<PAGE>

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

                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

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

                                   FORM 10-K

(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
    EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

  For the fiscal year ended December 31, 1999

                                       OR

[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
    EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

                        Commission file number 000-21043

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

                         PACIFIC GATEWAY EXCHANGE, INC.
             (Exact name of registrant as specified in its charter)

            Delaware                                      94-3134065
    (State or other jurisdiction of                 (IRS Employer
    incorporation or organization)                  Identification No.)

         500 Airport Boulevard, Suite 340, Burlingame, California 94010
                    (Address of principal executive offices)

                         Telephone Number: 650-375-6700
              (Registrant's telephone number, including area code)

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

          Securities registered pursuant to Section 12(g) of the Act:

                   Common Shares, Par Value $.0001 per Share
          Preferred Share Purchase Rights, Par Value $.0001 per Share
                                (Title of class)

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

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

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

  The aggregate market value of voting stock held by non-affiliates of the
registrant on March 27, 2000, was approximately $310.3 million computed upon
the basis of the closing sales price of the Common Shares on that date. For the
purposes of this computation, shares held by directors (and shares held by any
entities in which they serve as officers) and executive officers of the
registrant have been excluded. Such exclusion is not intended, nor shall it be
deemed to be, an admission that such persons are affiliates of the registrant.

  As of March 27, 2000, there were outstanding 20,067,835 Common Shares of
$.0001 par value, of the registrant.

                      DOCUMENTS INCORPORATED BY REFERENCE

1. The Registrant's definitive proxy statement to be filed with the Securities
   and Exchange Commission not later than 120 days after the end of the
   Registrant's fiscal year pursuant to Regulation 14A relating to the 1999
   Annual General Meeting of Shareholders.

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>

                                    PART I

ITEM 1. BUSINESS

Note on forward-looking statements

  This Annual Report contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Forward-looking
statements are statements other than historical information or statements of
current condition. Some forward-looking statements may be identified by use of
terms such as "believes," "anticipates," "plans," "intends," "may," "expects,"
"estimates," or other similar expressions. These forward-looking statements
relate to the plans, objectives, and expectations of Pacific Gateway Exchange,
Inc. ("Pacific Gateway," "we" or "our") regarding its future operations or
financial performance or related to the Company's expectations regarding the
telecommunications industry. In light of the inherent risks and uncertainties
of any forward-looking statement, the inclusion of forward-looking statements
in this report should not be regarded as a representation by the Company or
any other person that the forward-looking statements will come true.

  Our revenues and results of operations and future developments in the
telecommunications industry are subject to risks and uncertainties and could
differ materially from those projected in the forward-looking statements as a
result of numerous factors, including the following:

    1. availability of financing on acceptable terms, conditions in the
       credit market and availability of additional equity on acceptable
       terms;

    2. difficulties that may be encountered in the development of bandwidth
       services, including construction delays, regulatory obstacles,
       contract disputes, or the lack or opportunities for additional
       bandwidth purchases;

    3. uncertainties in the growth of our retail operations and the
       development of our new business lines, such as our VOIP, Internet, and
       bandwidth, operations, including uncertainties about the difficulty of
       integrating acquisitions, hiring appropriate personnel, and
       competitive conditions;

    4. the termination of operating agreements with other carriers or the
       inability to enter into additional operating agreements;

    5. inaccuracies in our forecasts of traffic;

    6. changes in the availability of transmission facilities such as
       domestic, international, and undersea fiber optic cable systems or in
       the feasibility, timing, or expense of building or leasing such
       facilities;

    7. loss of the services of key officers;

    8. loss of a customer that provides significant revenues;

    9. opportunities for, and problems relating from, the acquisition of
       other companies or facilities;

    10. changes in the ratios between the amount of telecommunication traffic
       that we deliver and the amount we receive from our foreign partners
       under our operating agreements and termination arrangements;

    11. Internet growth at slower rates than expected; or

    12. consolidation of our competitors within the telecommunications,
       bandwidth, or Internet industries.

  See "Risk Factors" for additional reasons why the forward-looking statements
may not be realized. The foregoing review of important factors, including
those discussed in detail in this 10-K, should not be construed as exhaustive.
We undertake no obligation to release publicly the results of any future
revisions it may make to forward-looking statements to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.

                                       1
<PAGE>

Overview

  We are a diversified global, facilities-based company providing
telecommunications, Internet and bandwidth services. We own and operate a
state-of-the-art high bandwidth fiber optic network connecting key
metropolitan centers in the United States, Europe, Asia and the Pacific. For
the twelve months ended December 31, 1999, our revenues, EBITDA and net income
were $604.6 million, $25.1 million and $8.0 million, respectively.

  We have acquired our own global network of undersea cables and land-based
facilities. As of December 31, 1999, we had partial ownership interests in 32
digital undersea fiber optic cable systems in service or under construction in
the Atlantic, Pacific and Caribbean regions, including investments in the
Japan-U.S. cable system and the TAT-14 trans-Atlantic cable system that are
currently being constructed. We have ten international gateway switches
located in the United States, Europe, Asia and the Pacific. Our global network
supports our three major lines of business:

  .  Telecommunications Services. Since 1995, we have consistently earned
     profits and generated positive operating cash flow by using our own
     facilities to deliver high quality telecommunications services to a
     diverse array of customers. We provide retail end-user
     telecommunications services on a pre-subscribed and dial around basis to
     our customers in the United States. We plan to offer bundled retail
     telecommunications and Internet services to our customers. We specialize
     in targeting ethnic groups that are high-volume consumers of
     international telecommunications services. We have established intensive
     marketing programs to the Filipino, Japanese, Chinese, Vietnamese,
     Russian, Romanian and Korean communities resident in the United States.
     Our retail business is growing rapidly through internal growth and
     strategic acquisitions and is a source of high margin revenues for us.
     Our previously announced acquisition of the international retail
     business of NOSVA Limited Partnership is currently scheduled to close
     this Spring, subject to closing conditions such as regulatory approval.
     Our wholesale operations enable us to own and operate our global network
     and maintain a low cost base that supports the growth of our retail and
     Internet operations. We are able to offer these services through our 44
     operating agreements and termination arrangements that provide for the
     exchange of traffic with major foreign carriers, as well as our own
     international bandwidth and transmission facilities with the capacity to
     meet their expanding needs. We have recently begun to provide voice over
     Internet Protocol ("VOIP") services to global carriers, Internet service
     providers (or ISPs) and other value-added service providers. We plan to
     continue to develop our VOIP operations.

  .  Internet Services. To take advantage of the synergies between our
     telecommunications services and the rapid growth of the Internet, we
     began offering Internet services in 1999. We currently provide
     connectivity services between San Francisco, Los Angeles, Chicago,
     Dallas, New York, Washington, D.C., London and Tokyo. We also provide
     co-location services at facilities in the United States, London and
     Tokyo. We plan to expand our connectivity services to additional key
     cities in the U.S. and abroad and add additional offshore co-location
     facilities beginning later in 2000. We also plan to offer enhanced
     services, including content distribution, hosting and other value-added
     Internet solutions, targeting our foreign partners and carrier
     customers, a wide range of Internet providers and small to medium-sized
     global corporations. We intend to provide these services using a
     combination of applications we develop ourselves and applications we
     obtain from Internet application and technology providers. For example,
     we recently entered into a strategic relationship with a leading
     developer of Internet infrastructure software to license their content
     distribution technology and jointly develop a content management
     interface to give our customers the ability to manage their content and
     services on our network. This company will also become an equity
     investor in our Onyx subsidiary, conditioned upon an equal amount being
     invested by other investors. We will use our global IP network to
     deliver these services. We are connected to six major Internet peering
     points in the United States, are members of the London and Japan
     Internet Exchanges and are in the process of joining the Amsterdam and
     Frankfurt Internet Exchange. In addition, in 1999, we acquired an
     Internet service provider and Web design company located in England,
     which serves as a springboard for the European expansion of our Internet
     operations.

                                       2
<PAGE>

  .  Bandwidth Services. We opportunistically sell and lease high bandwidth
     fiber optic capacity to other global telecommunications carriers,
     Internet service providers and satellite communications providers, and
     occasionally exchange bandwidth capacity with other carriers. We also
     generate recurring cash flow by providing maintenance services on sold
     and leased capacity. Our network connects North America, Europe, Asia
     and the Pacific, as well as key U.S. cities. To expand the reach of our
     network, we also plan to acquire strategic segments of domestic capacity
     in foreign countries. For example, in August 1999, we agreed to form a
     joint venture with KDD Submarine Cable Systems Inc. to construct and
     operate backhaul facilities in Japan connecting the Maruyama, Japan
     cable station with Tokyo. Our opportunistic purchases of extensive fiber
     optic capacity linking major international destinations give us a
     valuable asset that we can deploy in a number of ways, including, for
     example, to generate cash from the sale or lease of capacity, to use
     ourselves or exchange with other carriers for additional network assets
     to expand our global reach and to use in partnering arrangements with
     others to foster our Internet initiatives.

  Each of our business lines complements the others and creates synergies that
are highly conducive to further growth and profitability. Our fiber optic
network lowers the cost of our telecommunications operations in addition to
giving us a valuable asset for future sales, exchanges, leases and strategic
partnering arrangements. Our Internet operations capitalize on our network and
foreign partnerships and complete the suite of telecommunications, Internet
and bandwidth services that we can offer to customers.

                                       3
<PAGE>

Strategy

  Our goal is to provide high-quality telecommunications, Internet and
bandwidth services over our network. In particular, we plan to:

  .  Expand Our Higher Margin Retail Business. We plan to expand our retail
     customer base in the United States and offshore through focused
     marketing efforts and selected acquisitions. We plan to offer bundled
     retail telecommunications and Internet services to our retail customer
     base. We have succeeded in launching profitable marketing programs aimed
     at ethnic communities that are high volume users of international
     telecommunications services. In addition, we plan to target our offshore
     retail service offerings to markets where we have existing facilities,
     sales people and relationships with foreign partners. We expect the
     higher margins offered by our retail long distance services to support
     our traditional emphasis on generating cash flow.

  .  Grow Our Global Internet Operations. We plan to grow our Internet
     operations by offering our services in key U.S. cities and offshore
     markets to our existing foreign partners and carrier customers, a wide
     range of Internet service providers and small to medium sized global
     corporations. We will continue to establish peering and transit
     arrangements to provide these services. We also plan to construct, on
     our own or in partnership with others, global data centers in strategic
     locations and to offer additional enhanced Internet services, including
     content distribution, hosting and other value-added solutions. We plan
     to continue to develop strategic alliances with Internet application and
     service providers to develop the most advanced products and services. We
     also plan to continue to expand our global base through strategic
     acquisitions offshore. To further the expansion of our Internet
     operations, we may seek additional equity investors and other financing
     alternatives for our Internet business.

  . Develop our VOIP Operations. We are adding Internet Protocol, sometimes
    called "IP," equipment to our network to meet our customers' growing data
    needs. We believe that future IP technologies will gradually allow us to
    replace circuit switches and transform our network to a packet-based
    platform able to carry all types of communications traffic, including
    data, voice and video. We plan to become a leading provider of VOIP
    services. We are developing best-of-breed VOIP applications, including
    voice, fax and other value-added services, which we will deliver over our
    IP network. Leveraging our global relationships, we target global
    carriers and Internet service providers that we expect will be high-
    volume users of VOIP services. By providing these services over our
    network, we can ensure high quality services to our customers at higher
    margins to us. We plan to rapidly expand our VOIP service offerings
    through internal development and strategic acquisitions.

  .  Provide Services in Offshore Markets. We strategically enter offshore
     markets to expand our global reach and our customer base. Many offshore
     markets are deregulating and opening to competition. As customers in
     these markets will have an opportunity to choose among competing
     companies, we are positioned to compete as a low-cost provider of high-
     quality telecommunications, Internet and bandwidth services. We are
     focusing our strategy on developing a significant presence in a defined
     set of geographical routes, particularly in Europe, Latin America, Asia
     and the Pacific, where we have either strong relationships with foreign
     partners or the opportunity to gain market share at attractive margins.

  .  Expand our Global Network. We plan to continue to acquire and build
     undersea and land-based fiber optic cable capacity that extends our
     global reach, increases our network capacity and reduces our overall
     network costs. Continued development of our network will enhance our
     telecommunications operations and our Internet operations by enabling us
     to increase our control over operating costs and quality of services and
     provide additional opportunities for profitable bandwidth sales and
     leases to other carriers.

  . Leverage Wholesale Opportunities. We will continue to support our
    wholesale operations, which provide valuable synergies with our other
    business operations. For example, our wholesale operations optimize the
    use of our global network and maintain our global relationships with our
    wholesale customer base. We will increasingly focus on growing and
    developing our higher margin service offerings and de-emphasize our
    selling efforts into wholesale markets. However, we will continue to seek
    high margin wholesale arrangements and will offer our Internet and VOIP
    services to our wholesale customer base.

                                       4
<PAGE>

  . Pursue Strategic Financing Alternatives. We are considering various
    strategic alternatives, which may include mergers, acquisitions, private
    equity investments in us or our subsidiaries, or sales of selected
    assets. We have engaged Salomon Smith Barney to provide advice regarding
    strategic alternatives. In addition, Deutsche Bank Securities Inc. and
    Banc of America Securities LLC are providing assistance with respect to
    locating and identifying financing opportunities, including the possible
    initial public offering of the common stock of Onyx Networks, our
    Internet subsidiary.

Industry Background

  Global demand for telecommunications, Internet, and bandwidth services is
rapidly growing for several reasons, including:

  . deregulation and the privatization of government-owned telephone
  monopolies;

  . growth of the Internet;

  . technological improvements (including wireless technologies);

  . the development of new services requiring greater bandwidth capacity;

  . increased competition and declining prices; and

  . consolidation in the industry.

 Telecommunications

  According to TeleGeography, international telecommunications traffic
worldwide increased from approximately $26.8 billion in revenues and 22.3
billion minutes of use in 1988 to $65.9 billion in revenues and 81.8 billion
minutes of use in 1997, representing a compound annual growth rate of 10.6% in
revenues and 15.5% in minutes of use. Furthermore, TeleGeography projects that
the industry will reach approximately $79.9 billion in revenues and 158.6
billion minutes of use by the year 2001. According to International Data
Corporation, sometimes called "IDC," a market research firm, the market for
worldwide Internet telephony is projected to grow from $0.5 billion in
revenues in 1999 to $18.7 billion in revenues in 2004, approximately half of
which would be generated by new services, including voice-enabled e-commerce
and other enhanced services. Wholesale worldwide Internet telephony, including
wholesale international Internet telephony, is expected to grow to $2.0
billion in revenues by the same date. In addition, IDC projects that
international Internet telephony will comprise $17.3 billion in revenues of
the total $18.7 billion in revenues projected in 2004.

 Internet

  The Internet has experienced tremendous growth and is emerging as a global
medium for communications and commerce. According to IDC, the number of
Internet users worldwide reached approximately 142.2 million in 1998 and is
forecasted to grow to approximately 502.4 million by 2003, representing a
compound annual growth rate of 29%. Businesses increasingly use the Internet
not only to offer e-commerce to consumers and other businesses, but also for
mission critical applications such as sales, marketing, customer service and
project coordination worldwide. Most of these businesses, and substantially
all consumers, obtain Internet connections from one of the large number of
highly competitive ISPs which are seeking to increase their share of this
market. Total U.S.-based ISP revenues for the United States are projected by
IDC to grow from $10.7 billion in 1998 to $37.4 billion in 2003. Total ISP
revenues are projected to grow for Western Europe from $4.3 billion in 1998 to
$17.7 billion in 2003 and for Asia/Pacific (excluding Japan) from $457 million
in 1998 to $4.5 billion in 2003.


                                       5
<PAGE>

 Bandwidth

  International data traffic is expected to grow at a compound annual growth
rate of 85% through 2003, according to the Yankee Group. One of the key
factors contributing to the growth in data traffic is the increasing use of
broadband applications dominated by the Internet. The number of ISPs is
growing dramatically on a global basis. These ISPs are expected to require
significant bandwidth capacity to provide efficient service to their customers
and, in particular, to make available popular Internet web sites in the United
States. In addition to Internet growth, there has also been worldwide growth
in the use of other bandwidth-intensive applications, such as video
conferencing, distance learning, e-commerce and corporate intranets.

Global Network

  We have acquired our own global network of undersea cables and land-based
facilities. As of December 31, 1999, we had partial ownership interests in 32
digital undersea fiber optic cable systems in service or under construction in
the Atlantic, Pacific and Caribbean regions, including commitments to invest
in the Japan-U.S. and the TAT-14 cable systems that are currently being
constructed. We estimate that the fully-upgraded capacity we will have in the
Japan-U.S. and TAT-14 cable systems will far exceed the aggregate capacity of
our 30 other systems. We have international gateway switching facilities in
the United States, Europe, Asia and the Pacific, and expect to continue to add
switching and routing facilities to our network. Our network employs digital
switching and fiber optic technologies and is supported by comprehensive
monitoring and technical services. Our network covers certain major routes
over which the world's international telecommunications traffic travels and
where we believe Internet services are most in demand. We expect our network
to offer customers seamless connection for telecommunications, Internet and
bandwidth services. We will continue to expand and augment our network with
new technology advancements, including IP capability. We believe that our
network is fundamental to our ability to compete successfully in the
international telecommunications, Internet and bandwidth markets. We regard
our network as a significant competitive advantage that would be expensive and
time-consuming for a new entrant to replicate. We are continually evaluating
our network needs and may invest in additional undersea and land-based fiber
optic cable networks, switching and IP equipment and data centers.

 Japan-U.S. and TAT-14 Cable Systems

  As part of our mission to create an integrated global, high-capacity fiber
optic cable network, we are designing and developing our systems to connect
two heavily-used international corridors via two new high-capacity undersea
cable systems: the Japan-U.S. cable system and the TAT-14 cable system (United
States to Europe). We will own interests in these cable systems as a member of
a consortium.

  The Japan-U.S. cable system is being developed as a 21,000 km self healing
ring system planned for expansion to operate at 640 gigabits per second
(Gbps). Upon service initiation, which is expected to be in the fourth quarter
of 2000, it will connect California and three landing sites in Japan. The
Japan-U.S. cable system will operate initially at 80 Gbps of service capacity
and will be upgraded to 400 Gbps in 2001. We ultimately expect it to be
upgraded to 640 Gbps.

  Upon service initiation of this system, we will own 28 STM-1s, which we
expect will be expandable in 2001 to approximately 180 STM-1s at no additional
cost. (An STM-1 is a measure of fiber optic capacity equal to 156 megabits per
second; it is equal to an OC-3, another measure of capacity explained below.)
We have committed to invest $86 million in the Japan-U.S. cable system. As the
system capacity increases to 640 Gbps, we may exercise our option to acquire
an estimated additional 100 STM-1s at an approximate additional cost of $15
million.

  The TAT-14 cable system is being developed as a 15,000 km self healing ring
system planned for expansion to operate at 640 Gbps. Upon service initiation,
which is expected to be in the fourth quarter of 2000, it will connect the
United States and Europe with landing stations in the United States, the
United Kingdom, France, Germany, the Netherlands and Denmark.

                                       6
<PAGE>

 Peering Relationships

  Peering is the Internet practice under which ISPs exchange each other's
traffic without the payment of settlement charges; transit arrangements
involve cash settlement payments. By implementing our own network and
establishing peering relationships with ISPs, we believe we can lower the cost
of Internet transit and increase the performance and reliability of our
network operations. We are developing our portfolio of private and public
peering arrangements. For example, we are currently connected to six major
public Internet peering points in the United States, including MAE-ATM (East,
West and Dallas), the Palo Alto Internet Exchange, the Ameritech Advanced Data
Service Exchange and the Pacific Bell Network Access Point. We are also
members of the London and Japan Internet Exchanges and are in the process of
joining the Amsterdam and Frankfurt Internet Exchange.

Technology

  The fiber optic cables, switching and routing equipment and associated
assets that comprise the physical components of our network can support a
variety of communications technologies. We seek to offer customers a set of
technology options to meet their changing needs and to introduce new
technologies as necessary. Specifically, we believe that a service platform
based on IP equipment will provide us with significant future growth
opportunities because it will enable Internet, voice and video to be carried
inexpensively over our facilities-based network. We have, therefore, begun to
supplement our current voice and data switching technology with IP equipment.

  As we add IP equipment to our network, we will be able to offer our
customers additional services, such as high-speed Internet access, Internet
web hosting, e-commerce and other Internet services. Because it is more
efficient, IP technology increases the effective capacity of networks for
these types of applications, and in the future may become the preferred
technology for voice services and faxes as well.


                                       7
<PAGE>


  We expect to further expand our IP network in North America, Latin America,
Europe and Asia, as well as in other select offshore markets, and to acquire
fiber-based IRUs and other rights in telecommunications bandwidth in these
regions to support demand growth and reduce costs.

 Circuit Switching vs. Packet Switching

  As part of our migration to an IP network, we are configuring our network to
add packet switch-based technology to our current circuit switch-based
systems. Our goal is to meet the current demands of our customers for
reliable, high-quality switched voice connections, while also deploying the
facilities, hardware and software necessary to satisfy their growing demand
for high-speed data transmission.

  There are two widely used switching technologies in currently deployed
communications networks: circuit-switching systems and packet-switching
systems. Circuit switch-based communications systems, which currently dominate
the public telephone network, establish a dedicated channel for each
communication (such as a telephone call for voice or fax), maintain the
channel for the duration of the call, and disconnect the channel at the
conclusion of the call.

  Packet switch-based communications systems, on which the Internet relies,
format the information to be transmitted into a series of shorter digital
messages called "packets." Each packet consists of a portion of the complete
message plus the addressing information to identify the destination and return
address. A key feature that distinguishes Internet architecture from the
public telephone network is that on the packet-switched Internet a single
dedicated channel between communication points is not required.

  Packet switch-based systems offer several advantages over circuit switch-
based systems, particularly the ability to commingle packets from several
communications sources together simultaneously onto a single channel. For most
communications, particularly those with bursts of information followed by
periods of "silence," the ability to commingle packets provides for superior
network utilization and efficiency, resulting in more information being
transmitted through a given communication channel.

  We believe that a form of IP-based switching will eventually replace circuit
switched technologies, and will be the foundation of integrated networks that
treat all transmissions--including voice, fax and video--simply as forms of
data transmission.

Products and Services

 Telecommunications Services

  Our primary telecommunications services are wholesale and retail long-
distance services. We generated revenues from our telecommunications services
business of approximately $597.4 million in 1999.

                                       8
<PAGE>

  Retail Services. We provide retail end-user telecommunications services on a
pre-subscribed or dial around basis to our customers in the United States and
offshore. We plan to offer bundled retail telecommunications and Internet
services. We specialize in targeting ethnic groups residing in the United
States that are high-volume consumers of international telecommunications
services. We have established intensive marketing programs to the Filipino,
Japanese, Chinese, Vietnamese, Russian, Romanian and Korean communities
resident in the United States. In addition, we provide prepaid calling cards,
debit cards, international toll free and travel card services.

  Our retail long distance business leverages off our extensive global network
and termination arrangements. We have increased our retail customer base
through acquisitions and internal growth. To continue the growth of our retail
customer base, we may seek acquisitions of retail long distance businesses in
the United States and offshore. We plan to replicate in offshore markets the
retail business practices that we have developed and successfully applied in
the United States.

  Wholesale Long Distance Services. We sell our wholesale long distance
services to other U.S. and international carriers. These carriers use our
sevices to complete international calls originated by their customers. We
benefit from: (1) our extensive relationships in the long distance
telecommunications industry; (2) our ability to generate a high volume of long
distance call traffic; and (3) our advantageous arrangements we have
negotiated with foreign PTTs and other international carriers.

  VOIP Services. We provide high quality IP-based communications services to
telecommunications carriers, ISPs and other value-added communications service
providers. Our solution enables communications service providers to outsource
their international voice, fax and other value-added services over the
Internet at lower costs than over traditional networks while maintaining what
we believe to be high quality service. We provide our customers access to our
international IP network throughout the world.

 Internet Services

  We offer Internet services, targeting on our existing foreign partners and
carrier customers, a wide range of Internet service providers and small to
medium-sized global corporations. We are currently providing connectivity and
co-location services. We will use applications we develop ourselves and those
we obtain from Internet application and technology providers to expand our
service offerings and provide our customers enhanced services, including
content distribution, hosting and other value-added solutions.

  We currently deliver connectivity services over our network between San
Francisco, Los Angeles, Chicago, Dallas, New York, Washington, D.C., London
and Tokyo. We are currently providing co-location services at our facilities
in the United States, London and Tokyo and plan to offer them in other key
locations.

  We expect that our Internet product offerings will provide customers a range
of options in their Internet access and content and distribution needs--from
simple Internet access to complex outsourced content and application
distribution managed services. Our planned product offerings include hosting
our customers' Web sites, managing servers, maintaining networking equipment,
content and application distribution services, and offering a full range of
data transport options--from shared to dedicated capacity. These offerings
will allow customers to transfer their critical Internet operations to us,
resulting in several important benefits to them. First, outsourcing eliminates
the need to continuously implement rapidly changing technology and
applications. Second, customers do not have to try to attract and retain
scarce technical staff in an area (Internet applications) that is not core to
their businesses. Third, as a result of the first two benefits, customers
should experience lower operating costs for their Internet operations, and
achieve faster deployment of their Internet applications.

 Bandwidth Services

  We opportunistically sell and lease bandwidth capacity on our global network
to our customers. In addition, we exchange our capacity with other companies
for undersea or land-based capacity in different regions or on different cable
routes. We are designing our bandwidth sales and lease business to meet the
varying needs of the

                                       9
<PAGE>

global carrier market. For many of our customers, the substantial investment
required to participate in a global cable consortium or to construct similar
facilities is not a viable alternative.

  As of December 31, 1999, we had entered into agreements to sell or lease
bandwidth capacity (including maintenance services) valued by the parties at
$141.1 million. Of the $141.1 million, $30.0 million relates to operating and
maintenance revenues to be received over the terms of the contracts (which are
generally 20 years), $57.5 million consists of other cash proceeds we expect
to receive over time and the balance consists of network assets valued by the
parties at $53.6 million to be delivered over time in exchange for our
bandwidth capacity.

Sales and Marketing

  Telecommunications

  Retail Long Distance Services. Our revenues have grown through internal
growth and acquisitions. We market our retail long distance services to high-
volume users of international telecommunications services, including
individuals and small businesses in ethnic communities in the United States
that generate a high volume of telephone traffic to their home country.
Through our joint venture, called "PinTouch," with Globe Telecom, a
telecommunications company operating in the Philippines, we market
international long distance services primarily to the Filipino-American
community. In addition, through our acquisition of Robo Tel, Inc. in the
second quarter of 1999, we acquired approximately 25,000 Chinese and
Vietnamese residential customers and small businesses based in the United
States. In December 1999, we entered into an agreement to acquire the
international retail business of NOVSA Limited Partnership. If the acquisition
is consummated, we expect to enhance our telemarketing, billing, and customer
service platforms and add a substantial number of retail customers, many of
which are the ethnic customers targeted by our retail operations. The closing
of this acquisition is subject to the satisfaction of certain conditions,
including the receipt of regulatory approvals. The closing is scheduled to
occur this Spring.

  We also have ethnic marketing programs for the Japanese, Korean, Romanian
and Russian communities resident in the United States. We employ marketing
expertise that is tailored to each community. For each program we generally
market through newspaper, radio and television advertising, focusing on media
that is in the home country language. Our customer service representatives
speak the native languages of the ethnic communities that we serve. In
addition, we plan to market retail long distance services in our offshore
locations by employing local sales and marketing personnel who have expertise
in the local offshore markets. We will continue to use the breadth of ethnic
retail marketing expertise of our sales force to fuel further retail long
distance services growth in both the United States and offshore.

  In addition, in the United States we have formed a "winback center" that
focuses on regaining customers who are no longer using our retail long
distance services and a customer service center to more effectively serve our
existing customer base.

  Wholesale Long Distance Services. We market our wholesale long distance
services to other U.S. and international long distance carriers. We believe
that these customers choose Pacific Gateway because we offer comprehensive,
low-cost and highly reliable services. We are able to offer these services
through our 44 operating agreements and termination arrangements that provide
for the exchange of traffic with major foreign carriers, as well as our own
international bandwidth and transmission facilities with the capacity to meet
their expanding needs.

  As of December 31, 1999, we had approximately 225 wholesale customers,
including four of the largest U.S. long distance carriers and many of the
other largest telecommunications providers. Our foreign partners include both
PTTs, which may be wholly or partially government-owned, and nondominant
carriers that may have recently been established as a result of the
deregulation and privatization for foreign telecommunications markets. We
believe that many of the competitive carriers in developing countries, as well
as certain recently privatized PTTs, are likely to seek alliances,
partnerships or joint ventures with other international carriers to

                                      10
<PAGE>

expand their global networks. We currently derive revenues from traffic
originating in the United States, the United Kingdom, Germany, Russia, Japan,
Australia, New Zealand, France, Italy, Denmark and Switzerland.

  We have commission-based professionals dedicated to sales and marketing
activities with our U.S. carrier customers. Marketing is typically conducted
on a personalized basis. Participation at industry conferences, referrals from
other carriers and long-term relationships are key factors in establishing the
visibility, reputation and personal trust necessary to obtain and maintain our
wholesale business. We believe that we have been able to compete effectively
by offering more personalized service than our competitors and the assurance
of ongoing senior-level attention to each account.

  When we enter a new foreign market, we typically hire a local sales force
that is familiar with the wholesale long-distance telecommunications market.
Similar to U.S. wholesale operations, in each of our offshore locations our
target customer base includes the dominant carrier, as well as small to medium
sized carriers that do not have their own international network.

  VOIP Services. Our sales efforts target leading telecommunications carriers
and Internet service providers both in the United States and offshore. Our
sales force is made up of experienced personnel with long-time relationships
in the telecommunications industry. We sell directly to carriers and are
working to develop brand awareness and beneficial relationships through
numerous channels including the web, trade shows, speaking engagements and
joint marketing programs. The ability to provide quality acceptable to leading
carriers through our IP network is a strong selling point for us.

  Our marketing strategy includes public relations campaigns, interaction with
industry analysts and attendance at trade shows. We aggressively pursue
favorable coverage in the trade and business press and participate in industry
trade shows.

 Internet Services

  We are designing our Internet sales and marketing strategy to target our
foreign partners and carrier customers, a wide range of ISPs and small to
medium-sized global businesses that depend on the Internet for core business
operations. Our marketing strategy and infrastructure are geared to respond to
opportunities in the Internet market offshore. We utilize a multi-tiered
channel approach that combines the technical skill and Internet experience of
our direct sales force with the sales and marketing resources of our global
partners. We are thus able to deploy our products and services to a broad and
diverse range of international customers in targeted markets.

  Direct Sales. Our direct sales force is locally based in our targeted
markets. Marketing support for the sales staff includes direct contacts with
potential accounts, direct mail, telemarketing, seminars and trade shows. We
plan to develop competitive compensation programs as well as on-the-job and
third party training plans to attract, train and grow motivated, high
producing Internet sales staff.

  Strategic Alliances. We expect that strategic alliances will leverage the
existing network of sales people employed by our strategic partners to sell
our services. We plan on partnering with Internet application and service
providers who offer the most advanced products and services. We recently
entered into a strategic relationship with a leading developer of Internet
infrastructure software to license their content distribution technology and
jointly develop a content management interface. This would give our customers
the ability to manage their content and services on our network. This company
will also become an equity investor in our Internet subsidiary, conditioned
upon an equal amount being invested by other investors.

  Our Internet services marketing program is focused on building the
international, national and local strength and awareness of our network and
products. To this end, we print advertising in targeted markets and
publications to enhance awareness of our products and services and to generate
leads for our sales team. We focus print advertisements in trade journals,
special interest publications, and international business travel magazines
targeted at corporate management decision-makers.


                                      11
<PAGE>

  Brand awareness is enhanced by participation in industry trade shows such as
ISPCON, Internet World, and others. We also plan to utilize targeted
billboards placed adjacent to our global data centers, direct mailings,
telemarketing programs and other means to reach prospective ISP and corporate
customers.

 Bandwidth Services

  We have formed a bandwidth sales and lease group to capitalize on our
current and future opportunities resulting from our investments in our global
network. We sell and lease bandwidth capacity to telecommunications carriers,
ISPs and satellite companies, among others. We also use some of our bandwidth
capacity for our own telecommunications and Internet services.

Competition

 Telecommunications

  The international telecommunications industry is highly competitive and
affected by the introduction of new services facilitated by advances in
technology. International telecommunications providers compete on the basis of
price, customer service, transmission quality, breadth of service offerings
and value-added services. The U.S.-based international and retail
telecommunications services market is dominated by large incumbent providers
including AT&T, MCI WorldCom and Sprint. We also compete with other types of
carriers, including long distance carriers, such as Qwest, Global Crossing and
RSL, and international carriers such as Telstra and British Telecom. We may
compete in the future with new competitors including RBOCs. As our network
expands to serve a broader range of customers, we expect to encounter
increasing competition from these and other major domestic and international
communications companies. Moreover, competition is likely to intensify as a
result of the formation of global alliances and mergers among the largest
telecommunications carriers. Existing or planned global alliances or
combinations include Global One, AT&T and British Telecom, WorldCom, MCI and
Sprint, Global Crossing and Frontier, and Qwest, KPN and US West. We expect
that continued deregulation in global telecommunications markets will lead to
new market entrants and more competitors.

  The telecommunications industry is in a period of rapid technological
evolution, marked by the introduction of new product and service offerings and
increasing satellite transmission capacity for services similar to those we
provide. Technologies being developed or already introduced include
utilization of the Internet for international voice and data communications,
digital wireless communications systems such as personal communications
services, broadband multimedia applications and satellite networks such as
INTELSAT and PanAmSat.

 Internet

  The Internet business is intensely competitive. There are few substantial
barriers to providing connectivity and co-location services, and we expect
that we will face additional competition from existing providers and new
market entrants in the future. We believe that participants in this market
must grow rapidly and achieve a significant presence in the market in order to
compete effectively. We also believe that the principal competitive factors in
this market are uncongested connectivity, quality of facilities, level of
customer service, price, the financial stability and credibility of the
provider, brand name and the availability of network management tools.
Potential competitors in this market include:

  . global, regional and local telecommunications companies, such as MCI
    WorldCom, Sprint, which is being acquired by MCI WorldCom, AT&T and the
    RBOCs;

  . providers of connectivity and co-location services, such as Metromedia
    Fiber Network, Exodus Communications, Global Crossing and Verio;

  . international, national and regional ISPs, such as Concentric Network,
    PSINet, MCI WorldCom and certain subsidiaries of GTE; and

  . large information technology outsourcing firms, such as IBM and
    Electronic Data Systems.

                                      12
<PAGE>

 Bandwidth

  The market for undersea and land-based fiber optic bandwidth capacity is
highly competitive. We will face competition from existing and planned systems
along each of our planned routes. We compete with providers who construct and
operate their own cable networks, such as Global Crossing, Global TeleSystems,
Qwest, Williams Communications, Level 3 and Metromedia Fiber Network. We also
compete with other carriers which have acquired capacity on the same cable
networks as we have. We compete primarily on the basis of price, availability,
transmission quality and reliability, customer service and location of our
systems.

Billing and Management Information Systems

  Accurate operation of a management information system is vital to our
operations, given the high volume of transactions and the need to bill
customers accurately. We maintain our own staff of programming and management
information reporting personnel, as well as contract programmers dedicated to
maintaining our management information system. This system's functions include
reporting on revenues, long distance service costs and network performance,
performing margin analyses and tracking foreign payment settlements. As a
result of refinements that have occurred in this system, we can monitor our
revenues and gross margins. We provide common data access for system users to
support our customer service, accounting and network monitoring functions.

  We have developed our own customized billing and management information
systems software to meet the needs of our customers and vendors and to enhance
our ability to monitor our operations. We utilize an IBM AS400 computer system
and continually upgrade and enhance the system as computer technology
advances. We believe these computer systems are adequate to meet our needs and
the needs of our customers and our vendors.

  Furthermore, to support our expansion into retail services, we are refining
our systems to include retail end-user billing and accounting. In particular,
we have recently purchased, and are integrating into our systems, end-user
software that enables us to add sales and use taxes to customers' bills.
Future planned additions include software that tracks customers' credit and
collections and software that would enable us to accept credit-card payments.

  We are currently evaluating and developing software and billing systems to
support our Internet operations.

Regulation

  The following summaries of regulatory developments and legislation does not
purport to describe all present and proposed international, federal, state and
local regulations affecting the telecommunication Internet, and bandwidth
industries. Other existing international, federal, state and local legislation
and regulations are currently the subject of judicial proceedings, legislative
hearings and administrative proposals which could change, in varying degrees,
the manner in which this industry operates. Neither the outcome of these
proceedings nor their impact upon us or the telecommunications industry can be
predicted at this time.

Telecommunications

 United States

  Overview. Our business is subject to varying degrees of telecommunications
regulation by United States regulatory authorities at the federal and state
levels. In the United States, our services are subject to the provisions of
the Communications Act of 1934, as amended, sometimes called the
"Communications Act," FCC regulations under the Communications Act, as well as
the applicable laws and regulations of the various states and state regulatory
commissions. As a carrier offering international and interstate facilities-
based and resale telecommunications services to the public, we must comply
with the requirements of common carriage under the Communications Act,
including the requirement to offer service on a non-discriminatory basis at
just and

                                      13
<PAGE>

reasonable rates. Applicable state public service commissions or similar state
agencies, sometimes called "PSCs," have jurisdiction over telecommunications
services originating and terminating within the same state under separate
state statutes and regulations. The FCC and the PSCs generally have the
authority to condition, modify, cancel, terminate or revoke operating
authority for failure to comply with federal and state laws and applicable
rules, regulations and policies. Fines or other penalties also may be imposed
for violations, such as the unauthorized switching of carriers, also known as
"slamming." Any such action by the FCC or the PSCs could have a material
adverse affect on our business.

  International Service Regulation. In February 1997, 69 countries, including
the United States, signed the World Trade Organization Agreement on Basic
Telecommunications Services Agreement, sometimes called the "WTO Agreement,"
to facilitate competition in basic telecommunications services. The WTO
Agreement became effective February 5, 1998. Pursuant to the terms of the WTO
Agreement, signatories to the WTO Agreement have committed to varying degrees
and within varying time frames to allow access to their domestic and
international markets to competing telecommunications providers, allow foreign
ownership interests in existing telecommunications carriers, and establish
regulatory schemes to develop and implement policies to accommodate
telecommunications competition.

  In the United States, international telecommunications carriers are required
to obtain authority under Section 214 of the Communications Act in order to
provide international service that originates or terminates in the United
States. U.S. international common carriers also are required to file and
maintain international tariffs with the FCC specifying the rates, terms and
conditions of their services. We have obtained the required Section 214
authorization from the FCC to provide international facilities-based and
resale services, and have filed an international tariff. In addition, we are
classified by the FCC as a non-dominant carrier with respect to both
international and domestic services.

  We must conduct our international business in compliance with the FCC's
International Settlements Policy, the rules that establish the parameters by
which U.S.-based carriers and their foreign correspondents settle the cost of
terminating each other's traffic over their respective networks. Under the
FCC's International Settlements Policy, absent approval from the FCC,
international telecommunications service agreements with dominant foreign
carriers must be non-discriminatory, provide for settlement rates equal to
one-half of the accounting rate, and require proportionate share of return
traffic.

  In recent rule reforms, the FCC expressly exempted from the International
Settlements Policy rules U.S. carrier arrangements with non-dominant foreign
carriers, as well as arrangements with any foreign carrier (dominant or non-
dominant) on certain competitive routes where at least 50% of U.S.-billed
traffic is terminated at settlement rates at least 25% below the FCC's
applicable benchmark settlement rates. These routes currently include: Canada,
Denmark, France, Germany, Hong Kong, Ireland, Italy, the Netherlands, Norway,
Sweden and the United Kingdom. For arrangements that will continue to be
subject to the International Settlements Policy, the FCC imposes mandatory
settlement rate benchmarks. These benchmarks are intended to reduce the rates
that U.S. carriers pay foreign carriers to terminate traffic in their home
countries. The FCC also prohibits a U.S. carrier affiliated with a foreign
carrier from providing facilities-based switched or private line services to
the foreign carrier's home market unless and until the foreign carrier has
implemented a settlement rate at or below the relevant benchmark. Certain
confidential filing requirements still apply to dominant carrier arrangements.

  The FCC's revisions to the International Settlements Policy also affect the
FCC's rules on International Simple Resale ("ISR") which permit U.S. carriers
to provide international switched services over private lines interconnected
with the public switched telecommunications network on the current FCC-
authorized routes. The FCC declined to remove the International Settlements
Policy completely on all ISR-approved routes, and thus will continue to
maintain the distinction between routes it approves for ISR and routes on
which it removes the International Settlements Policy (where at least 50% of
U.S.-billed traffic is terminated at rates at least 25% below the applicable
settlement rates). Even though the FCC dramatically scaled back the
application of the International Settlements Policy, the FCC's ISR policy
still requires FCC approval to provide ISR service in an arrangement with a
foreign dominant carrier on non-competitive routes.

                                      14
<PAGE>

  To the extent that the International Settlements Policy still applies, the
FCC could find that we do not meet certain International Settlements Policy
requirements with respect to certain of our foreign carrier agreements.
Although the FCC generally has not issued penalties in this area, it has
issued a Notice of Apparent Liability to a U.S. company for violations of the
International Settlements Policy and it could, among other things, issue a
cease and desist order, impose fines or allow the collection of damages if it
finds that we are not in compliance with the International Settlements Policy.
Any of these events could have a material adverse effect on our business,
financial condition or results of operations.

  Domestic Interstate Regulation. Our provision of domestic long distance
service in the United States is subject to regulation by the FCC and certain
state PSCs, who regulate to varying degrees interstate and intrastate rates,
respectively, ownership of transmission facilities, and the terms and
conditions under which domestic services are provided. Under federal law, the
domestic interstate carriers are subject to a variety of regulations that, for
instance, govern the documentation and verifications necessary to change a
consumer's long distance carrier and require the filing of periodic reports.
Also, pursuant to federal law, such carriers must file domestic interstate
tariffs with the FCC. The FCC also has jurisdiction to act upon complaints
against any common carrier for failure to comply with its statutory
obligations.

  The Telecommunications Act of 1996 ("1996 Telecom Act") addresses a wide
range of other telecommunications issues that may potentially impact our
operations. For example, pursuant to the 1996 Telecom Act, the FCC established
a Universal Service Fund that provides subsidies to carriers that provide
service to under-served individuals and in high cost areas. A portion of
carriers' contributions to the Universal Service Fund will also be used to
provide telecommunications and certain other services to schools, libraries
and certain rural health care providers.

  The FCC is continuing to revise its universal service rules which may result
in further substantial increases in the overall cost of the subsidy program.
Our share of these federal subsidy funds will be based on our interstate and
international gross end-user telecommunications revenues. The contribution
factor issued by the FCC varies quarterly and is currently 5.7101%. The
amounts contributed may be billed to customers. The U.S. Court of Appeals for
the Fifth Circuit recently issued an order upholding in part, and reversing in
part, the initial FCC order implementing these funds. The Fifth Circuit order
has been appealed. Numerous FCC orders revising these funds are also subject
to petitions for reconsideration and further appeals. The outcome of these
proceedings or their effect cannot be predicted.

  Our costs of providing long distance services also will be affected by
changes in the access charge rates imposed by local exchange carriers for
origination and termination of calls over local facilities. The FCC has
significantly revised its access charge rules in recent years to permit
incumbent local exchange carriers greater pricing flexibility and relaxed
regulation of new switched access services in those markets where there are
other providers of access services. The FCC continues to adjust its access
charge rules and has indicated that it will promulgate additional rules
sometime in 2000 that may grant certain local exchange carriers further
flexibility.

  The 1996 Telecom Act also permits RBOCs to provide domestic and
international long distance services to customers located outside of the
RBOCs' home regions; permits a petitioning RBOC to provide domestic and long
distance service to customers within its operating area on a state-by-state
basis upon a finding by the FCC that a petitioning RBOC has satisfied certain
criteria for opening up its local exchange network to competition and that
provision of long distance services would further the public interest; and
removes existing barriers to entry into local service markets. Recently, the
FCC approved Bell Atlantic's petition to provide long distance service in New
York. As RBOCs are approved to provide in-region interLATA service, a logical
extension might be also to provide international services from their
respective regions. To the extent that RBOCs enter the national and
international long distance business, they could become major competitors. It
is also possible that they may become customers of our wholesale business
although there is no assurance that this would happen.

  State Regulation. In addition to regulation by the FCC, certain of our
subsidiaries are subject to varying degrees of state regulation regarding the
provision of intrastate long distance telecommunications services. Most

                                      15
<PAGE>

states require a certification or other authorization and the filing of
tariffs to offer intrastate long distance services, and require that common
carriers charge just and reasonable rates and not discriminate among
similarly-situated customers. Many states also require the filing of periodic
reports, the payment of various regulatory fees and surcharges, and compliance
with service standards and consumer protection rules, and for pre-paid or
debit card operations, the filing of a surety bond. Our subsidiaries that are
authorized to provide intrastate long distance services may be required by
certain states to obtain prior approval from or notify the relevant PSC of any
transfer of control, sale of assets, corporate reorganization, issuance of
stock or debt instruments and related transactions.

 Effect of United States and Foreign Laws on Certain Arrangements

  We have entered into, and expect to continue to enter into, certain
termination or origination arrangements in foreign countries that rely on
private lines for the termination of U.S.-originated traffic into, or the
origination of foreign-based traffic from, foreign countries. These
arrangements may be viewed by U.S. and foreign regulatory agencies as
"international simple resale" arrangements. We believe that U.S. and foreign
telecommunications regulations are being liberalized and that such
arrangements are permitted in some instances and may be expressly approved by
regulatory agencies in other instances. Nevertheless, at this time, the FCC or
a foreign regulatory agency in a particular country may take the view that
such arrangements are not in compliance with current regulatory policies. If
the FCC finds that such arrangements violate FCC rules, the FCC could impose a
variety of sanctions on us or our subsidiaries, possibly including rescission
of our authority pursuant to our Section 214 licenses.

  In addition, in arrangements where the counterparties compete with the PTT,
such competition may not be permitted by foreign regulatory agencies.
Regulatory authorities in Hong Kong and the PTT in Mexico have acted against
such arrangements. Moreover, the PTT may act unilaterally to cancel or
eliminate the private line service on which the foreign company depends. The
foreign companies with whom our subsidiaries enter into such arrangements, and
perhaps we or our subsidiaries, could be subject to a variety of penalties in
connection with such arrangements under foreign or United States law. Those
penalties could include orders to cease operations or to limit future
operations, loss of licenses or of license opportunities, fines, seizure of
equipment and, in certain foreign jurisdictions, criminal prosecution. The
revenue and/or profit generated under such arrangements may have become a
significant portion of our overall revenue and/or profit at the time such
arrangements are discovered and curtailed. Moreover, the discovery of the
existence of such arrangements by foreign PTTs could adversely affect our
business relationships with such foreign PTTs. Any of the developments
described above, i.e., the imposition of penalties, the loss of revenue and/or
profit generated by such arrangements whether as a result of regulatory
problems or otherwise, or the discovery of the existence of such arrangements
by foreign PTTs, could have a material adverse effect on our business,
financial condition or results of operations.

Internet and VOIP

  In the United States and most countries in which the Company conducts its
major operations, there is currently a small but growing body of laws and
regulations directly applicable to Internet access, Internet commerce and
VOIP. Due to the popularity and use of the Internet and VOIP, it is likely
that a growing number of laws and regulations may be adopted at the
international, federal, state and local levels. These regulations cover issues
such as user privacy, consumer protection, freedom of expression, encryption
standards, trade barriers, pricing, characteristics and quality of products
and services, taxation, advertising, intellectual property rights, information
security and the convergence of traditional telecommunications services with
Internet communications and licensing. Moreover, a number of laws and
regulations have been proposed and are currently being considered by federal,
state and foreign legislatures with respect to those issues. The nature of any
new laws and regulations and the manner in which existing and new laws and
regulations may be interpreted and enforced cannot be fully determined.
Internet service providers and VOIP providers are currently considered
"enhanced service providers" within the U.S. and are exempt from U.S. federal
and state regulations governing telecommunications common carriers.
Accordingly, our provision of Internet and VOIP services are currently

                                      16
<PAGE>

exempt from tariffing, certification and rate regulation. We cannot predict
the likelihood that state, federal, or foreign governments will impose
additional regulations on our Internet and VOIP operations or e-commerce
generally, nor can we predict the future impact that any such regulation will
have on our business, financial condition or results of operations.

  In April 1998, the FCC issued a report to Congress on the implementation of
the universal service provisions of the 1996 Telecom Act. In its report, the
FCC indicated that it would re-examine its policy of not requiring Internet
service providers and providers of certain forms of VOIP to contribute to the
universal service mechanisms. In addition, the FCC stated that it may
recognize whether phone-to-phone VOIP providers shall be regulated as
telecommunications service providers. The European Commission issued on
January 10, 1998, a Communication addressing whether VOIP should be considered
"voice telephony" and thus subject to regulation by the Member States.
Consistent with its earlier directives, the European Commission stated that
Internet telephony could properly be considered "voice telephony," and thus
subject to regulation by the Member States only if certain factors are
satisfied. The European Commission also held that at the time no form of VOIP
satisfied all of these factors. Currently, providers of VOIP within the EU
Member States are subject to no more than general authorization or declaration
requirements by the Member States. Within the U.S. or internationally, we
cannot predict the outcome of any future proceedings that may impact our
provision of Internet or VOIP services or that may impose additional
requirements, regulations, or changes upon our provision of such services.

  Several U.S. laws have attempted to regulate content on the Internet.
Although sections of the Communications Decency Act of 1996, sometimes called
"CDA," that, among other things, proposed to impose criminal penalties on
anyone distributing "indecent" material to minors over the Internet, were held
to be unconstitutional by the United States Supreme Court, there can be no
assurance that similar laws will not be proposed and adopted. In October 1998,
Congress enacted the Child Online Protection Act, sometimes called "COPA,"
which requires that material that is "harmful" to minors be restricted. This
law is currently being challenged in federal district court. On February 1,
1999, a U.S. District Court judge issued a preliminary injunction against
enforcement of portions of that act, and the U.S. Department of Justice has
appealed that decision. Oral arguments were held in November 1999. However,
the "filtering" requirements in COPA have not been stayed, and Internet
service providers must notify users of existing measures (e.g., hardware,
software and filtering devices) that may assist the users in limiting minors'
access to harmful material. Legislation similar to the CDA could subject us
and/or our customers to potential liability, which in turn could have a
material adverse effect on our business, financial condition or results of
operations. In addition, legislation that prohibits or limits sending
unsolicited commercial e-mails has recently been passed at the state level and
continues to be proposed at the federal level; this legislation could subject
us and our customers to potential liability. Moreover, foreign laws, including
Directive 95/46/EC of the European Parliament and of the European Council on
the protection of individuals with regard to the processing of personal data
and on the free movement of such data may be applied to online services and
Internet service providers such as the Company. The future adoption or
application of any future laws or regulations to the Internet might decrease
the growth of the Internet, decrease demand for our services, impose taxes or
other costly technical requirements or otherwise increase the cost of doing
business or in some other manner have a material adverse effect on us or our
customers, which, in turn, could have a material adverse effect on our
business, financial condition or results of operations. In addition, applying
existing laws governing issues such as property ownership, copyrights and
other intellectual property issues, taxation, libel, obscenity and personal
privacy to the Internet is uncertain. The vast majority of these laws were
adopted prior to the advent of the Internet and related technologies and, as a
result, do not contemplate or address the unique issues of the Internet and
related technologies. Changes to these laws intended to address these issues,
including some recently proposed changes, could create uncertainty in the
marketplace which could reduce demand for our services or increase the cost of
doing business as a result of costs of litigation or increased service
delivery costs, or could in some other manner have a material adverse effect
on our business, financial condition or results of operations. In addition, as
our services are available over the Internet in multiple states and foreign
countries, and as we facilitate sales by our customers to end-users located in
these states and foreign countries, these jurisdictions may claim that we are
required to qualify to do business as a foreign corporation in
each of these states or foreign countries. Any new legislation or regulation,
or the application of laws or

                                      17
<PAGE>

regulations from jurisdictions whose laws may not currently apply to our
business, could have a material adverse effect on our business, financial
condition or results of operations.

Employees

  As of December 31, 1999, we and our subsidiaries had 386 full time
employees. We believe our relations with our employees are generally strong.
We expect to continue to add personnel as we continue to expand our operations
and diversify our services. None of our employees are covered under collective
bargaining agreements.

Financial Information About Foreign And Domestic Operations And Export Sales

  We have offshore operations throughout the world. For information regarding
revenues by country see Note (12) entitled "Segment Data" in the Notes to the
Consolidated Financial Statements included in Part II, Item 8 of this 10-K.

Financial Information About Industry Segments

  Prior to 1999, our business consisted entirely of telecommunications
operations. We managed its wholesale, offshore, and retail telecommunication
operations. As a result of the diversification of our business, we now manage
telecommunications, Internet, and bandwidth services. The operating results of
these segments are regularly reviewed by and are integral to our management
and decision-making process. Financial information on our operating segments
is included in Note (12) entitled "Segment Data" in the Notes to the
Consolidated Financial Statements included in Part II, Item 8 of this 10-K.

                                      18
<PAGE>

Risk Factors

  Liquidity Issues--Although we have received an extension, we do not
currently have the funds to make a scheduled credit line reduction payment and
we have received a waiver of defaults under our credit agreement.

  We currently have approximately $75.6 million outstanding under our credit
agreement. The amount available for us to borrow was scheduled to be reduced
from $100 million to $50 million on April 1, 2000. In addition, we determined
that we are in default of certain provisions of this credit agreement, which
constituted an event of default. On March 31, 2000, we obtained a waiver of
these defaults and an extension of the repayment date from the lenders.
Pursuant to this waiver and extension the amount available for us to borrow
will be reduced to $75.6 million and reduced further to $50 million on May 15,
2000, which, will require us to pay approximately $25.6 million on or before
that date.

  We cannot assure you that we will be able to comply with the terms of the
waiver and extension. We do not currently have the funds for the repayment
scheduled on May 15, 2000. If we are unable to comply with the terms and make
this repayment or negotiate another extension of the date of repayment, we
will default under the credit agreement.

  If we default on our credit agreement, the banks have the right to
immediately accelerate this indebtedness and foreclose on the assets that we
have pledged as security. In addition, a default under this bank credit
agreement would result in a cross default under our Cisco financing
arrangement.

  We have substantial amounts that are payable currently or in the short term
that, absent additional financing, we do not have the funds to pay. We will
owe $5 million at the closing of our acquisition of NOSVA, which is scheduled
to occur this spring. This closing is subject to certain conditions, including
regulatory approval. We have discussed obtaining this amount from our lenders
but the lenders have not committed to fund this amount. We have experienced
difficulty in making timely payments on our vendor invoices. If we are unable
to pay these amounts, these parties may, among other things, interrupt service
to us or seek legal remedies against us. We cannot assure that you we will be
able to obtain the financing to satisfy these commitments.

  As a result of our liquidity situation, our auditors have included a going
concern explanation to its audit report. We are currently pursuing a number of
strategic and financing alternatives that are directed toward improving our
liquidity, which may include obtaining additional financing, obtaining private
equity investments in us or our subsidiaries, or sales of selected assets. We
have engaged Salomon Smith Barney to provide advice regarding strategic
alternatives. In addition, Deutsche Bank Securities Inc. and Banc of America
Securities LLC are providing assistance with respect to locating and
identifying financing opportunities, including the possible initial public
offering of the common stock of Onyx Networks, our Internet subsidiary. While
we are actively pursuing these alternatives, we cannot assure you that we will
be able to close any strategic transactions.

  Need for Additional Financing--Our success is significantly tied to our
ability to raise additional money.

  To avoid a default under our credit agreement and other financing
arrangements and to fulfill our long-range business plan, we must raise
substantial additional capital. The actual amount and timing of our future
capital requirements may differ materially from our estimates as a result of
financial, business and other factors, many of which are beyond our control,
as well as future acquisitions.

  Our credit facility will be reduced to $50 million on May 15, 2000. Since we
currently have $75 million outstanding under this facility, this reduction
will require us to repay $25 million. We will need to obtain additional
financing for this repayment. Our credit facility matures on November 23,
2000. At that time, we will need to replace it in order to fulfill our
business plan. We cannot assure you that we will be able to raise this
additional financing, or, if we are able to raise this additional financing,
that the terms of that financing will be favorable to us.

                                      19
<PAGE>

  Substantial Leverage--Our substantial indebtedness could adversely affect
our financial health and prevent us from fulfilling certain of our
obligations.

  We owe approximately $75 million under our credit facility and have
substantial current financial commitments. We also have a $10 million term
loan vendor financing facility outstanding and a $15 million vendor financing
facility that might be drawn on and increase our debt. Our Internet subsidiary
has committed to purchase approximately $28 million of software and services,
for which we have guaranteed payment. We may also seek additional debt
financing, including additional vendor or other equipment financing
facilities. Our substantial indebtedness could have important consequences.
For example, it could:

  .  increase our vulnerability to general adverse economic and industry
     conditions;

  .  require us to dedicate a substantial portion of our cash flow from
     operations to make interest and principal payments on our indebtedness,
     which would reduce the availability of our cash flow to fund working
     capital (including expansion of our retail, telecommunications and
     Internet operations), capital expenditures, diversification efforts and
     other general corporate purposes;

  .  limit our flexibility in planning for, or reacting to, changes in our
     businesses and the industries in which we operate;

  .  place us at a competitive disadvantage compared to our competitors that
     have less debt;

  .  limit our ability to borrow additional funds; and

  .  subject our business to restrictive covenants.

  Managing Diversification--The success of our business plan depends on our
ability to enter new lines of business.

  We have recently entered into a phase of rapid diversification. We are
expanding our business lines from being a provider of international wholesale
telecommunications services to becoming a diverse supplier of wholesale,
retail and VOIP telecommunications services, bandwidth services and Internet
services. These efforts require us to assume greater risks, such as:

  .  greater demands on management's time;

  .  the ability of management to learn new skills while continuing to manage
     effectively our existing operations;

  .  investment risks associated with expenditures for new lines of business;
     and

  .  increased pressures upon our operations and financial systems.

  As we grow and expand our business, if we are unable to attract and retain
additional qualified personnel, we could be materially and adversely affected.
We expect that our expansion and diversification will lead to increased
administrative demands, such as:

  .  increased operational complexity associated with expanded network
     facilities and service offerings; and

  .  administrative burdens associated with managing increased foreign
     operations, as well as with hiring, training and supervising new
     employees.

  If we do not manage our diversification effectively, our business, financial
condition or results of operations may be materially and adversely affected.
We cannot assure you that our bandwidth and Internet business lines will be
successful.

  Declining Prices--Each of our business lines is highly sensitive to
declining prices.

  Prices of telecommunications services have decreased, and are likely to
decrease in the future, for a variety of reasons, including:

  .  increased competition among existing carriers;

                                      20
<PAGE>

  .  new entrants into niche markets; and

  .  joint ventures and business combinations among large international
     carriers that facilitate targeted pricing and cost reductions.

As a result of declining prices, our average telecommunications price per
minute declined from $0.29 per minute during 1998 to $0.24 per minute during
the twelve months ended December 31, 1999.

  The prices we charge our customers for international wholesale and retail
services may also decrease in the future due to:

  .  the provision of international telecommunications services via non-
     traditional means (including the Internet); and

  .  recent technological advances that permit increases in transmission
     capacity of communications networks, including the rapid growth of
     international circuit capacity due to the deployment of new undersea
     fiber optic cables and new high capacity satellite systems in the
     Atlantic, Pacific and Indian Ocean regions.

  As a part of our business strategy to focus on our other lines of business,
we expect to handle less wholesale traffic in the future. This decrease in
wholesale traffic, coupled with declining wholesale prices, will cause our
wholesale business to become less profitable and generate less cash. We cannot
assure you that our retail, VOIP, Internet and bandwith operations will
generate sufficient profits and cash flow to offset these decreases. The
failure of our other operations to generate sufficient profits and cash flow
may have a material adverse effect on our business, financial condition or
results of operations.

  Retail long distance prices have also recently decreased and are likely to
continue to decrease due to increased competition and decreasing wholesale
prices. We cannot assure you that we will be able to increase our retail
traffic volume or reduce our operating costs sufficiently to offset retail
price decreases. Our inability to do so may have a material adverse effect on
our business, financial condition or results of operations.

  Prices for Internet services vary from country to country, but are generally
declining. Internet pricing is very competitive, and in some cases, our
competitors provide connectivity or co-location services for no charge. We
cannot assure you that these events will not have a material adverse effect on
our business, financial condition or results of operations.

  A decline in the price of undersea or land-based fiber optic capacity could
impair our bandwidth services strategy and have a material adverse effect on
our business, financial condition or results of operations. Factors that could
result in a price decline include availability of capacity and technological
innovations that increase the capacity of a particular system and provide
alternative communications technologies.

  Managing Rapid Growth--If we are unable to manage the demands that come with
rapid growth, we may be unable to compete successfully in the future.

  We are experiencing a period of rapid growth, which we expect to continue to
place a significant strain on our management and our operational and financial
resources. In order to manage our growth effectively, we must continue to:

  . accurately forecast demand for use of our network to optimize its usage
    in order to avoid insufficient or excessive transmission facilities,
    network capacity or disproportionate fixed expenses;

  . implement and improve our operational and financial systems and controls;
    and

  . expand, train and manage our employee base.

  If we do not have sufficient facilities to handle all of our traffic on a
given route, the overflow traffic is handled by other international carriers
on a minutes-of-use basis. We cannot predict at this time whether the quality
of these services will be satisfactory to us and our customers. Additionally,
we generally incur higher costs to handle overflow traffic.

                                      21
<PAGE>

  Our accounting systems and policies have been developed as we have
experienced significant growth. We cannot assure you that they will be
adequate to support our future operations. If we are not able to manage our
growth effectively, maintain the quality of our services and diversify our
services quickly and effectively, then our ability to achieve our business
plan may be materially and adversely affected.

  Risks of Reduced Profitability--We may experience lower earnings due to
substantial investments in network facilities and the expansion of our
Internet operations.

  The development of network facilities entails prior planning and the
incurrence of significant costs prior to generating any revenues from such
facilities. Our planning, in large part, is based upon our expectations
concerning future revenue growth and market developments. As we expand our
network, our cost of services will increasingly consist of fixed costs arising
from the ownership and maintenance of our switches and undersea fiber optic
cables. Cost increases and a decrease in our operating margins may occur in
the short-term, resulting in lower earnings. If we handle less traffic or
otherwise fail to make optimal use of our network, our gross margin could
decline significantly, which could have a material adverse effect on our
business, financial condition or results of operations.

  The construction of undersea and land-based cable facilities is ongoing and
time sensitive. Our business plan for the expansion of our network is based in
large part upon our expectations as to the construction costs and availability
of the Japan-U.S. and TAT-14 undersea cable systems which are currently under
construction. If construction costs of these systems exceed expectations or if
planned cable system marketing efforts do not succeed, we will be required to
contribute additional capital to fund these cable systems. If these cable
systems are not available for service on a timely basis, whether due to
construction delays or otherwise, the delay in receipt of revenues and the
obligation to provide services from other sources, perhaps at increased costs
(or risk of certain customers terminating their arrangement with us), could
have a material adverse effect on our business, financial condition or results
of operations.

  The terms of our cable system consortium arrangements, including the Japan-
U.S. and TAT-14 undersea cable systems, contain various obligations for which
we are responsible, including the payment of annual operating and maintenance
costs, compliance with operating and other technical standards and
restrictions as to the use, assignability and sale of capacity. If due to
disputes, breaches or otherwise, the cable facilities provided for in such
arrangements are not available to us, it would have a material adverse affect
on our business, financial condition or results of operations.

  The expansion of our Internet operations also will require substantial
investment in equipment, personnel and sales and marketing efforts, and may
involve substantial expenses that are not now anticipated. We expect that
these investments will decrease our profitability in the short-term.

  Risks from Internet Operations--We may not be able to successfully grow our
Internet operations.

  Our success in our Internet operations will depend on several factors,
including our ability to:

  .  expand into the Internet business;

  .  negotiate peering agreements with other Internet providers;

  .  achieve the "critical mass" necessary for success as an Internet
     company;

  .  compete successfully and earn profits in an increasingly competitive and
     price sensitive Internet marketplace;

  .  identify data center sites and install facilities in a timely and cost-
     effective manner;

  .  win customers from established vendors;

  .  develop or acquire leading technologies;

  .  obtain the necessary capital to finance business development;

                                      22
<PAGE>

  .  hire network, customer support, sales and marketing personnel to
     implement and manage our Internet operations; and

  .  comply with a growing number of domestic and foreign legal and
     regulatory requirements affecting Internet providers and their
     customers.

  The expansion of our Internet operations will require us to expend
substantial resources for the lease and build out of data centers, purchase of
equipment and hiring of network, customer support, sales and marketing
personnel. We also may make significant investments in sales and marketing and
the development of new services as we expand our Internet operations. These
investments will impose a substantial strain on our financial resources and
could impair our ability to pay interest and principal on the notes. We cannot
assure you that we will be able to successfully grow our Internet operations,
that our Internet operations will become profitable or that we will remain in
the Internet market. We are unable to predict the impact that existing or
future laws governing the Internet may have on our business.

  Risks from VOIP Operations--We may not be able to successfully develop our
VOIP operations.

  If the market for Internet telephony and new services does not develop as we
expect, or develops more slowly than expected, our business, financial
condition and results of operations may be materially and adversely affected.

  Our customers may be reluctant to use our VOIP services for a number of
reasons, including:

  . perceptions that the quality of voice transmitted over the Internet is
    low;

  . perceptions that Internet telephony is unreliable; and

  . our inability to deliver traffic over the Internet with significant cost
    advantages.

  The growth of our business depends on carriers and other communications
service providers generating an increased volume of international voice and
fax traffic and selecting our network to carry at least some of this traffic.
If the volume of international voice and fax traffic fails to increase, or
decreases, and our customers do not employ our network, our VOIP operations
will not be profitable, which may materially and adversely affect our
business, financial condition and results of operations.

  We cannot assure you that end-users will continue to purchase services from
our customers or that our customers will maintain a demand for our services.

  Our VOIP operations may become subject to regulation in the future. If VOIP
is regulated in a manner similar to traditional telephony, our VOIP operations
may be burdened and any cost advantages provided by VOIP may be eliminated. We
are unable to predict whether, and to what extent, VOIP will be regulated and
the impact such regulation may have on our business.



  Competition--We operate in highly competitive business sectors and compete
with many larger and better capitalized companies.

  The international telecommunications industry is highly competitive.
International telecommunications providers compete on the basis of:

  .  price;

  .  customer service;

  .  transmission quality;

  .  breadth of service offerings; and

  .  value-added services.

                                      23
<PAGE>

In addition, competition may increase due to deregulation of the
telecommunications industry in offshore markets.

  The wholesale and retail telecommunications, bandwidth and Internet markets
tend to be dominated by companies much larger than we are with financial and
network resources that far exceed ours. The wave of consolidation sweeping
through the telecommunications industry may increase the competition we face.

  Competition would further intensify if the Regional Bell Operating
Companies, sometimes called "RBOCs," are permitted to offer long distance
services. Any significant increase in competition could have a material
adverse effect on our business, financial condition or results of operations.

  Sufficiency of Our Network--We must be able to expand and adapt our network
infrastructure.

  We must continue to expand and adapt our network as the number of customers
we serve grows, our service portfolio expands and technology advances. If we
are unable to expand and adapt our network infrastructure, we may lose
customers. Furthermore, we only recently have deployed our Internet services.
Accordingly, it is difficult to determine if our network will be able to
handle, connect and manage large numbers of users at high transmission speeds.
We may not be able to provide our customers with the increasing levels of data
transmission capacity they may require for a number of reasons, such as our
possible inability to raise the funds needed to develop the network
infrastructure to maintain adequate data transmission speeds or our inability
to obtain additional network capacity. We may encounter unforeseen
circumstances that could require us to incur additional costs or to delay
necessary network upgrades. We may experience equipment or software
incompatibility, among other things, if we upgrade our network to increase its
capacity. This may cause delays in our attempts to expand or improve our
services.

  Technological Advances--Technological advances could impact our competitive
position.

  The communications industry is experiencing a period of rapid technological
evolution, marked by the introduction of new product and service offerings and
increasing fiber optic transmission capacity. The technologies being developed
or already introduced include:

  .  fiber optic cable systems having capacity far in excess of our current
     network capacity;

  .  satellite-based systems, such as the INTELSAT and PanAmSat systems;

  .  equipment utilizing the Internet for international telecommunications
     and data communications;

  .  digital wireless communications systems such as personal communications
     services;

  .  broadband multimedia applications; and

  .  digital subscriber line technology.

Any of these technologies could render some of our facilities obsolete or no
longer cost-effective.

  We are unable to predict which of the many possible future products and
service offerings will be important to maintain our competitive position or
what expenditures will be required to develop and provide those products and
services.

  Dependence on Operating Agreements With Foreign Partners--Termination of our
operating agreements or our inability to enter into operating agreements in
the future could materially and adversely affect our ability to compete in
foreign countries.

  We rely on operating agreements with foreign partners to terminate
telecommunications traffic in, and receive return telecommunications traffic
from, foreign countries. These operating agreements are generally for an
unspecified term in accordance with industry practice. Many of our foreign
partners have invested with us in our digital undersea fiber optic cable
systems to assure long-term telecommunications access between their countries
and the United States. While we have been successful in negotiating and
maintaining these operating agreements,

                                      24
<PAGE>

the trend toward deregulation of telecommunications in many countries and a
significant reduction in outgoing traffic carried by us, among other things,
could cause foreign partners to terminate their operating agreements or cause
these operating agreements to have substantially less value to us. Termination
of some of these operating agreements could have a material adverse effect on
our business, financial condition or results of operations.

  We cannot assure you that we will be able to enter into additional operating
agreements in the future. In some countries that have a monopoly carrier or
very few competing carriers, it may be difficult for us to negotiate operating
agreements for the termination of traffic on reasonable terms and at
acceptable rates, if at all. In addition, when there are very few carriers
available to terminate traffic in a given country, the transmission quality
provided in that country may be unacceptable, in which case, in order to
terminate traffic in that country, we would be required to find other carriers
willing to terminate traffic or use alternative arrangements that may be more
costly. The failure to enter into these types of additional operating
agreements could limit our ability to increase our revenues on a profitable
basis.

  Dependence on Availability of Transmission Facilities--We may not be able to
obtain the additional bandwidth capacity that we need on a timely basis, or at
all, in order to implement our business plan.

  We need access to substantial amounts of additional bandwidth capacity in
order to achieve our business plan. Our ability to obtain this capacity
depends on many factors, several of which are beyond our control, including:

  . the formation of new fiber optic cable consortiums;

  . the ability of the consortiums to obtain financing, the necessary rights
    of way and regulatory and environmental approvals;

  . the availability of personnel and equipment to construct the cables; and

  . political and economic events in the countries involved.

  These events could preclude or delay the construction or the completion of
facilities necessary for the achievement of our business plan and could have a
material adverse effect on our business, financial condition or results of
operations.

  System Security--We face risks associated with the security of our systems.

  Although we expect to design and implement a variety of network security
measures, unauthorized access, computer viruses, accidental or intentional
action and other disruptions could occur. In addition, we may incur
significant costs to prevent breaches in security or to alleviate problems
caused by breaches. Any breaches that may occur could result in liability to
us, loss of existing customers and the deterrence of future customers.

  Change in Accounting Standards--A change in accounting standards has
required us to change our timing of recognizing revenues.

  Effective June 30, 1999, the Financial Accounting Standards Board, ("FASB"),
issued FASB Interpretation No. 43 "Real Estate Sales," ("FIN 43"), which
affirms that sales of "integral equipment" be accounted for in accordance with
real estate accounting rules as previously set forth in FASB No. 66. The
application of FIN 43 has resulted in the classification of undersea and land-
based fiber optic cables and related equipment as "integral equipment" as
defined in FIN 43. This change in the accounting for indefeasible rights to
use ("IRUs,)" fiber optic capacity does not change the timing or amount of
cash proceeds or network assets we expect to receive under the commitments we
have made to sell or lease bandwidth capacity. It requires us, however, to
recognize the revenue from some agreements as operating leases over the lives
of the agreements as opposed to the industry practice prior to the adoption of
FIN 43, under which revenues were recognized during the period in which
initial access to the capacity was provided. As a result, this change in
accounting treatment reduces the revenues and income that we would recognize
in the earlier years of the agreements and spreads it out over the lives of
the agreements regardless of when the cash or network assets were received or
initial access to the capacity was

                                      25
<PAGE>

provided. Please refer to "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Overview."

  Risks of International Telecommunications Business--We have significant
operations that are subject to risks of operating in foreign countries.

  We currently generate a substantial portion of our revenues by providing
international telecommunications services to our customers in the United
States and in six offshore markets. The international nature of our operations
subjects us to certain risks, such as:

  .  changes in foreign government regulations and telecommunications
     standards;

  .  enforcement actions by government agencies charging that our foreign
     carrier arrangements are inconsistent with regulatory policy;

  .  changes in licensing requirements;

  .  changes in taxes;

  .  establishment of other trade barriers;

  .  ability to staff and manage our foreign operations; and

  .  political and economic instability in foreign nations.

  Our revenues and costs of long distance services are sensitive to:

  .  changes in international settlement rates;

  . differences in payment cycles between U.S. and foreign carriers;

  . changes in the ratios between traffic we deliver and traffic we receive;

  . foreign currency fluctuations; and

  . import and export regulations.

  In addition, our business could be adversely affected by a reversal in the
current trend toward deregulation of foreign government-owned
telecommunications carriers.

  If any dispute arises from our foreign operations, we may be subject to the
exclusive jurisdiction of foreign courts and may not be successful in having
those disputes brought to court in the United States. We also may be hindered
or prevented from enforcing our rights with respect to foreign governments
because of the doctrine of sovereign immunity.

  We cannot assure you that the laws, regulations or administrative practices
of foreign countries relating to our ability to do business in those countries
will not change. Any such change could have a material adverse effect on our
business, financial condition or results of operations. We will be
increasingly subject to these risks as we proceed with the planned expansion
of our international operations.

  Dependence on Key Personnel--Our success is significantly tied to the
continued services of certain of our officers and other key personnel.

  We are dependent on the efforts of certain key personnel to successfully
operate our business. These individuals include:

  .  Howard A. Neckowitz, Chairman of the Board, President and Chief
     Executive Officer;

  .  Gail E. Granton, Co-Chief Operating Officer, Global Marketing and
     Offshore Development and Secretary; and

  . Thomas J. Murphy, Co-Chief Operating Officer, Global Networks and IP
    Development.

                                      26
<PAGE>

as well as a group of employees with long-standing industry relationships and
technical knowledge of our operations. The loss of the services of one or more
of these individuals could materially and adversely affect our business and
our future prospects.

  Risks Associated with Joint Ventures, Direct Investments and Acquisitions--
We may not be able integrate these investments successfully with our existing
business.

  An important component in our business strategy is to expand through joint
ventures, investments and acquisitions. This growth strategy depends on the
continued availability of suitable strategic opportunities and subjects us to
certain risks. Pursuing these transactions could place significant demands on
our financial and management resources and potentially disrupt our ongoing
business. Transactions also may require integration of business and network
systems and other physical facilities and personnel. Difficulties in
integration could cause system degradation, added costs and loss of employees
and customers. We cannot assure you that we will be successful in overcoming
these risks or other problems in connection with future transactions.

  Government Regulation--We are subject to telecommunications regulation in
the United States and in foreign countries, and the manner in which such
regulation is interpreted or enforced could materially impact our business.

  As an international and U.S. domestic telecommunications company, we are
subject to varying degrees of regulation in the United States at the federal
and state level and in each of the other jurisdictions in which we provide our
services. Interpretation and enforcement of these laws and regulations vary
widely, can be unpredictable, and may be subject to the informal views of
government officials that regulate telecommunications in each country. To the
extent that the interpretation or enforcement of applicable laws and
regulations is uncertain or unclear: (1) we may provide services or use
transmission methods that violate U.S. or foreign laws or regulations; or (2)
we may fail to obtain approvals or to file certain reports or other documents
that may be required under such laws or regulations.

  If we are found to be in violation of applicable laws and regulations or if
our interpretation of such laws and regulations proves incorrect, we could be
subject to enforcement actions or lose, or be unable to obtain, regulatory
approvals necessary to provide certain services or to use certain transmission
methods. We cannot assure you that we will not be subject to fines, penalties
or other sanctions, including being denied the ability to offer products and
services, as a result of any violations, regardless or whether such violations
are corrected. In addition, we cannot assure you that future U.S. or foreign
regulatory, judicial and legislative actions or changes will not impair our
operations, or that domestic or international regulators or third parties will
not raise material issues with regard to our compliance with applicable
regulations. Any of these events could have a material adverse effect on our
business, financial condition or results of operations.

  Operating Results Subject to Significant Fluctuations--Our quarterly
operating results are subject to variation, which could cause us not to meet
the expectations of securities analysts, and should not be relied upon as an
accurate indicator of our overall performance.

  Our quarterly operating results are difficult to forecast with any degree of
accuracy because a number of factors subject these results to significant
fluctuations.

  Our operating results have fluctuated in the past and are likely to
fluctuate significantly in the future. These fluctuations could cause our
reported results to fall short of the expectations of securities analysts and
investors for such quarter, which could have a material adverse effect on the
market price of the notes, the warrants or our common stock. Factors that
could lead to such fluctuations include capital costs, the introduction of new
products and services, problems associated with entering new lines of business
and announcements about us or our competitors. Additional factors that may
contribute to variability of operating results include:

  .  the pricing and mix of services we offer;

  .  our customer retention rate;

                                      27
<PAGE>

  .  changes in pricing policies and product offerings by our competitors;

  .  growth in demand for network and Internet access services;

  .  one-time costs associated with acquisitions and regional consolidation;

  .  general telecommunications services' performance and availability; and

  .  other factors discussed in these risk factors.

  Our revenues in any given period can vary due to factors such as:

  .  delays or difficulties in the development of new products or programs or
     in the integration of business and network systems and other physical
     facilities and new management personnel;

  .  technical difficulties with or failures of portions of our network that
     impact our ability to provide services to or bill our customers;

  .  demand for and market acceptance of our Internet services;

  .  capacity utilization of our Internet service exchange facilities;

  .  the ability to maintain or increase peering relationships; and

  .  changes in our pricing policies and those of our competitors.

  In response to competitive pressures, we may take certain pricing or
marketing actions that could have a material adverse effect on our business,
financial condition or results of operations. Therefore, we believe that
period-to-period comparisons of our operating results are not necessarily
meaningful and cannot be relied upon as indicators of future performance.

  Customer Concentration--Our business would be seriously impaired if we lost
one or more of our significant customers.

  Our five largest customers accounted for approximately 29.3% of our revenues
for the twelve months ended December 31, 1999, and two of these customers
collectively accounted for approximately 19.0% of our revenues for that
period. Our operating and financial performance is currently dependent, in
large part, upon our relationships with these customers. We cannot assure you
that we will be able to maintain these relationships consistent with
historical levels or at all.

  Online Service Liability--We may face liability and other risks as a result
of information disseminated through our network.

  The law relating to the liability of Internet access, inter-connection and
service providers for information carried by their networks is currently
unsettled. It is possible that claims could be made against Internet access
and inter-connection providers under United States, European Union or other
foreign law for defamation, negligence, privacy, infringement, regulated
content or under other legal theories. We carry general liability insurance,
but it may not be adequate to compensate or cover us in the event that we
become liable for information carried by our network. In addition, legislation
has been recently passed, and continues to be proposed, that imposes liability
for or prohibits the transmission over the Internet of certain types of
information. The increased attention focused upon liability issues as a result
of potential lawsuits, new laws and legislative proposals could impact the
growth of Internet use.

  Anti-Takeover Provisions--Certain provisions of our charter, bylaws and
Delaware law may discourage or impede a change of control.

  Our board of directors has the authority to cause us to issue up to
5,000,000 shares of preferred stock and to determine the price, rights,
preferences and privileges of those shares without any further vote or actions
by the stockholders. Our board of directors authorized for issuance 50,000
shares of preferred stock designated as

                                      28
<PAGE>

Series A Junior Participating Preferred Stock. The rights of the holders of
our common stock will be subject to, and may be adversely affected by, the
rights of the holders of any preferred stock that we may issue in the future.
The issuance of shares of preferred stock could have the effect of making it
more difficult for a third party to acquire, or may discourage a third party
from attempting to acquire, a majority of our outstanding voting stock. Our
board is divided into three classes, each of which comes up for election once
every three years. As a result, it would not be possible for a person to take
control of our board in one election. We are subject to the anti-takeover
provisions of Section 203 of the Delaware General Corporation Law, which
prohibits us from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder unless the business
combination is approved in a prescribed manner. The application of Section 203
could have the effect of delaying or preventing a change of control.
Furthermore, certain provisions of our bylaws, including provisions that
provide that the exact number of directors shall be determined by a majority
of the board of directors, that vacancies on the board of directors may be
filled only by a majority vote of the directors then in office, though less
than a quorum, and that stockholder meetings may only be called by the board
of directors or the chairman of the board, may have the effect of delaying or
preventing a change in control, which could adversely affect the market price
of our common stock. In addition, our stockholders rights plan would cause
substantial dilution to a person or group that attempts to acquire us on terms
not approved by our board of directors. These provisions may discourage
takeover bids for us.

  No Future Dividends--We have not paid dividends on our common stock and do
not anticipate doing so in the foreseeable future.

  We have not paid dividends to date on our common stock and do not anticipate
paying any cash dividends on our common stock in the foreseeable future. Our
credit facility and the Cisco vendor financing facility restrict our ability
to pay dividends on our common stock. Future debt instruments may also contain
provisions restricting our ability to pay dividends on our common stock.

ITEM 2. PROPERTIES

  Our principal offices are located in 36,400 square feet of space in
Burlingame, California. We lease this space under agreements that expire in
December 2003 and beyond. We also lease a total of approximately 40,000 square
feet in the U.S. in New York, Los Angeles, Dallas, and Santa Ana, California
for our telecommunications switching equipment and retail operations and
75,000 square feet of space in the United Kingdom, New Zealand, Russia, Japan,
Germany, and Australia as sites for our offshore telecommunications switching
facilities. In addition, we lease a total of approximately 50,000 square feet
of space in the U.S., the United Kingdom, and Japan for our Internet
operations. We believe that our facilities are adequate to support our current
needs and that suitable additional facilities will be available, when needed,
on commercially reasonable terms.

ITEM 3. LEGAL PROCEEDINGS

  We are party to various legal proceedings in the ordinary course of
business. Although the ultimate resolution of the proceedings cannot be
ascertained, we do not expect that they will have a material adverse impact on
our business, financial condition, or results of operations.

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

  No matters were submitted to a vote of our shareholders during the fourth
fiscal quarter of the fiscal year ended December 31, 1999.


                                      29
<PAGE>

                                  MANAGEMENT

Our Executive Officers

  The following sets forth the names and ages of each of our executive
officers and the positions they hold:

<TABLE>
<CAPTION>
                Name                Age                 Position
                ----                ---                 --------
 <C>                                <C> <S>
 Howard A. Neckowitz..............  46  Chairman of the Board of Directors,
                                        President and Chief Executive Officer
 Gail E. Granton..................  44  Director, Co-Chief Operating Officer,
                                        Global Marketing and Offshore
                                        Development and Secretary
 Thomas J. Murphy.................  48  Co-Chief Operating Officer, Network
                                        Development and IP Services
 Robert F. Craver.................  57  Senior Vice President, International
                                        Relations
 Fred A. Weismiller...............  58  Executive Vice President, International
                                        Marketing
 Ronald D. Anderson...............  43  Senior Vice President, Operations and
                                        Engineering
 Sandra D. Grey...................  33  Chief Financial Officer and Vice
                                        President, Finance
</TABLE>


  Set forth below is a brief description of the business experience of each of
our executive officers.

  Howard A. Neckowitz has served as our President, Chief Executive Officer and
Chairman of the Board since our inception in August 1991. From 1986 to 1991,
Mr. Neckowitz served as a consultant to major U.S. and overseas
telecommunications companies with respect to valuation and due diligence
processes for the acquisition of ongoing foreign telecommunications operations
and the start-up of competitive carrier operations for international, long
distance, local and cellular operations in various countries. Mr. Neckowitz
served from 1982 to 1986 as Director, International Services, at GTE Sprint,
where he founded and developed GTE Sprint's international services operation.
In this position, he was responsible for feasibility analyses supporting GTE
Sprint's entrance into the international switch service market. From 1977 to
1982, Mr. Neckowitz worked at AT&T in its Overseas Department.

  Gail E. Granton became Co-Chief Operating Officer, Global Marketing and
Offshore Development in March 1999. Prior to her promotion, Ms. Granton served
as our Executive Vice President, International Business Development since our
inception in August 1991. Ms. Granton has been our Secretary and a Director
since our inception in August 1991. From August 1991 to August 1996, she
served as our Chief Financial Officer. From 1986 to August 1991, Ms. Granton
served as a consultant to major U.S. and overseas telecommunications
companies, focusing on the valuation and due diligence process for the
acquisition of ongoing foreign telecommunications operations and the start-up
of competitive carrier operations for international, long distance, local and
cellular operation in various countries. From 1982 to 1986, Ms. Granton worked
in the International Department of GTE Sprint as a Manager, International
Business Development, reporting to Mr. Neckowitz.

  Thomas J. Murphy became Co-Chief Operating Officer, Network Development and
IP Services in August 1999. Before that, he served as our Executive Vice
President, Global Networks and Multimedia Services since August 1998. From
1992 to 1998, Mr. Murphy worked at Cable and Wireless U.S., a
telecommunications company exclusively servicing the U.S. business market,
where he served as the Chief Operating Officer. Mr. Murphy has extensive
experience in telecommunications operational activities including facilities
management, technical operations, network operations, project management and
network planning. Mr. Murphy has worked in the telecommunications industry for
over 20 years.

                                      30
<PAGE>

  Robert F. Craver has served as our Senior Vice President, International
Relations since February 1994. Prior to joining us, Mr. Craver worked at GTE
Hawaiian Telephone Co., Inc. from 1987 to 1994. While at GTE Hawaiian
Telephone, Mr. Craver directed that company's international program as
Director of International Services. Mr. Craver has also held international
positions at Sprint and AT&T, for a total of more than 21 years of experience
in the international telecommunications industry. Mr. Craver has extensive
experience in international negotiations with foreign partners and has served
as an officer of the Pacific Telecommunications Council.

  Fred A. Weismiller has served as our Executive Vice President, International
Marketing since he joined us in November 1994. Mr. Weismiller's
responsibilities include developing foreign-based customers for basic
international long distance and IP-based services. From 1991 to 1994,
Mr. Weismiller served as Managing Director and Executive Director, Sales and
Marketing at Telecom New Zealand. Mr. Weismiller has 30 years of experience in
international and domestic telecommunications management, including 20 years
with AT&T, where his final assignment was in Hong Kong as the Managing
Director of the AT&T Regional Technical Center.

  Ronald D. Anderson has served as our Senior Vice President, Operations and
Engineering since December 1992. From 1986 to 1992, Mr. Anderson served in a
similar position with TRT International, Inc., an international
telecommunications carrier that has since been acquired by MCI WorldCom. Mr.
Anderson has more than 16 years of experience in domestic and international
telecommunications engineering and operations, with significant experience in
international signaling and transmission for cable and satellite, PTT
technical interface and bilateral technical negotiations.

  Sandra D. Grey has served as our Chief Financial Officer and Vice President,
Finance since August 1996. From 1989 to 1996, Ms. Grey worked for Telecom New
Zealand, the primary provider of telecommunications services in New Zealand,
where she was Chief Financial Officer of its international subsidiary. Ms.
Grey has more than eight years experience in the international
telecommunications industry. Ms. Grey has resigned her position to join
another company. We expect to name her successor shortly.


                                      31
<PAGE>

                                    PART II

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

  The Common Shares were initially offered to the public on July 19, 1996, at
a price of $12.00 per share. The Common Shares are quoted on the NASDAQ
National Market under the symbol "PGEX."

  The following table sets forth, for the periods indicated, the high and low
sales prices for the Common Shares as reported by the NASDAQ National Market.
Such prices reflect inter-dealer prices, without retail mark-up, mark-down or
commission, and do not necessarily represent actual transactions.

<TABLE>
<CAPTION>
                                                                 High     Low
                                                                ------- -------
   <S>                                                          <C>     <C>
   Quarter ended March 31, 1998................................ $57.875 $43.188
   Quarter ended June 30, 1998................................. $60.750 $38.875
   Quarter ended September 30, 1998............................ $46.750 $26.500
   Quarter ended December 31, 1998............................. $49.250 $23.250
   Quarter ended March 31, 1999................................ $47.563 $22.500
   Quarter ended June 30, 1999................................. $42.875 $26.375
   Quarter ended September 30, 1999............................ $31.000 $14.000
   Quarter ended December 31, 1999............................. $24.375 $15.438
</TABLE>

  As of March 27, 2000, there were 142 holders of record of our Common Shares.

  We have never paid cash dividends on our Common Stock and have no plans to
do so in the foreseeable future. We intend to retain earnings to develop and
expand our business.

ITEM 6. SELECTED FINANCIAL DATA

  The following selected consolidated financial data as of and for each of the
five years in the period ended December 31, 1999, have been derived from our
audited consolidated financial statements. The following data should be read
in conjunction with the consolidated financial statements and the notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included herein.

<TABLE>
<CAPTION>
                                         Year Ended December 31,
                               -----------------------------------------------
                                 1999      1998      1997      1996     1995
                               --------  --------  --------  --------  -------
                                (In thousands, except per share amounts)
<S>                            <C>       <C>       <C>       <C>       <C>
Statement of Operations Data:
Revenues...................... $604,591  $466,291  $298,609  $162,426  $76,416
Cost of long distance
 services.....................  516,671   393,640   254,076   140,340   66,346
                               --------  --------  --------  --------  -------
  Gross profit................   87,920    72,651    44,533    22,086   10,070
Selling, general and
 administrative expenses......   62,865    36,791    21,416    11,113    5,467
Depreciation and
 amortization.................   14,691     8,713     5,417     2,044    1,124
                               --------  --------  --------  --------  -------
Operating income..............   10,364    27,147    17,700     8,929    3,479
Other (income) expense, net...   (1,090)   (1,132)     (126)      129      --
Interest (income) expense,
 net..........................     (923)   (2,292)   (2,009)     (885)     538
                               --------  --------  --------  --------  -------
  Income before income taxes..   12,377    30,571    19,835     9,685    2,941
Provision for income taxes....    4,332    10,635     7,338     3,877    1,155
                               --------  --------  --------  --------  -------
  Net income.................. $  8,045  $ 19,936  $ 12,497  $  5,808  $ 1,786
                               ========  ========  ========  ========  =======
  Net income per share--
   diluted.................... $   0.41  $   0.97  $   0.64  $   0.34  $  0.12
                               ========  ========  ========  ========  =======
Weighted average number of
 common shares outstanding--
 diluted......................   19,772    20,495    19,497    16,872   14,535
                               ========  ========  ========  ========  =======
</TABLE>

                                      32
<PAGE>

<TABLE>
<CAPTION>
                                      Year Ended December 31,
                         ----------------------------------------------------
                            1999        1998        1997      1996     1995
                         ----------  ----------  ---------- -------- --------
                          (In thousands, except revenues per minute of use
                                              amounts)
<S>                      <C>         <C>         <C>        <C>      <C>
Other Operating Data:
EBITDA(1)............... $   25,055  $   35,860  $   23,117 $ 10,973 $  4,603
Capital expenditures.... $   69,644  $   49,611  $   36,725 $ 18,669 $  7,233
Minutes of use..........  2,465,003   1,635,285   1,025,649  563,495  252,925
Revenues per minute
 use.................... $     0.24  $     0.29  $     0.29 $   0.29 $   0.30
<CAPTION>
                                         As of December 31,
                         ----------------------------------------------------
                            1999        1998        1997      1996     1995
                         ----------  ----------  ---------- -------- --------
                                           (In thousands)
<S>                      <C>         <C>         <C>        <C>      <C>
Balance Sheet Data:
Cash and cash
 equivalents............ $   27,189  $   30,041  $   43,850 $ 45,563 $  1,792
Working capital
 (deficit).............. $  (54,388) $   (7,649) $   14,541 $ 35,051 $ (6,412)
Total assets............ $  374,805  $  235,637  $  171,617 $103,816 $ 29,976
Stockholders' equity.... $  115,019  $  100,639  $   76,573 $ 62,472 $  2,891
</TABLE>
--------
(1) EBITDA represents earnings before interest expense, income taxes,
    depreciation and amortization expense. EBITDA does not represent cash
    flows as defined by generally accepted accounting principles and does not
    necessarily indicate that cash flows are sufficient to fund all of our
    cash needs. EBITDA is a financial measure commonly used in our industry
    and should not be considered in isolation or as a substitute for net
    income, cash from operating activities, or other measures of liquidity
    determined in accordance with generally accepted accounting principles.

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

Note on forward-looking statements

  This Annual Report contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Forward-looking
statements are statements other than historical information or statements of
current condition. Some forward-looking statements may be identified by use of
terms such as "believes," "anticipates," "plans," "intends," "may," "expects,"
"estimates," or other similar expressions. These forward-looking statements
relate to the plans, objectives, and expectations of Pacific Gateway Exchange,
Inc. ("Pacific Gateway", "we", "our", or "the Company") regarding our future
operations or financial performance or related to our expectations regarding
the telecommunications industry. In light of the inherent risks and
uncertainties of any forward-looking statement, the inclusion of forward-
looking statements in this report should not be regarded as a representation
by us or any other person that the forward-looking statements will come true.

  Our revenues and results of operations and future developments in the
telecommunications industry are subject to risks and uncertainties and could
differ materially from those projected in the forward-looking statements as a
result of numerous factors, including the following:

    1. availability of financing on acceptable terms, conditions in the
       credit market and availability of additional equity on acceptable
       terms;

    2. difficulties that may be encountered in the development of bandwidth
       services, including construction delays, regulatory obstacles,
       contract disputes, or the lack or opportunities for additional
       bandwidth purchases;

    3. uncertainties in the growth of our retail operations and the
       development of our new business lines, such as our VOIP, bandwidth,
       and Internet operations, including uncertainties about the difficulty
       of integrating acquisitions, hiring appropriate personnel, and
       competitive conditions;


                                      33
<PAGE>

    4. the termination of operating agreements with other carriers or the
       inability to enter into additional operating agreements;

    5. inaccuracies in our forecasts of traffic;

    6. changes in the availability of transmission facilities such as
       domestic, international, and undersea fiber optic cable systems or in
       the feasibility, timing, or expense of building or leasing such
       facilities;

    7. loss of the services of key officers;

    8. loss of a customer that provides significant revenues;

    9. opportunities for, and problems relating from, the acquisition of
       other companies or facilities;

    10. changes in the ratios between the amount of telecommunication traffic
       that we deliver and the amount we receive from our foreign partners
       under our operating agreements and termination arrangements;

    11. Internet growth at slower rates than expected; or

    12. consolidation of our competitors within the telecommunications,
       bandwidth, or Internet industries.

  See "Risk Factors" included in Part I of this 10-K for additional reasons
why the forward-looking statements may not be realized. The foregoing review
of important factors, including those discussed in detail in this 10-K, should
not be construed as exhaustive. We undertake no obligation to release publicly
the results of any future revisions it may make to forward-looking statements
to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.

Overview

  Pacific Gateway Exchange was founded in August 1991 to capitalize on the
significant growth opportunities in the international telecommunications
services market. Since then, we have undertaken five strategic initiatives in
response to regulatory and technological developments: (1) as foreign
countries deregulated their telecommunications markets, we started offshore
wholesale operations; (2) in response to technological innovation and consumer
demand, we entered the market for retail services; (3) to participate in the
growth of the Internet, in 1999, we began our Internet operations by providing
connectivity and co-location services and it plans to provide other Internet
services to the global Internet community; (4) to take advantage of the
Internet as a medium of telephony, we recently began providing VoIP services
to telecommunications carriers, ISPs, and other value-added service providers;
and (5) to meet the growing global demand for high bandwidth fiber optic
capacity, we have acquired significant interests in strategic, state-of-the-
art undersea and land-based cable systems. We use the bandwidth capacity for
our own operations in addition to selling, leasing, and exchanging it in
opportunistic transactions.

  We expect our growth strategy to have a number of effects on our future
results of operations. In particular, we expect to: (1) generate losses from
our Internet services business as a result of substantial start-up costs;
(2) receive substantial cash proceeds from sales or leases of bandwidth
capacity; (3) incur increased interest costs attributable to indebtedness; and
(4) incur increased administrative expenses as we pursue strategic and
financing alternatives to address liquidity. As a result of our success in
expanding our service offerings, we are de-emphasizing our wholesale selling
efforts. Therefore, we expect; (1) lower future revenues and gross profits
from our wholesale telecommunications business; (2) revenues from our retail
and VoIP services to partially offset our decreased wholesale revenues in 2000
and fully offset them in 2001 and beyond; and (3) gross profits from our
retail operations and VOIP operations to fully offset our decreased wholesale
gross profits in 2000 and beyond.

  Prior to 1999, our business consisted entirely of telecommunications
operations. We managed our business in segments of wholesale, offshore, and
retail telecommunication operations. As a result of the diversification of our
business, we now manage our business in segments of telecommunications,
Internet, and bandwidth services. The operating results of these segments are
regularly reviewed by and are integral to management and its

                                      34
<PAGE>

decision-making process. Financial information on our new operating segments
is included in Note (12) entitled "Segment Data" in the Notes to the
Consolidated Financial Statements.

  As described above, we derive our revenues from three operating segments:
telecommunications, Internet, and bandwidth services. Our telecommunications
revenues are based upon the number of minutes billable and recorded upon
completion of a call. We derive telecommunication revenues from carrying a mix
of wholesale and retail long distance traffic in the U.S. and offshore. We
expect to increase our retail telecommunication revenues from internal growth
through sales and marketing efforts focused on customers with significant
international long-distance usage, including other telecommunications
carriers, ethnic, and other retail customers and re-sellers, and by offering
new products, such as bundled services. As it has done in the past, we plan to
seek strategic acquisitions that expand our customer base and increase our
market share.

  Prices in the long distance industry have decreased in recent years and, as
competition continues to increase, we believe that prices are likely to
continue to decrease. In addition, as deregulation accelerates and competition
increases in offshore markets, our revenues per minute are likely to be
adversely impacted. We believe that such decreases in prices will be offset by
increased telecommunications usage.

  Cost of telecommunications revenue is comprised primarily of costs incurred
from other domestic and foreign telecommunications carriers to originate,
transport, and terminate calls. The majority of our cost of telecommunication
revenue is variable, based upon the number of minutes of use, with
transmission and termination costs being our most significant expense. As we
increase the portion of traffic transmitted over our owned or leased
facilities, the cost of telecommunication revenue will be increasingly
comprised of fixed costs. We seek to lower our cost of telecommunication
revenue by:

  . optimizing the routing of calls over the lowest cost route;

  . increasing volumes on our owned lines;

  . negotiating lower variable usage based costs with domestic and foreign
    service providers and negotiating additional and lower cost foreign
    carrier agreements with the foreign incumbent carriers and others; and

  . continuing to expand our network to extend our global reach.

  We generally realize a higher average price per minute and gross margin on
our international calls as compared to our domestic long distance services and
a higher average price per minute and gross margin on our retail services as
compared to our wholesale services. Although wholesale services generate a
lower gross margin than retail services, they are an important part of our
business because the high traffic volume of our wholesale customers improves
the utilization of the network and allows for greater flexibility in
negotiating rates from suppliers. Our overall average price per minute and
gross margin may fluctuate based on our relative volume of international
versus domestic long distance services, wholesale services versus retail
services, and the proportion of traffic carried on our owned network versus
resale of other carrier services.

  We began generating Internet service revenues in the third quarter of 1999.
Internet revenues include service provider fees and web design revenues. In
1999, Internet service revenues accounted for 1% of our total revenues.

  We sell or lease bandwidth capacity on our global network. As of December
31, 1999, we had entered into agreements to sell or lease bandwidth capacity
(including maintenance services) valued by the parties at $141.1 million. Of
the $141.1 million, $30.0 million relates to operating and maintenance
revenues to be received over the terms of the contracts (which is generally 20
years), $57.5 million consists of other cash proceeds that we expect to
receive over time and the balance consists of network assets valued by the
parties at $53.6 million to be delivered over time in exchange for bandwidth
capacity. Of these amounts, we expect to receive cash proceeds, including
operating and maintenance revenues of $15.4 million in 2000. The proceeds from
these sales or leases will be used to fund the expansion of our network and to
meet working capital requirements and other

                                      35
<PAGE>

cash needs. The exchanged assets will provide us with a more extensive network
to support our other operations. We are considering significant sales of fiber
optic capacity to offset possible liquidity shortages in 2000.

  Effective June 30, 1999, the Financial Accounting Standards Board ("FASB")
issued FASB Interpretation No. 43, "Real Estate Sales," ("FIN 43"), which
affirms that sales of "integral equipment" be accounted for in accordance with
real estate accounting rules as previously set forth in FASB Statement No. 66.
The application of FIN 43 has resulted in the classification of undersea and
land-based fiber optic cables and related equipment as "integral equipment" as
defined by FIN 43. This change in the accounting for indefeasible rights to
use ("IRUs") fiber optic capacity does not change the timing or amount of cash
proceeds or network assets that we expect to receive under the commitments
that it has made to sell or lease bandwidth capacity. It does, however,
require us to recognize the revenue from some agreements as operating leases
over the lives of the agreements as opposed to prior industry practice. Prior
to the adoption of FIN 43, we recognized revenue during the period in which it
provided initial access to the capacity.

  By way of example, if we enter into a 20-year IRU capacity agreement that
provides for cash payments of $100 million, under prior industry practice, we
would have recorded revenues of $100 million when it delivered the capacity.
By contrast, in accordance with FIN 43, although we would still receive the
cash payments of $100 million at the same time, we would recognize revenues of
$5 million per year over the 20-year term of the agreement.

  Our selling, general, and administrative expenses are comprised primarily of
salaries, commissions, occupancy costs, sales and marketing expenses,
advertising expenses, administrative costs, and sales allowances. These
expenses have been increasing significantly with the expansion of our
operations into retail and Internet services. Management expects this trend to
continue and believes that we will incur additional selling, general and
administrative expenses to support the expansion of our operations into
Internet services. The rapid expansion of our Internet operations will require
significant additional personnel, which likely will affect our operating
results.


  We expect that our increased capital investment activity in the future to
affect our operating results in the near term due to increased depreciation
charges and interest expense in connection with borrowings to fund such
expenditures. These costs will be incurred in advance of the realization of
the expected improvements in operating results from such investments.

  Although our functional currency is the United States dollar, a significant
portion of our revenues are derived from sales and operations outside the
United States. In the future, we expect to continue to derive a portion of our
revenues and incur operating costs from our operations outside the United
States and therefore changes in exchange rates may have an effect on our
results of operations. We historically have not engaged in hedging
transactions and do not currently contemplate engaging in hedging transactions
to mitigate foreign exchange risks.

  As a result of our liquidity issues, our auditors have included a going
concern explanation to their opinion. See "Risk Factors" and "Liquidity and
Capital Resources."

                                      36
<PAGE>

Results of Operations

  The following table sets forth income statement data as a percentage of
revenues for the period indicated.

<TABLE>
<CAPTION>
                                                            Year Ended
                                                           December 31,
                                                         ---------------------
                                                         1999    1998    1997
                                                         -----   -----   -----
<S>                                                      <C>     <C>     <C>
Revenues................................................ 100.0 % 100.0 % 100.0 %
Cost of services and capacity sold......................  85.5 %  84.4 %  85.1 %
                                                         -----   -----   -----
  Gross profit..........................................  14.5 %  15.6 %  14.9 %
Selling, general and administrative expenses............  10.4 %   7.9 %   7.2 %
Depreciation and amortization...........................   2.4 %   1.9 %   1.8 %
                                                         -----   -----   -----
  Total operating expenses..............................  12.8 %   9.8 %   9.0 %
                                                         -----   -----   -----
Operating income........................................   1.7 %   5.8 %   5.9 %
Other (income) expense, net.............................  (0.1)%  (0.2)%   0.0 %
Interest (income) expense, net..........................  (0.2)%  (0.6)%  (0.7)%
                                                         -----   -----   -----
  Income before income taxes............................   2.0 %   6.6 %   6.6 %
Provision for income taxes..............................   0.7 %   2.3 %   2.4 %
                                                         -----   -----   -----
  Net income............................................   1.3 %   4.3 %   4.2 %
                                                         =====   =====   =====
</TABLE>

 Year Ended December 31, 1999, Compared to the Year Ended December 31, 1998

  Revenues: Total revenues increased 29.7% to $604.6 million in 1999 from
$466.3 million in 1998. The increase was a result of revenue growth in our
telecommunications services and the introduction of our bandwidth and Internet
services. Telecommunications revenues increased 28.1% to $597.4 million from
$466.3 million in 1998. The increase resulted from an increase in minutes of
use to 2.5 billion in 1999 from 1.6 billion in 1998. The increase in the
number of minutes also resulted from the elasticity associated with decreasing
prices, as the average price per minute charged to customers decreased to
$0.24 in 1999, from $0.29 in 1998. Also contributing to the increase in the
number of minutes was an increase in the number of retail customers primarily
attributable to our acquisition of several retail businesses. Bandwidth
revenues in 1999 were $6.6 million, representing sales of bandwidth capacity
delivered to customers. Refer to the discussion above on the accounting
treatment of revenue recognition of future sales and leases of bandwidth
capacity. Internet revenues in 1999 were $0.6 million, attributable to the
commencement of our Internet services in September 1999. There were no
bandwidth or Internet revenues in 1998.

  Gross profit: Gross profit increased 21.0% to $87.9 million in 1999 from
$72.7 million in 1998. Gross margin as a percentage revenues decreased to
14.5% in 1999, from 15.6% in 1998. Telecommunications gross profit increased
12% to $81.7 million in 1999 from $72.7 million in 1998. Increased competition
continues to drive wholesale telecommunications prices downward resulting in
decreased wholesale telecommunications gross margins. This decrease was
partially offset by higher retail gross profit. Bandwidth gross profit was
$5.8 million in 1999 due to the delivery of bandwidth capacity on our network.
Future bandwidth gross profits will be impacted by the application of FIN 43,
as discussed above. Internet gross profit was $0.4 million in 1999.

  Selling, general, and administrative expenses (SG&A): SG&A expenses
increased 70.9% to $62.9 million in 1999 from $36.8 million in 1998. As a
percentage of revenues, SG&A expenses were 10.4% in 1999, an increase from
7.9% in 1998. This increase was due primarily to increased personnel and sales
commission expenses. The increase in personnel expenses was directly related
to the increase in the number of employees in our wholly-owned subsidiaries to
386 at December 31, 1999, from 165 at December 31, 1998. In 1999, we hired
retail back-office and telemarketing personnel supporting our increasing
revenue base and additional personnel to support the commencement of our
Internet services' business. We may expand these functions to increase future
revenues and cash flows. In 1999, we also incurred $17.5 million in start-up
and related costs for our Internet initiatives. In the near term, we expect to
incur additional start-up costs to provide Internet services.

                                      37
<PAGE>

  Depreciation and amortization: Depreciation and amortization increased 68.6%
to $14.7 million in 1999, from $8.7 million in 1998. Depreciation as a
percentage of revenues was 2.4% in 1999 and 1.9% in 1998. The increase was
primarily due to depreciation of additional telecommunications equipment
acquired since December 31, 1998. Amortization of goodwill and software
development costs also contributed to the increase. Depreciation will continue
to increase as the Japan-U.S. and TAT-14 cable systems, the related back-haul
facilities, and our Internet service equipment are placed in service.

  Interest: Interest income decreased to $0.9 million in 1999, from $2.3
million in 1998 due to decreased average cash balances. We had $22.7 million
in average cash balances in 1999, compared to $33.6 million in 1998. In
addition, we have capitalized the interest costs that relate to network and
facility construction per SFAS No. 34, "Capitalization of Interest Cost." We
will amortize the capitalized interest over the related asset's life.

  Income tax: Income taxes decreased 59.3% to $4.3 million in 1999, from $10.6
million in 1998, primarily due to decreased operating income. The effective
tax rate increased to 35.0% in 1999 from 34.8% in 1998.

Year Ended December 31, 1998 Compared to the Year Ended December 31, 1997

  Revenues: Total revenues increased 56.2% to $466.3 million in 1998 from
$298.6 million in 1997. The increase was primarily the result of growth in our
U.S. wholesale, offshore and retail markets. U.S. wholesale revenues grew from
$279.8 million in 1997 to $390.6 million in 1998. This growth is attributed to
an increase in volume of traffic in the U.S. market and an increase in number
of U.S. wholesale customers to 102 at December 31, 1998, from 90 at December
31, 1997. Our offshore operations in the UK, Russia, New Zealand, and Japan
generated $55.7 million in revenue in 1998 compared to $17.7 million in 1997.
Offshore operations began in 1997 with 35 customers at December 31, 1997, and
grew to 61 customers at December 31, 1998. Retail services, which primarily
provides international long distance services to certain ethnic markets,
contributed $20.0 million to revenue in 1998 compared to $1.1 million in 1997.
As a result of this growth, total minutes increased 59% from 1997 while the
average price per minute charged to customers remained unchanged at $0.29.
During 1998, we experienced price decreases; however, our average price per
minute remained unchanged from 1997 because we were able to expand our
operations in the offshore markets and diversify our operations to include
retail services, both of which generally offer higher prices. The change in
the terminating country mix with significantly different rates per minute, the
reduction in the rates received for the traffic terminating in and transiting
the United States and the increase in the incidental United States domestic
terminating traffic are additional factors influencing the average price per
minute.

  Gross profit: Gross profit increased 63.1% to $72.7 million in 1998 from
$44.5 million in 1997. Gross margin as a percentage of revenues increased to
15.6% in 1998, from 14.9% in 1997, primarily due to the expansion of
operations to include additional offshore markets and the diversification of
operations to include retail services. The offshore and retail services
contributed to gross margin by maintaining higher prices while utilizing our
existing U.S. wholesale low-cost network and back-office systems. In addition,
in the U.S. wholesale operations, we generally paid lower access rates to
carriers terminating our traffic than we paid in 1997.

  Selling, general, and administrative expenses: SG&A expenses increased 71.8%
to $36.8 million in 1998 from $21.4 million in 1997. As a percentage of
revenues, SG&A expenses were 7.9% in 1998, an increase from 7.2% in 1997. This
increase was due primarily to increased personnel as the number of employees
at our wholly owned subsidiaries grew to 165 from 90 at December 31, 1997. In
addition, we incurred increased sales commission expenses payable to our joint
venture, PinTouch Telecom, which markets our retail services to the Filipino-
American ethnic market.

  Depreciation and amortization: Depreciation and amortization increased 60.9%
to $8.7 million in 1998 from $5.4 million in 1997 representing 1.9% of 1998
total revenues. The increase was primarily due to depreciation of the
additional transmission facilities acquired in 1998.

  Interest income: Interest income increased 14.1% to $2.3 million in 1998
from $2.0 million in 1997. We had average cash balances of $34 million in
1998, compared to $30 million in 1997.

                                      38
<PAGE>

  Other (income) expense, net: Other income was $1.1 million in 1998, compared
to $0.1 million in 1997. The increase was due to the equity earnings of our
unconsolidated joint venture, PinTouch Telecom.

  Income tax: Income taxes increased to $10.6 million from $7.3 million,
primarily due to increased operating income. However, the effective tax rate
decreased to 34.8% in 1998 from 37% in 1997. The decrease in the effective tax
rate was attributable to foreign subsidiaries' earnings, a portion of which we
intend to reinvest indefinitely in operations outside the U.S.

Liquidity and Capital Resources

  We use our existing cash balances, cash provided by operating activities,
existing lines of credit, and debt facilities to finance our operations.

  Net cash provided by operating activities increased to $30.4 million in 1999
from $28.9 million in 1998. This increase in cash provided by operating
activities was primarily due to increased liabilities and deferred revenues,
partially offset by increased accounts receivable balances. These increases
resulted from our expansion.

  Net cash used in investing activities increased to $87.1 million in 1999, up
from $52.9 million in 1998 and $36.5 million in 1997. Capital expenditures in
1999 totaled $69.6 million, compared to $49.6 million in 1998 and $36.7
million in 1997. The capital expenditures in 1999 were for undersea fiber
optic cable and offshore transmission equipment, while capital expenditures in
1998 were primarily for transmission equipment. Capital expenditures in 1997
were primarily for domestic switches. In 1999, we invested a total of $17.4
million in cash to acquire retail businesses and an Internet service provider.
Of the $17.4 million, we acquired: (1) telecommunications businesses for $15.0
million; and (2) Onyx Internet Ltd., a United Kingdom Internet service
provider and Web designer, for $2.4 million in cash. In the first quarter of
1998, we acquired 16.66% of a Mexican multimedia company for $3.3 million in
cash and $1.8 million in Pacific Gateway's common stock.

  Net cash provided by financing activities was $53.9 million in 1999, $10.2
million in 1998, and $0.5 million in 1997. In 1999, we borrowed an additional
$45.4 million under our credit facility (discussed below) and obtained $10.0
million in financing from GE Capital Corporation. We also received proceeds
from the exercise of stock options and dividends from our equity investment in
PinTouch.

  In November 1999, we obtained a one-year $100 million credit facility from
Deutsche Bank Securities Inc and Banc of America Securities LLC. At December
31, 1999, we had $54.1 million in borrowings under our credit facility. At
March 30, 2000, we had $75.6 million in borrowings under this facility.

  We were in default of certain provisions of this credit agreement, at
December 31, 1999, and on subsequent dates. On March 31, 2000, we obtained a
waiver of the defaults and an extension of the credit facility from April 1,
2000, to May 15, 2000. Pursuant to this waiver and extension: (1) the amount
available for us to borrow will be reduced to $75.6 million, which is the
amount currently outstanding; (2) the interest rate on our loans will increase
from LIBOR +3.5% to Bank of America's reference rate +2.5%; and (3) the credit
facility will be reduced to $50 million on May 15, 2000, which, will require
us to pay approximately $25.6 million on or before that date. In addition, we
will be responsible for certain fees and expenses of the banks, which we
expect will initially be $450,000. We cannot assure you that we will be able
to comply with the terms of the credit agreement as amended.

  If we default on our credit agreement, the banks have the right to
immediately accelerate this indebtedness and foreclose on the assets that we
have pledged as security. In addition, a default under this bank credit
agreement would result in a cross default under our Cisco financing
arrangement.

                                      39
<PAGE>

  In December 1999, we obtained $10.0 million in financing from GE Capital
Corporation (GECC), to be used to finance our expansion and to meet our
working capital needs. We plan to expand our financing with GECC.

  Also in December 1999, we obtained a $15.0 million vendor financing facility
from Cisco Systems Capital Corporation. The facility may be used to finance
the purchase of Cisco Internet routers and related hardware and software. At
December 31, 1999, we held no amount outstanding under this vendor financing.

  At December 31, 1999, we had outstanding commitments, due before December
31, 2000, of approximately $145.0 million. This includes the commitment to
purchase undersea fiber optic cable in the Japan-US cable network for $55.6
million and in the TAT-14 cable system for $64.1 million. As part of our
global network expansion, we plan to invest substantial amounts in back-haul
facilities in Europe, Japan, and the U.S. Also, we committed to purchase the
international retail division of NOSVA Limited Partnership in December 1999.
The

                                      40
<PAGE>

purchase price of $40.2 million is comprised of $21.0 million in cash and
$19.2 million in our common stock. Pending regulatory approval, we expect to
close the acquisition in the second quarter of 2000. In addition, we have
experienced difficulty in making timely payments on our vendor invoices.

  In March 2000, a leading developer of Internet infrastructure software
agreed to make an equity investment of up to $8 million in Onyx Networks, our
Internet subsidiary, conditioned upon an equal amount being invested by other
investors. In addition, our Internet subsidiary, Onyx Networks, committed to
purchase approximately $28 million of software. These amounts are payable in
monthly installments of varying length ranging from 15 to 24 installments,
beginning June 1, 2000. We have guaranteed these payments.

  As of December 31, 1999, we had entered into agreements to sell or lease
bandwidth capacity (including maintenance services) valued by the parties at
$141.1 million, of which $30.0 million relates to operating and maintenance
revenues to be received over the term of the contracts, which is generally 20
years. Of the $141.1 million: 1) we expect to receive cash proceeds over time
of $87.5 million, of which we expect to receive $15.4 million in 2000; and 2)
network assets valued by the parties at $53.6 million in exchange for our
bandwidth capacity delivered over time.

  Additional financing arrangements are necessary to satisfy our capital
requirements and the failure to obtain such arrangements could have a material
adverse effect on our results of operation or financial condition. As a result
of our liquidity situation, our auditors have included a going concern
explanation to their audit report. To fund our planned capital requirements
and operations, we are actively exploring several alternatives to fund or
reduce our capital commitments, including: 1) public or private sales of our
securities; 2) sales of fiber optic capacity; and 3) minority investments in
Onyx Networks, our Internet subsidiary; or 4) a sale of one or more of our
subsidiaries. The Company has engaged Salomon Smith Barney to provide
financial advisory and investment banking services regarding possible
strategic alternatives. In addition, Deutsche Bank Securities Inc. and Banc of
America Securities LLC are providing assistance with respect to locating and
identifying financing opportunities, including the possible initial public
offering of the common stock of Onyx Networks, our Internet subsidiary. The
timing and terms of any financing activities will be subject to market
conditions and other factors beyond our control. There can be no assurance
that such financing arrangements will be consummated.

Year 2000

  The "Year 2000" issue was the risk that our internal computer systems,
network elements, software applications, and other business systems may not
have properly reflected or recognized the year 2000. The expenses associated
with our Year 2000 remediation program did not have a material effect on our
operating results or financial condition in 1999. We experienced no
significant Year 2000 related problems, however, there can be no assurance
that and any loss incurred by any of our customers as a result of the Year
2000 problem will not have a material adverse impact on our financial
condition or results of operations in the future.

                                      41
<PAGE>

Quarterly Results of Operations

  The following tables set forth statement of operations data for each of our
last eight calendar quarters and the percentage of our revenues represented by
each line item reflected therein. This information has been prepared on the
same basis as the audited financial statements contained herein. In
management's opinion, reflects all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the information
for the periods presented. The operating results for any quarter are not
necessarily indicative of results for any future period.

<TABLE>
<CAPTION>
                                                        Quarter Ended:
                          -----------------------------------------------------------------------------------------
                          Dec. 31,     Sept.     June 30,   March 31,   Dec. 31,   Sept. 30,   June 30,   March 31,
                            1999      30, 1999     1999       1999        1998       1998        1998       1998
                          --------    --------   --------   ---------   --------   ---------   --------   ---------
                                      Restated   Restated   Restated
<S>                       <C>         <C>        <C>        <C>         <C>        <C>         <C>        <C>
(In thousands, except
 per share amounts)
Revenues................  $154,415    $170,061   $139,586   $140,529    $126,414   $124,853    $109,952   $105,072
Cost of services and
 capacity sold..........   128,839     144,964    121,433    121,435     106,804    104,644      92,951     89,241
                          --------    --------   --------   --------    --------   --------    --------   --------
 Gross profit...........    25,576      25,097     18,153     19,094      19,610     20,209      17,001     15,831
Selling, general, and
 administrative
 expenses...............    21,620      17,317     12,759     11,169      10,327     11,612       7,290      7,562
Depreciation and
 amortization...........     4,781       3,785      3,344      2,781       2,395      2,209       2,146      1,963
                          --------    --------   --------   --------    --------   --------    --------   --------
 Total operating
  expenses..............    26,401      21,102     16,103     13,950      12,722     13,821       9,436      9,525
                          --------    --------   --------   --------    --------   --------    --------   --------
 Operating income.......      (825)      3,995      2,050      5,144       6,888      6,388       7,565      6,306
Other (income) expense,
 net....................       (44)       (299)      (524)      (223)        (14)    (1,712)        496         98
Interest (income)
 expense, net...........      (298)       (158)      (249)      (218)       (591)      (532)       (556)      (613)
                          --------    --------   --------   --------    --------   --------    --------   --------
 Income before income
  taxes.................      (483)      4,452      2,823      5,585       7,493      8,632       7,625      6,821
Provision for income
 taxes..................      (169)      1,558        988      1,955       2,470      2,980       2,740      2,445
                          --------    --------   --------   --------    --------   --------    --------   --------
 Net income.............  $   (314)   $  2,894   $  1,835   $  3,630    $  5,023   $  5,652    $  4,885   $  4,376
                          ========    ========   ========   ========    ========   ========    ========   ========
 Net income per share--
  diluted...............  $  (0.02)   $   0.15   $   0.09   $   0.18    $   0.25   $   0.29    $   0.25   $   0.22
                          ========    ========   ========   ========    ========   ========    ========   ========


<CAPTION>
                                      As a Percentage of Revenues for the Quarter Ended:
                          -----------------------------------------------------------------------------------------
                          Dec. 31,     Sept.     June 30,   March 31,   Dec. 31,   Sept. 30,   June 30,   March 31,
                            1999      30, 1999     1999       1999        1998       1998        1998       1998
                          --------    --------   --------   ---------   --------   ---------   --------   ---------
                                      Restated   Restated   Restated
<S>                       <C>         <C>        <C>        <C>         <C>        <C>         <C>        <C>
Revenues................     100.0 %     100.0 %    100.0 %    100.0 %     100.0 %    100.0 %     100.0 %    100.0 %
Cost of services and
 capacity sold..........      83.4 %      85.2 %     87.0 %     86.4 %      84.5 %     83.8 %      84.5 %     84.9 %
                          --------    --------   --------   --------    --------   --------    --------   --------
 Gross margin...........      16.6 %      14.8 %     13.0 %     13.6 %      15.5 %     16.2 %      15.5 %     15.1 %
Selling, general, and
 administrative
 expenses...............      14.0 %      10.2 %      9.1 %      7.9 %       8.2 %      9.3 %       6.6 %      7.2 %
Depreciation and
 amortization...........       3.1 %       2.2 %      2.4 %      2.0 %       1.9 %      1.8 %       2.0 %      1.9 %
                          --------    --------   --------   --------    --------   --------    --------   --------
 Total operating
  expenses..............      17.1 %      12.4 %     11.5 %      9.9 %      10.1 %     11.1 %       8.6 %      9.1 %
                          --------    --------   --------   --------    --------   --------    --------   --------
 Operating income.......      (0.5)%       2.4 %      1.5 %      3.7 %       5.4 %      5.1 %       6.9 %      6.0 %
Other (income) expense,
 net....................       0.0 %      (0.2)%     (0.4)%     (0.1)%       --  %     (1.4)%       0.5 %      0.1 %
Interest (income)
 expense, net...........      (0.2)%      (0.0)%     (0.1)%     (0.2)%      (0.5)%     (0.4)%      (0.5)%     (0.6)%
                          --------    --------   --------   --------    --------   --------    --------   --------
 Income before income
  taxes.................      (0.3)%       2.6 %      2.0 %      4.0 %       5.9 %      6.9 %       6.9 %      6.5 %
Provision for income
 taxes..................      (0.1) %      0.9 %      0.7 %      1.4 %       2.0 %      2.4 %       2.5 %      2.3 %
                          --------    --------   --------   --------    --------   --------    --------   --------
 Net income.............      (0.2) %      1.7 %      1.3 %      2.6 %       3.9 %      4.5 %       4.4 %      4.2 %
                          ========    ========   ========   ========    ========   ========    ========   ========
</TABLE>

  The results of operations and statements of financial position as previously
reported in the Company's interim 1999 financial statements filed on Form 10-Q
have been restated to reflect certain adjustments. The adjustments resulted
from capitalization of certain expenses in incorrect quarters, inappropriate
capitalization of expenses, and other adjustments.


                                      42
<PAGE>

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

  Our revenue and capital spending is transacted in U.S. Dollars. As discussed
in the notes to the consolidated financial statements, our assets and
liabilities outside the United States, for which the functional currency is
not U.S. Dollars, are translated into U.S. Dollars. We transact business in
British Pounds, New Zealand Dollars, Australian Dollars, Japanese Yen, and
German Marks. We have not engaged in hedging transactions to reduce our
exposure to fluctuations that may arise from changes in foreign exchange
rates. Based on our overall currency rate exposure at December 31, 1999, a
near-term 10% increase or decrease would not have a material affect on our
operating results or financial condition.

                                      43
<PAGE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders
of Pacific Gateway Exchange, Inc.

  In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, cash flows, and changes in
stockholders' equity present fairly, in all material respects, the financial
position of Pacific Gateway Exchange, Inc. and subsidiaries as of December 31,
1999 and 1998, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 1999, in conformity
with accounting principles generally accepted in the United States. In
addition, in our opinion, the financial statement schedule listed in Item
14(a) of the Form 10-K presents fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management: our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in
the United States, which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.

  The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has current debt which is due
and payable in 2000 and also has significant future capital commitments that
raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 1.
The financial statements do not include any adjustments that might result from
the outcome of this uncertainty.

/s/ PricewaterhouseCoopers LLP

March 31, 2000
San Francisco, California

                                      44
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC.

                          CONSOLIDATED BALANCE SHEETS
                      (in thousands, except share amounts)

<TABLE>
<CAPTION>
                                                               December 31,
                                                             ------------------
                                                               1999      1998
                                                             --------  --------
<S>                                                          <C>       <C>
                          ASSETS

Current Assets:
Cash and cash equivalents..................................  $ 27,189  $ 30,041
Accounts receivable, net of allowance for doubtful accounts
 of $7,846 in 1999 and $4,312 in 1998......................   133,998    87,725
Prepaid expenses...........................................     1,065     1,244
Income taxes receivable....................................       --      1,358
Deferred income tax........................................     3,701     2,207
Other current assets.......................................     6,455     1,408
                                                             --------  --------
    Total current assets...................................   172,408   123,983
Property and equipment, net................................   169,187   103,047
Intangible assets, net.....................................    17,830     1,293
Deferred tax asset ........................................     2,227        78
Deposits and other assets..................................    13,153     7,236
                                                             --------  --------
    Total assets...........................................  $374,805  $235,637
                                                             ========  ========

           LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
Accounts payable...........................................  $154,601  $118,303
Line of credit.............................................    54,100     8,700
Accrued liabilities........................................    13,156     4,193
Income taxes payable.......................................     4,279       --
Current portion of capital lease obligations...............       660       436
                                                             --------  --------
    Total current liabilities..............................   226,796   131,632
Equipment financing........................................    10,000       --
Deferred tax liability.....................................     5,850     1,963
Long-term portion of capital lease obligations.............       604        99
Other liabilities..........................................    16,536     1,304
                                                             --------  --------
    Total liabilities......................................   259,786   134,998
                                                             --------  --------

Stockholders' Equity:
Preferred stock ($.0001 par value; 5,000,000 shares
 authorized, no shares issued).............................       --        --
Common stock and additional paid-in capital ($.0001 par
 value; 70,000,000 shares authorized, 19,665,352 shares
 issued and 19,521,792 shares outstanding at December 31,
 1999; and 19,363,777 shares issued and 19,220,217 shares
 outstanding at December 31, 1998).........................    76,534    65,433
Deferred compensation-restricted stock.....................    (8,065)   (4,618)
Foreign currency translation...............................    (1,285)       34
Retained earnings..........................................    48,235    40,190
Common stock held in treasury, at cost (143,560 shares at
 December 31, 1999 and 1998)...............................      (400)     (400)
                                                             --------  --------
    Total stockholders' equity.............................   115,019   100,639
                                                             --------  --------
    Total liabilities and stockholders' equity.............  $374,805  $235,637
                                                             ========  ========
</TABLE>

          See accompanying Notes to Consolidated Financial Statements

                                       45
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                  (in thousands, except net income per share)

<TABLE>
<CAPTION>
                                                  Year Ended December 31,
                                                 ----------------------------
                                                   1999      1998      1997
                                                 --------  --------  --------
<S>                                              <C>       <C>       <C>
Revenues........................................ $604,591  $466,291  $298,609
Cost of services and capacity sold .............  516,671   393,640   254,076
                                                 --------  --------  --------
    Gross profit................................   87,920    72,651    44,533
Selling, general, and administrative expenses...   62,865    36,791    21,416
Depreciation and amortization...................   14,691     8,713     5,417
                                                 --------  --------  --------
    Total operating expenses....................   77,556    45,504    26,833
                                                 --------  --------  --------
    Operating income............................   10,364    27,147    17,700
Interest income, net............................     (923)   (2,292)   (2,009)
Other income, net...............................   (1,090)   (1,132)     (126)
                                                 --------  --------  --------
    Income before income taxes..................   12,377    30,571    19,835
Provision for income taxes......................    4,332    10,635     7,338
                                                 --------  --------  --------
    Net income.................................. $  8,045  $ 19,936  $ 12,497
                                                 ========  ========  ========
    Net income per share--basic................. $   0.42  $   1.05  $   0.66
                                                 ========  ========  ========
    Net income per share--diluted............... $   0.41  $   0.97  $   0.64
                                                 ========  ========  ========
Weighted-average number of common shares
 outstanding--basic.............................   19,282    19,071    18,960
                                                 ========  ========  ========
Weighted-average number of common shares
 outstanding--diluted...........................   19,772    20,495    19,497
                                                 ========  ========  ========
</TABLE>


          See accompanying Notes to Consolidated Financial Statements.

                                       46
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)

<TABLE>
<CAPTION>
                                                   Year Ended December 31,
                                                  ----------------------------
                                                    1999      1998      1997
                                                  --------  --------  --------
<S>                                               <C>       <C>       <C>
Operating Activities:
Net income......................................  $  8,045  $ 19,936  $ 12,497
Adjustments to net income:
  Depreciation and amortization.................    14,691     8,713     5,417
  Stock compensation expense....................     1,181       674       146
  Bad debt provision............................     4,558     2,146     2,173
  Equity in earnings of affiliated companies,
   net..........................................    (1,500)   (1,499)      --
  Changes in operating assets and liabilities:
    Accounts receivable.........................   (49,668)  (27,558)  (38,681)
    Accounts receivable, related party..........       --        --      3,066
    Prepaid expenses............................       255      (733)      306
    Income taxes receivable.....................     1,358       --        --
    Deferred tax asset..........................    (3,643)   (1,189)       88
    Other current assets........................    (1,854)      --        --
    Deposits and other assets...................      (906)   (1,830)   (1,430)
    Accounts payable............................    34,379    30,322    48,309
    Accrued liabilities.........................     5,104       460     2,429
    Income taxes payable (recoverable)..........     4,703    (2,325)     (462)
    Deferred tax liability......................     3,887     1,006       249
    Other liabilities...........................     9,782       791       150
                                                  --------  --------  --------
Net cash provided by operating activities.......    30,372    28,914    34,257
                                                  --------  --------  --------
Investing Activities:
Purchase of property and equipment..............   (69,644)  (49,611)  (36,725)
Investments in subsidiaries and affiliates......   (17,435)   (3,314)      222
                                                  --------  --------  --------
Net cash used in investing activities...........   (87,079)  (52,925)  (36,503)
                                                  --------  --------  --------
Financing Activities:
Borrowings on revolving line of credit..........    45,400     8,700       --
Equipment financing.............................    10,000       --        --
Debt issuance costs.............................    (3,193)      (57)      --
Exercise of stock options.......................     1,299     1,157      (209)
Dividends received from affiliated company......       966       900       742
Repayments on capital lease obligations.........      (617)     (498)      --
                                                  --------  --------  --------
Net cash provided by financing activities.......    53,855    10,202       533
                                                  --------  --------  --------
Net decrease in cash and cash equivalents.......    (2,852)  (13,809)   (1,713)
Cash and cash equivalents at beginning of the
 period.........................................    30,041    43,850    45,563
                                                  --------  --------  --------
Cash and cash equivalents at end of the period..  $ 27,189  $ 30,041  $ 43,850
                                                  ========  ========  ========
Supplemental data:
Common stock issued to acquired businesses .....  $  4,750  $  1,800  $    --
Value of cable exchanged........................  $  7,532  $    --   $    --
Assets acquired under capital leases............  $  1,006  $    631  $    610
Interest paid...................................  $  1,537  $    --   $    --
Income taxes paid during period.................  $    677  $ 12,067  $  7,841
</TABLE>

          See accompanying Notes to Consolidated Financial Statements.

                                       47
<PAGE>

                        PACIFIC GATEWAY EXCHANGE, INC.

          CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                                (in thousands)

<TABLE>
<CAPTION>
                                                                     Comprehensive Income
                                                              ----------------------------------
                                                                                                   Treasury
                        Common Stock  Additional                Foreign             Accumulated      Stock
                        -------------  Paid-in     Deferred    Currency   Retained Comprehensive -------------
                        Shares Amount  Capital   Compensation Translation Earnings    Income     Shares Amount   Total
                        ------ ------ ---------- ------------ ----------- -------- ------------- ------ ------  --------
<S>                     <C>    <C>    <C>        <C>          <C>         <C>      <C>           <C>    <C>     <C>
Balance December 31,
1996................... 19,040 $   2   $55,113     $   --       $   --    $ 7,757     $ 7,757     (144) $(400)  $ 62,472
 Stock options
 exercised.............    102   --        742         --           --        --          --       --     --         742
 Stock compensation
 expense...............    --    --        146         --           --        --          --       --     --         146
 Tax effect of stock
 options exercised.....    --    --        714         --           --        --          --       --     --         714
 Issuance of restricted
 stock.................     75   --      4,134      (4,134)         --        --          --       --     --         --
 Foreign currency
 translation...........    --    --        --          --             2       --            2      --     --         --
 Net income............    --    --        --          --           --     12,497      12,497      --     --         --
                                                                                      -------
 Comprehensive income..    --    --        --          --           --        --       12,499      --     --      12,499
                        ------ -----   -------     -------      -------   -------     -------     ----  -----   --------
Balance December 31,
1997................... 19,217     2    60,849      (4,134)           2    20,254      20,256     (144)  (400)    76,573
 Stock options
 exercised.............     89   --      1,100         --           --        --          --       --     --       1,100
 Stock compensation
 expense...............    --    --        194         480          --        --          --       --     --         674
 Tax effect of stock
 options exercised.....    --    --        524         --           --        --          --       --     --         524
 Issuance of restricted
 stock.................     25   --        964        (964)         --        --          --       --     --         --
 Issuance of common
 stock, for investment
 in company............     33   --      1,800         --           --        --          --       --     --       1,800
 Foreign currency
 translation...........    --    --        --          --            32       --           32      --     --         --
 Net income............    --    --        --          --           --     19,936      19,936      --     --         --
                                                                                      -------
 Comprehensive income..    --    --        --          --           --        --       19,968      --     --      19,968
                        ------ -----   -------     -------      -------   -------     -------     ----  -----   --------
Balance December 31,
1998................... 19,364     2    65,431      (4,618)          34    40,190      40,224     (144)  (400)   100,639
 Stock options
 exercised.............     90   --      1,299         --           --        --          --       --     --       1,299
 Stock compensation
 expense...............    --    --         94       1,087          --        --          --       --     --       1,181
 Tax effect of stock
 options exercised.....    --    --        424         --           --        --          --       --     --         424
 Issuance of restricted
 stock.................     67   --      2,408      (2,408)         --        --          --       --     --         --
 Issuance of options
 below market..........    --    --      2,126      (2,126)         --        --          --       --     --         --
 Issuance of common
 stock, for acquisition
 of Robo Tel, Inc......    144   --      4,750         --           --        --          --       --     --       4,750
 Foreign currency
 translation...........    --    --        --          --        (1,319)      --       (1,319)     --     --         --
 Net income............    --    --        --          --           --      8,045       8,045      --     --         --
                                                                                      -------
 Comprehensive income..    --    --        --          --           --        --        6,726      --     --       6,726
                        ------ -----   -------     -------      -------   -------     -------     ----  -----   --------
Balance December 31,
1999................... 19,665 $   2   $76,532     $(8,065)     $(1,285)  $48,235     $46,950     (144) $(400)  $115,019
                        ====== =====   =======     =======      =======   =======     =======     ====  =====   ========
</TABLE>

         See accompanying Notes to Consolidated Financial Statements.

                                       48
<PAGE>

                        PACIFIC GATEWAY EXCHANGE, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) The Company and its Significant Accounting Policies

 Description of Business and Organization:

  Pacific Gateway Exchange, Inc. ("Pacific Gateway" or the "Company"), a
Delaware corporation, owns and operates an international switched and domestic
switched telecommunications network. The operations of Pacific Gateway include
wholesale and retail long distance, Internet, and bandwidth services.

  The Company is subject to various risks in connection with the operation of
its business. These risks include, but are not limited to, changes in
government regulation, dependence on transmission facilities-based carriers
and suppliers, price competition, and competition from larger industry
participants.

  At December 31, 1999, the Company had $54.1 million outstanding under its
$100 million credit facility. As discussed in Note 8 "Debt" and Note 16
"Subsequent Events," this credit facility must be reduced to $50 million on
May 15, 2000, and the remainder is due and payable in November, 2000. At March
30, 2000, the Company had $75.6 million (unaudited) outstanding on its $100
million line of credit. Also as discussed in the Note 10 - "Commitments and
Contingencies" the Company has approximately $145 million in capital
commitments due in the next twelve months. The Company will require additional
funding in order to meet these commitments and continue operations in the
normal course of business. Historically, the Company has funded its operations
primarily through positive operating cash flows. Management plans to pursue
additional equity from new or existing investors, debt financing, or asset
sales to refinance current outstanding debt, and fund future capital
commitments. There is no assurance that management will complete its plans.

 Principles of Consolidation:

  Consolidated Financial Statements include the accounts of Pacific Gateway
and its majority-owned and controlled subsidiaries in Bermuda, the United
Kingdom, Russia, New Zealand, Australia, Japan, Germany, and Cyprus. The
Company accounts for investments in 20% to 50%-owned companies and
partnerships using the equity method. Intercompany transactions have been
eliminated.

                                      49
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


 Foreign Currency Translation:

  Assets and liabilities of operations outside the United States, for which
the functional currency is not U.S. dollars, are translated into U.S. dollars
using the exchange rate in effect at each period end. Revenues and expenses
are translated at the average exchange rate prevailing during the period. The
effects of foreign currency translation adjustments arising from differences
in exchange rates from period to period are deferred and included as a
component of "Stockholders' Equity".

  For operations in highly-inflationary economies, principally in Russia,
assets and liabilities are maintained in the reporting currency, U.S. dollars.

  The effects of foreign currency transactions, and of remeasuring the
financial position and results of operations in the functional currency, are
included in "Selling, general and administrative expenses."

 Estimates:

  The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported assets and liabilities and disclosures of
contingent assets and liabilities at the dates of the financial statements and
reported amounts of revenues and expenses during the reported periods. Actual
results could differ from those estimates.

 Fair Value of Financial Instruments:

  The fair value of financial instruments, consisting of cash, cash
equivalents, accounts receivable, accounts payable, and the line of credit, is
based on interest rates available to the Company and comparisons to quoted
prices. At December 31, 1999 and 1998, the fair value of these financial
instruments approximates carrying value.

 Concentration of Credit Risk:

  Financial instruments that potentially subject the Company to concentration
of credit risk consist of cash and cash equivalents and accounts receivable.
At December 31, 1999 and 1998, the Company had bank deposits in excess of
federally insured limits of $19.4 million and $22.9 million respectively. The
Company's customer base includes domestic and international companies in the
telecommunications industry. The Company performs ongoing credit evaluations
of its customers, but generally does not require collateral to support
customer receivables. The Company's allowance for doubtful accounts is based
on current market conditions. Losses on uncollectible accounts have
consistently been within management's expectations.

  For the year ended December 31, 1999, the Company derived 11% of its
revenues from a single customer of $64.4 million. For the year ended December
31, 1998, there were no major customers that comprised ten percent or more of
the Company's revenues. For the year ended December 31, 1997, the Company
derived 10% of its revenues from a single customer of $31.0 million.

 Income Taxes:

  The Company accounts for income taxes in accordance with "Statement of
Financial Accounting Standards" No. 109, Accounting for Income Taxes. Under
SFAS No. 109, the Company recognizes current and

                                      50
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

deferred income tax assets and liabilities based upon all events that have
been recognized in the financial statements as measured by the provisions of
the enacted tax laws.

  Valuation allowances are established when necessary to reduce deferred tax
assets to the estimated amount to be realized. Income tax expense represents
the tax payable for the current period and the change during the period in the
deferred tax assets and liabilities.

 Property and Equipment:

  Property and equipment are stated at cost. Maintenance and repairs are
expensed as incurred. Replacements and betterments are capitalized. The
Company classifies costs incurred in connection with the construction of new
property and equipment, including labor, as construction in progress until the
property and equipment becomes operational. The Company capitalized $5.3
million and $3.2 million of direct labor and associated overhead in 1999 and
1998, respectively, exclusive of software development costs, discussed below.
The Company capitalized no labor or overhead costs in 1997. In addition, the
Company capitalizes the interest costs that relate to network and facility
construction per SFAS No. 34, "Capitalization of Interest Cost." The Company
capitalized $2.1 million of interest in 1999. The Company capitalized no
interest in 1998 or 1997. When the property and equipment becomes operational,
the Company places it in service and depreciates it using the straight-line
method over the estimated useful lives. The cost and related accumulated
depreciation of assets sold or retired are removed from the account balance
and any resulting gain or loss is reflected in results of operations.

  The Company invests in undersea fiber optic cable systems through the
purchase of indefeasible rights of use ("IRU's") or through an ownership
interest in cable construction consortia.

 Software Development Costs:

  In accordance with Statement of Position ("SOP") 98-1, Accounting for the
Cost of Computer Software Developed or Obtained for Internal Use, the Company
capitalizes certain costs related to its software developed for internal use
for which it has no plans to market externally. The Company amortizes
capitalized costs on a straight line basis over the estimated useful life of
the asset, which is between four and seven years. The Company adopted SOP 98-1
in 1998 and capitalized $4.0 million and $1.5 million in 1999 and 1998,
respectively.

 Intangible Assets:

  Intangible assets primarily include amounts allocated upon acquisitions of
businesses of the excess purchase price over the tangible assets acquired.
These assets are amortized on a straight-line basis over the expected period
of benefit. Intangibles are amortized over periods that do not exceed 10
years.

  Costs associated with potential acquisitions are initially deferred. When an
acquisition closes, the Company capitalizes the related costs as part of the
purchase price of the assets acquired. For those acquisitions that are not
completed, the Company expenses related costs in the period in which the
related acquisition is abandoned.

 Debt Issuance Costs:

  Debt issuance costs are included in other current assets and are being
amortized over the terms of the related debt.


                                      51
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 Accounting for Business Combinations:

  The Company generally records contingent payments as additional purchase
price and amortizes the payments over the estimated remaining useful life of
the acquired assets.

 Long-Lived Assets:

  Statement of Financial Accounting Standards "SFAS" No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of, requires that long-lived assets and certain intangible assets be reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. If undiscounted expected future cash
flows are less than the carrying value of the assets, then an impairment loss
is to be recognized based on the fair value of the assets. No impairment
losses have been recognized to date.

 Revenue Recognition:

  Revenues for telecommunications and Internet services provided to customers
are recognized as services are rendered. Revenues for return traffic received
according to the terms of the Company's operating agreements with its foreign
partners are recognized as revenue as the return traffic is received. Revenue
attributable to leases of bandwidth fiber optic capacity pursuant to ("IRUs")
that qualify for sales-type lease accounting and were entered into prior to
June 30, 1999, are generally recognized at the time of delivery and acceptance
of the fiber optic capacity by the lessee. Bandwidth fiber capacity IRU's that
do not meet the criteria for sales-type lease accounting are accounted for as
operating leases and revenue is recognized over the term of the lease.

  The Company's bandwidth fiber capacity agreements generally require the
customer to make a down payment due upon execution of the agreement with the
balance due upon delivery and acceptance of the fiber. Amounts billed or cash
received in excess of revenue earned are recorded as deferred revenue.

  The Company is obliged under its bandwidth capacity fiber agreements to
maintain its network in efficient working order and in accordance with
industry standards. The lessee is obligated for the term of the agreement to
pay operating and maintenance costs. The Company recognizes this revenue as
services are provided.

  For bandwidth fiber capacity agreements entered into prior to June 30, 1999,
the Company determined the cost of revenue based on an allocation of the total
estimated costs of the network to the fiber optic cable sold. The allocation
takes into account the service capacity of the specific fiber optic capacity
sold relative to the total expected capacity of the network.

  The Company is recognizing revenue in accordance with Financial Accounting
Standards Board ("FASB") Interpretation No. 43, "Real Estate Sales, an
interpretation of FASB Statement No. 66" ("FIN 43") and the Securities and
Exchange Commission ("SEC") Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements." However, accounting practice and
guidance with respect to the accounting treatment of bandwidth sales is
evolving. Any changes in the accounting treatment could affect how the Company
accounts for future bandwidth sales.

 Accounting for International Long Distance Traffic:

  The Company has entered into operating agreements with 44 telecommunications
carriers in 28 countries under which international long distance traffic is
both delivered and received. Under these agreements, the foreign carriers are
contractually obligated to adhere to the policy of the Federal Communications
Commission (the "FCC"), whereby traffic from the foreign country is routed to
international carriers, such as the Company,

                                      52
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
in the same proportion as traffic carried into the country. Mutually exchanged
traffic between the Company and foreign carriers is settled through a formal
settlement policy that generally extends over a six-month period at an agreed
upon rate. The Company records the amount due to the foreign partner as an
expense in the period the traffic is delivered. Of the 44 agreements the
Company had at December 31, 1999, 18 agreements provided that the Company
generally must wait up to six months before it actually receives the
proportional return traffic. In circumstances where the Company does not
receive the return traffic due from the foreign partner at the end of the
agreed-upon delayed return period, the Company and the foreign partner may
agree to a settlement that compensates the Company for the return traffic not
received, through greater return traffic in future periods, or a reduction to
the Company's current accounts payable balance.

 Earnings Per Share:

  In accordance with SFAS No. 128, basic earnings per share is calculated by
dividing net income by the weighted-average number of shares outstanding for
the period. Diluted earnings per share is calculated by dividing net income by
the weighted average number of shares outstanding during the period plus the
dilutive effect of stock options determined using the treasury stock method.

  There were no adjustments to net income in the calculation of basic and
diluted earnings per share for the years ended December 31, 1999, 1998, or
1997. The reconciliation of the weighted average shares outstanding used in
calculating basic and diluted earnings per share is as follows:

<TABLE>
<CAPTION>
                                              Income       Shares     Per-Share
                                            (Numerator) (Denominator)  Amount
                                            ----------  ------------  ---------
                                             (in thousands, except per share
                                                        amounts)
   <S>                                      <C>         <C>           <C>
   1999
   Basic EPS:
     Income available to common
      stockholders........................   $ 8,045       19,282      $ 0.42
     Effect of dilutive stock options.....       --           490      $(0.01)
                                             -------       ------      ------
   Diluted EPS............................   $ 8,045       19,772      $ 0.41
                                             -------       ------      ------
   1998
   Basic EPS:
     Income available to common
      stockholders........................   $19,936       19,071      $ 1.05
     Effect of dilutive stock options.....       --         1,424      $(0.08)
                                             -------       ------      ------
   Diluted EPS............................   $19,936       20,495      $ 0.97
                                             -------       ------      ------
   1997
   Basic EPS:
     Income available to common
      stockholders........................   $12,497       18,960      $ 0.66
     Effect of dilutive stock options.....       --           537      $(0.02)
                                             -------       ------      ------
   Diluted EPS............................   $12,497       19,497      $ 0.64
                                             =======       ======      ======
</TABLE>

                                      53
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


 Comprehensive Income:

  Comprehensive income includes all changes in equity (net assets) during a
period from non-owner sources. Comprehensive income includes foreign currency
translation adjustments, which are excluded from net income.

 Financial Statement Classifications:

  Certain prior-year amounts have been reclassified to conform to the 1999
financial statement presentation. Such reclassifications have no effect on net
income as previously reported.

(2) Recent Accounting Pronouncements

  In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
established accounting and reporting standards for derivative financial
instruments and hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. To date, the Company does not currently hold
any derivative instruments and does not engage in hedging activities. The
Company expects that the adoption of SFAS No. 133 will not have a material
impact on its financial position, results of operations, or cash flow. The
Company is required to adopt SFAS No. 133 on January 1, 2001.

  In June 1999, the FASB issued FIN 43. Under FIN 43, fiber optic cable is
considered integral equipment and accordingly, a lease must include a
provision allowing title to transfer to the lessee in order for that lease to
be accounted for as a sales-type lease. FIN 43 applies to leases of integral
equipment entered into after June 30, 1999.

  In November 1999, the SEC staff released Staff Accounting Bulletin No. 100,
"Restructuring and Impairment Charges" ("SAB 100"). SAB 100 provides
interpretive guidance on how companies should account for and disclose certain
expenses that are commonly reported in connection with exit activities and
business combinations. SAB 100 also addresses contingent liabilities assumed
in a purchase business combination and inventory valuation allowances. SAB 100
must be applied to the financial statements for financial years ending
December 31, 1999. The Company does not believe that the adoption of SAB 100
will have a material affect on its financial results.

  In December 1999, the SEC staff released Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 provides
interpretive guidance on the recognition, presentation, and disclosure of
revenue in the financial statements. SAB 101 must be applied to the financial
statements no later than the second quarter of 2000. The Company does not
believe that the adoption of SAB 101 will have a material affect on its
financial results.

                                      54
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(3) Income Taxes

  The provision for income taxes is comprised of the following:

<TABLE>
<CAPTION>
                                                         Year Ended December
                                                                 31,
                                                        ------------------------
                                                         1999     1998     1997
                                                        -------  -------  ------
                                                            (in thousands)
   <S>                                                  <C>      <C>      <C>
   Current tax expense:
     Federal........................................... $ 3,356  $ 7,318  $5,737
     State and local...................................     246    1,664     986
     Foreign...........................................     487    1,835     279
                                                        -------  -------  ------
     Total current..................................... $ 4,089  $10,817  $7,002
                                                        =======  =======  ======
   Deferred tax expense:
     Federal........................................... $ 1,305  $  (242) $  265
     State and local...................................     252     (146)     71
     Foreign...........................................  (1,314)     206     --
                                                        -------  -------  ------
     Total deferred.................................... $   243  $  (182) $  336
                                                        -------  -------  ------
   Total provision..................................... $ 4,332  $10,635  $7,338
                                                        =======  =======  ======
</TABLE>

  Undistributed earnings intended to be reinvested indefinitely in operations
outside the United States were approximately $19.6 million.

  The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rates as follows:

<TABLE>
<CAPTION>
                                                            Year Ended December
                                                                    31,
                                                            --------------------
                                                             1999   1998   1997
                                                            ------ ------ ------
   <S>                                                      <C>    <C>    <C>
   Expected statutory amount............................... 35.0 % 35.0 % 35.0 %
   State income taxes, net of federal benefit..............  3.2 %  3.2 %  3.8 %
   Tax exempt interest.....................................  --  %  --  % (0.5)%
   Undistributed earnings of certain subsidiaries.......... (3.7)% (5.0)% (2.5)%
   Other...................................................  0.5 %  1.6 %  1.2 %
                                                            ------ ------ ------
                                                            35.0 % 34.8 % 37.0 %
                                                            ====== ====== ======
</TABLE>

  Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and amounts used for income tax purposes and the impact of available
net operating loss carry-forwards.

                                      55
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  The tax effect of significant temporary differences, which comprise the
deferred tax assets and liabilities, are as follows:
<TABLE>
<CAPTION>
                                                                   Year Ended
                                                                  December 31,
                                                                  -------------
                                                                   1999   1998
                                                                  ------ ------
                                                                       (in
                                                                   thousands)
   <S>                                                            <C>    <C>
   Deferred tax assets:
     Allowance for doubtful accounts............................. $3,131 $1,483
     State taxes.................................................    293    581
     Accrued compensation........................................    174    139
     Foreign deferred assets.....................................  2,054    165
     Other.......................................................    --     111
                                                                  ------ ------
   Total gross deferred tax assets............................... $5,652 $2,479
                                                                  ------ ------
   Deferred liabilities:
     Depreciation................................................ $4,627 $1,658
     Foreign deferred liabilities................................    947    371
     Other.......................................................    --     128
                                                                  ------ ------
   Total gross deferred tax liabilities.......................... $5,574 $2,157
                                                                  ------ ------
   Net deferred tax assets....................................... $   78 $  322
                                                                  ====== ======
</TABLE>

(4) Property and Equipment

  The Company is currently expanding its communications network. Costs
associated directly with the construction are capitalized and depreciated over
their useful lives.

  Property and equipment consisted of:

<TABLE>
<CAPTION>
                                                                December 31,
                                                 Depreciable  -----------------
                                                Lives (Years)   1999     1998
                                                ------------- -------- --------
                                                               (in thousands)
   <S>                                          <C>           <C>      <C>
   Fiber optic cables..........................      20       $ 37,531 $ 34,663
   Long distance communications equipment......      5-7        84,433   48,710
   Computers and office equipment..............      4-7        16,725    9,352
   Leasehold improvements...................... Term of lease    8,332    2,004
   Construction in progress....................      --         12,605   13,587
   Cable construction in progress..............      --         40,782   12,066
                                                              -------- --------
                                                               200,408  120,382
                                                              -------- --------
   Less: accumulated depreciation..............                 31,221   17,335
                                                              -------- --------
     Total property and equipment, net.........               $169,187 $103,047
                                                              ======== ========
</TABLE>

  Related depreciation and amortization expense was $13.8 million, $8.6
million, and $5.4 million in 1999, 1998, and 1997, respectively.

                                      56
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(5) Acquisitions and Investments

  In 1997, the Company acquired a controlling interest in Rustelnet, a
provider of enhanced telecommunications services to the Russian market. Under
purchase accounting, the results of operations of the acquired business have
been included in the accompanying consolidated financial statements from the
date of acquisition. The Company purchased Rustelnet for a nominal amount
while it had cash balances of $0.3 million at the time. The fair value of net
liabilities acquired in the acquisition was $0.2 million. The excess of
purchase price over the estimated fair market value of $0.6 million has been
allocated to goodwill. Goodwill is being amortized on a straight-line basis
over a 10-year period. In connection with the acquisition of Rustelnet, the
Company purchased Rustelnet shares from individual shareholders who are
members of Pacific Gateway's management.

  In February 1998, the Company purchased 16.6% of the common stock of Ekonom
S.A. de C.V., a Mexican multimedia company, for $3.3 million in cash and $1.8
million in the Company's common stock. The Company's investment in Ekonom is
accounted for under the cost method.

  In 1998, the Company also acquired a retail business for approximately $0.8
million in cash. Under purchase accounting, the excess of the aggregate
purchase price over the net assets acquired resulted in total goodwill of $0.8
million, which will be amortized over 10 years.

  In June 1999, the Company acquired all of the retail customers and assets of
Robo Tel, Inc. for $6.7 million, consisting of $1.8 million in cash and $4.8
million in the Company's common stock. As part of the acquisition, the Company
recorded $0.9 million of accounts receivable and $0.6 million of accounts
payable; under purchase accounting, the excess of the aggregate purchase price
over the net assets acquired resulted in total goodwill of $6.4 million, which
will be amortized over 10 years.

  In the second half of 1999, the Company acquired two retail businesses for
$8.0 million in cash. For one of the acquisitions, the Company expects to pay
additional consideration based on earnings of the business acquired. Since the
commitment is not yet determinable, the contingent consideration has not been
recorded as of December 31, 1999. Under purchase accounting, the excess of the
aggregate purchase price over the net assets acquired resulted in total
goodwill of $7.7 million, which will be amortized over 10 years. In connection
with the acquisitions, the Company entered into management agreements, which
provided the Company with effective control during the regulatory approval
process. Pursuant to the terms of the agreements, the Company is responsible
for managing the retail operations. The Company has recognized revenues in
1999 under the management agreements. The Company closed these two
acquisitions in November and December 1999.

  In September 1999, the Company also acquired Onyx Internet, Ltd. for $2.7
million in cash. Onyx Internet serves small to medium sized business and
residential customers throughout England and Scotland. Under purchase
accounting, the excess of the aggregate purchase price over the net assets
acquired resulted in total intangible assets and goodwill of $2.4 million,
which will be amortized over periods ranging from two to 10 years.

  In October 1999, the Company entered into a lease agreement with a third
party that gave it effective control of a wholesale telecommunications
business. The assets leased included long distance telecommunications
equipment and wholesale telecommunications customers. Under the agreement, the
Company leased the telecommunications network for two years. In consideration
for the network lease, the Company paid $2.8 million in advance and is
obligated to pay the net operating expenses of the acquired business for the
term of the lease and manage the business during the term of the lease. It
also purchased an option to buy the assets of the business for one dollar at
the end of the lease term. The Company will pay combined consideration of
$2.3 million, consisting of $1.3 million in our common stock and $1.0 million
in cash in the year 2000 for the purchase option. In addition, it will pay
future consideration based on the revenue generated by the business in

                                      57
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

the 24 months after the close of the transaction. During the twelve months
ended December 31, 1999, the Company accrued consideration of $0.8 million,
which has been recorded as goodwill and will be amortized over 7 years, which
is the expected life of the network.

  In November 1999, the Company entered into agreements to acquire an
additional retail business for $2.7 million. In consideration, the Company
issued a $2.7 million promissory note bearing interest at 15% per annum due
February 28, 2000. In addition, the Company pledged $5.4 million of its common
stock as collateral. In connection with the acquisition, the Company entered
into a management agreement, which provides the Company with effective control
during the regulatory approval process. Pursuant to the terms of the
agreement, the Company is responsible for the management and operation of the
retail customer accounts. The Company has recognized revenues in 1999 under
the management agreement. The acquisition is pending regulatory approval and
the Company expects it to close in the second quarter of 2000. Consideration
given in advance of the close is recorded in deposits and other assets.

  Also in November 1999, the Company entered into an agreement to acquire a
retail business for $4.2 million in cash and the issuance of 60,000 shares of
its common stock on the date of closing. In 1999, the Company made payments
totaling $1.4 million towards the purchase price, which it recorded in
deposits and other assets. In connection with the acquisition, the Company
entered into a management agreement, which provides the Company with effective
control during the regulatory approval process. Pursuant to the terms of the
agreement, the Company is responsible for the management and operation of the
customer accounts. The Company has recognized revenues in 1999 under the
management agreement. The acquisition is pending regulatory approval and the
Company expects it to close in the second quarter of 2000.

  In December 1999, the Company agreed to purchase the international retail
division of NOSVA Limited Partnership. As a result of the acquisition, the
Company expects to increase its number of ethnic retail customers and
telemarketing employees through NOSVA's back-office operations in Las Vegas,
Nevada. The purchase price of $40.2 million is comprised of $21.0 million in
cash and $19.2 million in the Company's common stock. The Company expects to
pay additional consideration based on earnings of the business acquired. As of
December 31, 1999, the Company had made no payments. The Company paid $3.0
million in January 2000, and is obligated to pay $5 million at close, $8
million 90 days after closing, and $5 million 180 days after closing. Pending
regulatory approval, the Company expects to close the acquisition in the
second quarter of 2000.

(6) Intangible Assets

  Intangible assets consisted of:

<TABLE>
<CAPTION>
                                                                  December 31,
                                                                 --------------
                                                                  1999    1998
                                                                 ------- ------
                                                                 (in thousands)
   <S>                                                           <C>     <C>
   Goodwill..................................................... $17,590 $1,398
   Long-term non-compete agreement..............................     795    --
   Acquired intellectual property...............................     241    --
   Other........................................................     159    --
                                                                 ------- ------
                                                                  18,785  1,398
                                                                 ------- ------
   Less: accumulated amortization...............................     955    105
                                                                 ------- ------
     Intangible assets, net..................................... $17,830 $1,293
                                                                 ======= ======
</TABLE>


                                      58
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  Related amortization expense was $0.9 million, $0.1 million, and $0.0
million in 1999, 1998, and 1997, respectively. The increase in goodwill from
1998 to 1999 resulted from the acquisitions described in Note 5, Acquisitions
and Investments.

(7) Equity Investment

  In 1997, the Company and Globe Telecom, a company operating in the
Philippines, formed a joint venture, PinTouch Telecom, to market long distance
services to the Filipino-American community. In accordance with the joint
venture agreement, the Company receives 47.5% of PinTouch's net earnings. The
Company has recognized equity in earnings of $1.5 million and $1.7 million in
1999 and 1998, respectively and received dividends of $1.0 million and $0.9
million in 1999 and 1998, respectively. PinTouch receives commission payments
from the Company that represents the gross profit earned on referred business,
net of allowance for doubtful accounts and billing and collection fees paid by
the Company to third parties. PinTouch earns all of its commission revenues
from the Company.

  Condensed financial information for PinTouch, which is unconsolidated and
accounted for under the equity method:

<TABLE>
<CAPTION>
                                                           For the Year Ended
                                                              December 31,
                                                           -------------------
                                                            1999   1998  1997
                                                           ------ ------ -----
                                                             (in thousands)
   <S>                                                     <C>    <C>    <C>
   Commission revenues.................................... $7,241 $7,148 $ 195
                                                           ------ ------ -----
   Operating income (loss)................................  3,155  3,515  (321)
                                                           ------ ------ -----
   Net income (loss)......................................  3,196  3,547  (321)
   Other partners' share of net income (loss).............  1,678  1,870  (169)
                                                           ------ ------ -----
     Company's share of net income (loss)................. $1,518 $1,677 $(152)
                                                           ====== ====== =====
</TABLE>

<TABLE>
<CAPTION>
                                                                 December 31,
                                                                ---------------
                                                                 1999     1998
                                                                -------  ------
                                                                (in thousands)
   <S>                                                          <C>      <C>
   Current assets (1).......................................... $ 4,246  $2,444
   Non-current assets..........................................      22      13
   Current liabilities.........................................  (1,211)   (600)
                                                                -------  ------
   Total equity................................................   3,057   1,857
   Other partners' equity share................................   1,621     973
                                                                -------  ------
     Equity investment......................................... $ 1,436  $  884
                                                                =======  ======
</TABLE>
--------
(1) Current assets included $3.8 million and $2.0 million at December 31, 1999
    and 1998, respectively, in commission revenues, net of allowance, due from
    Pacific Gateway.

(8) Debt

 Line of Credit

  In November 1999, the Company obtained a one-year $100 million credit
facility from Deutsche Bank Securities Inc. and Banc of America Securities
LLC. The credit facility agreement: (1) states that the Company would use up
to $50 million of the net proceeds from any securities offering in which the
Company receives gross proceeds of $150 million or more to repay the credit
facility; and (2) requires a $50.0 million permanent

                                      59
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

reduction in the facility on or before April 1, 2000. As discussed in Note
16--"Subsequent Events," the date of the permanent reduction has been extended
to May 15, 2000. Thereafter, the credit facility would provide a $50.0 million
facility for the Company.

  At December 31, 1999, the Company had $54.1 million outstanding and $45.9
million available under this line of credit with an interest rate of 9.35%
(LIBOR plus a margin). The line of credit, which expires on November 23, 2000,
has financial covenants including a maximum ratio of debt to annualized
operating cash flow of 3 to 1 and a minimum interest coverage ratio (ratio of
operating cash flow to net interest expense) of 2.0 to 1.

  The Company did not comply with certain financial covenants at December 31,
1999, and received a waiver dated March 31, 2000, from its lenders, which
waived covenant violations as of December 31, 1999. Subsequent to December 31,
1999, the Company did not comply with certain financial covenants. The Company
has obtained a waiver for all covenant violations from January 1, 2000, to
March 31, 2000. The Company expects to amend or refinance its debt agreement
in the second quarter of 2000, although there is no assurance that it will be
able to do so.

  At December 31, 1998, the Company had $8.7 million outstanding and $21.3
million available under its previous line of credit with an interest rate of
7.75%. The Company replaced its $30 million line of credit with the $100
million credit facility described above. The line of credit also had financial
covenants including a maximum ratio of debt to annualized operating cash flow
of 3 to 1 and a minimum interest coverage ratio (ratio of operating cash flow
to net interest expense) of 2 to 1. The Company was in compliance with these
covenants at December 31, 1998.

 Financing

  In December 1999, the Company obtained $10.0 million in financing from GE
Capital Corporation (GECC), to be used to finance its rapid expansion and to
meet its working capital needs. The Company used certain of its switching
equipment as collateral for the 3 year financing arrangement, which is payable
on a monthly basis. At December 31, 1999, the Company had $10.0 million
outstanding, which bears interest at a fixed interest rate of 9.67%.

 Vendor Financing

  Also in December 1999, the Company obtained a $15.0 million vendor financing
facility from Cisco Systems Capital Corporation. The facility may be used to
finance the purchase of Cisco Internet routers and related hardware and
software. The facility expires in December 2000. Borrowings bear interest at
an annual rate of LIBOR plus 3%. The Company also pays a commitment fee of
0.5% on any unused portion of the facility and an annual commitment fee of
$50,000, which is due in quarterly installments. As of December 31, 1999, $15
million was available for future borrowings under this facility.

                                      60
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(9) Other Liabilities

  The Company's other liabilities consisted of:

<TABLE>
<CAPTION>
                                                                  December 31,
                                                                 --------------
                                                                  1999    1998
                                                                 ------- ------
                                                                 (in thousands)
   <S>                                                           <C>     <C>
   Bandwidth commitment (1)..................................... $ 7,532 $  --
   Deferred bandwidth revenue...................................   5,324    --
   Customer advances............................................   1,733    --
   Other........................................................   1,947  1,304
                                                                 ------- ------
     Other liabilities.......................................... $16,536 $1,304
                                                                 ======= ======
</TABLE>
--------
(1) The Company will settle this liability in kind with the delivery of
    bandwidth capacity to third parties as a part of the exchange transactions
    discussed in Note 11.

(10) Commitments and Contingencies

 Litigation

  The Company is party to various legal proceedings in the ordinary course of
business. Although the ultimate resolution of these proceedings cannot be
ascertained, management does not expect that they will have a material adverse
impact on the Company's financial position or results of operations.

 Leases

  The Company leases office space and equipment under noncancelable operating
leases. Rent expense for 1999, 1998, and 1997 was $4.3 million, $1.3 million,
and $1.0 million, respectively. The Company leases certain computer equipment
under capital lease agreements; the leases have terms of three years with a
minimum purchase price at the end of the leases. Leased capital assets
included in property and equipment at December 31, 1999 and 1998, were $2.2
million and $1.2 million, respectively.

  Future minimum lease payments under noncancelable operating and capital
leases as of December 31, 1999 were:

<TABLE>
<CAPTION>
                                                               Operating Capital
                                                                Leases   Leases
                                                               --------- -------
                                                                (in thousands)
   <S>                                                         <C>       <C>
   2000.......................................................  $ 5,341  $  660
   2001.......................................................    4,932     443
   2002.......................................................    4,958     353
   2003.......................................................    4,941     --
   2004.......................................................    2,176     --
   Thereafter.................................................    4,006     --
                                                                -------  ------
   Total minimum lease payments...............................  $26,354  $1,456
                                                                =======
     Amount representing interest.............................              192
                                                                         ------
     Present value of net minimum payments....................           $1,264
                                                                         ======
     Current portion..........................................           $  660
                                                                         ======
</TABLE>

                                      61
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


 Employment Agreements

  The Company has entered into employment agreements with certain employees
that provide that, in the event of a change in control, each of these
employees would be entitled to severance following their resignation from the
Company. Should such an event occur, the Company's aggregate obligation for
severance would be approximately $6.0 million. Upon any such change in
control, each of these individuals would also receive full vesting of any
outstanding stock options.

 Purchase Commitments

  At December 31, 1999, the Company had outstanding commitments, due before
December 31, 2000, of approximately $145.0 million. This includes the
commitment to purchase undersea fiber optic cable in the Japan-U.S. cable
network for $55.6 million and in TAT-14 cable system for $64.1 million. Also,
the Company has committed to purchase the international retail division of
NOSVA Limited Partnership in December 1999. The purchase price of $40.2
million is comprised of $21.0 million in cash and $19.2 million in the
Company's common stock. Pending regulatory approval, the Company expects to
close the acquisition in the second quarter of 2000.

 Sales Commitments

  As of December 31, 1999, the Company had entered into agreements to sell,
lease, or exchange bandwidth capacity (including maintenance services) that
represented 16% of the Company's interest in the Japan-US and TAT-14 cable
systems.

(11) Cable Exchanges and Sales

  In April 1999, the Company agreed to exchange, in a non-monetary
transaction, capacity on its Trans-Atlantic cable network for certain U.S.
domestic fiber optic cables owned by Williams Communications Group, Inc. The
Company took delivery of a portion of the capacity to be received (the
"Delivered Capacity") in the third quarter. The value applied to the capacity
was $7.5 million. In accordance with Accounting Principles Board Opinion No.
29 "Non Monetary Transactions" ("APB No. 29"), no gain has been recognized on
this transaction.

  In the second quarter of 1999, the Company entered into agreements to
provide 20 year IRUs to 10.7% of the capacity, which has been delivered to the
Company. The Company recorded these transactions as sales type leases and
recognized $6.5 million in revenues related to these transactions in 1999.

  As discussed in Note 1, "Significant Accounting Policies", sales or leases
of bandwidth capacity entered into after June 30, 1999, are accounted for as
operating leases. In the third quarter, the Company entered into an agreement
to lease capacity under a 20-year IRU agreement. The Company delivered
capacity and recorded revenue in the fourth quarter of $0.1 million for this
lease. The Company has deferred revenues of $5.3 million.

(12) Segment Data

  The Company previously reported the business segments of wholesale,
offshore, and retail. As a result of capital investment activities into
diversified business segments, management of the Company now views the results
of operations for wholesale, offshore, and retail as one segment, referred to
as "Telecommunications". The Company has also introduced new reporting
segments in line with its businesses diversification. These are bandwidth
services and Internet services. Bandwidth services represents the Company's
interests in high capacity fiber optic networks. Internet services represents
the Company's acquisition of Onyx Internet during the third quarter and its
increased focus on the provision of services to the Internet industry.

  Telecommunication services includes U.S. and offshore wholesale and retail
services. U.S. wholesale provides international telecommunications services
to: (1) U.S.-based carriers that originate international traffic,

                                      62
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

but do not have operating agreements with foreign carriers; (2) existing
international carriers who terminate their overflow telecommunications traffic
on its system; and (3) customers with smaller traffic volumes. Revenues from
the Company's offshore wholesale operations is generated from country-
specific, usage-sensitive rates charged to the Company's carrier customers and
from traffic terminated in its international switching facilities. The Company
operates switching facilities in the United Kingdom, Russia, Australia, Japan,
New Zealand, and Germany. The Company provides retail international long
distance services to the Filipino, Japanese, Chinese, Vietnamese, Russian,
Korean, and Romanian-American communities.

  The Company has begun to sell excess bandwidth capacity on its global
network. As discussed in Note 1, "The Company and its Significant Accounting
Policies", future sales or leases of bandwidth capacity will be accounted for
in accordance with FIN 43. The Company also exchanged bandwidth capacity for
additional network facilities, which it will record as fixed assets.

  Lastly, the Company began generating Internet service revenues, including
connectivity revenues, in the third quarter of 1999.

  Corporate and other includes cash, equity investments, and other
miscellaneous current and non-current assets. These assets are not allocated
to the three operating segments.

  The results of operations for the Company's operating segments for each of
the three years ended December 31, were:

<TABLE>
<CAPTION>
                               Telecom-
                              munication Bandwidth Internet  Corp./
                               Services  Services  Services   Other   Total
                              ---------- --------- --------  ------- --------
                                              (in thousands)
   <S>                        <C>        <C>       <C>       <C>     <C>
   1999
   Total sales...............  $679,709   $ 6,560  $    614  $   --  $686,883
   Inter-company.............   (82,292)      --        --       --   (82,292)
                               --------   -------  --------  ------- --------
   Revenues..................  $597,417   $ 6,560  $    614  $   --  $604,591
                               --------   -------  --------  ------- --------
   Depreciation..............  $ 14,457   $   --   $    234  $   --  $ 14,691
                               --------   -------  --------  ------- --------
   Operating income..........  $ 22,849   $ 4,644  $(17,129) $   --  $ 10,364
                               ========   =======  ========  ======= ========
   1998
   Total sales...............  $522,575   $   --   $    --   $   --  $522,575
   Inter-company.............   (56,284)      --        --       --   (56,284)
                               --------   -------  --------  ------- --------
   Revenues..................  $466,291   $   --   $    --   $   --  $466,291
                               ========   =======  ========  ======= ========
   Depreciation..............  $  8,713   $   --   $    --   $   --  $  8,713
                               ========   =======  ========  ======= ========
   Operating income..........  $ 27,147   $   --   $    --   $   --  $ 27,147
                               ========   =======  ========  ======= ========
   1997
   Total sales...............  $323,800   $   --   $    --   $   --  $323,800
   Inter-company.............   (25,191)      --        --       --   (25,191)
                               --------   -------  --------  ------- --------
   Revenues..................  $298,609   $   --   $    --   $   --  $298,609
                               ========   =======  ========  ======= ========
   Depreciation..............  $  5,417   $   --   $    --   $   --  $  5,417
                               ========   =======  ========  ======= ========
   Operating income..........  $ 17,700   $   --   $    --   $   --  $ 17,700
                               ========   =======  ========  ======= ========
   Total assets at December
    31, 1999.................  $261,381   $53,054  $  8,998  $51,372 $374,805
                               ========   =======  ========  ======= ========
   Total assets at December
    31, 1998.................  $192,179   $   --   $    --   $43,458 $235,637
                               ========   =======  ========  ======= ========
</TABLE>


                                      63
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  The Company sells to long distance international telecommunications
companies, foreign partners and to retail customers. At December 31, 1999, the
Company had 44 operating agreements with foreign partners and approximately
225 worldwide telecommunications customers, excluding U.S. retail customers.
Total telecommunications revenues from external customers, including U.S.
retail customers, by country for each of the three years ended December 31,
were:

<TABLE>
<CAPTION>
                                                       Year Ended December 31,
                                                      --------------------------
                                                        1999     1998     1997
                                                      -------- -------- --------
                                                            (in thousands)
   <S>                                                <C>      <C>      <C>
   United States..................................... $455,158 $334,746 $216,286
   United Kingdom....................................   79,917   51,378   21,625
   Russia............................................   10,771   11,877    6,733
   Australia.........................................   14,387   10,988    6,377
   New Zealand.......................................   10,553    7,681    2,222
   Other.............................................   26,631   49,621   45,366
                                                      -------- -------- --------
   Total revenues.................................... $597,417 $466,291 $298,609
                                                      ======== ======== ========
</TABLE>

  Revenues are attributed to countries based on the location of customer.
Other includes revenues from customers located in countries that individually
represented less than 2% of total revenues.

(13) Employee Benefit Plans

  In September 1995, the Company established an Employee Stock Purchase Plan
(the "Purchase Plan") which is intended to qualify under section 423 of the
Internal Revenue Code. The Purchase Plan was not active for the years ended
December 31, 1999, 1998, or 1997. Under the Purchase Plan, the Company
reserved up to 400,000 shares of common stock for purchase by employees who
meet certain eligibility requirements. Eligible employees may contribute up to
10% of their compensation to the Purchase Plan to purchase shares at 85% of
the fair market value of the stock on the first or last day of each six-month
offering period as defined in the Purchase Plan.

  The Company maintains a 401(k) plan pursuant to which eligible employees may
accumulate savings on a tax-deferred basis. Each year the Company may make a
discretionary profit sharing contribution to the 401(k) plan which will be
allocated to the accounts of eligible employees who are employed on the last
day of the year. The profit sharing allocation is made on a pro rata basis in
proportion to the compensation of the eligible employees. The Company did not
make a contribution in 1999, 1998, or 1997.

(14) Stock Option Plan

  In September 1995, the Company adopted the 1995 Stock Option Plan (the "1995
Plan"). The 1995 Plan provided non-qualified and incentive stock options to
purchase up to 1,200,000 shares of common stock. Options granted under the
1995 Plan generally vested over four years. The maximum term of options
granted was ten years. The Company granted options to purchase 883,411 shares
of common stock under the 1995 Plan.

  In February 1997, the Company adopted the 1997 Long-Term Incentive Plan (the
"1997 Plan"), replacing the 1995 Plan. The 1997 Plan provided for non-
qualified and incentive stock option awards, stock appreciation rights, stock
grants, and stock-based performance units. The Company may award 4,500,000
shares under the 1997 Plan; with respect to stock option and stock
appreciation right awards, no more than 500,000 shares may be awarded to any
one individual in any one-year period. The remaining terms of the 1997 Plan
are similar to those described in the 1995 Plan. In July 1999, shareholders
voted to increase the number of shares available

                                      64
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

under the plan to 4,500,000 shares from 4,000,000 shares. In addition, the
Company's Board of Directors approved the 1997 Supplemental Long-Term
Incentive Plan (the "1997 Supplemental Plan") with 2,500,000 shares. The 1997
Supplemental Plan provides non-qualified stock options to non-officer
employees. In January 2000, the Company's Board of Directors increased the
number of shares available under the 1997 Supplemental Plan to 4,500,000
shares.

  In September 1998, the Company repriced 768,500 options to purchase the
Company's common stock granted under the 1997 plan to $27.688 per share, the
fair market value of the Company's common stock on September 18, 1998.

  SFAS No. 123, Accounting for Stock-Based Compensation, encourages adoption
of a fair value-based method for valuing the cost of stock-based compensation.
However, it allows companies to continue to use the intrinsic value method
prescribed under Accounting Principles Board Opinion ("APB") No. 25,
Accounting for Stock Options Issued to Employees, for options granted to
employees and disclose pro froma net income and earnings per share in
accordance with SFAS No. 123. Had compensation cost for the Company's stock-
based compensation plans been determined consistent with SFAS No. 123, the
Company's net income and earnings per share would have been as follows:

<TABLE>
<CAPTION>
                                             Year Ended December 31,
                                    ------------------------------------------
                                        1999           1998          1997
                                    -------------  ------------- -------------
                                    (in thousands, except per share amounts)
   <S>                              <C>            <C>           <C>
   Net income--as reported......... $       8,045  $      19,936 $      12,497
   Net income--pro forma........... $      (8,082) $      14,308 $      11,469
   Earnings per share--basic as
    reported....................... $        0.42  $        1.05 $        0.66
   Earnings per share--basic pro
    forma.......................... $       (0.42) $        0.75 $        0.60
   Earnings per share--diluted as
    reported....................... $        0.41  $        0.97 $        0.64
   Earnings per share--diluted pro
    forma.......................... $       (0.41) $        0.70 $        0.59
</TABLE>

  The fair value of the options granted is approximately $118.6 million on the
date of the grant using the Black-Scholes Model for those options issued after
the Company's initial public offering and the Minimum Value methodology for
those options granted prior to the offering. The assumptions used in the
Black-Scholes model were as follows:

<TABLE>
<CAPTION>
                                                         Year Ended December 31,
                                                         -----------------------
                                                          1999    1998    1997
                                                         ------- ------- -------
   <S>                                                   <C>     <C>     <C>
   Dividend yield.......................................    0.0%    0.0%    0.0%
   Volatility...........................................   94.3%   49.4%   40.9%
   Risk-free interest rate..............................    5.6%    4.5%    5.8%
   Assumed forfeiture rate..............................    0.0%    0.0%    0.0%
   Expected life........................................ 5 years 5 years 5 years
</TABLE>

  SFAS No. 123 requires that stock-based compensation granted to non-employees
be accounted for based on the fair value-based method described above. It also
requires that restricted stock granted to employees be recognized as
compensation expense over the vesting period, measured at the fair market
value on the grant date. In 1999, 1998, and 1997, the Company granted 66,750,
25,000, and 75,000 shares, respectively, of restricted stock under the 1997
Plan. In 1999, the Company also granted 150,000 stock options at prices below
market value at the date of the grant. The Company recorded deferred
compensation of $4.5 million, $1.0 million, and $4.1 million for the years
ended December 31, 1999, 1998, and 1997, respectively. This amount was
recorded as a reduction of stockholders' equity and is being amortized as an
expense to operations over the applicable vesting periods. For the years ended
December 31, 1999, 1998, and 1997, $1.2 million, $0.7 million, and $0.1
million,

                                      65
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

respectively, was recognized as compensation expense for restricted stock,
options granted below market, and stock options granted to non-employees.

  Stock Option Awards were:

<TABLE>
<CAPTION>
                                            Year Ended December 31,
                          --------------------------------------------------------------------
                                 1999                   1998                   1997
                          ---------------------- ---------------------- ----------------------
                                       Weighted-              Weighted-              Weighted-
                                        Average                Average                Average
                           Option      Exercise   Option      Exercise   Option      Exercise
                           Shares        Price    Shares        Price    Shares        Price
                          ---------    --------- ---------    --------- ---------    ---------
<S>                       <C>          <C>       <C>          <C>       <C>          <C>
Options outstanding,
 beginning of year......  3,991,071     $31.36   2,296,065     $32.14     883,411     $ 9.77
Options granted.........  3,003,410      23.34   2,608,800      32.50   1,610,000      41.60
Options exercised.......    (90,886)     14.90     (88,887)     13.02    (101,660)      7.30
Options
 forfeited/canceled.....   (195,883)     28.13    (824,907)     39.12     (95,686)     11.08
                          ---------              ---------              ---------
Options outstanding, end
 of year................  6,707,712     $28.09   3,991,071     $31.36   2,296,065     $32.14
                          =========     ======   =========     ======   =========     ======
Option price range at
 end of                   $   5.000 to           $   8.500 to           $   8.500 to
 year...................  $  53.125              $  53.125              $  50.188
Option shares available
 for grant at end of
 year...................  2,703,673                621,107              2,405,000
                          =========              =========              =========
</TABLE>

  The following table summarizes information concerning currently outstanding
and exercisable options:

<TABLE>
<CAPTION>
                                      Options Outstanding                Options Exercisable
                          ------------------------------------------- --------------------------
                                      Weighted-Average   Weighted-                  Weighted-
                            Number       Remaining        Average       Number       Average
Range of Exercise Prices  Outstanding Contractual Life Exercise Price Exercisable Exercise Price
------------------------  ----------- ---------------- -------------- ----------- --------------
<S>                       <C>         <C>              <C>            <C>         <C>
       $ 5.000-
        $19.875..          1,614,981        3.60           $15.43        466,227      $ 9.03
       $23.625-
        $29.500..          3,807,731        3.85            27.05        794,366       27.80
       $38.500-
        $53.125..          1,285,000        3.38            47.05        504,997       46.89
                           ---------                                   ---------
       $ 5.000-
        $53.125..          6,707,712        3.69           $28.09      1,765,590      $28.30
                           =========        ====           ======      =========      ======
</TABLE>

(15) Stockholders' Rights Plan

  On November 17, 1997, the Board of Directors of the Company declared a
dividend of one preferred share purchase right (a "Right") for each
outstanding share of Common Stock. Subject to certain exceptions, each Right,
when exercisable, entitles the registered holder to purchase from the Company
one one-thousandth of a share of Series A Junior Participating Preferred
Stock, par value $0.0001 per share (the "Preferred Stock"), of the Company at
a price of $200, subject to adjustment (the "Purchase Price").

  The Rights generally will only be exercisable (i) ten days following a
public announcement that a person or group of affiliated or associated persons
(an "Acquiring Person") has acquired, or obtained the right to acquire, 15% or
more of the outstanding shares of the Company's Common Stock or (ii) 15
business days following commencement of (or an announcement of an intention to
make) a tender or exchange offer for 15% or more of the outstanding shares of
the Common Stock. The Rights will expire, if not previously exercised,
exchanged or redeemed, on December 1, 2007.

  If any person or group generally acquires 15% or more of the Company's
outstanding Common Stock, each Right, except those held by such an Acquiring
Person, would entitle each holder of a Right to acquire, upon

                                      66
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

exercise at the then current exercise price of the Right, Common Stock having
a value equal to two times the exercise price of the Right.

  At anytime after a person or group generally acquires more than 15% of the
outstanding Common Stock and prior to their acquisition of 50% or more of the
outstanding Common Stock, each Right, except those held by such an Acquiring
Person, may be exchanged by the Board of Directors for one share of Common
Stock.

  If the Company is acquired in a merger or other business combination
transaction or 50% or more of the Company's assets or earnings power is sold,
then each Right will entitle the holder thereof (except for the Acquiring
Person) to receive, upon exercise at the then current exercise price of the
Right, common stock of the acquiring or surviving company having a value equal
to two times the exercise price of the Right.

  At any time prior to the time an Acquiring Person becomes such, the Board of
Directors may redeem the Rights in whole, but not in part, at a price of $.01
per Right (the "Redemption Price").

(16) Subsequent Events

  In March 2000, a leading developer of Internet infrastructure software
agreed to make an equity investment of up to $8 million in Onyx Networks, our
Internet subsidiary, conditioned upon an equal amount being invested by other
investors. In addition, the Company's Internet subsidiary, Onyx Networks,
committed to purchase approximately $28 million of software and services.
Under the transaction, Onyx will license the vendor's content distribution
technology. The amounts are payable in monthly installments of varying length
ranging from 15 to 24 installments, beginning June 1, 2000. The Company has
guaranteed these payments.

  On March 31, 2000, the Company reached an agreement to extend the permanent
reduction of its $100 million line of credit from April 1, 2000, to May 15,
2000. Pursuant to this agreement: (1) the credit facility will be reduced to
$76 million, which is the amount currently outstanding; and (2) the credit
facility will be reduced to $50 million on May 15, 2000, which, will require
the Company to repay approximately $30 million on or before that date.

(17) Selected Quarterly Financial Data (unaudited)

  The following table contains selected unaudited consolidated statements of
income for each quarter of fiscal 1999 and 1998. The Company believes this
information reflects all normal recurring adjustments necessary for
presentation of the information for the periods presented. The operating
results for any quarter are not necessarily indicative of results for any
future period.

                                      67
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


<TABLE>
<CAPTION>
                                                 For the Three Months Ended:
                          --------------------------------------------------------------------------
                          Dec. 31,   Sept.   June 30, March 31, Dec. 31,  Sept.   June 30, March 31,
                            1999    30, 1999   1999     1999      1998   30, 1998   1998     1998
                          --------  -------- -------- --------- -------- -------- -------- ---------
                                    Restated Restated Restated
<S>                       <C>       <C>      <C>      <C>       <C>      <C>      <C>      <C>
(In thousands, except
 per share amounts)
Revenues................  $154,415  $170,061 $139,586 $140,529  $126,414 $124,853 $109,952 $105,072
Gross profit............  $ 25,576  $ 25,097 $ 18,153 $ 19,094  $ 19,610 $ 20,209 $ 17,001 $ 15,831
Net income..............  $   (314) $  2,894 $  1,835 $  3,630  $  5,023 $  5,652 $  4,885 $  4,376
Net income per share:*
 Basic..................  $  (0.02) $   0.15 $   0.10 $   0.19  $   0.26 $   0.30 $   0.26 $   0.23
 Diluted................  $  (0.02) $   0.15 $   0.09 $   0.18  $   0.25 $   0.29 $   0.25 $   0.22
</TABLE>

*Net income per share is computed independently for each of the quarters
presented, therefore, the sum of the quarterly net income per share may not
equal the annual net income per share.

(18) Restatement (unaudited)

  The results of operations and statements of financial position as previously
reported in the Company's interim 1999 financial statements filed on Form 10-Q
have been restated to reflect certain adjustments. The adjustments resulted
from capitalization of certain expenses in incorrect quarters, inappropriate
capitalization of expenses and other adjustments.

  The net effect of the restatement was:

<TABLE>
<CAPTION>
                                               For the Three Months Ended
                         -----------------------------------------------------------------------
                             March 31, 1999           June 30, 1999        September 30, 1999
                         ----------------------- ----------------------- -----------------------
                         As Reported As Restated As Reported As Restated As Reported As Restated
                         ----------- ----------- ----------- ----------- ----------- -----------
<S>                      <C>         <C>         <C>         <C>         <C>         <C>
Revenues................  $140,529    $140,529    $139,586    $139,586    $170,061    $170,061
Gross profit............  $ 19,094    $ 19,094    $ 18,153    $ 18,153    $ 25,288    $ 25,097
Net income..............  $  4,223    $  3,630    $  2,571    $  1,835    $  3,456    $  2,894
Net income per share:
 Basic..................  $   0.22    $   0.19    $   0.13    $   0.10    $   0.18    $   0.15
 Diluted................  $   0.22    $   0.18    $   0.13    $   0.09    $   0.18    $   0.15
</TABLE>

                                      68
<PAGE>

                                   PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS

  The information concerning directors required by this item is incorporated
by reference to the information contained under the captions "Election of
Directors", "Meetings and Committees of the Board" and "Section 16(a)
Beneficial Ownership Reporting Compliance" in our Proxy Statement for the 2000
Annual Meeting of Stockholders to be filed within 120 days of the end of 1999.

ITEM 11. EXECUTIVE COMPENSATION

  The information required by this item is incorporated by reference to the
information contained under the caption "Compensation of Directors and
Executive Officers" in our Proxy Statement for the 2000 Annual Meeting of
Stockholders to be filed within 120 days of the end of 1999.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

  The information required by this item is incorporated by reference to the
information contained under the caption "Ownership of the Capital Stock of the
Company" in our Proxy Statement for the 2000 Annual Meeting of Stockholders to
be filed within 120 days of the end of 1999.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

  The information required by this item is incorporated by reference to the
information contained under the caption "Certain Relationships and Related
Transactions" in our Proxy Statement for the 2000 Annual Meeting of
Stockholders to be filed within 120 days of the end of 1999.

                                    PART IV

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

  (a) 1. Financial Statements*

    Consolidated Balance Sheets as of December 31, 1999 and 1998

    Consolidated Statements of Operations for the Years Ended December 31,
  1999, 1998 and 1997

    Consolidated Statements of Cash Flows for the Years Ended December 31,
  1999, 1998 and 1997

    Consolidated Statements of Changes in Stockholders' Equity for the Years
  Ended December 31, 1999,   1998 and 1997

    Notes to Consolidated Financial Statements
--------
  *  Included in Item 8 of this 10-K

  (a) 2. Financial Statement Schedule

    Schedule II--Valuation and Qualifying Accounts

                                      69
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

  (a) 3. Exhibits

<TABLE>
<CAPTION>
Exhibit
Number   Description                                  Method of Filing
-------  -----------                                  ----------------
<S>      <C>                                          <C>
 2.1     Asset Purchase Agreement between             Filed with this document
         International Exchange Communications and
         NOSVA Limited Partnership dated December 29,
         1999
 3.1.1   Amended and Restated Certificate of          Incorporated by reference to
         Incorporation, as Amended May 20, 1997       Quarterly Report on Form 10-Q for
                                                      the quarter ended June 30, 1997
                                                      (No. 000-21043)
 3.1.2   Certificate of Amendment of Amended and      Incorporated by reference to Form
         Restated Certificate of Incorporation as     10-K for the year ended December
         amended June 19, 1998                        31, 1998 (No. 000-21043)
 3.2     Amended and Restated Bylaws, as amended      Incorporated by reference to
         October 23, 1998                             Quarterly Report on Form 10-Q for
                                                      the quarter ended September 30
                                                      1998 (No. 000-21043)
 4.1     Specimen Certificate for Common Stock        Incorporated by reference to
                                                      Registration Statement on Form S-
                                                      1 (No. 33-80191)
 4.2.1   Amended and Restated Certificate of          Incorporated by reference to
         Incorporation, as Amended May 20, 1997       Quarterly Report on Form 10-Q for
                                                      the quarter ended June 30, 1997
                                                      (No. 000-21043)
 4.2.2   Certificate of Amendment of Amended and      Incorporated by reference to Form
         Restated Certificate of Incorporation as     10-K for the year ended December
         amended June 19, 1998                        31, 1998 (No. 000-21043)
 4.3     Rights Agreement dated as of November 17,    Incorporated by reference to Form
         1997, between the Company and Norwest Bank   8-K filed November 21, 1997
         Minnesota, N.A. as Rights Agent              (No. 000-21043)
10.1     Form of Indemnification Agreement for        Incorporated by reference to Form
         directors and officers                       10-K for the year ended December
                                                      31, 1997 (No. 000-21043)
10.2.1   1997 Long-Term Incentive Plan, as Amended    Filed with this document
10.2.2   1997 Supplemental Long-Term Incentive Plan   Incorporated by reference to
                                                      Quarterly Report on Form 10-Q for
                                                      the quarter ended June 30, 1999
                                                      (No. 000-21043)
10.3     Employee Stock Purchase Plan                 Incorporated by reference to
                                                      Registration Statement on Form S-
                                                      1 (No. 33-80191)
10.4.1   Proxy dated December 10, 1994 by Julie J.    Incorporated by reference to
         Jensen                                       Registration Statement on Form S-
                                                      1 (No. 33-80191)
10.4.2   Proxy dated December 10, 1994 by Jeffrey J.  Incorporated by reference to
         Jensen                                       Registration Statement on Form S-
                                                      1 (No. 33-80191)
10.4.3   Proxy dated December 10, 1994 by Janet       Incorporated by reference to
         Jensen Kreiger                               Registration Statement on Form S-
                                                      1 (No. 33-80191)
10.4.4   Proxy dated December 10, 1994 by James J.    Incorporated by reference to
         Jensen                                       Registration Statement on Form S-
                                                      1 (No. 33-80191)
10.4.5   Proxy dated December 10, 1994 by Jami J.     Incorporated by reference to
         Jensen                                       Registration Statement on Form S-
                                                      1 (No. 33-80191)
</TABLE>

                                       70
<PAGE>

                         PACIFIC GATEWAY EXCHANGE, INC

<TABLE>
<CAPTION>
Exhibit
Number   Description                                  Method of Filing
-------  -----------                                  ----------------
<S>      <C>                                          <C>
10.4.6   Proxy dated March 23, 2000 by Gail E.        Filed with this document
         Granton individually and as trustee of The
         Granton Foundation
10.4.7   Proxy dated June 10, 1996 by Ronald L.       Incorporated by reference to
         Jensen                                       Registration Statement on Form S-
                                                      1 (No. 33-80191)
10.5.1   Employment Agreement dated as of January 1,  Incorporated by reference to
         1998 between Howard A. Neckowitz and Pacific Quarterly Report on Form 10-Q for
         Gateway Exchange, Inc.                       the quarter ended June 30, 1998
                                                      (No. 000-21043)
10.5.2   Employment Agreement dated as of January 1,  Incorporated by reference to
         1998 between Gail E. Granton and Pacific     Quarterly Report on Form 10-Q for
         Gateway Exchange, Inc.                       the quarter ended June 30, 1998
                                                      (No. 000-21043)
10.5.3   Employment Agreement dated as of January 1,  Incorporated by reference to
         1998 between Ronald D. Anderson and Pacific  Quarterly Report on Form 10-Q for
         Gateway Exchange, Inc.                       the quarter ended June 30, 1998
                                                      (No. 000-21043)
10.5.4   Employment Agreement dated October 1, 1995   Incorporated by reference to
         between Robert F. Craver and Pacific Gateway Quarterly Report on Form 10-Q for
         Exchange, Inc.                               the quarter ended June 30, 1998
                                                      (No. 000-21043)
10.5.5   Employment Agreement dated October 1, 1995   Incorporated by reference to
         between Fred A. Weismiller and Pacific       Quarterly Report on Form 10-Q for
         Gateway Exchange, Inc.                       the quarter ended June 30, 1998
                                                      (No. 000-21043)
10.5.6   Restricted Stock Award Agreement dated       Incorporated by reference to
         December 30, 1997 between Howard A.          Quarterly Report on Form 10-Q for
         Neckowitz and Pacific Gateway Exchange, Inc. the quarter ended June 30, 1999
                                                      (No. 000-21043)
10.5.7   Restricted Stock Award Agreement dated July  Incorporated by reference to
         21, 1998 between Thomas J. Murphy and        Quarterly Report on Form 10-Q for
         Pacific Gateway Exchange, Inc.               the quarter ended June 30, 1999
                                                      (No. 000-21043)
10.5.8   Employment Agreement dated September 3, 1998 Incorporated by reference to Form
         between Thomas J. Murphy and Pacific Gateway 10-K for the year ended December
         Exchange, Inc.                               31, 1998 (No. 000-21043)
10.6     Telephone Service dated May 1, 1995 between  Incorporated by reference to
         Matrix Telecom, Inc. and Pacific Gateway     Registration Statement on Form S-
         Exchange, Inc.                               1 (No. 33-80191)
10.7     Agreement for Billing Services dated         Incorporated by reference to
         November 24, 1995 Between Matrix Telecom,    Registration Statement on Form S-
         Inc. and Pacific Gateway Exchange, Inc.      1 (No. 33-80191)
10.8     First Amended and Restated Credit Agreement  Filed with this document
         among Pacific Gateway Exchange, Inc.,
         Pacific Gateway Exchange (Bermuda) Limited,
         Bank of America, N.A. and Deutsche Bank
         Securities Inc. dated November 23, 1999
21.1     Subsidiaries                                 Filed with this document
23.1     Consent of Independent Accountants           Filed with this document
27.1     Financial Data Schedule                      Filed with this document
</TABLE>

  (b) Reports on Form 8-K

  None.

                                       71
<PAGE>

                                  SIGNATURES

  Pursuant to the requirements of section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized, in
Burlingame, California, on the 30th day of March, 2000.

                                          Pacific Gateway Exchange, Inc.

                                          By:   /s/ Howard A. Neckowitz
                                             __________________________________
                                                   Howard A. Neckowitz
                                           President, Chief Executive Officer
                                                and Chairman of the Board

  Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed by the following persons on behalf of the
Registrant and in the capacities indicated and on the 30th day of March, 2000.

<TABLE>
<CAPTION>
              Signature                          Title
              ---------                          -----

<S>                                    <C>                        <C>
       /s/ Howard A. Neckowitz         President, Chief Executive
______________________________________  Officer and Chairman of
         Howard A. Neckowitz            the Board (Principal
                                        Executive Officer)

         /s/ Gail E. Granton           Executive Vice President,
______________________________________  International Business
           Gail E. Granton              Development, Secretary
                                        and Director

          /s/ Sandra D. Grey           Chief Financial Officer,
______________________________________  and Vice President,
            Sandra D. Grey              Finance (Principal
                                        Financial Officer)
                                        (Principal Accounting
                                        Officer)

        /s/ Robert C. Calafell         Director
______________________________________
          Robert C. Calafell

        /s/ Charles M. Dalfen          Director
______________________________________
          Charles M. Dalfen

        /s/ James J. Junewicz          Director
______________________________________
          James J. Junewicz

         /s/ Barry J. Volante          Director
______________________________________
           Barry J. Volante
</TABLE>

                                      72
<PAGE>

                         Pacific Gateway Exchange, Inc.

                                  Schedule II

                       Valuation and Qualifying Accounts
                                 (in thousands)

<TABLE>
<CAPTION>
                                             Additions
                                  Balance at Charged to Deductions--  Balance
                                  Beginning  Costs and    Accounts    at End
   Description                    of Period   Expenses  written off  of Period
   -----------                    ---------- ---------- ------------ ---------
   <S>                            <C>        <C>        <C>          <C>
   Allowance for doubtful
    accounts:
     1999........................   $4,312     $4,558      $1,024     $7,846
     1998........................   $2,230     $2,146      $   64     $4,312
     1997........................   $1,679     $2,173      $1,622     $2,230
</TABLE>

                                      S-1