting the reduced cash balances and the recording of any such
income as reorganization costs in accordance with SOP-90-7. 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 three months
ended June 30, 2003, compared to a charge of $2.0 million for the three months
ended June 30, 2002. The provision for taxes was a charge of $0.6 million for
the six months ended June 30, 2003, compared to a credit of $0.2 million for the
six months ended June 30, 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
applicable to us or to any of our operations, or to the shares, capital or
common stock of FLAG

23

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 three months ended June 30, 2003, we recorded a net loss of
$25.8 million, compared to a net loss of $656.1 million for the three months
ended June 30, 2002.

Basic and diluted loss per common share was $12.92 for the three months
ended June 30, 2003, compared to basic and diluted loss per common share of
$4.89 for the three months ended June 30, 2002.

For the six months ended June 30, 2003, we recorded a net loss of
$41.0 million, compared to a net loss of $736.5 million for the six months ended
June 30, 2002.

Basic and diluted loss per common share was $20.52 for the six months ended
June 30, 2003, compared to basic and diluted loss per common share of $5.49 for
the six months ended June 30, 2002.

LIQUIDITY AND CAPITAL RESOURCES

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

CASH AND CASH EQUIVALENTS

As at June 30, 2003, the Company currently had cash and cash equivalents of
$95.4 million. 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. In addition to current operating
requirements, we are expecting to repay the indebtedness under the Indenture
during the next three months and as a result our cash balance is expected to
decrease. This will be partly offset by the receipt of expected VAT refunds
during the next six months.

RESTRICTED CASH

The Company designates funds held by banks or other third parties as
collateral for guarantees and performance bonds as restricted cash.

CASH FLOWS AND WORKING CAPITAL

At June 30, 2003, working capital, defined by the Company as net current
assets, had decreased to $52.2 million from $103.3 million at December 31, 2002
primarily as a result of the reclassification of long-term debt to short-term
debt as it falls due within the next 12 months, along with a reduction in the
total cash balance. Total cash, excluding restricted cash, had decreased by
$30.4 million from $125.8 million at December 31, 2002. This decrease was
primarily due to net cash used in operating activities of $31.4 million and net
cash used in financing activities of $2.0 million, partially offset by net cash
provided by investing activities of $1.3 million during the six months ended
June 30, 2003.

24

Net cash used in operating activities for the six months ended June 30, 2003
of $31.4 million was primarily due to a net loss of $41.0 million, and payments
made to reduce our trade creditors balance by $16.6 million, partially offset by
an increase in our deferred revenue balance of $9.3 million and a depreciation
charge of $15.9 million.

Net cash used in financing activities for the six months ended June 30, 2003
of $2.0 million was due to the repayment of long-term debt.

Net cash provided by investing activities for the six months ended June 30,
2003 of $1.3 million was primarily due to a decrease in our restricted cash
balance of $4.1 million, partially offset by payments made for construction
costs and investment in plant and equipment of $2.8 million.

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
$292.8 million at June 30, 2003, compared to $302.5 million at December 31,
2002. The increase of $3.4 million (excluding depreciation charged in the six
months ended June 30, 2003 of $13.1 million) is mainly attributed to an overall
increase in network capacity and construction in progress.

Our other property and equipment consist primarily of office furniture,
leasehold improvements and computer equipment that had net book values of
$9.7 million and $12.6 million as of June 30, 2003 and December 31, 2002,
respectively.

ACCOUNTS RECEIVABLE

The accounts receivable balance at June 30, 2003 was $74.8 million compared
to $81.9 million at December 31, 2002. The allowance for doubtful accounts at
June 30, 2003 was $20.5 million, compared to $10.4 million at December 31, 2002.
This increase is attributable to additional provisions against specific credit
concerns as well as certain customer disputes.

We are aware that one of our customers, Global Crossing, has announced that
it has filed for bankruptcy protection under chapter 11. As at June 30, 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. These credits expire on December 31, 2009.

Other customers have credits totaling $25.5 million to be used on our
fiber-optic system, subject to certain provisions under our agreements with
these customers. These credits generally expire over the lifetime of the cable.

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. 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

25

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

The Company's disclosure controls and procedures ("Disclosure Controls") are
controls and other procedures that are designed with the objective of ensuring
that information required to be disclosed by the Company in the reports that it
files under the Exchange Act is recorded, processed, summarized and reported,
within the time periods specified in the Securities and Exchange Commission's
rules and forms. Disclosure Controls are also designed with the objective of
ensuring that such information is accumulated and communicated to the Company's
management, including the Chief Executive Officer and the Chief Financial
Officer, as appropriate to allow timely decisions regarding required disclosure.

Internal control over financial reporting ("Internal Controls") is a process
designed by, or under the supervision of, the Company's Chief Executive Officer
and the Chief Financial Officer, and effected by the Company's board of
directors, management and other personnel, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with U.S. GAAP.
Internal Controls include policies and procedures that: (i) pertain to the
maintenance of records that in reasonable detail accurately and fairly reflect
the transactions and dispositions of the assets of the Company; (ii) provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with U.S. GAAP, and that
receipts and expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company; and (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the Company's assets that could have a
material effect on the Company's financial statements.

CHANGES IN INTERNAL CONTROLS

As discussed in our Annual Report on form 10-K for the year ended
December 31, 2002, which was filed with the Securities and Exchange Commission
on July 3, 2003, certain reportable Internal Controls deficiencies were
identified within the 90-day period prior to the date of the report. Our
independent auditors, Ernst & Young, LLP advised the Audit Committee that these
Internal control deficiencies constituted reportable conditions and,
collectively, a "material weakness" as defined in Statement on auditing
Standards No. 60:

1. Bank reconciliations

2. Accounts payable, and

3. Financial statements close process.

To date, a number of corrective actions and changes to the Internal Controls
have been taken to address these weaknesses. However, they have not yet been
fully implemented.

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To further address the deficiencies and weaknesses identified, we are
implementing additional changes appropriate to our processes, procedures,
systems and personnel. The corrective actions taken to date include, among other
things:

- 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;

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

- Focusing internal audit work on the major business cycles to identify
control weaknesses and recommend appropriate corrective action.

Furthermore, management has developed a Finance Improvement Plan, the key
elements of which are as follows:

- Further review of the organization of the Finance department;

- Review and clean up of subsidiary ledgers to improve the quality of
management information;

- Review and improvement of processes and procedures for recording inventory
and capital asset transactions, including physical verification and
development of asset registers reconciled to the general ledger;

- Review and improvement of billing, collection and bad debt procedures;

- Review and improvement of month end accounting procedures to ensure
production of timely and relevant management information; and

- Engagement of external consultants to assist process mapping and
documentation of key business cycles and controls pursuant to Section 404
of the Sarbanes-Oxley Act of 2002.

Our independent auditors have also raised management letter comments that
will be addressed through our Finance Improvement Plan.

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

As of June 30, 2003, 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-15 of the
Securities Exchange Act of 1934. In addition, we evaluated whether there was any
change in our Internal Controls that occurred during the past fiscal quarter
that has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting. As a result of this review and
evaluation, which was concluded in the course of preparing our financial
statements for the three months ended June 30, 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 significant progress had been made, all our planned corrective
actions and changes to the Internal Controls had not yet been fully implemented
and tested.

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 that 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.

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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.

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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 of Predecessor 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.

A Motion to Dismiss was filed by the defendants, including FLAG Telecom, on
July 7, 2003.

As we, 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. 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. Based on the likelihood of this event occurring, no
provision for these liabilities has been made in our financial statements.

INJUNCTIVE RELIEF--FNAL NOTE

On August 7, 2003, the Company and certain of its subsidiaries commenced an
action for injunctive and declaratory relief (the "Action") in the United States
Bankruptcy Court for the Southern District of New York naming Kensington
International Ltd. ("Kensington"), Springfield Associates, LLC ("Springfield"),
Wilmington Trust Company, and The Bank of New York as defendants. Kensington and
Springfield allege to be the holders of the FNAL Note (defined below) issued by
FLAG Asia Limited, a subsidiary of the Company. The Company is a guarantor of
the FNAL Note. By letter dated August 4, 2003 and addressed to FLAG Asia
Limited, Kensington and Springfield alleged that a default occurred arising from
an alleged failure of a subsidiary of the Company to further perfect the
interests in the collateral that secures the FNAL Note in Taiwan. Further, the
letter declared that the alleged default caused an acceleration of the
indebtedness underlying the FNAL Note. In the Action, the Company and certain of
its subsidiaries seek a prompt entry of an order declaring that FLAG Asia
Limited has not defaulted on the FNAL Note. The Action further seeks to enjoin
the defendants from accelerating the amounts owed on the FNAL Note, as well as
certain other

29

senior secured notes issued under that certain Indenture, dated as of
October 9, 2002 among the Company, certain subsidiaries of the Company that are
guarantors thereto, and The Bank of New York, as trustee (the "Indenture"). As
previously announced, the Company intends to redeem the notes issued under the
Indenture on August 25, 2002 at a discount of $35.25 million plus accrued
interest.

Management believes that the alleged default under the FNAL Note is without
merit and the likelihood of the allegation being upheld is remote. Consequently,
no provision has been made. In arriving at its opinion, management has consulted
external counsel.

A hearing on the matter is currently scheduled for August 21, 2003 and a
judgment is expected on August 22, 2003.

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.

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

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

10.1* Employment Agreement, dated as of June 10, 2003, between the
Company and Alexander Gersh.

10.2* Compromise Agreement, dated as of June 13, 2003, between the
FLAG Telecom Limited and Michel Cayouette.

10.3* Variation to Employment Agreement, dated as of July 31,
2003, between the Company and Alexander Gersh.

31.1* Certification of the Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.

31.2* Certification of the Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.

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

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

30

99.1* Risk Factors Affecting Future Financial Performance.

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

* Filed herewith

+ Furnished herewith

(b) Reports on Form 8-K.

The Company filed the following Form 8-K Current Reports during the period
from April 1, 2003 through June 30, 2003:

April 1, 2003 Announcing the Company's intention to file its Annual Report
on Form 10-K in May 2003.

31

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 14th day of August 2003.

FLAG TELECOM GROUP LIMITED

By: /s/ ALEXANDER GERSH
----------------------------------------
Alexander Gersh
CHIEF FINANCIAL OFFICER

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

S-1