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


                                   FORM 10-Q


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

                   FOR THE QUARTER ENDED September 30, 1998

                      COMMISSION FILE NUMBER   000-21043

                        PACIFIC GATEWAY EXCHANGE, INC.
                        ------------------------------
            (Exact Name of Registrant as Specified in its Charter)


              Delaware                              94-3134065
  (State of Other Jurisdiction                    (IRS Employer
  of Incorporation or Organization)               Identification Number)

  533 Airport Blvd, Suite 505, Burlingame, California,       94010
       (Address of Principal Executive Offices)            (Zip Code)

     Registrant's Telephone Number, Including Area Code  (650) 375-6700
                                                        ------------------

                                     None
                                     ----
                       (Former Name, Former Address and
               Former Fiscal Year if Changed Since Last Report)

  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 
                                     ---     ---     

As of October 30, 1998, the number of the registrant's Common Shares of $.0001
par value outstanding was 19,184,499

<PAGE>
 
                        PACIFIC GATEWAY EXCHANGE, INC.



                               TABLE OF CONTENTS
                               -----------------
 
<TABLE> 
<CAPTION> 
                                                                        Page
                                                                        ----
<S>                                                                     <C>
Part I -  FINANCIAL INFORMATION

Item 1: Financial Statements
 
        Consolidated condensed balance sheets as of
        September 30, 1998 and December 31, 1997                        1
 
        Consolidated condensed statements of income
        for the three-month and nine-month periods ended
        September 30 , 1998 and 1997                                    2
 
        Consolidated condensed statements of cash flows
        for the nine-month periods ended
        September 30 , 1998 and 1997                                    3
 
        Notes to consolidated condensed financial statements            4
 
Item 2: Management's discussion and analysis
        of financial condition and results
        of operations                                                   6
 

Part II - OTHER INFORMATION
 
Item 1: Legal Proceedings                                               11
                                                              
Item 2: Changes in Securities and Use of Proceeds                       11
                                                              
Item 3: Defaults upon Senior Securities                                 11
                                                              
Item 4: Submission of matters to a vote of security holders             11
                                                              
Item 5: Other information                                               11
 
Item 6: Exhibits and reports on Form 8-K                                12
</TABLE>
<PAGE>
 
ITEM 1.  FINANCIAL STATEMENTS

                        PACIFIC GATEWAY EXCHANGE, INC.
                     CONSOLIDATED CONDENSED BALANCE SHEETS
                                (in thousands)
<TABLE> 
<CAPTION> 
                                                                                (Unaudited)
                                                                               SEPTEMBER 30,  DECEMBER 31, 
                                                                                   1998          1997      
                                                                              --------------- ------------ 
<S>                                                                           <C>             <C>          
                                ASSETS                                                                                     
CURRENT ASSETS:                                                                                            
Cash and cash equivalents                                                         $ 31,471       $ 43,850  
Accounts receivable, net of allowance for doubtful accounts                                                
      of $3,503 in 1998 and $2,230 in 1997                                          86,219         62,313  
Prepaid expenses                                                                     1,440            511  
Income taxes receivable                                                              2,254              -  
Other current assets                                                                 1,927          1,769  
                                                                              --------------- ------------ 
             Total current assets                                                  123,311        108,443  
Property and equipment, net                                                         85,819         61,433  
Investment in companies                                                              6,610            184  
Deposits and other assets                                                            1,739          1,557  
                                                                              --------------- ------------ 
             Total assets                                                        $ 217,479      $ 171,617  
                                                                              =============== ============ 
                  LIABILITIES AND STOCKHOLDERS' EQUITY                                                       
CURRENT LIABILITIES:                                                                                       
Accounts payable                                                                 $ 116,411       $ 87,949  
Accrued liabilities                                                                  4,669          3,733  
Income taxes payable                                                                     -          1,491  
Other liabilities                                                                    2,213          1,871  
                                                                              --------------- ------------ 
             Total liabilities                                                     123,293         95,044  
                                                                              --------------- ------------ 
Commitments and contingencies (Note 6).                                                                    

STOCKHOLDERS' EQUITY:                                                                                      
Preferred stock, $.0001 par value, authorized                                                              
      5,000,000 shares, no shares issued                                                 -              -  
Common stock, $.0001 par value, authorized 70,000,000 shares,                                              
      issued 19,323,809 shares, outstanding 19,180,249 shares                                              
      in 1998 and issued 19,216,710 shares, outstanding 19,073,150                                         
      shares in 1997                                                                     2              2  
Additional paid in capital                                                          64,226         60,849  
Deferred compensation-restricted stock                                              (4,821)        (4,134) 
Foreign currency translation                                                           147              2  
Retained earnings                                                                   35,032         20,254  
Common stock held in treasury, at cost                                                                     
      (143,560 shares in 1998 and 1997)                                               (400)          (400) 
                                                                              --------------- ------------ 
             Total stockholders' equity                                             94,186         76,573  
                                                                              --------------- ------------ 
             Total liabilities and stockholders' equity                          $ 217,479      $ 171,617  
                                                                              =============== ============ 
</TABLE> 

     See Accompanying Notes to Consolidated Condensed Financial Statements


                                       1
<PAGE>
 
<TABLE>
<CAPTION>
                                                 PACIFIC GATEWAY EXCHANGE, INC.
                                           CONSOLIDATED CONDENSED STATEMENTS OF INCOME
                                           (in thousands, except net income per share)

                                                             THREE MONTHS                          NINE MONTHS
                                                          ENDED SEPTEMBER 30,                  ENDED SEPTEMBER 30,
                                                   ----------------------------------  -------------------------------------
                                                         1998              1997              1998               1997
                                                   ------------------ ---------------  ------------------ ------------------
                                                                                 (Unaudited)
<S>                                                <C>                <C>              <C>                 <C>
 Revenues                                                  $ 124,853        $ 76,087           $ 339,877          $ 183,015
 Revenues - related party                                          -           3,910                   -             11,619
                                                   ------------------ ---------------  ------------------ ------------------
            Total revenues                                   124,853          79,997             339,877            194,634
 Cost of long distance services                              104,644          68,099             286,836            163,207
                                                   ------------------ ---------------  ------------------ ------------------
            Gross margin                                      20,209          11,898              53,041             31,427
 Selling, general and administrative expenses                 11,612           5,587              26,464             15,030
 Depreciation                                                  2,209           1,595               6,318              3,715
                                                   ------------------ ---------------  ------------------ ------------------
            Total operating expenses                          13,821           7,182              32,782             18,745
                                                   ------------------ ---------------  ------------------ ------------------
            Operating income                                   6,388           4,716              20,259             12,682
 Other (income) expense, net                                  (1,712)           (162)             (1,118)              (330)
 Interest (income) expense, net                                 (532)           (377)             (1,701)            (1,392)
                                                   ------------------ ---------------  ------------------ ------------------
      Income before income taxes                               8,632           5,255              23,078             14,404
 Provision for income taxes                                    2,980           1,965               8,165              5,610
                                                   ------------------ ---------------  ------------------ ------------------
            Net income                                       $ 5,652         $ 3,290            $ 14,913            $ 8,794
                                                   ================== ===============  ================== ==================

            Net income per share, basic                      $ 0.30          $ 0.17              $ 0.78             $ 0.46
                                                   ================== ===============  ================== ==================


            Net income per share, diluted                    $ 0.29          $ 0.17              $ 0.75             $ 0.45
                                                   ================== ===============  ================== ==================

</TABLE>

          See Accompanying Notes to Consolidated Condensed Financial Statements.

                                       2
<PAGE>
 
                        PACIFIC GATEWAY EXCHANGE, INC.
                CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
                                (IN THOUSANDS)

<TABLE> 
<CAPTION> 
                                                                           NINE MONTHS
                                                                       ENDED SEPTEMBER 30,
                                                               ----------------------------------
                                                                     1998                1997
                                                               ----------------    --------------
                                                                           (Unaudited)
<S>                                                            <C>                 <C>
OPERATING ACTIVITIES:
Net income                                                         $ 14,913            $ 8,794
Adjustments to net income:
     Depreciation                                                     6,318              3,715
     Stock compensation expense                                         456                 84
     Bad debts provision                                                620              1,829
     Equity in net income of affiliated companies                    (1,311)                 -
     Changes in operating assets and liabilities:
        Accounts receivable                                         (24,526)           (30,113)
        Accounts receivable, related party                                -                444
        Prepaid expenses                                               (929)               (26)
        Deposits and other assets                                      (387)            (1,217)
        Accounts payable                                             28,607             25,302
        Accrued liabilities                                             936              2,127
        Federal income taxes payable (recoverable)                   (3,745)            (1,385)
        Other liabilities                                               723                944
                                                               ----------------    --------------
     Net cash provided by operating activities                       21,675             10,498
                                                               ----------------    --------------

INVESTING ACTIVITIES:
Purchase of property and equipment                                  (30,924)           (26,483)
Purchase of investment                                               (3,314)               222
                                                               ----------------    --------------
Net cash used in investing activities                               (34,238)           (26,261)
                                                               ----------------    --------------

FINANCING ACTIVITIES:
Exercise of stock options                                               491                528
Other                                                                   (57)              (154)
                                                               ----------------    --------------
Net cash provided by financing activities                               434                374
                                                               ----------------    --------------
Net decrease in cash and cash equivalents                           (12,129)           (15,389)
Cash and cash equivalents at beginning of the period                 43,850             45,563

                                                               ----------------    --------------
Cash and cash equivalents at end of the period                     $ 31,721           $ 30,174
                                                               ================    ==============

Supplemental data for non-cash investing
  and financing activities:
Common stock issued to investee                                     $ 1,800                $ -

</TABLE>

    See Accompanying Notes to Consolidated Condensed Financial Statements.

                                       3
<PAGE>
 
             NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
                                        
(1) GENERAL
-----------

     The financial statements included herein are unaudited and have been
prepared in accordance with generally accepted accounting principles for interim
financial reporting and Securities Exchange Commission ("SEC") regulations.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations.  In the
opinion of management, the financial statements reflect all adjustments (of a
normal and recurring nature) that are necessary to present fairly the financial
position, results of operations and cash flows for the interim periods.  These
financial statements should be read in conjunction with the annual report on
Form 10-K of Pacific Gateway Exchange, Inc. (the "Company" or "Pacific Gateway")
for the year ended December 31, 1997.  The results for the three- and nine-month
periods ended September 30, 1998 are not necessarily indicative of the results
that may be expected for future periods.

     In accordance with American Institute of Certified Public Accountants
Statement of Position 98-1 "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use", during the first quarter of 1998, the
Company began capitalizing costs associated with developing computer software
for internal use.

     Certain prior-year amounts have been reclassified to conform to the 1998
financial statement presentation.


(2)  ACQUISITIONS
-----------------

     On February 13, 1998, the Company purchased of 16.6% of Ekonom S.A. de
C.V., a Mexican multimedia company existing under the laws of the United Mexican
States, for $3,300,000 in cash and $1,800,000 in Pacific Gateway's common stock.
The Company's investment in Ekonom is accounted for under the cost method.


(3)  EARNINGS PER SHARE
-----------------------

<TABLE>
<CAPTION>
                                                    INCOME                  SHARES               PER-SHARE
(in thousands, except per share amounts)          (NUMERATOR)           (DENOMINATOR)              AMOUNT
<S>                                             <C>                   <C>                      <C>
Three Months Ended September 30, 1998
BASIC EPS:
Income available to common stockholders                $ 5,652                   19,065                 $0.30
Effect of stock-based compensation                                                  687
                                              ----------------      -------------------      ----------------
DILUTED EPS                                            $ 5,652                   19,752                 $0.29
                                              ================      ===================      ================
 
THREE MONTHS ENDED SEPTEMBER 30, 1997
BASIC EPS:
Income available to common stockholders                $ 3,290                   18,938                 $0.17
Effect of stock-based compensation                                                  759
                                              ----------------      -------------------      ----------------
DILUTED EPS                                            $ 3,290                   19,697                 $0.17
                                              ================      ===================      ================

     Nine Months Ended September 30, 1998
BASIC EPS:
Income available to common stockholders                $14,913                  19,056                $0.78
Effect of stock-based compensation                                                 868
                                              ----------------      -------------------      ----------------
DILUTED EPS                                            $14,913                  19,924                $0.75
                                              ================     ===================     ================
 
NINE MONTHS ENDED SEPTEMBER 30, 1997
BASIC EPS:
Income available to common stockholders                $ 8,794                  18,938                $0.46
Effect of stock-based compensation                                                 795
                                              ----------------      -------------------      ----------------
DILUTED EPS                                            $ 8,794                  19,733                $0.45
                                              ================     ===================     ================
</TABLE>


                                       4
<PAGE>
 
(4)  COMPREHENSIVE INCOME
-------------------------

     In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income".  SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components in a financial statement that is
displayed with the same prominence as other financial statements.  Comprehensive
income as defined includes all changes in equity (net assets) during a period
from non-owner sources.  Examples of items to be included in comprehensive
income, which are excluded from net income, include foreign currency translation
adjustments.  In accordance with the adoption of SFAS No. 130, total other
comprehensive income consisted of foreign currency translation gains totaling
approximately $87,000 and $145,000 for the three- and nine-month period ending
September 30, 1998, respectively.



(5)  NEW ACCOUNTING PRONOUNCEMENTS
----------------------------------

     In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information".  This statement establishes standards
for the way companies report information about operating segments in annual
financial statements.  It also establishes standards for related disclosures
about products and services, geographic areas, and major customers.  The Company
is in the process of evaluating the disclosure impact of adopting this new
standard.  The disclosures prescribed by SFAS No. 131 will be made for the full
year financial statements for the year ended December 31, 1998.

     In March 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits". SFAS No. 132 significantly changes
current financial statement disclosure requirements from those that were
required under SFAS 87.  The Company currently does not have a pension or other
postretirement benefit plan.  Therefore, SFAS No. 132 will not be applicable to
the Company.

     In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities."  SFAS No. 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities.  The
adoption of SFAS No. 133 must be made by the first quarter of the year 2000.
Because the Company has not entered into derivative financial instruments, the
implementation of SFAS No. 133 will not have an impact on the Company's
consolidated results of operations, financial position or cash flows.

(6)  CONTINGENCIES
---  -------------

     The Company currently has operating subsidiaries in foreign locations
including, the U.K., New Zealand and Russia.  The location of these subsidiaries
in foreign countries gives rise to particular risks, such as the possibility of
unexpected and adverse changes in foreign government regulations and
telecommunications standards, licensing requirements, tariffs, taxes and other
trade barriers, as well as general political and economic instability. During
the third quarter, the Company's Russian subsidiary, Rustelnet, was notified by
the Russian local tax authorities of a potential local tax liability. The
management of Rustelnet has advised the Company that Rustelnet has strong
defenses and intends to defend itself vigorously in this matter, and that
Rustelnet follows policies that are consistent with tax practices utilized in
the Russian telecommunications industry. Although no assurances are possible,
the Company does not believe that this development will have a material adverse
effect on its financial condition or results of operations.


<PAGE>
 
Item 2: Management Discussion and Analysis of Financial Condition and Results of
        Operations
                                        
     This Quarterly 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, including
statements regarding expected future revenue from delayed proportional return
traffic from foreign partners pursuant to certain operating agreements.
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"
or "expects." These forward-looking statements relate to the plans, objectives
and expectations of Pacific Gateway Exchange, Inc. ("Pacific Gateway" or the
"Company") 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.  The revenues and results of
operations of the Company, and future developments in the telecommunications
industry, are difficult to forecast and could differ materially from those
projected in the forward-looking statements as a result of numerous factors,
including the following: (i) changes in international settlement rates; (ii)
changes in the ratios between outgoing and incoming traffic; (iii) foreign
currency fluctuations; (iv) termination of certain operating agreements or
inability to enter into additional operating agreements; (v) inaccuracies in the
Company's forecasts of traffic; (vi) changes in or developments under domestic
or foreign laws, regulations, licensing requirements or telecommunications
standards; (vii) foreign political or economic instability; (viii) changes in
the availability of transmission facilities such as undersea fiber optic cable
or in the feasibility of building such facilities; (ix) loss of the services of
key officers, such as Howard A.  Neckowitz, Chairman of the Board, President and
Chief Executive Officer or Gail E. Granton, Executive Vice President,
International Business Development and Secretary; (x) loss of a customer which
provides significant revenues to the Company; (xi) highly competitive market
conditions in the industry; (xii) future management decisions regarding, for
example, acquisitions, capital expenditures or financings;  (xiii) concentration
of credit risk; (xiv) natural disasters and catastrophic events; (xv)
opportunities for (and problems resulting from) the acquisition of other
companies or offshore facilities; or (xvi) the impact of the year 2000 issue and
any related noncompliance.  The foregoing review of important factors, including
those discussed in detail below, should not be construed as exhaustive.  The
Company undertakes 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.

     The following table sets forth income statement data as a percentage of
revenues for the period indicated.
<TABLE>
<CAPTION>
                                                Three Months                         Nine Months
                                                    Ended                               Ended
                                                September 30,                        September 30,
                                           ----------------------------     ----------------------------
                                               1998             1997            1998             1997
                                           -----------      -----------     -----------      -----------
<S>                                        <C>              <C>             <C>              <C>
Total Revenues                                   100.0%           100.0%          100.0%           100.0%
 Cost of long distance services                   83.8%            85.1%           84.4%            83.9%
                                           -----------      -----------     -----------      -----------
      Gross margin                                16.2%            14.9%           15.6%            16.2%
Selling, general and administrative
 expenses                                         9.3%              7.0%            7.8%             7.2%
Depreciation                                       1.8%             2.0%            1.9%             1.9%
                                           -----------      -----------     -----------      -----------
      Total operating expenses                    11.1%             9.0%            9.6%             9.6%
                                           -----------      -----------     -----------      -----------
      Operating income                             5.0%             5.9%            6.0%             6.5%
Interest (income) expense, net                    -0.4%            -0.2%           -0.5%            -0.2%
Other (income) expense, net                       -1.4%            -0.5%           -0.5%            -0.7%
                                           -----------      -----------     -----------      -----------
      Income before income taxes                   6.9%             6.6%            6.8%             7.4%
Provision for income taxes                         2.4%             2.5%            2.4%             2.9%
                                           -----------      -----------     -----------      -----------
      Net income                                   4.5%             4.1%            4.4%             4.5%
                                           ===========      ===========     ===========      ===========
</TABLE>
<PAGE>
 
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS 
--------------------------------------------------------------
ENDED SEPTEMBER 30, 1997.
------------------------

REVENUES:    Total revenues for the three months ended September 30, 1998
--------
increased 56% to $124.9 million from $80.0 million for the three months ended
September 30, 1997 and increased 14% from $110.0 million in the quarter ended
June 30, 1998.  The increase from the quarter ended September 30, 1997 was the
result of several factors.  First, the Company increased the number of its
operating agreements to 44 at September 30, 1998 from 37 at September 30, 1997.
Second, the number of wholesale carrier customers increased to 157 at September
30, 1998 from 115 at September 30, 1997.   Third, revenues from the Company's
retail customers were $5.5 million for the quarter ended September 30, 1998,
while the Company was not engaged in the retail business for the quarter ended
September 30, 1997.  As a result of these factors, total minutes increased 60.3%
from the three months ended September 30, 1997, while the average price per
minute charged to customers declined slightly to $0.28 in the three months ended
September 30, 1998, compared to $0.29 in the same quarter last year.  Changes in
the terminating country mix with significantly different rates per minute,
reductions in the rates received for the traffic terminating in and transiting
the U.S. and increases in the incidental U.S. domestic terminating traffic
influenced the average customer price per minute. During the third quarter of
1998 (as in all prior quarters), the Company sent more minutes out than it
received under its operating agreements.  Because the same rate is charged by
the foreign carrier to terminate calls in their country as the Company charges
the foreign carrier to terminate calls in the United States, declining rates
have an adverse effect on revenue and estimated return traffic revenue backlog,
but, as a result of sending more calls out than the Company receives, declining
rates improve the gross margin received on the entire transaction of a minute
delivered with such foreign carriers.

GROSS MARGIN:  As a percentage of revenue, gross margin was 16.2% in the current
------------
three-month period, an increase from 14.9% in the same period in the prior year.
The increase in margin resulted from the reconfiguring of the U.S. network,
which led to lower costs per minute of revenue and traffic from the Company's
retail customers that yielded a higher profit margin.  The cost of long distance
service increased to $104.6 million in the three months ended September 30, 1998
from $68.1 million in the three months ended September 30, 1997.  This increase
in costs represents continued growth in outbound traffic on new and existing
routes.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:  Selling, general and
--------------------------------------------
administrative expenses ("SG&A") as a percentage of revenues were 9.3% in the
three months ended September 30, 1998, an increase from 7.8% in the same period
in the prior year.  Actual expenses increased to $11.6 million in the three
months ended September 30, 1998 from $5.6 million in the three months ended
September 30, 1997.   During the third quarter of 1998, SG&A increased by $2.4
million to reflect commissions paid by the Company to its joint venture,
PinTouch Telecom LLC.  This increase in SG&A is offset by a corresponding
increase in the Company's equity in earnings of PinTouch Telecom LLC , of $2.4
million which is included in Other (income)expense, net, the remaining 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 the Company's wholly owned subsidiaries to 142 at
September 30, 1998 from 71 at September 30, 1997. The increase in sales
commission expenses was primarily due to increased revenues.

DEPRECIATION:   Depreciation increased 38.5% to $2.2 million in the quarter
------------
ended September 30, 1998 from $1.6 million in the quarter ended September 30,
1997.  Depreciation as a percentage of revenues was 1.8% of revenue for the
current quarter, and 2.0% for the same quarter in the prior year.  The increase
in the dollar amount was primarily due to depreciation of additional
transmission facilities acquired since September 30, 1997.

INCOME TAX:   Income taxes increased to $3.0 million in the three months ended
----------
September 30, 1998 from $2.0 million in the three months ended September 30,
1997, primarily due to increased operating income.  The effective tax rate was
37% in 1997 and 35% in 1998.  The decrease in effective tax rate was
<PAGE>
 
attributable to earnings of certain non-U.S. subsidiaries.  A portion of these
earnings is intended to be reinvested indefinitely in operations outside the
U.S.

NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS 
------------------------------------------------------------
ENDED SEPTEMBER 30, 1997.
------------------------

REVENUES:    Total revenues for the nine months ended September 30, 1998
--------
increased 75% to $339.9 million from $194.6 million in the nine months ended
September 30, 1997.  The increase was primarily the result of increased sales to
existing customers, an increase in the number of operating agreements with
foreign partners to 44 at September 30, 1998 from 37 at September 30, 1997, and
an increase in the number of wholesale customers to 157 at September 30, 1998
from 115 at September 30, 1997.  In addition, revenues from the Company's retail
customers were $13.2 million for the nine months ended September 30, 1998, while
there were no retail revenues for the nine months ended September 30, 1997.

GROSS MARGIN:  As a percentage of revenue, gross margin was 15.6% for the nine
------------
months ended September 30, 1998, a decrease of 0.6% from 16.2% for the same
period in the prior year.  The small decrease in margin resulted from higher
fixed costs due to offshore start-ups and reconfiguring of the U.S. network.
The cost of long distance service increased to $286.8 million in the nine months
ended September 30, 1998 from $163.2 million in the nine months ended September
30, 1997.  This increase in costs represents continued growth in outbound
traffic on new and existing routes.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:  Selling, general and
--------------------------------------------
administrative expenses as a percentage of revenues were 7.8% in the nine months
ended September 30, 1998,  a slight increase from 7.7% in the same period in the
prior year.  Actual expenses increased 76.1% to $26.5 million in the nine months
ended September 30, 1998 from $15.0 million in the nine months ended September
30, 1997.  In the third quarter of 1998, SG&A was increased by $2.4 million to
reflect commissions paid to its joint venture, PinTouch Telecom LLC. This
increase in SG&A is offset by a corresponding increase in the Company's equity
in earnings of PinTouch Telecom LLC of $2.4 million which is included in Other
(income)expense, net, the remaining increase was primarily due to increased
personnel and sales commission expenses. The increase in personnel expenses was
directly related to the increase in the number of employees in the Company's
wholly owned subsidiaries to 142 at September 30, 1998 from 71 at September 30,
1997. The increase in sales commission expenses was primarily due to increased
revenues.

DEPRECIATION:   Depreciation increased 70.0% to $6.3 million in the nine months
------------
ended September 30, 1998 from $3.7 million in the nine months ended September
30, 1997.  Depreciation as a percentage of revenues was 1.9% of revenue for the
nine months ended September 30, 1998 and 1997.  The increase in the dollar
amount was primarily due to depreciation of additional transmission facilities
acquired since September 30, 1997.

INCOME TAX:   Income taxes increased to $8.2 million in the nine months ended
----------
September 30, 1998 from $5.6 million in the nine months ended September 30,
1997, primarily due to increased operating income.  The effective tax rate was
39.8% in 1997 and 35.6% in 1998.  The decrease in effective tax rate was
attributable to earnings of certain non-U.S. subsidiaries.  A portion of these
earnings is intended to be reinvested indefinitely in operations outside the
U.S.

LIQUIDITY AND CAPITAL RESOURCES

     The Company has financed its rapid growth, including its capital
expenditures, through funds provided by operations and the funds from the public
offering completed in the third quarter of 1996.  Due to the timing differences
in the international settlement process, the Company's accounts receivable
turnover varies from its accounts payable turnover.  The length of these
turnovers is a function of different timing requirements in the Company's
agreements with foreign partners.  For example, the length of the Company's
accounts payable turnover is partially due to its accounts payable with foreign
partners, which generally have 180 day terms as a result of the six-month lag in
the international settlement process.
<PAGE>
 
     Net cash provided by operating activities was $21.7 million for the nine
months ended September 30, 1998 and $10.5 million for the nine months ended
September 30, 1997.  This increase in cash provided by operating activities was
primarily due to cash inflows from greater cash generating net income, payments
received reducing accounts receivable balances and higher accounts payable
balances which is partially offset by cash outflows from income tax payments.

     Net cash used in investing activities was $34.2 million for the nine months
ended September 30, 1998 and $26.3 million for the nine months ended September
30, 1997. Capital expenditures for the nine months in 1998 were $30.9 million,
an increase from $26.5 million in the same period in the prior year.  Capital
expenditures in both 1997 and 1998 were for the acquisition of partial ownership
interests in international fiber optic cable transmission systems and related
equipment.  In addition, in the first quarter of 1998, the Company acquired
16.66% of Ekonom S.A. de C.V. ("Ekonom"), 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 $0.4 million for the nine
months ended September 30, 1998 and 1997.  Substantially all of these cash
inflows were from the exercise of stock options.

     During October 1998, the Company signed a  commitment letter from Bank of
America, NT&SA and NationsBancMontgomery LLC as lead arranger for a one-year
revolving line of credit of up to $30 million.  This credit line will be used to
fund the Company's purchase commitments, letters of credit, working capital and
for general corporate purposes.

     At September 30, 1998, the Company had outstanding commitments of $160
million for the acquisition of additional ownership in digital undersea fiber
optic cables and network equipment.  This includes the commitment to purchase
undersea fiber optic cable in the US-Japan cable network for $86 million and in
TAT-14 cable system for $64 million.  These cable commitments are expected to be
expended over the next two years and funded through expected operating cash
flows and existing cash balances and credit lines.

     The Company believes that existing cash balances, together with cash
provided by operating activities and other existing sources of liquidity, will
be sufficient to meet its outstanding capital commitments and its expected
capital expenditures and working capital needs through the end of 1998.
However, the Company may raise additional funds through offerings of equity or
debt securities or other financing arrangements to fund growth opportunities
that management believes are beneficial to the Company.

YEAR 2000 ISSUE

     The "Year 2000" issue affects the Company's internal computer systems,
network elements, software applications and other business systems that have
time-sensitive programs that may not properly reflect or recognize the year
2000.  Because many computers and computer applications define dates by the last
two digits of the year, "00" may not be properly identified as the year 2000.
This error could result in miscalculations or system failures. The Year 2000
issue may also affect the systems and applications of the Company's vendors and
customers.

     The Company has identified its Year 2000 risk in three categories: internal
information systems; non-financial software; and external noncompliance by
vendors and customers.

     Internal information systems.  The Company's internal information systems
     ----------------------------
were initially designed to be Year 2000 compliant.  These systems, such as the
Company's billing system, have been extensively tested in a simulated Year 2000
environment and were preliminarily determined to be in compliance.  Additional
tests will be conducted for final determination of Year 2000 compliance by mid-
<PAGE>
 
1999.  The costs associated with testing the Year 2000 compliance are not
expected to be material to the Company's business, financial condition or
results of operations.

     Non-financial software.  The Company is in the process of assessing the
     ----------------------
impact of the Year 2000 on its non-financial software, such as
telecommunications switching equipment.  The Company has conducted extensive
tests on its significant non-financial software and has preliminarily determined
it to be Year 2000 compliant.  The Company intends to continue its testing for
final determination of Year 2000 compliance by mid-1999.  The costs associated
with testing the Year 2000 compliance are not expected to be material to the
Company's business, financial condition or results of operations.

     External noncompliance by vendors and customers.  The Company is in the
     -----------------------------------------------
process of preparing letters to send to its significant vendors and customers
requesting a response from those third parties on their Year 2000 readiness with
respect to information systems used by those entities which could impact
business with the Company.  There is no assurance, however, that full Year 2000
compliance will be achieved by such third parties or that the Company will
receive assurances from such third parties.  To the extent that responses to
Year 2000 readiness are unsatisfactory, the Company intends to identify
alternative and/or new vendors and customers who have demonstrated Year 2000
readiness.    In the event that any of the Company's significant vendors and
customers do not successfully and timely achieve Year 2000 compliance, and the
Company is unable to replace them with new and/or alternative vendors and
customers, the Company's business or operations could be adversely affected.












<PAGE>
 
                         PART II.   OTHER INFORMATION
                                        

Item 1.  Legal proceedings

         None


Item 2.  Changes in Securities and Use of Proceeds

         None


Item 3.  Defaults upon Senior Securities

         None


Item 4.  Submission of Matters to a Vote of Security Holders

         None


Item 5.  Other Information

                Stockholder proposals must be received in writing by the
         Secretary of the Company no later than February 3, 1999 and must comply
         with the requirements of the Securities and Exchange Commission in
         order to be considered for inclusion in the Company's proxy statement
         and form of proxy relating to the Company's 1999 stockholder 
         meeting.

                The Company's bylaws provide that for business to be properly
         brought before a meeting by a stockholder, or for a stockholder to
         nominate a person for election as a director, the stockholder must have
         given timely notice thereof in writing to the Secretary of the Company.
         To be timely, a stockholder proposal or nomination to be presented at
         an annual meeting shall be received at the Company's principal
         executive offices not less than 120 calendar days in advance of the
         date that the Company's (or the Company's predecessor's) proxy
         statement was released to stockholders in connection with the previous
         year's annual meeting of stockholders. In the event of a nomination for
         director to be elected at a special meeting at which directors are to
         be elected pursuant to the Company's notice of special meeting, notice
         by the stockholders to be timely must be received not later than the
         closing of business on the tenth day following the day on which such
         notice of the date of the special meeting was mailed. A stockholder's
         notice to the Secretary with reference to a stockholder proposal shall
         set forth as to each matter the stockholder proposes to bring before
         the annual meeting (a) a brief description of the business desired to
         be brought before the annual meeting and the reasons for conducting
         such business at the annual meeting, (b) the name and address, as they
         appear on the Company's books, of the stockholder proposing such
         business, (c) the class and number of shares of the Company which are
         beneficially owned by the stockholder, and (d) any material interest of
         the stockholder in such business. A stockholder's notice to the
         Secretary with reference to a nomination for director shall set forth:
         (a) the name and address of the stockholder who intends to make the
         nomination and of the person or persons to be nominated; (b) a
         representation that the stockholder is a holder of record of stock of
         the Company entitled to vote for the election of directors on the date
         of such notice and intends to appear in person or by proxy at the
         meeting to nominate the person or persons specified in the notice; (c)
         a description of all arrangements or understandings between the
         stockholder and each nominee and any other person or persons (naming
         such person or persons) pursuant to which the nomination or nominations
         are to be made by the stockholder; (d) such other information regarding
         each nominee 

                                       11
<PAGE>
 
         proposed by such stockholder as would be required to be included in a
         proxy statement filed pursuant to the proxy rules of the Securities and
         Exchange Commission, had the nominee been nominated, or intended to be
         nominated, by the Board of Directors; and (e) the consent of each
         nominee to serve as a director of the Company if so elected.

                Under the circumstances described in, and upon compliance with
         Rule 14A-4(c) under the Securities Exchange Act of 1934, management may
         solicit proxies which confer discretionary authority and vote such
         proxies with respect to stockholder proposals which do not meet the
         above described advance notice requirements.


Item 6.  Exhibits and Reports on Form 8-K

         (a)  The Exhibits filed as part of this report are listed below:

         3.2    Amended and Restated Bylaws, as amended October 23, 1998
         27     Financial Data Schedule

         (b)  No reports on Form 8-K have been filed during the quarter ended
              September 30, 1998

                                       12
<PAGE>
 
                                  SIGNATURES

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


                               PACIFIC GATEWAY EXCHANGE, INC.



Dated: November 11, 1998


                               By: /s/ Howard A. Neckowitz
                                   ------------------------
                                   Howard A. Neckowitz
                                   President and CEO
                                   (Authorized Signatory)
                               
                               
                               By:  /s/ Sandra Grey
                                   ------------------------
                                   Sandra Grey
                                   Chief Financial Officer
                                   (Principal Financial and Accounting Officer)