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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 March 31, 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 April 30, the number of the registrant's Common Shares of $.0001 par value
outstanding was 19,114,111
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PACIFIC GATEWAY EXCHANGE, INC.
TABLE OF CONTENTS
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Page
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Part I -FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated condensed balance sheets as of
March 31, 1998 and December 31, 1997 1
Consolidated condensed statements of income
for the three-month periods ended
March 31, 1998 and 1997 2
Consolidated condensed statements of cash flows
for the three-month periods ended
March 31, 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 9
Item 2: Changes in Securities and Use of Proceeds 9
Item 3: Defaults upon Senior Securities 9
Item 4: Submission of matters to a vote of security holders 9
Item 5: Other information 9
Item 6: Exhibits and reports on Form 8-K 9
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<TABLE>
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Item 1. Financial Statements
PACIFIC GATEWAY EXCHANGE, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(in thousands)
(Unaudited)
MARCH 31, DECEMBER 31,
1998 1997
--------- ---------
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ASSETS
CURRENT ASSETS:
Cash and cash equivalents .................................................... $ 31,383 $ 43,850
Accounts receivable, net of allowance for doubtful accounts
of $3,610 in 1998 and $2,230 in 1997 ................................... 64,486 62,313
Accounts receivable, related party ........................................... -- --
Prepaid expenses ............................................................. 23 511
Other current assets ......................................................... 1,806 1,769
--------- ---------
Total current assets ............................................ 97,698 108,443
Property and equipment, net .................................................. 68,562 61,433
Investment in companies ...................................................... 5,188 184
Deposits and other assets .................................................... 2,191 1,557
--------- ---------
Total assets .................................................... $ 173,639 $ 171,617
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ............................................................. $ 80,348 $ 87,949
Accrued liabilities .......................................................... 4,015 3,733
Income taxes payable ......................................................... 3,119 1,491
Other liabilities ............................................................ 3,045 1,871
--------- ---------
Total liabilities ............................................... 90,527 95,044
--------- ---------
STOCKHOLDERS' EQUITY:
Preferred stock, $.0001 par value, authorized
5,000,000 shares, no shares issued ..................................... -- --
Common stock, $.0001 par value, authorized 50,000,000 shares,
issued 19,257,671 shares, outstanding 19,114,111 shares
in 1998 and issued 19,216,710 shares, outstanding 19,073,150
shares in 1997 ......................................................... 2 2
Additional paid in capital ................................................... 63,021 60,849
Deferred compensation-restricted stock ....................................... (4,031) (4,134)
Foreign currency translation ................................................. 34 2
Retained earnings ............................................................ 24,486 20,254
Common stock held in treasury, at cost
(143,560 shares in 1997 and 1996) ...................................... (400) (400)
--------- ---------
Total stockholders' equity ...................................... 83,112 76,573
--------- ---------
Total liabilities and stockholders' equity ...................... $ 173,639 $ 171,617
========= =========
</TABLE>
See Accompanying Notes to Consolidated Condensed Financial Statements
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PACIFIC GATEWAY EXCHANGE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(in thousands, except net income per share)
THREE MONTHS
ENDED MARCH 31,
--------------------------
1998 1997
--------- ---------
(Unaudited)
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Revenues ................................................. $ 105,072 $ 47,524
Revenues - related party ................................. -- 3,927
--------- ---------
Total revenues ................................ 105,072 51,451
Cost of long distance services ........................... 89,241 43,141
--------- ---------
Gross margin .................................. 15,831 8,310
Selling, general and administrative expenses ............. 7,562 3,825
Depreciation ............................................. 1,963 853
--------- ---------
Total operating expenses ...................... 9,525 4,678
--------- ---------
Operating income .............................. 6,306 3,632
Other (income) expense, net .............................. 98 --
Interest (income) expense, net ........................... (613) (488)
--------- ---------
Income before income taxes .......................... 6,821 4,120
Provision for income taxes ............................... 2,445 1,658
--------- ---------
Net income .................................... $ 4,376 $ 2,462
========= =========
Net income per share, basic ................... $ 0.23 $ 0.13
========= =========
Net income per share, diluted ................. $ 0.22 $ 0.13
========= =========
</TABLE>
See Accompanying Notes to Consolidated Condensed Financial Statements.
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PACIFIC GATEWAY EXCHANGE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
THREE MONTHS
ENDED MARCH 31,
------------------------
1998 1997
-------- --------
(Unaudited)
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OPERATING ACTIVITIES:
Net Income ...................................................................... $ 4,376 $ 2,462
Adjustments to net income:
Depreciation ............................................................... 1,963 853
Stock compensation expense ................................................. 152 --
Bad debts provision ........................................................ 1,372 750
Equity in net loss of affiliated companies ................................. 96 --
Changes in operating assets and liabilities:
Accounts receivable ..................................................... (3,655) (4,975)
Accounts receivable, related party ...................................... -- 502
Prepaid expenses ........................................................ 488 (72)
Deposits and other assets ............................................... (310) (309)
Accounts payable ........................................................ (7,605) (457)
Accrued liabilities ..................................................... 282 (519)
Federal income taxes payable (recoverable) .............................. 1,706 (732)
Other liabilities ....................................................... 993 98
-------- --------
Net cash used in operating activities ...................................... (142) (2,399)
-------- --------
INVESTING ACTIVITIES:
Purchase of property and equipment .............................................. (9,098) (8,771)
Purchase of investment .......................................................... (3,300) --
-------- --------
Net cash used in investing activities ........................................... (12,398) (8,771)
-------- --------
FINANCING ACTIVITIES:
Exercise of stock options ....................................................... 73 183
Other ........................................................................... -- (46)
-------- --------
Net cash provided by financing activities ....................................... 73 137
-------- --------
Net decrease in cash and cash equivalents ....................................... (12,467) (11,033)
Cash and cash equivalents at beginning of the period ............................ 43,850 45,563
-------- --------
Cash and cash equivalents at end of the period .................................. $ 31,383 $ 34,530
======== ========
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
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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) which 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-month period
ended March 31, 1998 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1998.
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 stock. The
Company's investment in Ekonom is accounted for under the cost method.
(3) EARNINGS PER SHARE
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INCOME SHARES PER-SHARE
(in thousands, except per share amounts) (NUMERATOR) (DENOMINATOR) AMOUNT
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THREE MONTHS ENDED MARCH 31, 1998
BASIC EPS:
Income available to common stockholders $4,376 19,018 $0.23
Effect of stock-based compensation 912
---------------- ------------------- ----------------
DILUTED EPS $4,376 19,930 $0.22
================ =================== ================
THREE MONTHS ENDED MARCH 31, 1997
BASIC EPS:
Income available to common stockholders $2,462 18,938 $0.13
Effect of stock-based compensation 540
---------------- ------------------- ----------------
DILUTED EPS $2,462 19,478 $0.13
================ =================== ================
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4
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(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, for the three
months ended March 31, 1998, total other comprehensive income consisted of
foreign currency translation totaling approximately $32,000.
(5) NEW ACCOUNTING PRONOUNCEMENTS
- ----------------------------------
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprises 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 must 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 Post Retirement 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
post retirement benefit plan. Therefore, SFAS No. 132 will not be applicable to
the Company.
5
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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; or (xiv) natural disasters and catastrophic events. 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.
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THREE MONTHS
ENDED MARCH 31,
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1998 1997
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Total revenues 100.0 % 100.0 %
Cost of long distance services 84.9 % 83.8 %
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Gross margin 15.1 % 16.2 %
Selling, general and administrative 7.2 % 7.4 %
expenses
Depreciation 1.9 % 1.7 %
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Total operating expenses 9.1 % 9.1 %
---------------- -------------
Operating income 6.0 % 7.1 %
Other (income) expense, net 0.1 % - %
Interest (income) expense, net (0.6)% (0.9)%
---------------- -------------
Income before income taxes 6.5 % 8.0 %
Provision for income taxes 2.3 % 3.2 %
---------------- -------------
Net income 4.2 % 4.8 %
================ =============
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6
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THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THREE MONTHS ENDED MARCH 31, 1997.
REVENUES: Total revenues in the three months ended March 31, 1998 increased
104% to $105.1 million from $51.5 million in the three months ended March 31,
1997 and increased 1% from $104.0 million in the last quarter ended December 31,
1997. The increase from the quarter ended March 31, 1997 was the result of
several factors, including an increase in the number of operating agreements to
43 at March 31, 1998 from 32 at March 31, 1997. The number of wholesale carrier
customers increased to 146 at March 31, 1998 from 78 at March 31, 1997. In
addition, revenues from the Company's retail customers were $3.0 for the quarter
ended March 31, 1998. As a result, total minutes increased 79.8% from the three
months ended March 31, 1997, while the average price per minute charged to
customers improved to $0.30 in the three months ended March 31, 1998, compared
to $0.28 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 are factors influencing the average
customer price per minute. During the first quarter of 1998 (as in all prior
quarters), Pacific Gateway 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 15.1% in the current
period down slightly from 16.2% in the prior period. The 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 $89.2 million
in the three months ended March 31, 1998 from $43.1 million in the three months
ended March 31, 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 7.2% in the three
months ended March 31, 1998, down slightly from 7.4% in the same period in the
prior year. Actual expenses increased 97.7% to $7.6 million in the three months
ended March 31, 1998 from $3.8 million in the three months ended March 31, 1997.
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 the Company's wholly-owned subsidiaries
to 107 at March 31, 1998 from 53 at March 31, 1997. The increase in sales
commission expenses was primarily due to increased revenues.
DEPRECIATION: Depreciation increased 130.1% to $2.0 million in the three
months ended March 31, 1998 from $0.9 million in the three months ended March
31, 1997. Depreciation as a percentage of revenues was 1.9% of revenue for the
three months ended March 31, 1998 and 1.7% for the same quarter last year. The
increase in the dollar amount was primarily due to depreciation of additional
transmission facilities acquired since March 31, 1997.
INCOME TAX: Income taxes increased to $2.4 million in the three months ended
March 31, 1998 from $1.7 million in the three months ended March 31, 1997,
primarily due to increased operating income. The effective tax rate was 40.0%
in 1997 and 36.0% 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.
7
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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.
Net cash used in operating activities was $0.1 million for the three months
ended March 31, 1998 and $2.4 million for the quarter ended March 31, 1997.
This decrease was primarily a result of the greater cash generating net income
as well as increases in income taxes payable and other liabilities that exceeded
the decreases in accounts payable.
Net cash used in investing activities was $12.4 million for the three
months ended March 31, 1998 and $8.8 million for the three months ended March
31, 1997. The increase was due to the acquisition of 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. Capital expenditures for the first
quarter of 1998 were $9.1 million up slightly from $8.8 million in the first
quarter of the prior year. Substantially all of these expenditures were for the
acquisition of partial ownership interests in international fiber optic cable
transmission systems and related equipment.
Net cash provided by financing activities was $0.1 million for the three
months ended March 31, 1998 and $0.1 million for the three months ended March
31, 1997. Substantially all of these cash inflows were from the exercise of
stock options.
At March 31, 1998, the Company had outstanding commitments of $9.3 million
for the acquisition of additional ownership in digital undersea fiber optic
cables and network equipment. 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.
8
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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
None
Item 6. Exhibits and Reports on Form 8-K
No reports on Form 8-K have been filed during the quarter ended March
31, 1998. The Exhibits filed as part of this report are listed below:
27 Financial Data Schedule
9
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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: May 15, 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)
10
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<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED CONDENSED FINANCIAL STATEMENTS AS AT AND FOR THE PERIOD ENDED MARCH
31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 31,383
<SECURITIES> 0
<RECEIVABLES> 64,486
<ALLOWANCES> 3,610
<INVENTORY> 0
<CURRENT-ASSETS> 97,698
<PP&E> 79,461
<DEPRECIATION> 10,899
<TOTAL-ASSETS> 173,639
<CURRENT-LIABILITIES> 90,527
<BONDS> 0
0
0
<COMMON> 2
<OTHER-SE> 83,110
<TOTAL-LIABILITY-AND-EQUITY> 173,639
<SALES> 105,072
<TOTAL-REVENUES> 105,072
<CGS> 89,241
<TOTAL-COSTS> 89,241
<OTHER-EXPENSES> 98
<LOSS-PROVISION> 1,372
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 6,821
<INCOME-TAX> 2,445
<INCOME-CONTINUING> 4,376
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,376
<EPS-PRIMARY> 0.23
<EPS-DILUTED> 0.22
</TABLE>
