**As filed with the Securities and Exchange Commission on May9, 2003**

 

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**Form 20-F**

 

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

 

**For the fiscal year ended December31, 2002**

 

**Commission file number 1-14540**

 

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| **MAGYAR TÁVKÖZLÉSI RT.**                |
|---------------------------------------------------------|
| (Exact Name of Registrant as Specified in Its  Charter) |
|                                                    |
| **HUNGARIAN TELECOMMUNICATIONS CO. LTD.**               |
| (Translation of Registrant’s Name Into English)    |
|                                                    |
| **Hungary**                                             |
| (Jurisdiction of Incorporation or Organization)         |
|                                                    |
| **Budapest,  1013, Krisztina krt. 55, Hungary**         |
| (Address of Principal Executive Offices)                |

 

Securities registered or to be registeredpursuant to Section 12(b) of the Act

* *

| ***Title of each class***                                           |   | ***Name of each exchange  on which registered*** |
|---------------------------------------------------------------------|--------|--------------------------------------------------|
| American Depositary Shares, each representing  five Ordinary Shares |   | New York Stock Exchange                          |
| Ordinary Shares                                                     |   | New York Stock Exchange*                         |

 

Securities registered or to be registeredpursuant to Section 12(g) of the Act

 

**NONE**

**(Title of Class)**

 

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Securities for which there is a reportingobligation pursuant to Section 15(d) of the Act

 

**NONE**

**(Title of Class*****)***

 

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Indicate the number of outstanding shares of eachof the issuer’s classes of capital or common stock as of the close of theperiod covered by the annual report:

 

Ordinary Shares......1,042,811,600

nominal value HUF 100 per share

(as of December 31, 2002)

 

Indicate by check mark whether the registrant (1)has filed all reports required to be filed by Section 13 or 15 (d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter 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 |   | ý | NO | o |
|--------|--------|--------|--------|-----|--------|--------|----|---|

 

Indicate by check mark which financial statementitem the registrant has elected to follow.

* *

|   |   |   |   | Item 17 |   | ý | Item 18 | o |
|--------|--------|--------|--------|---------|--------|--------|---------|---|

 

*Not for trading, but only in connection withthe registration of American Depositary Shares.

 

 

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**TABLEOF CONTENTS**

 
| **PART I** |
|------------|
|       |   |
| Item 1     | Identity of Directors,  Senior Management and Advisers |
| Item 2     | Offer Statistics and  Expected Timetable |
| Item 3     | Key Information. |
|       | Selected Financial Data |
|       | Risk Factors |
| Item 4     | Information on the  Company |
|       | History and  Development of the Company |
|       | Organization |
|       | Historical Background |
|       | Business  Overview |
|       | Business Summary |
|       | Business Strategy |
|       | Overview of Matáv’s  Revenues |
|       | Fixed  Line Telecommunications Services Segment |
|       | Mobile  Telecommunications Services Segment |
|       | International Segment  (MakTel) |
|       | Marketing and Distribution |
|       | Competition |
|       | Regulation and Pricing. |
|       | Overview  of the Regulatory Regime until December 23, 2001 |
|       | The  Act on Communications and the Contract on Universal Service Provision. |
|       | Mobile Concession  Contracts |
|       | Competition Law  Restrictions |
|       | EU  Association Agreement and European Directives. |
|       | Broadcasting and  Transmission |
|       | Pricing |
|       | Organizational Structure |
|       | Property, Plants and  Equipment. |
|       | Infrastructure and  Technology |
|       | Information Technology |
| Item 5     | Operating and  Financial Review and Prospects |
|       | Operating  results. |
|       | Results of Operations – Total |
|       | Results of Operations – By Segment |
|       | Significant Accounting  Policies |
|       | Liquidity and Capital  Resources |
|       | Capital Expenditures |
|       | Reconciliation to U.S.  GAAP |
|       | Research and Development |
| Item 6     | Directors, Senior  Management and Employees |
|       | Board of Directors. |
|       | Management Committee |
|       | Supervisory Board |
|       | Indemnification  of the Board of Directors and the Supervisory Board |
|       | Compensation of  Directors and Officers |
|       | Board Practices |
|       | Employees |
|       | Share Ownership of  Management |

 

i

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| Item 7       | Major Shareholders and  Related Party Transactions.                           |
|--------------|-------------------------------------------------------------------------------|
|         | Major Shareholders.                                                           |
|         | Related Party Transactions                                                    |
| Item 8       | Financial Information                                                         |
|         | Consolidated  Financial Statements                                            |
|         | Other Financial  Information                                                  |
|         | Legal proceedings                                                             |
|         | Dividend Policy                                                               |
|         | Significant Changes                                                           |
| Item 9       | The Offer and Listing                                                         |
| Item 10      | Additional  Information                                                       |
|         | Share Capital                                                                 |
|         | Memorandum and  Articles of Association                                       |
|         | Material Contracts                                                            |
|         | Exchange Control                                                              |
|         | Taxation                                                                      |
|         | Documents on Display                                                          |
| Item 11      | Quantitative and  Qualitative Disclosures About Market Risk                   |
| Item 12      | Description of  Securities Other than Equity Securities                       |
|         |                                                                          |
| **PART II**  |
|         |                                                                          |
| Item 13      | Defaults, Dividend  Arrearages and Delinquencies                              |
| Item 14      | Material  Modifications to the Rights of Security Holders and Use of Proceeds |
| Item 15      | Controls and  Procedures                                                      |
| Item 16      | {Reserved}                                                                    |
|         |                                                                          |
| **PART III** |
|         |                                                                          |
| Item 17      | Financial Statements                                                          |
| Item 18      | Financial Statements                                                          |
| Item 19      | Exhibits                                                                      |

 

ii

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**CertainDefined Terms and Conventions**

 

In this annual report, the terms “Matáv”, the “Group” and the “Company” refer to Matáv Rt. and its directand indirect subsidiaries as a group; the term “Westel” refers to Westel Mobil TávközlésiRt.; the term “Westel 0660” refers to Westel Rádiótelefon Kft. and the term “MakTel” refers to MakedonskiTelekommunikacii AD. The Company owns 100 percent of each of the Westelcompanies. In this annual report, the term “Minister” refers to the Minister heading theMinistry of Informatics and Communications, to whom the rights of the PrimeMinister Office were transferred as of May 27, 2002. The rights belonging tothe Prime Minister Office belonged to the Ministry of Transport,Telecommunications and Water Management prior to June 1, 2000.

 

Totals in tables may be affected by rounding. Segment revenue andoperating expense figures included in this annual report do not give effect tointersegment eliminations.

 

**Forward-lookingStatements May Not Be Accurate**

 

The Company may from time to time make written or oral forward-lookingstatements. Written forward-looking statements appear in documents the Companyfiles with the Securities and Exchange Commission, including this annualreport, reports to shareholders and other communications. The U.S. PrivateSecurities Litigation Reform Act of 1995 contains a safe harbor forforward-looking statements. Factors identified in filings with the Commissionmay cause actual results to differ materially from a forward-looking statementmade by Matáv or on its behalf. Readers should also consider the informationcontained in Item 3, “Key Information -Risk Factors” and Item 5, “Operating andFinancial Review and Prospects”, as well as the information contained in the Company’s periodicfilings with the Securities and Exchange Commission for further discussion ofthe risks and uncertainties that may cause such differences to occur. TheCompany’s forward-looking statements speak only as of the date they are made,and the Company does not have an obligation to update or revise them, whetheras a result of new information, future events or otherwise.

 

iii

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**PART I**

 

# ***ITEM1***— IDENTITY OF DIRECTORS, SENIORMANAGEMENT AND ADVISERS

 

Not applicable.

 

1

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# ***ITEM2***— OFFER STATISTICS AND EXPECTEDTIMETABLE

 

Not applicable.

 

2

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# ***ITEM 3***— KEY INFORMATION

# *** ***

# ***SELECTEDFINANCIAL DATA***

# *** ***

This selectedconsolidated financial and statistical data should be read together with theconsolidated financial statements, including the accompanying notes, includedin this annual report. Matáv derived the financial data from Matáv’sconsolidated financial statements as of and for the years ended December 31,1998, 1999, 2000, 2001 and 2002 and the accompanying notes, whichPricewaterhouseCoopers Könyvvizsgáló és Gazdasági Tanácsadó Kft., Matáv’sindependent accountants, have audited. This consolidated financial data isqualified by reference to Matáv’s consolidated financial statements andaccompanying notes, which the Company has prepared in accordance withInternational Financial Reporting Standards (“IFRS”). IFRS differs from U.S.Generally Accepted Accounting Principles (“GAAP”). For a discussion of theprincipal differences between IFRS and U.S. GAAP as they relate to the Company,see Note 32 to the consolidated financial statements.

 
|                                    |   | **Year  ended December 31,**                 |       |
|-----------------------------------------|--------|----------------------------------------------|------------|
|                                    |   | **1998**                                     |       | **1999** |   | **2000  (3)** |   | **2001  (3)** |   | **2002** |   | **2002** |   |
|                                    |   | **HUF**                                      |       | **HUF** |   | **HUF** |   | **HUF** |   | **HUF** |   | **U.S.$(1)** |   |
|                                    |   | **(in  millions, except per share amounts)** |       |
|                                    |   |                                         |       |   |   |   |   |   |   |   |   |   |   |
| **Consolidated Income Statement Data:** |   |                                         |       |   |   |   |   |   |   |   |   |   |   |
|                                    |   |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Amounts in accordance with IFRS         |   |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Revenues                                |   | 318,060                                      |       | 384,932 |   | 445,945 |   | 547,735 |   | 590,585 |   | 2,623 |   |
| Operating profit                        |   | 96,109                                       |       | 121,131 |   | 96,091 |   | 119,400 |   | 122,240 |   | 543 |   |
| Net income                              |   | 58,337                                       |       | 78,632 |   | 66,652 |   | 82,560 |   | 68,128 |   | 303 |   |
| Net income per share(2)                 |   | 56.24                                        |       | 75.81 |   | 64.27 |   | 79.61 |   | 65.66 |   | 0.29 |   |
| Diluted net income per share(2)         |   | 56.24                                        |       | 75.52 |   | 63.97 |   | 79.61 |   | 65.66 |   | 0.29 |   |
|                                    |   |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Amounts in accordance with U.S. GAAP    |   |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Revenues                                |   | 318,342                                      |       | 385,306 |   | 461,537 |   | 550,900 |   | 592,294 |   | 2,631 |   |
| Operating profit                        |   | 96,346                                       |       | 121,460 |   | 90,456 |   | 120,144 |   | 132,585 |   | 589 |   |
| Net income                              |   | 58,564                                       |       | 78,721 |   | 64,508 |   | 82,231 |   | 78,153 |   | 347 |   |
| Net income per share(2)                 |   | 56.46                                        |       | 75.89 |   | 62.20 |   | 79.30 |   | 75.32 |   | 0.33 |   |
| Diluted net income per share(2)         |   | 56.46                                        |       | 75.61 |   | 61.91 |   | 79.30 |   | 75.32 |   | 0.33 |   |
|                                    |   |                                         |       |   |   |   |   |   |   |   |   |   |   |
| **Consolidated Balance Sheet Data:**    |   |                                         |       |   |   |   |   |   |   |   |   |   |   |
|                                    |   |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Amounts in accordance with IFRS         |   |                                         | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Total assets                            |   | 549,540                                      |       | 647,870 |   | 954,424 |   | 1,104,196 |   | 1,077,451 |   | 4,785 |   |
| Net assets                              |   | 269,380                                      |       | 350,591 |   | 638,509 |   | 508,469 |   | 575,580 |   | 2,556 |   |
| Capital stock                           |   | 103,728                                      |       | 103,728 |   | 103,736 |   | 103,736 |   | 104,281 |   | 463 |   |
| Total shareholders’ equity         |   | 257,245                                      |       | 327,579 |   | 637,281 |   | 460,300 |   | 516,144 |   | 2,292 |   |
|                                    |   |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Amounts in accordance with U.S. GAAP    |   |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                            |   | 549,149                                      |       | 647,239 |   | 962,379 |   | 1,114,742 |   | 1,096,006 |   | 4,868 |   |
| Net assets                              |   | 256,918                                      |       | 338,260 |   | 624,168 |   | 490,084 |   | 566,913 |   | 2,518 |   |
| Total shareholders’ equity         |   | 244,783                                      |       | 315,248 |   | 622,941 |   | 445,167 |   | 511,036 |   | 2,270 |   |

 

3

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|                              |   | **Year  ended December 31,** |       |
|-----------------------------------|--------|------------------------------|------------|
|                              |   | **1998**                     |       | **1999** |   | **2000** |   | **2001** |   | **2002** |   |
|                              |   |                         | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Other data:**                   |   |                         |       |   |   |   |   |   |   |   |   |
|                              |   |                         |       |   |   |   |   |   |   |   |   |
| Weighted average number of shares |   |                         |       |   |   |   |   |   |   |   |   |
| Basic                             |   | 1,037                        |       | 1,037 |   | 1,037 |   | 1,037 |   | 1,038 |   |
| Diluted                           |   | 1,037                        |       | 1,041 |   | 1,042 |   | 1,037 |   | 1,038 |   |

 

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(1)                                 Translated into U.S. dollars at the official closing rate of theNational Bank of Hungary on December 31, 2002 of U.S. dollar 1.00 – HUF 225.16.These translations are unaudited and presented for convenience purposes only.

(2)                                 Net income per share under IFRS and net income per share under U.S.GAAP are calculated by dividing net income by the weighted average number ofshares outstanding during each period.

(3)                                 In December 2001 the Company acquired 49 percent of the common sharesof Westel and Westel 0660 (“the Westels”) from Deutsche Telekom AG. The Companyis controlled by Deutsche Telekom AG so this was a transaction between partiesunder common control. The financial statements have been restated as if theWestels were wholly owned subsidiaries of Matáv since March 23, 2000, the datewhen Deutsche Telekom AG acquired 49 percent of the Westels.

 

# ***Dividends***

 

The followingtable sets forth the dividend per Matáv ordinary share for the years 1998,1999, 2000, 2001 and 2002. The table shows the dividend amounts in HungarianForints, together with U.S. dollar equivalents, for each of the yearsindicated.

 
|     |   | **Dividend  Paid Per Ordinary  Share** |   |
|----------|--------|----------------------------------------|--------|
|     |   | **HUF**                                |   | **U.S.$(1)** |   |
| **Year** |   |                                   |   |   |   |
| 1998     |   | 8                                      |   | 0.0365 |   |
| 1999     |   | 9                                      |   | 0.0356 |   |
| 2000     |   | 10                                     |   | 0.0351 |   |
| 2001     |   | 11                                     |   | 0.0394 |   |
| 2002     |   | 18                                     |   | 0.0799 |   |

 

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(1)                               Translated into U.S. dollars at theofficial closing rate of the National Bank of Hungary on December 31, 2002 ofU.S. dollar 1.00 = HUF 225.16, December 31, 2001 of U.S. dollar 1.00 = HUF279.03, on December 31, 2000 of U.S. dollar 1.00 – HUF 284.73, on December 31,1999 of U.S. dollar 1.00 = HUF 252.52 and on December 31, 1998 of U.S. dollar1.00 = HUF 219.03.

 

# ***ExchangeRate Information***

 

The National Bankof Hungary sets the official rate of exchange for Hungarian Forints. UntilDecember 31, 1998, the rate was based on a basket of currencies consisting of30 percent U.S. dollars and 70 percent Deutsche marks. On January 1, 1999, theNational Bank of Hungary replaced the Deutsche mark with the Euro to change thecurrency basket to 30 percent U.S. dollars and 70 percent Euros. On January 1,2000, the National Bank of Hungary removed the U.S. dollars from the basket andbased the Hungarian Forint solely on the Euro.

 

On March 12,1995, the National Bank of Hungary announced a crawling peg system fordevaluing the Hungarian Forint against a basket of foreign currencies. Underthe crawling peg devaluation regime, the Hungarian Forint was devalued each dayby a fixed percentage rather than intermittently. The National Bank of Hungarydetermined and announced in advance the monthly rate of devaluation.

 

4

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On any given day,the actual exchange rate of the Hungarian Forint against the basket ofcurrencies may vary from the rate the National Bank of Hungary has announced.Before May 4, 2001, the National Bank of Hungary had stated a policy ofintervening in the foreign currency market if the actual exchange rate movesmore than 2.25 percent above or below the announced rate. On May 4, 2001, theNational Bank of Hungary announced that it has widened this intervention bandsignificantly to 15 percent above or below the announced rate. The move wasexplained as a step towards convergence with the European Union exchange rateregime and as an effective tool to fight inflation. Matáv’s exposure to risksfrom exchange rate fluctuations has increased as a result of this band wideningbecause the National Bank of Hungary is less likely to act to stabilize thevalue of the Hungarian Forint during periods of exchange rate volatility.

 

The National Bankof Hungary has devalued the Hungarian Forint continuously in recent years. Themonthly devaluation rate was reduced from 1.2 percent on January 1, 1996 to 1.1percent in April 1997 and to 1.0 percent in August 1997. The National Bank ofHungary announced further cuts to the crawling peg, decreasing it to 0.9percent in January 1998, 0.8 percent in June 1998, 0.7 percent in October 1998,0.6 percent in January 1999, 0.5 percent in July 1999, 0.4 percent in October1999, 0.3 percent in April 2000 and 0.2 percent in April 2001. In October 2001,the crawling peg system ceased to exist. The middle of the intervention bandwas set at 276.1 HUF/EUR.

 

The following tables set forth, for the periods and dates indicated,the period-end, average, high and low official rates set by the National Bankof Hungary for Hungarian Forints per U.S.$1.00, DM1.00 and EUR1.00,respectively. The Company makes no representation that the Hungarian Forintamounts referred to in this annual report could have been or could be convertedinto any currency at any particular rate or at all.

 
|     |   | **Exchange  Rates  (amounts in HUF/U.S.$)** |   |
|----------|--------|---------------------------------------------|--------|
|     |   | **Period-End**                              |   | **Average(1)** |   | **High** |   | **Low** |   |
| **Year** |   |                                        |   |   |   |   |   |   |   |
| 1998     |   | 219.03                                      |   | 214.45 |   | 227.07 |   | 203.24 |   |
| 1999     |   | 252.52                                      |   | 237.30 |   | 252.63 |   | 212.31 |   |
| 2000     |   | 284.73                                      |   | 282.27 |   | 318.71 |   | 245.57 |   |
| 2001     |   | 279.03                                      |   | 286.54 |   | 304.06 |   | 271.35 |   |
| 2002     |   | 225.16                                      |   | 258.00 |   | 283.98 |   | 225.16 |   |
|     |   |                                        |   |   |   |   |   |   |   |
| 2002     |   |                                        |   |   |   |   |   |   |   |
| October  |   | 244.67                                      |   | 248.18 |   | 252.39 |   | 244.67 |   |
| November |   | 239.01                                      |   | 237.63 |   | 242.80 |   | 233.59 |   |
| December |   | 225.16                                      |   | 231.87 |   | 238.75 |   | 225.16 |   |
|     |   |                                        |   |   |   |   |   |   |   |
| 2003     |   |                                        |   |   |   |   |   |   |   |
| January  |   | 225.49                                      |   | 226.03 |   | 231.74 |   | 222.03 |   |
| February |   | 226.33                                      |   | 227.53 |   | 229.73 |   | 224.59 |   |
| March    |   | 227.02                                      |   | 227.25 |   | 232.60 |   | 222.15 |   |

 

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(1) The averageof the exchange rates on each business day during the relevant period.

 

5

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|     |   | **Exchange  Rates  (amounts in HUF/DM)** |   |
|----------|--------|------------------------------------------|--------|
|     |   | **Period-End**                           |   | **Average(1)** |   | **High** |   | **Low** |   |
| **Year** |   |                                     |   |   |   |   |   |   |   |
| 1998     |   | 130.65                                   |   | 122.15 |   | 132.66 |   | 112.95 |   |

 

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(1) The averageof the exchange rates on each business day during the relevant period.

 
|     |   | **Exchange  Rates  (amounts in HUF/EUR)** |   |
|----------|--------|-------------------------------------------|--------|
|     |   | **Period-End**                            |   | **Average  (1)** |   | **High** |   | **Low** |   |
|     |   |                                      |   |   |   |   |   |   |   |
| **Year** |   |                                      |   |   |   |   |   |   |   |
| 1999     |   | 254.92                                    |   | 252.80 |   | 258.86 |   | 248.23 |   |
| 2000     |   | 264.94                                    |   | 260.04 |   | 265.67 |   | 254.47 |   |
| 2001     |   | 246.33                                    |   | 256.68 |   | 267.29 |   | 241.45 |   |
| 2002     |   | 235.90                                    |   | 242.97 |   | 252.38 |   | 235.17 |   |
|     |   |                                      |   |   |   |   |   |   |   |
| 2002     |   |                                      |   |   |   |   |   |   |   |
| October  |   | 241.49                                    |   | 243.61 |   | 245.94 |   | 241.26 |   |
| November |   | 237.48                                    |   | 238.13 |   | 241.56 |   | 236.12 |   |
| December |   | 235.90                                    |   | 236.14 |   | 237.50 |   | 235.17 |   |
|     |   |                                      |   |   |   |   |   |   |   |
| 2003     |   |                                      |   |   |   |   |   |   |   |
| January  |   | 243.93                                    |   | 239.98 |   | 248.39 |   | 234.69 |   |
| February |   | 243.33                                    |   | 245.09 |   | 246.65 |   | 243.14 |   |
| March    |   | 246.84                                    |   | 245.64 |   | 246.88 |   | 244.58 |   |

 

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(1) The averageof the exchange rates on each business day during the relevant period.

 

The Company willpay any cash dividends in Hungarian Forints, and exchange rate fluctuationswill affect the U.S. dollar amounts received by holders of American DepositoryShares (“ADSs”) on conversion of cash dividends on the shares those ADSsrepresent. Fluctuations in the exchange rate between the Hungarian Forint andthe U.S. dollar will also affect the prices of shares and ADSs.

 

6

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**RISK FACTORS**

 

Prior to making any investment decision, youshould carefully consider the risks set forth below in addition to the otherinformation contained in thisannual report. The risks describedbelow are not the only risks we face. Additional risks not currently known tous or risks that we currently regard as immaterial also could have a materialadverse effect on our financial condition or results of operations. Thisannual report contains certain “forward-looking” statements. These includestatements on expectations of Matáv’s businesses. You will find below andelsewhere in this annual report important factors that could cause the resultsof Matáv to differ materially from such forward-looking statements. Matávdisclaims any obligation to update information contained in any forward-lookingstatement.

 

# ***Matáv’soperations are subject to substantial government regulation, which can resultin adverse consequences for the Company’s business and results of operations.***

 

Matáv hadexclusive rights until December 23, 2001 to provide domestic long distance andinternational public voice telephony services throughout Hungary. The Companyalso had exclusive rights until December 23, 2001 to provide local public fixedline telephony service in 31 of 54 local primary areas in Hungary. Matáv’sexclusive rights expired in May 2002 in an additional five local primary areas,while its subsidiary, Emitel had exclusive rights in an additional three concessionareas through November 2002. Following the expiration of the exclusivity of theconcession agreements of Matáv and other local telephone service providers, ActXL of 2001 on Communications (“Act on Communications”) became the basis for theliberalized telecommunications market in Hungary.

 

The Act onCommunications was approved by the Hungarian Parliament in June 2001 andentered into force on December 23, 2001. The Act on Communications establisheda new regime of retail price controls on fixed line voice telephony services,introduced a universal service obligation and designated Matáv as a companywith significant market power on the voice telephony market. The Act onCommunications also requires unbundling of local loops, transparency ofcost-based pricing, and reference offers for interconnection, and for leasedline interconnection services. The cost base of the price of these services hasto be calculated using Long Run Incremental Costs (“LRIC”) from January 1,2003. The Act on Communications introduced carrier selection and carrierpre-selection possibilities.

 

The Act onCommunications and related executive decrees are subject to modification inrelation to harmonization with the New European Union (“EU”) RegulatoryFramework for Telecommunications and in order to further increase competition.Modifications are expected to take force at the latest by May 1, 2004 whenHungary is expected to join the EU. The regulatory review is focusing on thefollowing areas: EU harmonization and competition, Internet regulation,universal service obligation regulation, cost accounting and price regulation,carrier selection, unbundling, number portability regulation and institutionalissues.

 

The Companycannot fully anticipate the combined impact of these changes on its businessand results of operation. Matáv’s business and results of operations may beadversely affected by the new Hungarian telecommunications regulatory regimeand by the application of LRIC based interconnection tariffs for unbundledlocal loop, interconnection and leased line interconnection services.

 

Matáv became auniversal service provider as a consequence of the universal service contractthat was concluded between Matáv and the Minister on January 28, 2002 (the“Contract on Universal Service Provision”). Universal service providers areentitled to compensation for their loss of revenue resulting from the low priceof universal service packages. The EU system, however, does not subsidizetelecommunications service providers based on their revenue shortfall, but onnet cost principles. The implementation of the EU financing system, as part ofthe modifications of the Act on Communications, may result in Matáv not gettingany further subsidies for its universal service packages.

 

7

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Theliberalization of the fixed line telecommunications market is expected to havean effect on the mobile telecommunications industry as well. On November 4,2002, the National Regulatory Authority (“NRA”, Hírközlési Felügyelet)pronounced Westel as a significant market power in the interconnections market;therefore, it had to submit to the NRA cost-based interconnection fees within30 days for approval. Westel complied with this obligation but later withdrewits interconnection offer. It is expected that government regulated fees andinterconnection prices will significantly change and these changes will impactthe operations of Westel. The extent and timing of this change is not knownyet, but it is not expected to be retrospective to 2002.

 

In 2003, the NRAmay introduce a directive on number portability for mobile phones. This mayresult in a larger churn rate among the more price-sensitive prepaid mobilecustomers, thus negatively impacting the total revenue of Matáv.

 

See “Item 4 -Regulation and Pricing”

 

**Matáv is subject to increased competition due totelecommunications sector liberalization.**

 

Competition inthe Hungarian telecommunications sector is increasing as a result of marketliberalization measures. Since December 23, 2001, other service providers havehad the right to compete directly for Matáv’s customers across Hungary in thepublic telephony services.

 

Managementbelieves that following the liberalization of the Hungarian telecommunicationssector, competition in the provision of telecommunications infrastructure, aswell as in domestic and international telephony services may arise from avariety of new entrants, including telecommunications service providers fromother countries and companies currently providing other telecommunicationsservices previously liberalized in Hungary. Although the exact identities ofthe first new entrants are already known, the scope of competition and anyadverse effect on the Company’s results will depend on a variety of factorsthat we currently cannot assess with precision and are for the most part notwithin the Company’s control. Among such factors are the business strategiesand capabilities of potential competitors, prevailing market conditions, theeffect of an EU conform regulation on the Hungarian telecommunications market,which substantially differs from other European markets, as well as theeffectiveness of the Company’s efforts to prepare for increased competition.

 

In the mobilecommunications business, Matáv already faces intense competition. As alltelecommunications markets have become increasingly saturated, the focus ofcompetition is starting to shift from customer acquisition to customerretention. Significant customer defections would have an adverse effect onresults of operations, and customer acquisition and retention expenses aresubstantial. Due to the increased competition, prices for mobile voicetelephony have been declining over the past several years and may continue todecline. Matáv also faces intense competitive pressure in the market forInternet services, as well as in the data communications markets.

 

Competition inany or all of Matáv’s principal lines of business could lead to:

 

•                  price erosion ofMatáv’s products and services;

 

•                  inability to increasemarket share or loss of market share;

 

•                  loss of existing orprospective customers and greater difficulty in retaining existing customers;

 

•                  more rapid deploymentof new technologies and obsolescence of existing technologies; and

 

•                  other developments thatcould have a material adverse effect on Matáv’s financial condition and resultsof operations.

 

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**Matáv’s ability to sustain revenue growth willdepend in part on increasing traffic and offering value added and data servicesto its customers.**

 

Matávexpects the number of fixed access lines and tariffs for telephony services todecrease as competition in fixed and mobile telephony increases. Matáv’sability to sustain revenue growth will therefore depend on increasing theamount of traffic over existing fixed lines and on increasing revenues fromvalue added and data services. Matáv also plans to sustain revenues by growingits mobile subscriber base and expanding its related lines of business, such asInternet and cable television, as well as by geographic expansion. Matáv maynot be able to sustain revenue growth, if it is not able in the future to offerattractive and affordable value added services or if the Company’s customers donot purchase its services.

 

### ***Matáv may be unable to adapt totechnological changes in the telecommunications market.***

 

Thetelecommunications industry is characterized by rapidly changing technologywith related changes in customer demands and the need for new products andservices at competitive prices. Technological developments are also shorteningproduct life cycles and facilitating convergence of different segments of theincreasingly global information industry. Matáv’s future success will beimpacted by its ability to anticipate, invest in and implement new technologieswith the levels of service and prices that customers demand. Technologicaladvances may also affect Matáv’s level of earnings by shortening the usefullife of some of its assets.

 

Theoperation of Matáv’s businesses depends in part upon the successful deploymentof continually evolving mobile communications technologies, which will requiresignificant capital expenditures. There can be no assurance that suchtechnologies will be developed according to anticipated schedules, that theywill perform according to expectations, or that they will achieve commercialacceptance. Matáv may be required to make more capital expenditures than arecurrently expected if suppliers fail to meet anticipated schedules, if atechnology’s performance falls short of expectations, or if commercial successis not achieved.

 

The effectof technological changes on Matáv’s businesses cannot be predicted. Inaddition, it is impossible to predict with any certainty whether the technologyselected by Matáv will prove to be the most economic, efficient or capable ofattracting customer usage. There can be no assurance that Matáv will developnew products and services that will enable Matáv to compete effectively in theHungarian telecommunications market.

 

**Developments in thetechnology and telecommunications sectors have resulted and may in the futureresult in substantial write-downs of the carrying value of certain of ourassets.**

 

Recentdevelopments in the technology and telecommunications sectors, includingsignificant declines in stock prices, market capitalization and credit ratingsof market participants may result in substantial write-downs of our intangibleor other assets. Future changes in these areas could lead to furtherwrite-downs at any time. Recognition of impairments of tangible, intangible andfinancial assets could adversely affect our results of operations and financialcondition and might lead to a drop in the trading price of our shares. Wereview on a regular basis the value of each of our subsidiaries and theirassets. In addition to our regular valuations, whenever indications exist (dueto changes in the economic, regulatory, business or political environments)that goodwill, intangible assets or fixed assets may be impaired, we considerthe necessity of performing certain valuation tests which may result in animpairment charge.

 

**We depend on a limited numberof suppliers for equipment and maintenance services.**

 

In each ofour operating divisions, there are a limited number of suppliers for requiredequipment and maintenance services. The failure of these suppliers to meet ourequipment and service needs in a timely manner 

 

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might have asignificant effect on our revenues and market position. The construction andoperation of our networks and the provision of our services and networkinfrastructure, especially mobile telecommunications services, are dependent onour ability to obtain adequate supplies of a number of items on a timely andcost-efficient basis. These include handsets and transmission, switching andother network equipment. Significant delays in obtaining certain equipment andmaintenance services could have a material adverse effect on our business orresults from a particular operating division.

 

### ***Matáv’s business may be adverselyaffected by actual or perceived health risks associated with mobilecommunications technologies.***

 

Mediareports have suggested that certain radio frequency emissions from cellulartelephones may be linked to certain medical conditions such as cancer. Inaddition, certain consumer interest groups have requested investigations intoclaims that digital transmissions from handsets used in connection with digitalmobile technologies pose health concerns and cause interference with hearingaids and other medical devices. There can be no assurance that the findings ofsuch studies will not have a material effect on Matáv’s mobile business or willnot lead to government regulation. Matáv’s ability to install new mobiletelecommunications base stations and other infrastructure may also be adverselyaffected, and related costs may increase, due to regulation or consumer actionin response to concerns over health risks and the impact on the value ofproperties adjacent to such infrastructure. The actual or perceived healthrisks of mobile communications devices could adversely affect mobilecommunications service providers, including Matáv, through increased barriersto network development, reduced subscriber growth, reduced network usage persubscriber, threat of product liability lawsuits or reduced availability ofexternal financing to the mobile communications industry.

 

**System failures could resultin reduced user traffic and reduced revenue and could harm Matáv’s reputation.**

 

Matáv’stechnical infrastructure (including its network infrastructure forfixed-network services and mobile telecommunications services) is vulnerable todamage or interruption from information technology failures, power loss,floods, windstorms, fires, intentional wrongdoing and similar events.Unanticipated problems at its facilities, system failures, hardware or softwarefailures or computer viruses could affect the quality of Matáv’s services and causeservice interruptions. Any of these occurrences could result in reduced usertraffic and reduced revenue and could harm Matáv’s reputation.

 

**Matáv’s credit rating may belinked to the credit rating of its parent company, Deutsche Telekom AG.**

 

Matáv’s creditrating was lowered by Standard & Poor’s Ratings Services (“S&P”) inApril 2002, because of the decreased credit rating of its parent company,Deutsche Telekom AG (“DT”). Moody’s Investors Services (“Moody’s”), however,maintained its credit rating of Matáv, while lowering DT’s rating in January2003.

 

DT hassubstantially increased its outstanding debt to finance acquisitions andinvestments, resulting in a lowering of the credit rating on its long-termdebt. If it is unable to reduce its indebtedness as planned, its credit ratingsmay be further lowered.

 

BothS&P and Moody’s assigned a credit rating to Matáv in November 2000. S&Prated Matáv’s long term foreign currency debt BBB+ and local currency debt A-,while Moody’s rated Matáv’s long term debt Baa1. S&P upgraded Matáv’sforeign currency debt to A- in line with the Hungarian sovereign in January2001. Matáv has sustained its Moody’s rating since then and is still ratedBaa1, even after Moody’s upgraded the Hungarian sovereign from A3 to A1 in November2002. S&P, however, downgraded Matáv to BBB+ in April 2002, following DT’sdecreased rating. S&P sees Matáv as a strategic investment of DT;therefore, it is very likely that Matáv’s rating will move parallel with thatof DT’s in the future as well. Presently Matáv’s credit rating at

 

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Moody’s is betterby two notches than that of DT’s (split rating). However, a further downgradeof DT by Moody’s would probably result in a downgrade of Matáv’s credit ratingas well.

 

DeutscheTelekom is committed to an ongoing debt reduction, but we cannot assure youthat circumstances will permit these goals to be reached on time or that itscredit rating will not be further downgraded by S&P, Moody’s or otherrating agencies. Future possible decreases of DT’s rating may also affectMatáv’s rating.

 

Theinterest rates on Matáv’s current indebtedness contractually are not linked toits credit rating; therefore, such current interest rates will not increasebecause of downgrades of Matáv’s long term debt. However, any such downgrademay increase the cost of future long-term indebtedness if Matáv’s credit ratingis considered when obtaining financing.

 

**Loss of key personnel couldweaken Matáv’s business expertise.**

 

Matáv’soperations are managed by a small number of directors and key executiveofficers. The loss of directors or key executive officers could significantlyimpede Matáv’s financial plans, marketing and other objectives. Matáv believesthat the growth and future success of its business will depend in large part onits continued ability to attract and retain highly skilled and qualifiedpersonnel at all levels; however, the competition for qualified personnel inthe telecommunications industry is intense. Matáv can give no assurances thatit will be able to hire or retain necessary personnel.

 

### ***Matáv’s share price may bevolatile, and your ability to sell Matáv shares may be adversely affected dueto the relatively illiquid market for Matáv securities.***

 

TheHungarian equity market is relatively small and illiquid compared with majorglobal markets. As a result of the limitations of the Hungarian equitiesmarket, the general turmoil in emerging markets beginning in 1998 and thevolatility of the telecommunications sector, the price of Matáv shares may berelatively volatile, and you may have difficulty selling your shares in theevent of unfavorable market conditions.

 

**Matáv faces limitations onfurther extension of its cable television business under the Act on Communications.**

 

The Act onCommunications, which has been the basis for the telecommunications market inHungary since December 23, 2001, restricts Matáv from purchasing cabletelevision networks until January 1, 2004 and also restricts the Company frombuilding its own cable television networks in those areas where Matáv oranother significant competitor has a telephone network. These measuressignificantly limit the expansion of Matáv’s cable television business.

 

**Matáv has a substantialbusiness interest based in Macedonia, and ethnic hostilities and economicpressures could reduce the value of Matáv’s investment in that region.**

 

Matáv ownsan 86.5 percent interest in Stonebridge Communications AD (“Stonebridge”),which owns a 51 percent interest in MakTel, the formerly state owned publictelecommunications service provider in Macedonia. MakTel became a consolidatedsubsidiary of Matáv beginning on January 15, 2001.

 

Ethnichostilities, while getting better, are still a risk to the economy ofMacedonia. The negative pressure on the economy could lead to a devaluation ofthe currency. In case of a devaluation of the Macedonian Denar, the value ofMatáv’s interest in MakTel would be reduced and Matáv’s future results ofoperations may be adversely affected.

 

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**The value of our investments,the results of our operations and our financial condition could be affected byeconomic developments in Hungary and other countries.**

 

 Our business depends on general economic conditionsin Hungary and abroad. In 2001 and 2002 there was a downturn in global economicconditions in general and in the telecommunications industry in particular.This downturn has continued into 2003 and is expected to continue for the restof the year. However, there are many factors that influence global and regionaleconomies, which factors are outside of our control. The climate for and valuesof investments in the business sector have been worsening over the past year. Acautious or negative business outlook may cause our customers to delay orcancel investment in information technology and telecommunications systems andservices, which may adversely affect revenues directly and in turn slow thedevelopment of new services and applications that could become future revenuesources for us. If the global and regional economies do not improve, we maycontinue to experience material adverse effects on our business, operatingresults and financial condition. In addition, it is still unknown what economiceffect there may be from Hungary’s expected accession to the European Union.

 

**Matáv is subject to risksresulting from fluctuations in exchange rates.**

 

Matáv issubject to risks resulting from fluctuations in exchange rates, which canadversely affect costs associated with Matáv’s foreign currency denominateddebt obligations and certain other payments. Our exposure to risks fromexchange rate fluctuations has increased as a result of the National Bank ofHungary’s policy change to less intervention with the foreign currency market.

 

During2002, the HUF continuously strengthened against the EUR, until the HUFvulnerability was seen in June 2002 when EUR gained about HUF 10 against theHUF in a few days. Then, beginning in November 2002, the HUF again stronglystrengthened against EUR until January 2003, when the HUF/EUR reached thestrong edge of the intervention band (234 HUF/EUR). To prevent speculation anda potential band widening, the strong exchange rate forced the National Bank ofHungary to intervene with a purchase of about EUR 5 billion, and then todrastically reduce the HUF reference interest rate by 200 basis points in twodays. As a result of the steps taken by the National Bank of Hungary, the EURincreased by more than HUF 20 in one day (from 235 HUF/EUR to 255 HUF/EUR),then reached a stable level at 245-247 HUF/EUR in February 2003. This shows theincreased volatility of EUR/HUF exchange rates. See “Item 11 Quantitative andQualitative Disclosures about Market Risk”.

 

Inaddition, the devaluation of the Macedonian Denar and the strengthening of theHungarian Forint may exert a negative influence on MakTel’s results that areconverted into HUF, thereby lowering Matáv’s results.

 

**Matáv is subject to risksresulting from fluctuations in interest rates.**

 

Matáv issubject to risks resulting from fluctuations of interest rates, which canaffect costs associated with Matáv’s interest bearing obligations and certainother payments. Matáv’s debt portfolio mostly consists of floating rateelements, which inherently decrease the predictability of Matáv’s financingcosts since interest is always paid according to the current market interestrates. Fixed-rate loans also bear risks of fluctuating interest rates as Matávmay have to pay more interest on fixed-rate loans than on floating rate loanswhen interest rates decrease (they become more expensive), and in this caseMatáv loses the possibility of financing itself at a lower cost.

 

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**ITEM 4****— INFORMATION ON THE COMPANY**

 

**HISTORY AND DEVELOPMENT OFTHE COMPANY**

 

**Organization**

 

Matáv is the principal provider of fixed line telecommunicationsservices in Hungary. Its shares are listed on the Budapest Stock Exchange, andits ADSs are listed on the New York Stock Exchange. Matáv’s headquarters arelocated at 55 Krisztina krt., 1013 Budapest, Hungary. Its telephone numbers are36-1-458-0000 or 36-1-458-7000. Matáv operates under the laws of Hungary. ItsU.S. agent for federal securities law purposes is CT Corporation, 111 EightAvenue, New York, New York 10011, USA.

 

## ***Historical Background***

 

Prior to 1990, the Hungarian national postal, telephone and telegraphauthority, Magyar Posta, provided all public telephony services in Hungary. Asof January 1, 1990, the Hungarian Government split Magyar Posta into threedistinct entities along the lines of its three main areas of operation: postalservices, telecommunications and broadcasting. The Hungarian Government madeMagyar Távközlési Vállalat, the predecessor entity to Matáv, responsible fortelecommunications operations. This entity was transformed on December 31, 1991into a stock corporation, Magyar Távközlési Rt., or Matáv, then wholly owned bythe predecessor of the Állami Privatizációs és Vagyonkezelő Rt. (the “StatePrivatization and Holding Company” or the “ÁPV”).

 

MagyarCom GmbH (“MagyarCom”), a holding company in which DeutscheTelekom AG and Ameritech Corporation (“Ameritech”) each held a 50 percentinterest, was selected by the Minister in an international tender andsubsequently purchased a 30.1 percent stake in Matáv for approximately U.S.dollar 875 million. The ÁPV contributed U.S. dollar 400 million of the purchaseprice paid by MagyarCom to Matáv to provide it with capital to expand thetelephone network. MagyarCom entered into a concession agreement with theHungarian Government on December 19, 1993. MagyarCom then assigned certain ofits rights under the concession agreement to Matáv. On December 22, 1993, Matáventered into a concession contract with the Hungarian Government, which gaveMatáv the exclusive right to provide domestic long distance and internationalpublic telephony services throughout Hungary and local public fixed line voicetelephony services in 31 of 54 Local Primary Areas for a term of eight yearsending December 22, 2001. On May 24, 1994, Matáv obtained the right to providetelephony services in an additional five Local Primary Areas for a term ofeight years ending May 25, 2002.

 

On October 8,1999, SBC Communications Inc. (“SBC”) completed its acquisition of Ameritechand thus gained control over Ameritech’s 50 percent interest in MagyarCom.

 

On July 3,2000, SBC sold its 50 percent ownership in MagyarCom to Deutsche Telekom AG.

 

As ofDecember 31, 2002, 59.21 percent of Matáv’s ordinary shares was held byMagyarCom, 40.32 percent of the ordinary shares was publicly traded and theCompany had 0.47 percent treasury shares. The Hungarian Government controls oneSeries “B” voting preference share to which special rights attach.

 

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**BUSINESS OVERVIEW**

 

### ***Business Summary***

 

Matáv isthe principal provider of fixed line telecommunications services in Hungary,with approximately 2.9 million fixed access lines at December 31, 2002. TheCompany is also Hungary’s largest mobile telecommunications service provider,with more than 3,426,000 mobile subscribers (including users of prepaid cards)at December 31, 2002. The Company’s total consolidated revenues were HUF590,585 million, and its total consolidated net income was HUF 68,128 millionin 2002.

 

Matáv is afull-service telecommunications provider operating in three business segments:

 

*Fixed LineTelecommunications Services*.  The Company’s fixed line telecommunicationsservices consist of local, long distance, international and othertelecommunications services, including data transmission, cable television andInternet services. The Company had exclusive rights through December 2001 toprovide domestic long distance and international public telephony servicesthroughout Hungary and to provide local public fixed line telephony service in31 of the 54 local primary areas in Hungary. The Company had exclusive rightsin five of the 54 local primary areas until May 2002, while its subsidiary,Emitel had exclusive rights in an additional three concession areas throughNovember 2002. The Company’s 36 former local concession areas coverapproximately 70 percent of Hungary’s geographic area and include Budapest aswell as nearly all of the other major cities in Hungary. As there is verylimited competition for public voice telephony services following theliberalization of the telecommunications market, Matáv is still the dominantservice provider in these 36 areas. Matáv also provides leased lines, datatransmission services and corporate network services, sells telecommunicationsequipment and offers network construction and maintenance services. Matáv isthe market leader in Hungary for most of these services.

 

*Mobile TelecommunicationsServices.** *Throughits two mobile telecommunications subsidiaries, Westel and Westel 0660, theCompany is a market leader in the provision of mobile telecommunicationsservices in Hungary. Westel currently is one of three GSM digital providers,and Westel 0660 is the sole provider of analog mobile telecommunicationsservices in Hungary. Mobile telecommunications services have contributedsignificantly to the Company’s revenue growth. Revenues from mobiletelecommunications services increased from HUF 159,345 million, before intersegmenteliminations in 2000 to HUF 232,612 million before intersegment eliminations in2002, while the number of subscribers increased to approximately 3.4 million bythe end of 2002 from 0.9 million at the end of 1999. In 1999, Westel won one ofthe new 1800 GSM mobile telecommunications operating licenses. One new entrantin the Hungarian digital cellular market started operations in December 1999offering GSM services. The winners of the two other 1800 GSM licenses,including Westel, entered the 1800 GSM market in December 2000.

 

*InternationalActivities. *Matáv purchased**an 86.5 percent stake in Stonebridge,which owns 51 percent of MakTel. MakTel, the first international subsidiary ofMatáv, became a consolidated subsidiary as of January 15, 2001, the date whenthe closing of the purchase transaction took place. This transaction hascontributed significantly to the Company’s revenue growth. Revenues frominternational activities were HUF 67,562 million before intersegmenteliminations in 2002. MakTel is the sole fixed line service provider and theleading mobile service provider in Macedonia. Its exclusive rights in fixedline telecommunications services will expire in December 2004. These exclusiverights include local, national and international long distance public voiceservices, voice over Internet Protocol (“IP”) services, leased lines servicesand building and operating public voice network services.

 

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**Business Strategy**

 

***High-level Strategic Objectives  –*“*FromSubscriber Growth to Customer Management”***

 

Matáv ispositioned to be the dominant player in the Hungarian telecommunicationsindustry in 2003. The total Hungarian market grew by an estimated 10 percentfrom 1999, and the mobile market proved to be the main growth area. It appearsthat the Hungarian mobile penetration level will reach Western European levelsin the next couple of years. In line with the evolving requirements of thecontinuous market developments, Matáv continues the shift in strategy from thesubscriber growth to customer management in both the fixed and mobile segments.New growth areas in the data and Internet businesses are gradually gainingenough maturity to contribute to growth at the group level.

 

Regulatorychange and the moderate increase in competitive intensity in all business linescaused a slight erosion of Matáv’s market share. The decline is far less thanthe comparable figures in Western Europe, and Matáv’s clear market leaderposition remains firm and stable in all areas of the business. Matáv looksforward to and prepares itself for new, sustainable growth opportunities in thefuture, which should predominantly be based on its large customer base.

 

WhileMatáv has a strong balance sheet despite the acquisition of Westel and MakTel,its immediate focus is on consolidating market positions and strengthening itsfinancial structure. Accordingly, three overarching strategic themes dictateMatáv’s Group-level and business line-level strategy for 2003:

 

•                  *Maintain and consolidate industry-leadingposition*: focus on completing the transformation froman access penetration/installation growth-driven business to a customer valuemanagement/customer retention-driven business; improve customer segmentationand renew Matáv’s value propositions, especially in the fixed-line residentialbusiness; and proactively manage the regulatory environment;

 

•                  *Minimize margin erosion of Earnings BeforeInterest, Tax, Depreciation and Amortization (“EBITDA”)*: exploit all opportunities to optimize pricing; continue to increaseproductivity by driving costs down; reduce cost burden of the network byutilizing/selling excess capacity; and

 

•                  *Increase Free Cash-Flow (*“*FCF*”*) generationthrough efficient Capital Expenditure (“CAPEX”) management*: optimizeCAPEX levels and allocation to reduce overall investment while continuing toinvest in areas where such further investment is justified by market growth.

 

From theindustry perspective Matáv sees itself in the midst of a globalretrenchment/consolidation period, which the Company believes will lead to anew period of sustainable growth. This growth period will be different fromthat of the past, as it will be based on a wide (existing) customer base andpenetration of new, value added services. Following the euphoric growthexpectations and heavy debt-financed investment levels of the period leading upto 2000, the industry now faces a new set of challenges and investorexpectations.

 

Matávbelieves a new set of growth opportunities, based on innovation and widelyaccepted applications like broadband solutions and mobile non-voice services,will emerge in the next few years. As the dominant Hungarian industry playerwith a sound balance sheet, Matáv is in a strong position to play a leadershiprole in new markets and continue its course of sustainable growth.

 

Meanwhile,Matáv views the coming year as part of the retrenchment period, which theCompany must use to consolidate its market leader position, improve itscompetitiveness, increase its financial strength further, and maximizeproductivity. While analysts are expecting declining EBITDA margins in theoverall telecommunications industry, Matáv is determined to maintain excellentfinancial performance as it did in the past year.

 

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***Business structure***

 

Driven bystrategic guidance during the past few years, Matáv’s Mobile, Residential,Business, Internet and Network Lines of Business (“LoB”) now operate asbusiness units responsible for their markets. The LoB structure allows resourceallocation (e.g., CAPEX) in accordance with growth potential and the respectivecompetitive situation. In effect, an internal “competition for resources” iswell established.

 

The firststrategic priority is to increase the value of Matáv through profit and lossresponsibility and competitiveness of the LoBs, thus using the market to drivegroup synergies. This allows Matáv to provide services across the entiretelecommunications value chain and to realize synergies by sharing assets andcoordinating marketing and sales campaigns. This is crucial to Matáv’s positionas an integrated telecommunications service and solutions provider.

 

***Implications for the LoBs and MakTel***

 

Thestrategic objectives and Group-level priorities have been applied to each LoBand to MakTel to develop a set of specific strategies for each business linetaking into account the specific life-cycle and market position of the businessline.

 

**Fixed Line TelecommunicationsService Segment**

 

*Residential Line of Business*

 

TheResidential LoB’s strategic position is characterized by a generally stagnantmarket for fixed-line services. The access base has been declining slightlysince 2000 mostly because of mobile substitution in certain segments. Longdistance and international long distance traffic declined and traffic shiftedto fixed-to-mobile and mobile-to-mobile, which have different outpaymentcharacteristics. Despite the increasing demand for broadband, significantgrowth of the access base cannot be expected in the coming years. Switchedvoice traffic will remain to be subject to mobile substitution and competitivepressure. Still, landline remains the least costly and highest-capacitycommunications network available, for both data and voice.

 

Ratherthan alternative fixed-line operators, the main competitors of the ResidentialLoB are the mobile carriers, which pose the greatest threat to the Company’saccess base as mobile substitution has a noticeable impact on Matáv’sresidential customer base. Although alternative operator services such ascall-by-call long distance service may result in the loss of some trafficrevenue, Matáv’s main priority is to protect its access line base and theresulting subscription revenue from mobile operators.

 

TheResidential LoB’s strategy, therefore, will need to be four-pronged:

 

•                  stabilize accesscustomer base, as a first line of defense against aggressive mobilesubstitution;

 

•                  complete thetransformation from an access penetration/installation driven business to acustomer service/churn management driven business;

 

•                  carefully managewholesale pricing; and

 

•                  continue to increaseproductivity.

 

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Severalkey initiatives are planned to support these objectives:

 

•                  implementation of acustomer value management program to identify churn-likely customers early andto provide a method of targeting cross selling offers with greater accuracy byapplying proactive communication;

 

•                  design a set of freshand compelling value propositions based on (i) price, since mobile servicesstill carry a price premium in terms of average minute rates, (ii) convenience(e.g., bundled high-end Customer Premises Equipments (“CPEs”), enriched serviceportfolio, positioning as a family communication tool versus mobile as anindividual communication tool), and (iii) broadband, since broadband is a keyunique selling point for fixed line access and retail ADSL (“AsynchronousDigital Subscriber Line”) is viewed as a crucial tool in enhancing Matáv’s residentialvalue proposition and increasing Matáv’s market share of the broadband accessmarket; and

 

•                  provide tailoredpackages for individual segments with clear marketing in order to protecttraffic. Soft re-balancing (i.e. increasing the ratio of fixed monthly revenuesby bundling and packaging value added products with the subscription) will playa key role in defending Matáv’s traffic, as it is its main tool to preemptcompetition by reducing the vulnerability of the Company’s fixed-line usagerevenue base.

 

*Business Solutions Line ofBusiness*

 

TheBusiness LoB’s market continues to grow as demand for business data servicesincreases. Nevertheless, a significant part of the Business LoB’s retailrevenues comes from voice services, which are highly vulnerable to competition.Competitors with different cost structures (based on IP networks) have beenaggressively targeting these customers. The result for Matáv has been some lossof market share, especially in the data market. In summary, the Business LoB hasto address IP and mobile substitution as well as maintaining its customer basewithout getting into the ‘discount trap’, i.e. lowering the prices in amargin-eroding way.

 

TheBusiness LoB is therefore focused on halting or reversing the declining marketshare trend by:

 

•                  protecting voicetraffic from competition – especially fixed to mobile traffic;

 

•                  growing the market withcommunications solutions;

 

•                  reducing the cost baseto secure competitiveness in commodity products; and

 

•                  executing segment specificpricing strategies that apply major discounts only where and when it isnecessary to pre-empt the churn of business customers.

 

The mainemphasis in the near future will be to implement a customer segment dedicatedsales force concept and leverage that structure to sell solutions. The segmentdedicated sales system is viewed as Matáv’s primary method of differentiatingitself in the marketplace and regaining the high ground from aggressivecompetitors. Therefore, execution must be carefully monitored and must includeelements of skill building for the account managers to enable consultativeselling and familiarize account managers with the offers of all divisions ofthe Group.

 

*Internet Line of Business*

 

Matáv’sInternet LoB, represented by Axelero, will remain relatively small in terms ofrevenue contribution. It will play, however, an important role in the growthsegments of the fixed line business, mainly broadband, and is expected to be afuture value driver of the Company.

 

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Axeleromust develop ways to move beyond the original dial-up Internet Service Provider(“ISP”) business model, as that model has now proven unable to deliver positivefinancial results without additional revenue sources (e.g. broadband). Axelerocontinues its realigned strategy in 2003 with the focus on simplifying thevalue propositions and internal processes to accelerate growth while improvingprofitability. The main strategic objectives of Axelero will be to:

 

•                  generate positiveEBITDA in 2003 and improve that further in the subsequent years;

 

•                  improve marketpositions in all three major operational areas (i.e., residential, corporateISP services and online portal);

 

•                  pursue OperationalExcellence to deliver best price/quality ratio;

 

•                  find ways to betterleverage Axelero as the sole integrated ISP in the market capable of offeringservices throughout the complete Internet value chain targeting all customersegments; and

 

•                  increasingly tieInternet access and fixed telephony services, as the Internet is the mostimportant element to enhance the landline value proposition.

 

Theseobjectives will be achieved with the following major initiatives planned for2003 within the Internet LoB:

 

•                  communicate in abetter, more targeted fashion to educate the market why Internet access is a“value for money” product and combine promotions and marketing activities withthe government’s personal computer subsidy programs to maximize penetration andAxelero’s incremental market share;

 

•                  create an essentialbase for broadband migration with a further simplified product portfolio in thedial-up segment. Also, this can help to utilize Matáv’s excess capacity byoffering tailor-made packages;

 

•                  support the re-launchof retail ADSL with Matáv to accelerate broadband penetration and improve thebroadband access market share position of Matáv; and

 

•                  continue Axelero’sMedia Division focus on the news portal (“origo”) business that should beleveraged into different loyalty programs such as Axelero Club. Distinguish thepremium paid-for content, which can deliver additional revenues to the ISP.

 

*Network Services Line ofBusiness*

 

NetworkServices LoB is the “factory”, i.e. a service unit offering a shared platformfor the fixed line based units and selected basic infrastructure elements forthe mobile unit. The major strategic objective of the Network LoB is to improvethe competitiveness of the other lines of business within the Group. Thisrequires the Network Services LoB to:

 

•                  translate efficiencypressure from market related LoBs into network strategy and development;

 

•                  utilize the performanceand features of existing network elements to the greatest possible extent;

 

•                  dispose or graduallymigrate from non-utilized and/or under-utilized platforms and network elements;

 

•                  avoid investments ininfrastructure areas with questionable return on investment or excessivepayback cycle; and

 

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•                  make evolutionarydevelopment steps in order to follow migration and convergence trends andsecure demand driven capacity increases.

 

**Mobile TelecommunicationsService Segment (Mobile LoB)**

 

The mobilebusiness represented by Westel as a subsidiary and a strong brand image willremain the growth driver of the Group. Even so, the characteristics of themobile business and mobile competition will change as the mobile marketapproaches its saturation point and a new non-voice mobile business emerges.

 

Given theforecasted market development, customer growth slowdown and regulatoryenvironment change, the Company believes that the following key strategicissues need to be addressed by Westel:

 

•                  the optimal balancebetween preserving a premium market share position as the basis for futuregrowth with the need to improve profitability;

 

•                  the way to extend theCompany’s customer portfolio management in order to fully exploit a profitablecustomer base; and

 

•                  the answers todeclining Average Revenue Per User (“ARPU”) and Minutes of Use (“MoU”) trendsdriven by dilution of customer base.

 

As anunderlying strategy, the Mobile LoB will continue the gradual shift from thesubscriber growth to a customer management driven strategy. The objective is tofind an optimal balance between growth and profitability. The main focus of the2003 strategy is, therefore, to manage the entire customer base more activelyto maintain market share and EBITDA level.

 

To successfullyexecute the above strategy, Westel will concentrate its efforts in thefollowing major initiatives:

 

•                  introduce activecustomer portfolio management by embedding the theme of “customer value” in allbusiness processes. This will help to stabilize customer base and growrevenues, to plan and budget activities based on EBITDA contribution and toincrease satisfaction of heavy users by differentiated service levels;

 

•                  migrate high-endprepaid customers to postpaid to the greatest extent possible. This is a keyelement of improving Westel’s overall financial performance through increasingaverage MoU, which is the single largest driver of Westel’s results. Onaverage, postpaid customers typically have approximately four to five times theMoU of prepaid; and

 

•                  utilize the availableplatforms, such as General Packet Radio Service (“GPRS”) and WirelessApplication Protocol (“WAP”) to push demand for non-voice services such asMultimedia Messaging Service (“MMS”), Bulk Short Message Service (“SMS”),Mobile e-mail, and Mobile banking. Introduction of new services is viewed ascrucial because it will play a role in lifting ARPU and MoU, lock in earlynon-voice customers for future applications and improve Westel’s corporateimage as a leading innovator. New Mobile MultiMedia services are to be launchedfor both residential and corporate customers.

 

**International Segment (MakTel)**

 

Matáv seesMakTel, its consolidated subsidiary, as a sustainable value contributor of theGroup. In the long term, Matáv’s objective is to make MakTel the mostsuccessful telecommunications company in the Balkans. After the crisis in thecountry, MakTel’s strategic targets must be quickly aligned with the new marketrequirements to secure sustainable profitability and strong financialperformance.

 

19

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The mainstrategic actions are the following:

 

•                  maintain strongfinancial performance by strictly planned and allocated CAPEX in growth areasonly; and where customer demand is not sufficient, scale back developmentplans;

 

•                  apply lessons learnedfrom Hungary and other Central and Eastern European countries for networkrollout and balancing fixed versus mobile growth;

 

•                  build a more efficientand lean organization by improving employee productivity;

 

•                  increase focus onmarketing by enlarging the sales and marketing resources;

 

•                  strengthen the cooperationbetween MakTel and MobiMak (MakTel’s digital cellular service provider) insales and marketing from planning to execution; and

 

•                  more proactively buildregulatory intelligence.

 

***Strategic Value Proposition of the Group***

 

Matáv’sGroup strategy is a combination of the specific LoB strategies, which aim foreach business to achieve and maintain the most competitive position, while alsomaximizing Group value. Consequently, Matáv’s Group strategy will focus on:

 

•                  maximizing shareholdervalue, having emphasis on the LoBs’ growth and allowing them to be the mostcompetitive in their respective businesses;

 

•                  responding to globalproduct development challenges, while adapting to service offers and seamlessservices driven by Deutsche Telekom AG; and

 

•                  creating the basis of amarket driven integrated value proposition that builds on efficiencies and costadvantages achieved by integrating (network) platforms; unique serviceofferings leveraging marketing synergies and enhanced sales opportunities viacombined channels of the Group that can only be achieved by an integratedservice provider.

 

InDecember 2002, SGS, the largest independent quality surveillance andcertification body in the world, completed the certification of the qualitymanagement Framework developed by Matáv. Thus Matáv has obtained a group levelISO 9001:2000 compliant certification, which is a unique accomplishment inHungary and is very rare even by international standards.

 

20

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**Overview of Matáv’s Revenues**

 

For theyears ended December 31, 2000, 2001 and 2002, Matáv’s total revenues bybusiness segments were as follows:

 
|                                           |   | **Year ended December 31,** |   | **Year ended December 31,** |   |
|------------------------------------------------|--------|-----------------------------|--------|-----------------------------|--------|
|                                           |   | **2000**                    |   | **2001**                    |   | **2002** |   | **2002/2001** |   |
|                                           |   | **(in HUF millions)**       |   | **(% change)**              |   |
| Fixed line telecommunications services segment |   |                        |   |                        |   |   |   |   |   |
| Subscriptions, connections and other charges   |   | 84,016                      |   | 97,942                      |   | 98,797 |   | 0.9 |   |
| Domestic traffic revenues                      |   | 129,517                     |   | 123,366                     |   | 118,839 |   | (3.7 | ) |
| Other usage                                    |   | 26,679                      |   | 24,276                      |   | 20,885 |   | (14.0 | ) |
| International traffic revenues                 |   | 39,008                      |   | 32,339                      |   | 27,274 |   | (15.7 | ) |
| Leased lines                                   |   | 16,453                      |   | 18,010                      |   | 20,377 |   | 13.1 |   |
| Data transmission and related services         |   | 11,241                      |   | 15,184                      |   | 17,597 |   | 15.9 |   |
| Telecommunications equipment sales             |   | 4,810                       |   | 3,582                       |   | 3,671 |   | 2.5 |   |
| Other revenues                                 |   | 14,556                      |   | 18,986                      |   | 28,866 |   | 52.0 |   |
| Total fixed line segment                       |   | 326,280                     |   | 333,685                     |   | 336,306 |   | 0.8 |   |
| Mobile telecommunications services segment     |   | 159,345                     |   | 198,947                     |   | 232,612 |   | 16.9 |   |
| International segment                          |   | 0                           |   | 60,034                      |   | 67,562 |   | 12.5 |   |
| Intersegment eliminations                      |   | (39,680                     | )      | (44,931                     | )      | (45,895 | ) | 2.1 |   |
| Total                                          |   | 445,945                     |   | 547,735                     |   | 590,585 |   | 7.8 |   |

 

### ***Fixed Line Telecommunications Services Segment***

 

In 2002, Matáv’s fixed line telecommunications services generatedrevenues of HUF 336,306 million before intersegment eliminations. Fixed linetelecommunications services consist of domestic and international services,leased lines, data transmission, cable television and Internet services,telecommunications equipment sales, construction, maintenance and otherservices.

 

***Domestic Services***

 

Domesticfixed line voice telephony, Matáv’s principal business activity, generatedrevenues of HUF 238,521 million in 2002, HUF 245,584 million in 2001 and HUF240,212 million in 2000, in each case before intersegment eliminations.

 

Revenuesfrom domestic fixed line voice telephony consist of:

 

•             subscriptions, connectionsand other charges;

 

•             domestic traffic revenues;and

 

•             other usage.

 

*Products and Services*

 

*Local and Long DistanceCalling Services*.  Matáv provides local, domestic and international long distancetelephony service to its fixed line telephony subscribers.

 

21

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*Digifon Services.* The improved level ofdigitalization of its exchanges permits the Company to offer value addeddigifon services, such as call forwarding and call waiting, to a significantnumber of its fixed line telephony subscribers. These services contribute toincreased fixed line usage by avoiding busy signals or unanswered calls. In2001, the Company introduced the Call Completion to Busy Subscriber service,whereby customers can request to get called back when a busy line they calledbecomes available. In 2002, 1.4 million Matáv subscribers used this free ofcharge service regularly.

 

*Shared Cost/Toll FreeNumbers. *To enable business customers to better meet the needs of their clients,Matáv has introduced a wide range of “blue” numbers, which are shared costnumbers, and “green” numbers, through which businesses provide toll-free accessfor their customers. In 1999, the Company introduced Private Green Numbers,which are targeted at residential users.

 

*Special AdministratorService. *In 2001, Matáv introduced the SignPronounce service, which allowshearing-impaired or speech defective customers to communicate directly viatelephone with the help of an operator.

 

*Voice-mail.*  In November 1999, Matávlaunched a voice-mail product. Matáv believes voice-mail is an attractiveservice for subscribers while it simultaneously increases the number of completedcalls. In August 2000, Matáv enriched the service by introducing call returnand call capture functions as part of the basic voice-mail service. In July2001, Matáv introduced voice-mail SMS service, which provides an SMS alert tothe mobile handset of the customer each time he receives a message on hisvoicemail. These services allow better usage of the network, more comfort inusing the phone and decrease the ratio of uncompleted calls. As of December 31,2002 Voice-mail subscribers amounted to 414,187.

 

*Fixed SMS.*  In September 2002, Matávlaunched a new messaging service called Fixed SMS. The service operates withinMatáv’s network and between Matáv’s and Westel’s networks. From the fixed line,short text messages can be sent with an SMS-capable phone set and the SMStermination is available for its every subscriber. If the SMS’s addressee doesnot have an SMS-capable phone set, the text message is sent as voice message(text-to-speech function). The maximum length of an SMS is 160 characters. The servicehas other useful functions as well: SMS to fixed fax machines, SMS redirectionand multi-SMS sending.

 

*IntegratedServices Digital Network (*“*ISDN*”*) Services.* ISDN allows a single access line to be usedsimultaneously for a number of purposes, including voice, data, facsimile andvideo transmission. ISDN also provides higher quality connections with fastertransmission of signals while increasing the bandwidth capacity of the network.The coverage of ISDN is 95 percent of Matáv’s network. Matáv offers both basicISDN access lines with two channels and multiplex ISDN access lines with 30channels. As of December 31, 2002, Matáv had installed 179,223 ISDN accesslines with two channels and 5,096 ISDN access lines with 30 channels, amountingto 511,326 total ISDN channels compared to 114,466 channels at the end of 1999.

 

*Private Branch Exchange (*“*PBX”)Services*.  Matáv offers PBXservices through one of its subsidiaries, Matávcom Kft. As of December 31,2002, Matávcom Kft. leased and sold approximately 25,000 ports. The vastmajority of the equipment leased is digital and meets the demands of developingtechnologies such as ISDN and digital enhanced cordless telecommunications.

 

*Calling Cards.*  In 2002, the SokatmondóCalling Card was introduced for residential customers choosing the Sokatmondópackage. The business customers subscribing for the Ritmus package can alsopurchase Ritmus Calling Cards. These calling cards allow customers to enjoy thediscounts provided by their fixed line packages when using their cards frompublic payphones in Hungary or abroad.

 

*Directory Assistance.* The Company offers customersdirectory inquiry services. On March 1, 1997, the Company introduced a new,high quality directory assistance service, which received more than 34.5million inquiries relating to domestic and 0.6 million inquiries relating toforeign phone numbers in 2002. In May 1999, the service was further developedto offer a call completion option, whereby calls may be connected

 

22

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automatically.Matáv’s directory services center performed 6.4 million call completion in2002. The directory assistance database includes all fixed line and mobilesubscribers’ data in Hungary. On February 15, 2001, Matáv introduced its newDirectory Assistance-Plus (“DA-Plus”) service. DA-Plus offers a wide range ofinformation including Yellow Pages, residential classified advertisements,encyclopaedias, dictionaries, recipes, poems, as well as telephone numbers,postal, e-mail and website addresses without any quantity restrictions. In2002, it was extended to include additional services, such as flower and pizzadelivery. The tariff of calling the service is based on per minute prices. Thenumber of calls received by DA-Plus service was over 4.66 million in 2002.

 

*Subscribers*

 

The following table sets forth information regarding total fixed accesslines and penetration rates in Matáv’s local concession areas:

 
|                                                                             |   | **At December 31,** |   |
|----------------------------------------------------------------------------------|--------|---------------------|--------|
|                                                                             |   | **2000**            |   | **2001** |   | **2002** |   |
| Lines in service in Matáv Rt.’s local concession  areas:               |   |                |   |   |   |   |   |
| Residential lines                                                                |   | 2,296,351           |   | 2,151,346 |   | 2,055,338 |   |
| Business lines                                                                   |   | 326,503             |   | 299,267 |   | 282,406 |   |
| Public payphones                                                                 |   | 36,774              |   | 37,432 |   | 33,316 |   |
| Total                                                                            |   | 2,659,628           |   | 2,488,045 |   | 2,371,060 |   |
| ISDN channels                                                                    |   | 305,882             |   | 448,396 |   | 511,326 |   |
| Total                                                                            |   | 2,965,510           |   | 2,936,441 |   | 2,882,386 |   |
| Lines in service in Emitel’s local concession areas:                        |   | n.a.                |   | 80,899 |   | 79,460 |   |
|                                                                             |   |                |   |   |   |   |   |
| Lines installed per 100 inhabitants:                                             |   |                |   |   |   |   |   |
| in Matáv Rt.’s local concession areas                                  |   | 39.5                |   | 39.1 |   | 38.4 |   |
| Waiting list (in thousands)(1)                                                   |   | 19                  |   | 15 |   | 7 |   |
| Digital exchange capacity as % of Matáv Rt.’s total  exchange capacity |   | 85.1                |   | 85.4 |   | 87.1 |   |

 

----

(1)       The waiting list consists ofcustomers whose application for connection to an access line has been outstandingfor 60 days or more.

 

Matáv’sdomestic fixed line telephony subscribers are primarily in two categories:residential customers and business customers. Matáv includes the governmentamong its business customers. As of December 31, 2002, 75 percent of Matáv’saccess lines were connected to residential customers and 24 percent to businesscustomers. The remaining one percent of access lines was connected to publicpay phones. Matáv’s top 400 customers account for less than 15 percent of theCompany’s revenues.

 

TheHungarian government, through its various institutions and departments,constitutes Matáv’s largest customer group. Matáv develops separate servicepackages for each of these institutions and departments, because each generallyhas its own annual budget, particular telecommunications needs, independentorganization and responsibility. From a strategic perspective, however, Matávconsiders the Hungarian government to be a single customer. Matáv offers itslargest customers, including the government, discounts for the services itprovides. Matáv estimates that revenues from the Hungarian government in theaggregate accounted for less than five percent of its total revenues in 2002.

 

23

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*Traffic*

 

Thefollowing table sets forth the total minutes of domestic telephony traffic thatMatáv’s fixed line subscribers generated, including calls from the fixed linenetwork to mobile subscribers:

 
|                              |   | **Year ended December 31,** |   |
|-----------------------------------|--------|-----------------------------|--------|
|                              |   | **2000**                    |   | **2001** |   | **2002** |   |
|                              |   | **(thousands of minutes)**  |   |
|                              |   |                        |   |   |   |   |   |
| Domestic traffic at Matáv Rt |   | 9,692,678                   |   | 10,088,137 |   | 8,820,201 |   |
| Domestic traffic at Emitel(1)     |   | n.a.                        |   | 91,567 |   | 179,670 |   |

 

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(1) Trafficgenerated since July 1, 2001, the date when Emitel became a fully consolidatedsubsidiary of the Company.

 

*Tariffs*

 

Matávcharges fixed line subscribers a one-time entrance fee, monthly subscriptioncharges and traffic charges based on usage. Matáv’s tariffs for its fixed linevoice telephony services are regulated by the Minister. Matáv may, however,offer services at prices lower than those established by the Minister.

 

 Commencing January 1, 1999, the Companyintroduced a time-based billing system. Under this system, a call chargecontains two elements: a call set-up charge and a traffic charge measured inseconds based on the call’s duration.

 

Thefollowing table sets forth Matáv Rt.’s domestic fixed line tariffs in each ofthe years indicated in nominal Hungarian Forints. In 2000 and 2001, tariffchanges were effective from February 1 for analog lines and from January 1 forISDN lines. In 2002, monthly subscription fees for analog and ISDN lineschanged from February 1. From September 1, 2002 subscription fees for analoglines changed again and local and long distance tariffs have been altered aswell. International tariffs changed from July 1, 2002 by introduction of the 11zones.

 

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|                                                 |   | **As of**                       |   |
|------------------------------------------------------|--------|---------------------------------|--------|
|                                                 |   | **December 31,  2000**          |   | **December 31,  2001** |   | **December 31,  2002** |   | **February 1,  2003** |   |
|                                                 |   | **(HUF, exclusive of VAT) (1)** |   |
| Entrance fee:                                        |   |                            |   |   |   |   |   |   |   |
| Residential                                          |   | 27,000                          |   | 27,000 |   | 27,000 |   | 27,000 |   |
| Business                                             |   | 60,000                          |   | 60,000 |   | 60,000 |   | 60,000 |   |
| Standard monthly subscription charge:                |   |                            |   |   |   |   |   |   |   |
| Residential                                          |   | 1,814                           |   | 2,308 |   | 2,464 |   | 2,568 |   |
| Business                                             |   | 2,440                           |   | 3,100 |   | 3,320 |   | 3,424 |   |
| ISDN entrance fee:                                   |   |                            |   |   |   |   |   |   |   |
| Basic                                                |   | 99,000                          |   | 60,000 |   | 60,000 |   | 60,000 |   |
| Multiplex                                            |   | 1,350,000                       |   | 990,000 |   | 990,000 |   | 990,000 |   |
| ISDN standard monthly subscription charge:           |   |                            |   |   |   |   |   |   |   |
| Basic                                                |   | 3,700-6,900                     |   | 3,900-6,900 |   | 4,080-7,600 |   | 4,080-8,240 |   |
| Multiplex                                            |   | 53,400-69,900                   |   | 57,600-75,500 |   | 65,000-85,000 |   | 68,500-89,600 |   |
| Charge for a three minute peak                       |   |                            |   |   |   |   |   |   |   |
| rate call:(2)                                        |   |                            |   |   |   |   |   |   |   |
| Local                                                |   | 27.6                            |   | 25.4 |   | 27.2 |   | 28.4 |   |
| From the fixed line network to mobile subscribers(2) |   | 186.0                           |   | 183.8 |   | 183.4 |   | 183.2 |   |
| Domestic long distance:(2)                           |   |                            |   |   |   |   |   |   |   |
| Zone 1 (Extended local)                              |   | 27.6                            |   | 25.4 |   | 27.2 |   | 28.4 |   |
| Zone 2 (Budapest metropolitan area)                  |   | 45.6                            |   | 48.8 |   | 48.4 |   | 57.2 |   |
| Zone 3 (Long distance)                               |   | 87.0                            |   | 75.8 |   | 75.4 |   | 75.2 |   |

 

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(1)       Reflects listed tariffs. From timeto time, the Company may offer promotions and discounts from these listedtariffs.

(2)       Includes a call set-up charge (HUF6.0 in 2000, HUF 3.8 in 2001, HUF 3.4 in 2002 and HUF 3.2 in 2003).

 

Matáv’sone-time entrance fee and monthly subscription charge are different forresidential and business customers. The Company does not charge its businessand residential customers different traffic tariffs. Matáv charges the sametariffs for voice traffic on fixed telephone lines and on ISDN lines. In 1999,the Company’s tariffs for data traffic on ISDN lines were 25 percent higherthan for voice traffic. Matáv decreased this data surcharge to 10 percent onJanuary 1, 2000 and eliminated it on January 1, 2001.

 

The pricesabove reflect the tariffs for Matáv’s Bázis package. In 2002, Matáv increasedthe number of price packages to allow customers in different market segments tochoose packages that suit their calling patterns the most. These packages alsoserved as a tool to protect Matáv’s customer base in the fully liberalizedmarket as those customers receive the highest discounts who select Matáv as theoperator for every traffic direction (local, long distance and international).

 

The mostimportant tariff packages are the following:

 

# ***Minimál tariff package***.  This packageis targeted for residential customers with analog lines who use their phonesless often but want to be available for incoming calls and would like to paylower monthly fees. Customers using this package pay a significantly discountedmonthly subscription fee and are allowed a 66.7 percent discount on call set-upfees and call charges to fixed line numbers. The discount shall not exceed HUF

# *** ***

25

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# ***500 per month, above which customers have to pay three timesthe Bázis package rates. At the same time, the customers using the Minimáltariff package have the option to select a favorite friend or relative’s fixedline number in Hungary to call at a low, Basic rate throughout the whole month.By the end of 2002, over 550,000 customers chose this package.***

 

*Csevegő tariff package*.  On December 27, 2001, Matáv launched thefirst tariff package for residential customers enabling higher savings the morethe customers talk. The discount is 20 percent from the 5th minuteand 30 percent from the 10th minute up to the 60th minuteof the call. The discount is valid for all calls all day. In 2002, it was thesecond most popular tariff package with over 320,000 customers at December 31,2002.

 

*Control tariff package*.  Matáv’s first tariff package involvingneither monthly subscription nor call set-up fees for residential customerswith analog lines is the Control tariff package. Subscribers may chose a 60-daycard for HUF 8,400, a 90-day card for HUF 12,000, or a 180-day card for HUF22,000. The card can be refilled during its period of validity or within 10days after expiry. This package is similar to the mobile pre-paid offers.

 

*Sokatmondó tariff package*.  Matáv launched this tariff package onOctober 1, 2002. Signing a definite-period pre-selection contract is a preconditionfor this offer. The elements of the package:

 

•                  Peak period lasts until3 p.m. in Matáv, i.e. non-Local Telecommunications Operator (“LTO”) or mobiledirections;

 

•                  30 SMSs free of chargeper month (in Matáv and Westel directions);

 

•                  60 minutes freeInternet access (in cooperation with Axelero); and

 

•                  Sokatmondó Digifonpackage (with caller identification function).

 

Thesubscribers of the Sokatmondó tariff package can order the Sokatmondó callingcard, by which calls can be originated at the per minute rates of the packagefrom Matáv’s area and from abroad.

 

*Ritmus tariff package*.  Matáv offers the Ritmustariff package for residential and business customers making calls mainly inpeak hours. The package is available for customers with analog or ISDN lines.Signing a definite-period pre-selection contract is a precondition for thisoffer. By subscribing to this package the customers receive discounted perminute rates. Members of the Ritmus tariff package family:

 

•                  Ritmus100 package;

 

•                  Ritmus200 package;

 

•                  Ritmus Calling Card,which is available with any of the Ritmus packages free of charge and can beused to enjoy the rates of the Ritmus package from any Matáv telephone inHungary; and

 

•                  Ritmus+ InternationalModule to further reduce the preferential international per minute charges ofthe Ritmus package.

 

*Tariff Rebalancing. *Historically,Matáv, like government-owned operators in other countries, maintainedrelatively low subscription charges and relatively high tariffs for domesticlong distance and international calls. Since 1995, the Company has beengradually rebalancing its tariffs within the constraints of the price capregime to more closely reflect the underlying costs of services. See “—Regulation and Pricing.” The Company has accelerated its drive towards tariffrebalancing in 2001 and 2002 to stimulate usage and to prepare for futurecompetition. The monthly subscription fee increased in 2001 and 2002significantly over the prior year’s fee. In contrast, usage charges decreasedon average in both 2001 and 2002.

 

26

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# ***Public Telephones***

 

As of December 31, 2002, Matáv Rt. operated 33,316 public pay phones,representing a penetration rate of approximately 4.4 per 1,000 inhabitants inMatáv Rt.’s concession areas. Approximately 47 percent of these telephones werecard operated. The traffic tariffs charged for calls from public pay phones areat a 60 percent premium to those charged to fixed line subscribers.

 

***International Telephone Services***

 

Internationaltelephone services consist of outgoing and incoming international telephonytraffic, including voice, data and switched transit traffic through Hungary. In2002, outgoing international telephony traffic generated revenues of HUF 12,018million before intersegment eliminations, and incoming international telephonytraffic generated revenues of HUF 15,256 million before intersegmenteliminations.

 

*Products and Services*

 

Matáv provides international calling access to its fixed line telephonysubscribers and to subscribers of other local telephone operators and mobileservice providers. In 1992, Matáv introduced Hungary Direct and Country Directservices, which permit customers to charge calls made from 50 countries abroadto their home phone numbers. In 1998, this service was widened with a post-paidinternational calling-card.

 

International toll-free service was launched in 1998. This serviceenables the caller to make international calls free of charge to and from 36countries, while the call charges are covered by the subscriber of thetoll-free number.

 

The Company provides signaling links for mobile operators to facilitateinternational roaming. Matáv also sells international leased lines, includinginternational managed leased lines, and international ISDN, X.400, X.25, telexand telegraph services. The sales of international leased lines are steadilygrowing, partly due to the introduction of one-stop-shopping agreements,whereby customers can order and pay for the service at only one end-point ofthe connection, therefore they need to be in contact with only one serviceprovider. International Internet connectivity was enhanced in 2000 in order toprovide services for Internet service providers.

 

In June2000, Matáv introduced the international pre-paid calling card, “Barangoló”,which enables customers to make phone calls, including IP based calls, in 40countries of the world. This service enables customers to call from touch-tonepayphones in Hungary and abroad until the card expires.

 

*Traffic*

 

Thefollowing table sets forth information regarding international telephonytraffic to and from Hungary, transited by Matáv Rt., including other LTOs’ andmobile service providers’ international traffic and transit traffic throughHungary. In addition to international traffic through fixed lines and mobileservice providers, the figures also include traffic based on IP technology, butdo not include traffic through international leased lines.

 

27

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|                                           |   | **Year ended December 31,**                                   |   |
|------------------------------------------------|--------|---------------------------------------------------------------|--------|
|                                           |   | **2000**                                                      |   | **2001** |   | **2002** |   |
|                                           |   | **(millions of minutes, except for percentages and  ratios)** |   |
| Outgoing traffic:                              |   |                                                          |   |   |   |   |   |   |   |   |   |   |   |
| Germany and Austria                            |   | 125.1                                                         |   | 36.9 | % | 114.9 |   | 35.9 | % | 94.5 |   | 33.4 | % |
| Neighboring countries other than Austria       |   | 58.3                                                          |   | 17.2 | % | 56.6 |   | 17.7 | % | 52.2 |   | 18.4 | % |
| United States                                  |   | 14.1                                                          |   | 4.2 | % | 14.8 |   | 4.6 | % | 11.1 |   | 3.9 | % |
| United Kingdom                                 |   | 17.8                                                          |   | 5.3 | % | 16.5 |   | 5.2 | % | 16.0 |   | 5.6 | % |
| Italy                                          |   | 19.2                                                          |   | 5.7 | % | 19.4 |   | 6.0 | % | 16.6 |   | 5.9 | % |
| All other countries                            |   | 104.2                                                         |   | 30.8 | % | 97.9 |   | 30.6 | % | 92.7 |   | 32.8 | % |
| Total outgoing traffic                         |   | 338.7                                                         |   | 100.0 | % | 320.1 |   | 100.0 | % | 283.1 |   | 100.0 | % |
| Growth in total outgoing traffic (% per annum) |   | —                                                        |   | 4.4 | % |   |   | (5.5 | )% |   |   | (11.6 | )% |
|                                           |   |                                                          |   |   |   |   |   |   |   |   |   |   |   |
| Incoming traffic:                              |   |                                                          |   |   |   |   |   |   |   |   |   |   |   |
| Germany and Austria                            |   | 149.2                                                         |   | 31.4 | % | 115.5 |   | 28.5 | % | 117.4 |   | 31.8 | % |
| Neighboring countries other than Austria       |   | 43.7                                                          |   | 9.2 | % | 45.4 |   | 11.2 | % | 41.7 |   | 11.2 | % |
| United States                                  |   | 55.8                                                          |   | 11.8 | % | 65.5 |   | 16.2 | % | 43.5 |   | 11.8 | % |
| United Kingdom                                 |   | 74.4                                                          |   | 15.7 | % | 40.3 |   | 9.9 | % | 33.9 |   | 9.2 | % |
| Italy                                          |   | 19.0                                                          |   | 4.0 | % | 20.3 |   | 5.0 | % | 18.3 |   | 5.0 | % |
| All other countries                            |   | 132.3                                                         |   | 27.9 | % | 118.1 |   | 29.2 | % | 114.3 |   | 31.0 | % |
| Total incoming traffic                         |   | 474.4                                                         |   | 100.0 | % | 405.1 |   | 100.0 | % | 369.1 |   | 100.0 | % |
| Growth in total incoming traffic (% per annum) |   | —                                                        |   | 7.5 | % |   |   | (15.0 | )% |   |   | (8.9 | )% |
|                                           |   |                                                          |   |   |   |   |   |   |   |   |   |   |   |
| Ratio of incoming to outgoing traffic          |   | —                                                        |   | 1.4 |   |   |   | 1.3 |   |   |   | 1.3 |   |
| Transit traffic (millions of minutes)          |   | 80.7                                                          |   | — |   | 88.4 |   |   |   | 87.0 |   |   |   |

 

A substantial portion of international traffic in terms of minutesconsists of calls to and from Germany, Austria, the United States, the UnitedKingdom and Italy, which, in the aggregate, accounted for approximately 48.8percent of the outgoing traffic and 57.8 percent of the incoming traffic in2002.

 

In 2000, growth in incoming traffic outpaced growth in outgoingtraffic. In 2001 incoming traffic decreased more than outgoing traffic, whilethis trend changed during 2002. In 2000, 2001 and 2002 the volume of incomingtraffic exceeds the volume of outgoing international traffic. The Companybelieves that outgoing traffic did not reach the volume of incoming trafficbecause customers are increasingly using leased lines and private branchexchange services such as call blocking.

 

Despite the increasing competition in the international transit market,Matáv carried a considerable amount of switched transit traffic between Westernand Central/Eastern Europe. In 2002, international transit traffic hasdecreased compared to the previous year’s figure. This decrease was due to theliberalization in the neighboring countries, which made it possible for newtelecommunications operators to handle some of Matáv’s previous transittraffic. Matáv’s international switched transit service has provided a realback-up gateway to reach this part of the continent.

 

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*Tariffs*

 

UntilDecember 1998, Matáv’s international traffic charges were based on afixed-price pulse. Commencing January 1, 1999, Matáv switched to time-basedbilling. The call charge for an international call, like that for a domesticcall, now contains two elements: a call set-up charge and a traffic chargemeasured in seconds based on the call’s duration.

 

*Tariff Rebalancing. *Since 1995,as part of the rebalancing of its tariffs*,*Matáv reduced its international tariffsfor outgoing calls, thus moving towards rates that foreign telecommunicationsservice providers charge for calls to Hungary and taking into account therelated international accounting rates. International tariffs introduced in2002 have decreased on average compared to 2001. On September 1, 2002 Matávintroduced eleven international tariff zones instead of the former six zones tobe able to better differentiate the rates of the international fixed line andmobile calls. As part of its ongoing tariff rebalancing, the Company expects tocontinue to lower its international tariffs to stimulate usage.

 

*Settlement Arrangements.* Under bilateral settlementarrangements, Matáv pays other carriers for the use of their networks foroutgoing international calls and receives payments from other carriers for theuse of its network for incoming international calls. In Europe, such settlementarrangements fall under the general auspices of the InternationalTelecommunication Union. Settlement payments, which are generally denominatedin Special Drawing Rights (“SDR”), are calculated using a currency basket inwhich U.S. dollars have the greatest weight. Matáv is prepared to use anyforeign currency in its international settlement system, so SDR can be replacedby Euro or any other currency in international accounting rate negotiations.

 

*InternationalTelecommunications Hub*

 

Matáv believes that Hungary is well located to serve as atelecommunications gateway between Eastern and Western Europe. Matáv has twostate-of-the-art international gateways as well as fiber optic cableconnections serving 12 border crossings. These fiber optic cable connectionsuse synchronous digital hierarchy transmission facilities. The Company has X.25links, which are used for packet switched data transmission with 83international networks. It also has ISDN connections with 49 internationalnetworks. In order to increase the utilization of its transmission network,Matáv offers advantageous tariff packages for dedicated transit services via Hungary.Matáv has launched its own Dense Wavelength-Division Multiplexing (“DWDM”)backbone network and is DT’s partner in Delivery of Advanced Network Technologyto Europe (“DANTE”), which provides 2.5 Gb/s transmission paths forinterconnecting Budapest and Zagreb into the European research and educationalnetwork, GEANT. Matáv has established its own point of presence in Austria,which enables the Company to engage in telephone and Internet business withalternate telecommunications carriers located in Vienna. Matáv is present atthe Vienna Internet Exchange and has peering arrangements (dedicated circuitfor Internet data exchange) with approximately 49 ISPs there. Matáv has adirect Internet peering connection with Ukraine and Slovakia and provides high-capacityinternational Internet transit service to ISPs in Moldova and Macedonia.

 

***Leased Lines***

 

Revenues from leased lines totaled HUF 20,377 million in 2002, HUF18,010 million in 2001 and HUF 16,453 million in 2000, in each case beforeintersegment eliminations. Matáv is the principal provider of leased lines inHungary.

 

Leasedline service establishes a permanent connection for the transmission of voiceand data traffic between two geographically separate points (point to pointconnection) or between a point and several other points (point to multipointconnection). These points can be either all within Hungary or partly in Hungaryand partly abroad.

 

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TheCompany leases lines to other local telephone operators and mobile serviceproviders, who use such lines as part of their networks. It also leases linesto providers of data services. In addition, the Company leases lines tomulti-site business customers who use leased lines to transmit voice and data trafficamong their respective sites.

 

TheCompany offers a broad variety of standard analog and digital lines for lease,including two-wire and four-wire analog lines and digital lines with capacitiesfrom 4.8 Kb/s to 2.0 Mb/s. Matáv also offers high capacity customized digitallines to other telecommunications providers.

 

*Flex-Com. *Since 1996,Matáv has offered Flex-Com, domestic and international digital leased lineswith managed back-up systems that are dedicated to transmitting data. In 1998,the Company launched the Flex-Com Network Management Service (Virtual SwitchedNetwork) network management system and ISDN-Flex and Voice-Flex services. In1999, higher quality (Gold and Silver), secure access, and quick installation(Express, Profi) Flex-Com services were introduced. The Gold and the Silverquality services increase the annual availability to 99.9 percent and 99.7percent respectively, as compared to the 99.5 percent annual availability ofthe Flex-Com basic service. The secure access provides two way subscriberaccess through separate routes or transmission media at one termination pointof the connection. The quick installation services are connected within tendays (Express) or within five days (Profi) as compared to the normalprovisioning time (20 days). In 2000, Matáv launched two new services. Flex-Comhigh-speed (E3) access service provides 34Mb/s central access for the main siteof a large enterprise network. City-Voice service is a version of theVoice-Flex service, which offers hot-line voice and fax communicationcapabilities on the managed leased line network between two customer premises.

 

Matávfurther widened the range of access options to the service in 2002. Itdeveloped and launched the outdoor Flex-Com subscriber access and the KiloflexP type subscriber access. The outdoor access provides an opportunity for theoutdoor installation of terminating equipment of lines with maximum 1984 Kb/s,focusing on the demands of mobile service providers. Kiloflex P provides acheaper access in the speed range from 192 Kb/s to one Mb/s than the previoussubscriber access, for example for IP purposes.

 

In 2002,Matáv launched the Service Level Agreement (“SLA”) report service of Flex-Comand Frame-Flex, which provides an opportunity to issue the monthly and annualprinted report of the SLA parameters specified in the customer contracts. TheSLA report, as an additional service, shows our customers the monthly andannual fulfillment of the commitments identified in the SLA. The reports aregenerated automatically in order to regularly monitor and check the actualservice quality.

 

Matávincreased the number of its Flex-Com connections from 7,007 at December 31,1999 to 12,716 lines at December 31, 2002.

 

*Frame-Flex. *Matáv alsouses its managed leased line network to offer Frame-Flex, a public frame relayservice that is particularly suited to customers who transmit data in bursts,such as connections between local area networks. At December 31, 2002, Matávhad 1,060 Frame-Flex connections. In 2000, Matáv introduced LANConnect, a framerelay based managed router service. LANConnect is primarily targeted at smalland medium size enterprises allowing them to seamlessly interconnect theirLocal Area Networks (“LANs”).

 

*HighSpeed Leased Line (“HSLL”)*.  TheHSLL service provides permanent, digital, transparent, point-to-point leasedline service between service access points (“SAPs”) which meet the ETSI OpenNetwork Provision (“ONP”) specifications. The connections are established bythe service provider according to the needs of its customers. Transmissionrates provided by the HSLL service are 2, 34 and 140 Mbit/s. In 2001, Matávenlarged its HSLL services portfolio by offering new speed elements at 45 and155 Mbit/s. Matáv increased its HSLL connections to 432 by December 31, 2002.

 

TheCompany’s leased line customers pay a one-time connection fee based on the typeof line leased. Monthly subscription charges vary with the type and length ofline leased and, in some cases, with the term of the lease. With the exceptionof leased lines required for connection with other networks, leased linetariffs are not subject to regulation. As part of the overall rebalancing ofits tariffs, Matáv has reduced its leased line tariffs in real terms

 

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over the last fewyears in response to competition, which partly offset the revenue increasegenerated by volume increases of the leased line services.

 

***Data Transmission and Related Services***

 

Revenuesfrom data transmission and related services amounted to HUF 17,597 million in2002, HUF 15,184 million in 2001 and HUF 11,241 million in 2000, in each casebefore intersegment eliminations. Data transmission and related servicesconsist primarily of data transmission and network services for businesscustomers, such as financial institutions and insurance companies, and, to alesser extent, residential customers. The market for data transmission andrelated services in Hungary is highly competitive. The Company is the leadingsupplier of data transmission and related services in Hungary.

 

Matáv’s revenues from data transmission have grown significantly as aresult of both the development of the Hungarian economy and the Company’sincreasingly sophisticated services. Matáv expects the market for theseservices to grow with the proliferation of personal computers and increasingconsumer demand. Matáv believes that the ability to offer new data products andservices will be critical to competing effectively in the future, particularly withrespect to business customers.

 

*Internet.* Since the introduction of theCompany’s Internet service in the spring of 1997, the number of subscribers hasgrown rapidly. By December 31, 2002, Axelero (formerly known as Matávnet),Matáv’s fully owned ISP subsidiary had approximately 150,000 customers comparedto 51,315 at December 31, 1999. Axelero is the largest Internet serviceprovider in Hungary with an estimated 43 percent market share based on thenumber of dial up subscribers and continues to strengthen its position as amarket leader in Internet services, from access to e-commerce. Within the salesof the dial-up access products the ratio of the prepaid type netQuick packagehas increased significantly and reached 16 percent of the total number of dial-upcustomers by the end of 2002. This product can be recharged via the Internet.Axelero offers Internet services based on ADSL technology as well as accessthrough cable television, to provide residential and business customers withbroadband, fast Internet service at affordable prices. The number of broadband(ADSL and cable television) customers has grown dynamically and reached 20,913at December 31, 2002 compared to 4,291 a year earlier.

 

Forbusiness users, Axelero offers Internet access through leased line and ADSLconnections as well as web based Electronic Data Interchange (“webEDI”) andhosting and collocation services in its Internet Data Center. In addition tothe success of the ADSL packages, the revenues from collocation services andvalue added e-business services (webEDI, consulting) increased significantly.

 

The growthof Axelero was greatly fostered by [origo], the most frequently visited portalsite in Hungary with an average of approximately 700,000 sessions per day inthe last quarter of 2002, including Vizsla, one of the most well known searchengines in the Hungarian language. Axelero also operates Freemail, the mostpopular free e-mail service in Hungary with over 1.1 million registeredmailboxes at the end of 2002.

 

Axelerohas four subsidiaries, including Fokuszonline Rt., which operates an onlinebookstore and Marketline Rt., which operates an electronic market betweencompanies. In August 2002, the quality management systems of Axelero Internetwas assessed and registered as meeting the requirements of ISO 9001-2000 bySGS.

 

To helpstimulate demand and promote wider Internet usage, Matáv offered discountedlocal call packages that charged a flat fee per local call during certain hoursof the day. In 2002, these packages were terminated and replaced by two newflat rate Internet packages. These schemes were developed in cooperation withthe government in order to contribute to the development of the Internetcommunity and to stimulate usage.

 

*Datex-P. *Matáv offersDatex-P, a packet-switched data transmission service based on the X.25protocol. At December 31, 2002, Matáv had 3,268 Datex-P terminals. The serviceprovides low to medium speed domestic switched data communication services withinternational connectivity to business customers.

 

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*rEDInet. *The Companyalso offers rEDInet, an electronic data interchange service. This servicefacilitates private exchanges of internationally standardized electronicdocuments.

 

*Security Services. *On July 5,1998, Matáv established Matávőr Kft., a wholly owned subsidiary, toprovide security-monitoring services. On June 15, 2001, Matáv and Group 4Securitas Kft. established Group 4 Matávőr Rt. The operations andcustomers of Matávőr Kft. were taken over by the newly establishedassociated company. As of December 31, 2002 Group 4 Matávőr Rt. had 10,619customers.

 

*Matáv ADSL. *ADSL is an**AsynchronousTransfer Mode (“ATM”) and ADSL technology based broadband access productdeveloped for continuous, high speed Internet connection. The service bundlescost efficient broadband Internet access with telephony service over existingcopper wires. Matáv sells these services mainly on a wholesale basis to ISPs,which in turn distribute the services to residential and small businesscustomers. The service has been available in certain parts of Budapest sinceSeptember 1, 2000, and its coverage is rapidly expanding. In 2002, the numberof service areas increased to 49 cities from 12 cities a year earlier. In 2002,this service had significant growth with the number of ADSL connectionsreaching 33,951 by December 31, 2002 from 6,201 at December 31, 2001. InNovember 2002, Matáv introduced Digital Subscriber Line (“DSL”) Bridge, whichcombines ADSL and Lan-Flex, an ATM based broadband service. In December 2002,Matáv introduced ADSL Komplex, a new retail package combining ADSL and PublicSwitched Telephone Network (“PSTN”)/ISDN access, as well as a certain amount ofusage at favorable per minute rates.

 

*IP Connect. *In September2000, Matáv introduced IP Connect service.**This service is a complete solution forISPs providing transport and access facilities to IP traffic. It includes theprovision of ports in the service area, required for the subscribers of ISPs todial-in from analog or ISDN lines. The service also enables leased line access,and it ensures that traffic will be forwarded to both domestic andinternational switches as well as to the domestic switch of a particular ISP.The domestic switch of the ISP is connected to Matáv’s IP network via a leasedline.

 

*IP Complex*.  IP Complex is an IP basedVirtual Private Network (“IP-VPN”) service.**IP Complex service is offered to retailand wholesale customers having multiple remote sites. This service enables themto establish data traffic between sites without the need of setting up“point-to-point” connections between two sites. Customers’ VPNs are securedsince they remain separated from each other*.*The share of this product is relativelylow in the data service portfolio, but the growth rate of its revenues wasremarkable in 2002. Developments of supplementary services, such as ISDNbackup, integrated voice, data and ISDN access to IP-VPNs make this productmore attractive to a growing number of business customers.

 

*MultiLAN. *Matáv’ssystem integration services are primarily targeted at business customers withseparately located branch offices. It includes the installation of LANs atcustomer premises and the provisioning of Wide Area Network (“WAN”) services.Matáv provides integrated network management, fault clearance and customersupport for the LAN and WAN segments.

 

*CityNet.*  Matáv introduced CityNet, aGigabit Ethernet technology based innovative high speed service in October2002. This service provides Gigabit speed connectivity for large businesses.

 

***Fixed Line Telecommunications Equipment Sales***

 

Matávdistributes an extensive range of telecommunications equipment, from individualtelephone sets to facsimile terminals, PBXs and complete network systems,through a network of customer service centers. Cardnet Rt., in which Matávacquired a majority interest in the second half of 1998, sells point of saleterminals. Matávcom Kft., Matáv’s fully owned subsidiary, sells PBX equipment.Sales of fixed line telecommunications equipment generated revenues of HUF3,671 million in 2002, HUF 3,582 million in 2001 and HUF 4,810 million in 2000,in each case before intersegment eliminations. Matáv does not manufacturetelecommunications equipment but rather resells and leases equipmentmanufactured by other companies.

 

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Thetelecommunications equipment sector is highly competitive and characterized byrapid technological innovation and intense competition. Matáv believes that thesupply and service of telecommunications equipment are integral parts of beinga full service telecommunications provider and are necessary for the expansionof its customer base. In addition, these activities permit Matáv to ensure thattechnologically advanced equipment required for new services is available inthe Hungarian market.

 

***Other Revenues***

 

Otherrevenues include cable television revenues, construction and maintenanceservices and miscellaneous other revenues, such as subsidies receivable fromthe Universal Telecommunication Support Fund. Other revenues generated HUF28,866 million in 2002, HUF 18,986 million in 2001 and HUF 14,556 million in2000, in each case before intersegment eliminations.

 

Matáv’scable television (“CATV”) group has several companies providing cabletelevision services in Hungary. The ownership structure of the variouscompanies is determined by regulatory requirements. On July 1, 1998, Matávestablished MatávkábelTV Kft. (“MatávkábelTV”), which began providing cabletelevision services on January 1, 1999. In 2000, MatávkábelTV became asubsidiary of InvesTel Rt., a subsidiary of Matáv, which became the CATV assetmanagement holding entity of Matáv. Through network development andacquisitions, Matáv’s CATV group significantly increased its number of cabletelevision customers during the past three years, and it strengthened itssecond position in the market despite the increasing competition. The Companyhad approximately 340,000 subscribers as of December 31, 2002, compared toabout 124,000 at December 31, 1999. MatávkábelTV offers 41 television channelsand three program packages in its network. The cable television market inHungary is characterized by strong price competition, especially in Budapest,where cable operators often connect new customers without entrance fees. Incooperation with ISPs, Matáv’s CATV firms offer Internet services through thecable television network. CATV firms provide bi-directional network capacities,while the ISPs provide the Internet service. The number of Internet subscribersthrough the cable television network exceeded 4,000 at December 31, 2002. TheCompany’s cable television activities benefit from Matáv’s long termrelationship with the customers, its thorough market knowledge as well as itsstrong brand name. The main goals in this area are to increase market sharethrough further acquisitions, further connections in the already acquiredareas, network improvement and to increase ARPU.

 

In 2002,Matáv introduced the Audiofix (Drop Charge) product, which is an IntelligentNetwork (“IN”) premium rate service enabling content providers to offer contentservices for fixed call rates. The product is mainly used in the media’scall-in programs. The product was especially successful in 2002 due to theintroduction of reality shows and other interactive programs on the Hungariantelevision channels.

 

Matávconstructs fixed telecommunications networks and offers network maintenanceservices to other telecommunications operators in Hungary. These constructionand maintenance services are ancillary to the construction and maintenance ofMatáv’s networks.

 

Matávcarries out its construction through subcontractors. The majority ofconstruction revenue is derived from optical network construction, networkconstruction related to subscriber connections and project planning. Inaddition, Matáv’s fully owned subsidiary, Matávcom Kft. is also engaged incomplete network construction activities.

 

Matáv ownsa 25 percent interest in Magyar RTL Televízió Rt. (“MRTL”), a nationalterrestrial television broadcaster entitled to provide commercial televisionprograms but not to engage in broadcast diffusion or distribution activities.CLT-UFA S.A. owns 49 percent, Pearson Netherlands B.V. owns 20 percent andRaiffeisen Group owns six percent of MRTL. MRTL has a concession for a periodof ten years with an option for a five-year extension. The Program ProvisionAgreement was signed on July 9, 1997, the starting date of the license. MRTLoperates a channel under brand name RTL KLUB.

 

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Since itslaunch in 1997, RTL KLUB has rapidly established a strong position in Hungary’stelevision market. Market share among the targeted age 18-49 audience rosesubstantially from 1997 to 2002, from 21 percent to 35 percent considering thewhole day and from 20 percent to 42 percent during prime-time (between 7 and 11p.m.). The television advertising market in Hungary recorded 4.3 percent growthin 2002 despite international trends. At the same time, RTL KLUB’s advertisingmarket share further increased to approximately 57 percent by the end of 2002based on RTL KLUB’s estimates. RTL KLUB seeks to maintain and increase audienceshare through investing in local productions, including successfulinternationally licensed programs, and through its continued long termrelationships with major film distributors, including Warner Brothers, Fox,Buena Vista and Universal. Furthermore, MRTL won the right to broadcast FormulaOne races for five years commencing in 2002. In reaction to the maincompetitor’s launching of Big Brother, MRTL started its own reality show: ValóVilág (Real World), which enabled MRTL to maintain its leading position andgenerated increased non-spot (prime-rate audiotex and SMS) revenues.

 

In 2000,RTL KLUB became profitable for the first time on an annual basis. In 2001 and2002, operating profitability was further increased.

 

### ***Mobile Telecommunications Services Segment***

 

Matáv’smobile telecommunications services generated revenues of HUF 232,612 million in2002, HUF 198,947 million in 2001 and HUF 159,345 million in 2000, in each casebefore intersegment eliminations. Matáv provides mobile telecommunicationsservices through two subsidiaries, Westel and Westel 0660, each of which is 100percent owned by Matáv.

 

Westelprovides digital services and Westel 0660 provides analog services. At December31, 2002, Westel and Westel 0660 together accounted for an estimated 49.8percent of the total Hungarian mobile telephony market in terms of subscribers.The aggregate penetration rate of digital and analog mobile telephone servicesin Hungary increased from 16.2 percent at December 31, 1999 to 67.8 percent atDecember 31, 2002.

 

Each ofthe Westel companies operates on a stand-alone basis as required by itsconcession. The companies cooperate with each other in certain areas andprovide each other with certain services on an arm’s length basis.

 

In 2001,the Wireless Competence Center project was launched to exploit the synergiesbetween Matáv Rt., Westel and Westel 0660. As a result, operation andmaintenance of all Matáv owned radio equipment as well as the staff employed inconnection with these services has been transferred to Westel. In addition,Westel 0660 transferred all its operations, for which Westel was in a betterposition to deliver the services under more attractive conditions and wherethere was no legal obligation to retain the activity by Westel 0660, to Westel.

 

***Westel***

 

Westelcommenced offering commercial Global System for Mobile Telecommunications(“GSM”) digital mobile telecommunications services on March 31, 1994, pursuantto a concession awarded in November 1993. GSM affords high quality digitaltransmission and is the dominant digital mobile telecommunications standard inEurope. During 2000, Westel was rebranded as a service provider on both 900 and1800 MHz bands. Westel offers basic GSM voice telephony services and a numberof value added services, such as voice mail, call forwarding, SMS, call waiting,conference call, caller identification (“ID”), company call and dual SubscriberIdentity Module (“SIM”) card. GPRS, which is also known as “2.5G” wasintroduced in 2001 for Westel’s postpaid customer. Westel also providesGSM-based data and facsimile transmission services as well as SimToolKitapplications, mobile Internet services and a number of content services. Westeloffers several different service packages designed for different customerrequirements, including various traffic packages targeted at low volumeresidential customers and higher volume business and governmental customers. In2002, new value added services were introduced, including MMS, Video Streaming,Video Messaging, Mobilbank and mobile purchase.

 

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Theprepaid card of Westel, Domino, provided 95.7 percent of net customer additionsin 2002. Since the introduction of the SMS for prepaid customers in 1999,Westel has made more value added services available to prepaid customers, suchas caller ID, Domino data and fax. Prepaid users witnessed a significantincrease in content provision in 2002, as a result of which they are able touse digital services (such as oplogo, ringtone, etc.) and acquire informationon weather, traffic, news, economy, sport, gambling, et cetera via premium-rateSMS or WAP. SimToolKit applications also became available for prepaidcustomers, and electronic recharge opportunities are available at AutomatedTeller Machines (“ATMs”), petrol stations, via Internet-banks, Telebanks andMobilbank. Similar to 2001, prepaid customers (especially young people andsecurity users) induced the majority of Westel’s growth in 2002.

 

Afterintroducing GPRS in 2002, Westel continued enhancing its value-added servicesand introduced more new products in 2002:

 

•                  DOMINO customers wereable to use their subscription in 52 countries using 105 operators’ networks asof December 31, 2002 without any limitation. They are able to initiate andreceive calls and to send and receive SMSs.

 

•                  Content provision wasone of the services that went through a major development: WAP, infoSMS, andpremium-rate SMS are the major supporting pillars of content-provision. WAP isused by hundreds of thousands of Westel customers regularly, and nearly everysecond Westel customer tried WAP at least once. The number of infoSMSsubscriptions continuously increased during 2002 and reached 400,000subscriptions by the end of the year. Users can register to several infoSMScategories like news, traffic, weather, entertainment, gambling-results andhoroscope. Westel users sent approximately two million premium rate SMSs permonth in 2002.

 

•                  In 2002, Westel was thefirst operator in the world to introduce fully commercial MMS-service for bothprepaid and postpaid users. Westel and Pannon GSM Rt. (“Pannon”) connectedtheir MMS-centers, enabling MMS-sending across their networks.

 

•                  In the spring of 2002,Westel elaborated the country-wide service of premium rate SMS. Both Westel andits competitor, Pannon users are able to acquire information by sending SMS toone dedicated number. This agreement between the two mobile operators ofHungary enabled the involvement of third parties to a great extent, which meansmore convenience and larger scope of available content for customers.

 

•                  In the summer of 2002,the e-commerce site of Westel, Webshop was renewed. Webshop is a virtual pointof sale with all the possibilities of a regular shop. Webshop offers quick andconvenient services, and it is integrated with Westel’s other services. Webshopis also beneficial in the field of customer-management as users can be retainedin a better and more efficient way, and potential customers can be recruited atthe same time.

 

•                  Since early autumn2002, Westel subscribers are able to use location based services, i.e. they canfind the nearest petrol station, ATM, pharmacy, Westel outlet, et cetera bysending an SMS or selecting this service on WAP. This service is dynamicallydeveloping as the range of available services extends.

 

•                  In October 2002, Westelintroduced a unique Mobilbank solution. Having registered both at OTP (thelargest Hungarian commercial bank) and at Westel, customers are able toinitiate active bank transactions by secure SMS (using their SimToolkit menu).The technology is fully secure as it electronically signs the SMS and encodesit and the bank decodes and validates the SMS before fulfilling the request.Using this service, customers can also top-up their own or other prepaid(DOMINO) accounts without any additional fee.

 

•                  In November 2002,Westel was the first in Hungary to introduce video streaming and videomessaging. By using specific handsets, Westel customers are able to recordshort movies and send them to other Westel 

 

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customers.In addition, they are able to download various short movies form Westel’sWAP-site.

 

•                  Also in November 2002,Westel was the first in Hungary, and one of the first operators in Europe, tointroduce mobile purchasing via WAP. Westel subscribers (both pre- andpostpaid) are able to make purchases using their own mobile phone by justentering a code. The first products to be bought via WAP are oplogos andringtones, however, other products and services are to follow.

 

•                  Late autumn in 2002,Westel introduced a Wireless LAN (“WLAN”) pilot. Customers equipped with anappropriate device in their computer are able to access Intranet and Internetvia high-speed (up to 11 Mbit/sec) wireless connection. The target group ismainly the key and corporate customers.

 

Westelencourages customer loyalty with various programs. Gold Cards are awarded tocustomers based on length of service, and bonus points are awarded to thesecardholders based on level of usage. These points can be accumulated and thenredeemed for various products and services in retail stores, via the Internetor through call centers. The price of the selected products and services can bepaid by combining HUF and points. During 2002 Westel introduced a new GoldPartner Card offer. Gold Partner Cards can be purchased as additionalsubscriptions with an especially low monthly fee. From 2002, the amount of theGold Partner Card monthly fee can be used as airtime or as SMS. Gold PartnerCards also collect points to the main Gold Card.

 

Thebuild-out of Westel’s mobile network has been substantially completed. Itprovides nationwide coverage and is being developed to cope with the trafficdemand of new, innovative services.

 

Westel’sprincipal objectives are to maintain market leadership in the rapidly growingmobile telecommunications market, expand its brand recognition and focus onproviding high quality customer service.

 

*Subscribers.* The number of Westelsubscribers has grown significantly over the past three years. The table belowsets forth information concerning the number of Westel subscribers at the datesindicated:

 
|                             |   | **At December 31,** |   |
|----------------------------------|--------|---------------------|--------|
|                             |   | **2000**            |   | **2001** |   | **2002** |   |
|                             |   |                |   |   |   |   |   |
| Regular subscribers              |   | 760,575             |   | 811,864 |   | 850,615 |   |
| Prepaid subscribers              |   | 838,511             |   | 1,681,621 |   | 2,552,173 |   |
| Total subscribers                |   | 1,599,086           |   | 2,493,485 |   | 3,402,788 |   |
| Annual growth in subscribers (%) |   | 89.9                |   | 55.9 |   | 36.5 |   |

 

The rapidincrease in the number of Westel subscribers since December 31, 2000 isattributable to a number of factors, including reductions in handset prices andtraffic tariffs in real terms. Growth also can be attributed to installmentpurchase plans and aggressive marketing. In addition, the introduction of morevalue added services that are aimed to enhance customer satisfaction increasedthe retention of the customers.

 

Accordingto Telecommunications Inspectorate sources, as of December 31, 2002, Westelheld approximately 49.6 percent of the Hungarian market for GSM mobile digitalservices in terms of subscriber base. The Company expects to initiateadditional marketing campaigns to stimulate further subscriber growth and tomaintain its market leadership.

 

*Traffic.* Westel’s average traffic persubscriber remains relatively high in Europe at 118 minutes per month in 2002.Traffic per subscriber has declined over the past few years as the subscriberbase has expanded to include lower volume users. During 2002, SMS-trafficwitnessed a large increase: 586 million SMS were sent by Westel users during2002 compared to 436 million in 2001. This amounts to 17 SMS/month/subscriberin 2002.

 

*Tariffs.* Since January 1998, mobilesubscriber tariffs have been deregulated, and carriers have had the freedom toset the level of the various tariff elements (i.e. connection fee, subscriptioncharge and traffic 

 

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charges). Westelcharges subscribers a one-time connection fee, monthly subscription charges,event charges and time based traffic charges. Customers using prepaid cards donot pay monthly subscription charges. Westel does not charge subscribers forincoming calls, other than calls received while roaming, although it receivespayments from other telecommunications service providers for terminating callson its network. Westel is very innovative in tariffing. In 2000, it introduceda new location dependent tariff plan boosting rural usage. The liberalizationof the fixed line telecommunications market in December 2001 is expected tohave an effect on the mobile telecommunications industry as well. It isexpected that government regulated fees and interconnection prices willsignificantly change and these changes will impact the operations of Westel.The extent and timing of these changes are not known yet, but they are notexpected to be retrospective to 2002.

 

*Distribution. *Westel has26 Building Value showrooms, 14 Economy Shops, a mobile showroom and ahigh-tech showroom in Hungary. Building Value showrooms engage in sales,customer service and repair service. Economy Shops primarily engage in sales,but they also provide some customer service and receive phones to be repaired.In 2000, Westel opened a new high-tech showroom called “Enternet” to popularizevalue added services and high-tech mobile handsets. Westel also broadened itssales channels by engaging independent sales representatives and began offeringfree home delivery service. The Major Account department with 71 employeesserves the needs of Westel’s major account customers on a segmented basis.Through a Sales Support department Westel operates a regular home delivery anda Webshop service for its Internet sales. In addition to distributing productsand services through its own sales network, Westel distributes products throughmaster dealers (FOTEX Group, Matáv) in 197 outlets on an agency basis, throughlarge Hungarian retail and distribution chains (Shell, MOL, OMV, TESCO, Auchan,Billa, Cora, METRO, Lapker) in 6,511 outlets and through 150 franchisepartners. In total, Westel’s products are available in almost 6,900 outlets.

 

***Westel 0660***

 

Westel0660 is the sole provider of analog mobile telecommunications services inHungary. Westel 0660 commenced operations in 1990 and was the only provider ofmobile services in Hungary until the commencement of GSM operations in 1994.

 

Westel0660 service is based on the Nordic Mobile Telephony (“NMT”) standard, whichpredates digital mobile telephony services, including GSM. The Westel 0660network covers over 95 percent of Hungary’s geographic area.

 

Westel0660 has been loss making due to the declining revenues combined withsignificant fixed costs. This trend is not expected to change; therefore Matávhas started investigating the possibility of closing the network in 2003. Thecurrent concession contract is valid until 2005, so negotiations with thegovernment have started to resolve this issue.

 

*Subscribers.* The table below sets forth thenumber of Westel 0660 subscribers at the dates indicated:

 
|                                       |   | **At December 31,** |   |
|--------------------------------------------|--------|---------------------|--------|
|                                       |   | **2000**            |   | **2001** |   | **2002** |   |
|                                       |   |                |   |   |   |   |   |
| Subscribers                                |   | 75,866              |   | 44,308 |   | 23,345 |   |
| Annual growth/(decline) in subscribers (%) |   | (22.4               | )      | (41.6 | ) | (47.3 | ) |

 

 

The number of Westel 0660 subscribers decreased from 2000 due to thelack of promotional programs and innovative service offers. Due to thedeclining demand for NMT handsets worldwide, the Westel 0660 is not able toacquire NMT handsets at a reasonable price. This fact limits the ability toretain and acquire customers, so the three GSM operators acquire the churningNMT customers with their attractive price packages and handset offers.

 

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*Tariffs. *Westel 0660charges its subscribers monthly subscription charges and traffic charges foroutgoing calls. Westel 0660 does not charge subscribers for incoming calls,although it receives payments from other telecommunications service providersfor terminating calls on its network. Westel 0660 offers a number of differentpackages of services designed for different customer requirements, including apackage for low volume users.

 

*Distribution.* Westel 0660 markets itsservices through its own salesforce and through Westel salespeople on an agencybasis.

 

**International Segment (MakTel)**

 

InDecember 2000, the Company, on behalf of a consortium, reached agreement withthe government of Macedonia to purchase 51 percent of MakTel on itsprivatization. The closing of the transaction took place on January 15, 2001whereby the Company paid EUR 343.3 million on behalf of the consortium inaccordance with the relevant agreement. The 51 percent ownership acquired by Matávwas contributed on January 16, 2001 to a newly established Macedonianacquisition vehicle, Stonebridge.

 

Inaccordance with a subscription and shareholders’ deed (“Deed”) between Matáv,SEEF Holdings Ltd. (“SEEF”) and CosmoTelco Added Value Services S.A.(“CosmoTelco”), the latter two acquired a 6.1 percent and a 7.4 percentownership respectively in Stonebridge reducing Matáv’s investment inStonebridge to EUR 301.5 million. Matáv, consequently, has an 86.5 percentstake in Stonebridge, which owns 51 percent of MakTel, thereby Matáv has aneffective ownership percent in MakTel of approximately 44 percent.

 

See “Item10 - Material contracts”.

 

MakTel hasbeen a consolidated subsidiary of the Group from January 15, 2001.

 

## ***Overview of MakTel’s revenues***

 

In 2002,approximately 47 percent of the total revenue of MakTel was derived fromdomestic fixed line telecommunications services. Mobile services contributedabout 33 percent, while international telecommunications services contributedabout 12 percent to total revenues. Various data services (telegraph, X.25,Frame Relay, leased lines, and Internet access) contributed only three percentof the total. Five percent of total revenues were derived from othermiscellaneous services.

 

In thesecond half of 2001, the mobile operation of MakTel, MobiMak was established asa separate 100 percent owned subsidiary of MakTel.

 

Therevenue stream of MakTel largely depends on international traffic (reflectingthe historically high international charges and low domestic tariffs). Theproportion of mobile revenue is increasing, while data revenue is stillinsignificant.

 

## ***Fixedline Telecommunications Operations of MakTel***

 

MakTel isthe sole fixed line service provider and the leading mobile service provider inMacedonia. Its exclusive rights in fixed line telecommunications services willexpire in December 2004. These exclusive rights include local, national andinternational long distance public voice services, voice over IP services,leased lines services and building and operating public voice network services.MakTel’s objectives for the next two years are to become established as aleader in technology and to provide excellent services with attractive pricesin order to prepare for the future competition.

 

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During thelast three years, MakTel’s major operational goals were to digitalize the fixednetwork and to increase the number of subscribers. The digitalization rateincreased from 82.1 percent at the end of 2000 to 96.3 percent at the end of2002. MakTel has 571,863 analog fixed lines and 22,350 ISDN channels as ofDecember 31, 2002, and fixed line penetration reached 28.0 percent inMacedonia.

 

MakTelintroduced several value added services, such as call waiting, conferencecalling, abbreviated dialing and automatic redial.

 

MakTelprovides Internet services through its Internet business unit, MTNet. MTNet hasa 49 percent market share in Macedonia. The number of Internet subscribers andthe time they spend on the world wide web is climbing rapidly. MTNet providesInternet access via the public switched telephone network and leased lines. Bythe end of 2002, MTNet had 34,222 Internet subscribers compared to 21,674 as ofDecember 31, 2001, which amounts to a 58 percent growth. MakTel also providesweb hosting, web design, web content-oriented IP applications and portalservices. MTNet has established an IP backbone network with points of presence(“PoPs”), allowing customers to access Internet services with a local callanywhere in the country.

 

MakTelalso has data transmission services, such as satellite communications,frame-relay, X.25 and audiotex services.

 

Historically,MakTel, like government-owned operators in other countries, maintainedrelatively low domestic charges and high tariffs for international calls. SinceNovember 1999, MakTel has been gradually rebalancing its tariffs in accordancewith its long-term rebalancing strategy. International tariffs are expected todecrease significantly by 2004, bringing them in line with EU standards priorto liberalization. Local tariffs and basic access charges are expected toincrease in order to reflect costs, but MakTel will not seek to exploit themaximum increases allowed by the regulation in order to keep the ratesaffordable to Macedonian citizens.

 

MakTel iscontinuously expanding and improving its access network. MakTel has a digitalfiber optic national long distance network that connects local primary areanetworks. The Company has implemented three Synchronous Digital Hierarchy(“SDH”) rings that serve both the national long distance and internationalnetworks. In addition to cost advantages, SDH systems provide a flexibletransmission infrastructure with automatic transmission paths. Additionalroutes of optical cable and SDH systems are being installed in the longdistance network and the city networks, increasing both network availabilityand transmission capacity.

 

MakTel hasinstalled a modern, packet optimised IP network based on Multi Protocol LabelSwitching (“MPLS”). The network is fully operational and already carriescommercial traffic. This network is the first of its kind in the entireSoutheastern European Region, establishing MakTel as an undisputed leader inthis field. It uses DPT STM-4 (packets on fiber technology) at its core andpacket over SDH STM-1 at the edges. It has nine large PoPs equipped withhigh-end routers and eleven small PoPs. The network provides a variety of VPNsolutions for its business customers, offering secure, scalable remote siteinterconnection over a shared IP backbone. The company realizes the enormousimportance of IP for its future and is considering this network to be the bestfoundation for its future generation of IP based services, combining voice anddata and offering versatile multimedia capability.

 

## ***MobileTelecommunications Operations of MakTel***

 

Mobiletelephony was a significant growth driver in 2001 at MakTel. MobiMak is thedigital cellular service provider of MakTel, which became a fully ownedsubsidiary of MakTel on June 4, 2001.

 

As one ofthe first important steps in its transformation, MobiMak introduced a new brandimage to the market. For this activity MobiMak hired the advertising agencyIndigo-Ogilvy. The new image is built on the slogan “connecting your worlds”(connecting past, present and future, connecting work and private life,

 

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connecting familyand friends, et cetera). With a strong campaign, MobiMak hopes the new imagewill be successful as a marketing tool.

 

MobiMak’soperations are based on GSM technology in the 900 MHz frequency band. Thenumber of mobile subscribers increased by 66 percent to 366,348 subscribers atthe end of 2002 from 221,336 at the end of 2001. The mobile penetration ratealso grew significantly, to 18 percent at the end of 2002 compared to 11percent a year earlier, but it is still well below the European average.MobiMak offers value-added services, such as call waiting, call forwarding,conference call, SMS, voice mail, international roaming and itemized bill.

 

MobiMakentered into a frame contract with the main network and infrastructure vendorswhereby MobiMak could fix the prices of different services and products. Thisframe contract resulted in significantly lower prices for MobiMak to use theservices of the main network and infrastructure. Based on the contract, MobiMakinitiated a fast network development project in September 2001. By the end of2002, MobiMak had 371 base-stations. As a result, MobiMak reached over 98percent of the population and 90 percent of the territorial coverage.

 

MobiMakput a high emphasis on marketing activities. It introduced new services (likeSMS service, Info Services) and new tariff packages (Day and Night - flat rateprepaid tariff package, Tandem – free of monthly fee postpaid partner cardtariff package). In addition, it also carried out a series of attractive salespromotions with good brand handsets based upon frame agreements with the mainhandset vendors. To focus on customer retention, MobiMak introduced a customerloyalty program with valuable benefits for loyal customers. To measure theeffectiveness of the marketing activity, MobiMak introduced a customersatisfaction measurement system, which monitors the satisfaction of thecustomers on a quarterly basis.

 

## ***Marketingand Distribution***

 

While theHungarian telecommunications market has been fully liberalized since December23, 2001, the liberalization process started years earlier in datacommunications, international voice and Internet services. The advent of newcompetitors was coupled with the mass proliferation of mobile devices, whichled to the saturation of the traditional voice business and strong competitionin the business communication arena. The high mobile penetration rate is due tothe fact that the mobile phone is viewed as a substitute, rather thancomplementary to fixed telephones because of the low disposable income level ofthe country.

 

Having thelargest market share makes Matáv vulnerable to losing the largest number ofcustomers, to other fixed-line operators, but in particular to mobileoperators. Similarly to other operators, Matáv realized that if it wanted toavoid a downward spiral of falling prices and decreasing market share, it hadto change its strategy and shift towards competitive tariff packages that areprice positioned not only against its fixed line competitors but also againstthe rapidly increasing mobile package offerings of the mobile vendors. Matáv’smarketing strategy is therefore based on four key objectives:

 

•                  Positioning againstmobile operators;

 

•                  Reducing churn;

 

•                  Boosting broadbandpenetration; and

 

•                  Leveragingopportunities in the Small and Medium Enterprises (“SME”) segment.

 

*Positioning against mobileoperators*. Until 2000 Matáv’s key objective was to fully build out the accessnetwork in order to eliminate the waiting list and to digitalize switching. Bystreamlining the operations, Matáv successfully prepared for the fullliberalization. The first year of liberalization ended with moderatecompetition from the fixed competitors due to the unfavorable internationalinvestor climate, leading the way for the mobile operators to aggressivelyacquire customers. In the fast moving mobile environment Matáv changed product 

 

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developmentobjectives in order to shorten cycle times. Launching several optional callingplans (“OCPs”), Matáv successfully transformed service development fromtechnology focused product innovation towards market based product enhancementthat requires less capital investment and more customer focus. Backed up byanalytical marketing tools, such as data mining, Matáv tailored its callingplans to the calling patterns of its various customer segments.

 

The mostsuccessful product of 2002 was Csevegő, a preselection package which givesdiscounts based on call length. Twice as many customers chose this calling planin 2002 as the government-subsidized Minimál package, Matáv’s Universal ServiceObligation product. Friday 13th, an enhancement of Csevegő offers 13 hoursof free local calls on Fridays in the off-peak period.

 

Althoughmobile penetration is almost double of the fixed penetration rate,approximately 75 percent of the mobile users have prepaid SIM cards. The lowlevel of postpaid users shows that customers do not wish to pay monthly fees.As further tariff rebalancing is not a viable option based on low perceivedvalue of the monthly fee Matáv also launched an enhancement of its prepaidpackage (Kontroll) with a lower reload fee. Kontroll can also be reloaded byATMs operated by OTP Bank, Hungary’s largest commercial bank.

 

Among themost innovative ideas are the calling cards available for both the residential(Sokatmondó) and business (Ritmus) preselection packages. Calling cards makethe reduced package tariffs “portable”: the user can make calls with thecalling card from any phone located in the Matáv area with the discountedtariffs while being billed regularly. Moreover, the “phone home” discount includedin the package provides a 30 percent discount for the subscribers to call theirhome phones.

 

Matávcompetes with mobile operators not only with its low-cost calling plans butalso with technology: a state-of-the-art development enabled Matáv to launchSMS capability on fixed lines. This service was launched in the autumn of 2002and by the end of the year more than 18,000 Matáv customers owned anSMS-capable fixed line telephone.

 

*Reduce churn.* PSTN churn is driven by a) customers’ requests, b) lines terminateddue to non-payment and c) ISDN service orders. As broadband access services(e.g. ADSL) have become available in recent years and customers become moreaware of its availability, migration to ISDN slowed down from levels observedin 2000. Customers are not aware enough of the ISDN service as a primary meansof Internet access, therefore Matáv introduced aggressive pricing of one timefees and ISDN CPEs in 2002 in order to increase ISDN penetration. Smallbusinesses are more churn-prone because of mobile bypass cards installed in thePBXs or by simple mobile substitution of fixed lines. As business ARPU issignificantly higher than residential ARPU, small business customer retentionis a primary goal of Matáv. As churn plateaued in 2001, Matáv faces thechallenge of an increasing amount of excess PSTN capacities. A key initiativeto utilize free capacities is supporting elderly homes, hospitals and campuseswith one-way phone lines free of charge. At the end of 2002, Matáv operatedalmost 20,000 of these lines. These phones function with special calling cardsif someone would like to initiate a call but the lines are available every timeto receive calls. Calling cards can be obtained at the premises that enablecustomers to control their phone costs e.g. while in hospital.

 

Anothersuccessful technique Matáv uses to manage churn is customer segmentation. Withanalytical marketing tools, Matáv analyses possible causes of churn anddevelops retention programs that help prevent line termination. Key accountcustomers are already segmented based on their Customer Lifetime Value that notonly defines customer profitability but also serves as a basis of service levela customer receives through Matáv’s dedicated account managers. CustomerRelationship Management (“CRM”) is a very powerful tool to understand customerbehavior and service usage patterns. Matáv rethought its CRM strategy in orderto avoid unsuccessful system implementation and to demonstrate true andmeasurable benefits of using such a system.

 

*Boost broadband penetration*. Matáv considers the promotion of Internet usage in Hungary as one ofits main tasks in the present and also in the near future. Most of the Internetsubscribers in Hungary today use PSTN or ISDN dial-up to access the Internet.Using government subsidies, the company developed its 15-hour and 40-hourflat-rate Internet packages Kezdőnet and Haladónet. Both enable customersto get acquainted with the

 

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Internet and useit regularly every day; however, these packages offer only a limited bandwidthand a metered service to the customers. To those who need unmetered (flat-rate)and high bandwidth service to be able to download video content or usestreaming media applications, Matáv offers ADSL access products that areavailable through its Internet subsidiary, Axelero, and through other ISPs. Forthose customers who have high voice telephony usage and are heavy Internetusers, Matáv introduced ADSL Komplex service in 2002 that includes free voiceminutes bundled with PSTN/ISDN access and ADSL. ADSL Komplex pricing enablestechnology upgrades (e.g. ADSL and ISDN together) at a much lower incrementalcost for the customer than the initial ADSL end-user investment.

 

*Leverage opportunities inthe SME segment*. In the key account segment,the focus is put on marketing integrated communication offerings that bundlevoice, Virtual Private Network (“VPN”) data and Internet coupled with systemintegration, while in the SME segment the focus is on lower Total Cost ofOwnership (“TCO”) solutions. Reducing Information Technology (“IT”) andtelecommunications costs is a major issue also in the Hungarian business sectoras increasing competitive pressure and slowing pace of economic growth threatensbusiness profitability. Nevertheless, lower TCO justifies lower qualityparameters that allow Matáv to offer solutions that require less expensivetechnology resulting in lower capex and higher return on investment. One ofthese services is called Business VPN Access, where expensive leased-lineaccess to IP-VPN is substituted with DSL technology. Although this solutionoffers lower network availability, it is still suitable for SME needs and has asignificant cost advantage. Another service supporting this strategic goal iscalled DSL Bridge that enables remote offices or remote workers to connect tohigh bandwidth Asynchronous Transfer Mode corporate backbone via DSL access. Inorder to reach the target segment, Matáv will also build up a direct sales channelserving the SME sector which is currently served only by an indirect channel,namely Value Added Resellers. Matáv is an active participant in across-industry cooperation focusing on providing relevant business informationto the SME sector. Through the Business and Success initiative founded byFigyelő, a Hungarian partner of Business Week, Matáv signed partnershipagreements with Citibank, Shell and Microsoft.

 

Productdevelopment

 

In thepast few years many promising technology developments proved to be immature orunsuccessful in the market. The forecasted Internet boom has not happened anddemand for Web services is still to come. One of these technologies Matávinvested heavily in is IP. Matáv has a state-of-the art nationwide IP networkbut revenues coming from IP services are relatively small compared to thetraditional data transmission products. Customers need reliable services andinvestors need stable return on investment. Matáv is well aware of that andtherefore changed its product development strategy. Instead of huge upfronttechnology investment without proven customer demand and uncertain Return onInvestment (“ROI”), Matáv’s product development focuses on serviceenhancements, including OCPs or scalable development such as ADSL. By doing so,Matáv’s activity is transforming from technology-focused development towardscompetition and customer driven service introduction requiring less capitalexpenditure and faster payback periods.

 

*New Voice Services.*  Matáv’s product portfolio iscontinuously adjusted and developed in response to customers’ needs. Matávoffers package solutions for all calling habits. Low-usage customers can choosethe Minimál package with a cheaper monthly fee or our pre-paid package,Kontroll. For those residential customers who usually make longer calls, ourCsevegő package gives progressive quantity discount on calling timeexceeding 5, 10 and 60 minutes. The Ritmus package-family is offered tobusiness customers with reasonable monthly usage and very competitive perminute fees of international, mobile and national long distance directions.

 

Matáv wasthe first among the fixed line operators to introduce fixed SMS. With the helpof an adequate CPE, customers can now send short messages to another fixed lineor to mobile phones. Receiving an SMS does not require an adequate CPE, sincethe message arrives in this case as a voice-message through a text-to-speechapplication. We consider the primary function of this service as being a bridgebetween mobile and fixed lines.

 

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Our comfort services are getting more and more popular. DA-Plus serviceis available for inquires of numbers with little information at hand about theowner of the number. In addition, flowers and food orders are possible withthis service as well as thematic inquiry about location or contact details ofcertain business services.

 

One of the success stories of 2002 was Matáv’s Audiofix service.Through Audiofix, customers gain access to various entertainment TV programslike jackpots or reality shows, which became increasingly popular.

 

*New Data Services.* Several new services were developed for Matáv’s data communicationsproduct-portfolio. In order to respond to customer needs, new access, back-up andSLA-reporting services were developed as an add-on to corporate WAN products.With the new cost-effective DSL based access solutions, Matáv enables the SmallOffice Home Office (“SOHO”) and SME segment to implement IP-VPNs more easily.For the ATM based VPN (Lan-Flex) customers, a cost-effective solution isoffered to connect sites where asymmetric data communication is requested toaccess the VPN. With the IPSec service, an attractive Internet based remoteaccess solution is offered for our IP-VPN customers with ISDN-backup servicewhich provides a new solution for quality-sensitive customers to enhance theirIP-VPN leased line access availability.

 

For the SME segment and the largest 5400customers (“TOP5400”), an Integrated Services portfolio was created, withPublic Key Infrastructure technology based Certificate Authority and One TimePass products. High bandwidth customers can make use of our new GigabitEthernet technology enabled CityNet service, which facilitates the creation ofcost-effective Metropolitan Area Network solutions.

 

Internet Service Providers can differentiate theirInternet services for their customers with Matáv’s new value added serviceofferings. The Fixed IP Address service provides the same IP address every timefor the customers of our wholesale partners to retain their mobility. The PerUser Filter service supports our partners in offering differentiated accessesto their Internet service servers. Both services are widely used by Axelero.With the Hot Spot solutions Matáv provides different schemes for the Hot SpotSite Owners when giving them the opportunity to implement Hot Spot services attheir sites using the WLAN technology.

 

Distribution and Sales

 

2002 wasanother year of high level customer service. In order to improve customerexperience Matáv focuses on opening new distribution channels. Matáv opened a24/7 Internet Customer Service as a unique differentiator from competitors.Matáv uses the Internet also as a sales channel; on the Web sitewww.epont.matav.hu almost every Matáv service can be ordered with reasonablediscounts. Matáv expanded the opening hours of its call center (1212) so thatnow customers can call from Monday 6.00 a.m. until Saturday 8.00 p.m. and ithas also been expanded to provide for English speakers. Business customers cancontact Matáv on a separate call center number where operators are trained todeal also with small and medium enterprise communication needs.

 

Matávenhanced its local presence by raising the number of Matávpont retail shops to23. Matáv served 1.5 million customers in 2002 through its retail shops.Customer satisfaction measured in Matávpont shops is highest within Matáv.Matáv also has 52 Matávpont official partners that help in retail distribution.Key account customers receive dedicated service by account managers, whereassmall business customers are primarily served by Matáv’s indirect saleschannel. These resellers provide personalized service and can offer complextelecommunications solutions (e.g. voice, data, PBX, router).

 

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## ***Competition***

 

Despitethe high expectations related to market liberalization, the Hungariantelecommunications market did not see the development of fierce competition.Even though alternative carriers emerged, Matáv managed to retain its leadingrole on the voice services market. The largest competitors, Pannon and Vivendi,operate in the mobile and fixed segments, respectively, lacking the potentialto cover the entire telecommunications value chain and realize cross-segmentsynergies, i.e. Matáv is the only integrated player in the market.

 

***Domestic Fixed Line Telecommunications Services***

 

Until theend of 2002, the Company was subject to indirect competition from mobiletelecommunications providers. In addition, following full liberalization offixed line voice telephony, a variety of market entrants providing public fixedvoice telephony service, either by interconnecting with Matáv’s network or viatheir own infrastructure, could begin to compete. Existing and potentialservice providers include other LTOs, operators of existing alternativenetworks, such as public utilities, railways and mobile telecommunicationsproviders and global alliances of international telecommunications providers.In 2002, the mobile carriers remained to be Matáv’s key competitors relating tothe domestic calls. While several service providers target business customers,on the residential market Vivendi is the only player among the fixed linecarriers who generates competition in the Matáv service area (75 percent of thecountry), since this is the only company offering call by call carrierselection.

 

***International Fixed Line Telecommunications Services***

 

In theinternational voice and data transmission market, Matáv’s key competitors arethe carriers offering IP based services. Market pressure in this area isincreasing since more alternative carriers provide various IP based services inaddition to the leased line offerings. Service providers offering datatransmission via leased line to international directions are also competitorsof Matáv on the international telecommunications market.

 

***Leased Lines and Data Transmission Services***

 

TheHungarian data transmission market is continuously expanding. Consequently,Matáv is realizing a growing volume of revenues in this area (within this, thegrowth rate of revenues derived from IP services is significant). Matáv’s datatransmission services continue to be subject to strong competition since anumber of Hungarian companies have set up private data transmission networks.In recent years, Matáv’s key data market challengers (Pantel, GTS) weresuccessful in enhancing their market penetration. Pantel acquired a sizeableshare of the large business market, while GTS gained a strong position in theSME/SOHO segment. Both enterprises established solid strongholds on the fixedvoice market via their Internet and Voice over IP (“VoIP”) offers. Matávexpects that the corporate communications market competitors are going tocontinue their business segment specific niche-market strategies and will notmove into lower business and residential segments. In the data transmissionmarket Matáv is also facing competition from ISPs and mobile carriers offeringdata transmission services.

 

The Internetmarket is dominated by five major ISPs, although over 100 small Internetproviders are registered in the market. Apart from Axelero, every major playerfaces financial difficulties and strategic uncertainties.

 

Themanagement of the Company believes that the penetration and quality of Matáv’sdata transmission services as well as their attractive pricing ensure acompetitive edge for Matáv on the market of data transmission services.

 

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***Mobile Telecommunications Services***

 

TheHungarian mobile telecommunications market is characterized by fiercecompetition driven not just by new services and attractive prices but intensivemarketing as well. The rapid growth in the number of subscribers in the mobilemarket has come to an end. From this point on, no significant upswing can beexpected, instead Matáv expects migration between service providers. In linewith that, in the future mobile carriers will shift the focus from customeracquisition to customer retention. A new phenomenon on the Hungarian mobilemarket is that data transmission services and content services are playing anincreasingly stronger role in the carrier offerings. Westel continues to be thebiggest service provider of the mobile telecommunications market. In somespecific areas of operation, to avoid parallel investments, Westel hasnetwork-sharing cooperation with Pannon (subway system, tower usage).

 

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### ***REGULATION AND PRICING***

 

**Overview of the RegulatoryRegime until December 23, 2001**

 

Theregulatory regime governing telecommunications services in Hungary has beensubstantially revised since 1990, when the former state postal, telephone andtelegraph authority, Magyar Posta, was divided into three distinct operations.Act LXXII of 1992 on Telecommunications, as amended (the “TelecommunicationsAct”), established the general regulatory framework for the Hungariantelecommunications sector. The Telecommunications Act provided for thepromulgation of additional decrees by the Hungarian government and theMinistry. The concession telecommunications market was also governed by otherlegislation that is not specific to telecommunications, including, amongothers, Act XVI of 1991 on Concessions, as amended (the “Concessions Act”), ActLXXXVII of 1990 on Pricing, as amended (the “Pricing Act”), and Act LVII of1996 on the Prohibition of Unfair and Restrictive Market Practice (the“Competition Act”).

 

In 1993,the Minister divided Hungary into 54 local primary geographic areas (“LocalPrimary Areas”) for local public fixed line voice telephony service. In August1993, the Minister issued an international tender for the right to provideinternational and domestic long distance telephone services throughout Hungaryand to provide local public fixed line voice telephony services in 29 of the 54Local Primary Areas, including Budapest. The Minister selected MagyarCom,Matáv’s parent holding company, as the winning bidder in the tender.

 

MagyarComthen assigned certain of its rights to Matáv. On December 22, 1993, Matáventered into a concession contract (the “Concession Contract”) with theMinister. The Concession Contract gave Matáv the exclusive right to providedomestic long distance and international public fixed line voice telephonyservices throughout Hungary and local public fixed line voice telephonyservices in 29 Local Primary Areas for a term of eight years ending December22, 2001.

 

InSeptember 1993, the Minister issued a second competitive tender for theexclusive right to provide local public fixed line voice telephony services inthe remaining 25 of the 54 Local Primary Areas. Matáv obtained the right toprovide services directly in seven of those areas by being the successfulbidder in respect of five areas and the default provider in two areas wherethere was no successful bidder. Matáv also obtained the right to provideservices indirectly in an additional three areas through joint ventures. Withrespect to the five areas where it was the successful bidder, Matáv’s rightsare governed by separate concession contracts. Rights to service the remaining15 areas were distributed among 12 local telephone operators.

 

In 2000,the government disintegrated the Ministry of Transport, Telecommunications and WaterManagement in order to establish the Ministry of Transport and Water Managementand the Telecommunications Government Commissioner’s Office, which was a partof the Prime Minister’s Office and bear sole responsibility for all mattersrelated to telecommunications. The rights of the Prime Minister Office weretransferred as of May 27, 2002 to the Ministry of Informatics andCommunications.

 

Theregulation of the Hungarian telecommunications market was fundamentally changedon December 23, 2001 when the Act on Communications came into force. The Act onCommunications superseded the Telecommunications Act on December 23, 2001. TheAct on Communications provides the main legal framework for the Hungarianliberalized telecommunications market, and it provides for the promulgation ofadditional (governmental and ministerial) decrees.

 

On January28, 2002, the Minister and Matáv concluded the Contract on Universal ServiceProvision. According to this contract, the national concession was terminatedon January 31, 2002, while in the five local areas (Debrecen, Nyíregyháza,Szentendre, Székesfehérvár and Szolnok) the local concessions terminated on May24, 2002.

 

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**The Act on Communications and the Contract on UniversalService Provision**

 

Act onCommunications was approved by the Parliament on June 12, 2001 and entered intoeffect on December 23, 2001. The main goal of the Act is to promote and securethe liberalization of the telecommunications market via establishingasymmetrical regulation. Set forth below is a brief summary of certainprovisions of the Act on Communications.

 

The Act onCommunications has fundamentally changed the authority structure of theliberalized telecommunications market. The NRA is the supreme supervisory body,which includes three separate organizations: the Communications Inspectorate(Hírközlési Főfelügyelet), the Communications Regional Office (HírközlésiTerületi Hivatal) and the Communications Arbitration Committee (Hírközlési Döntőbizottság),which have independent responsibilities and rights. The scope of tasks,authority and competence of the communications authority as well as its rulesof procedure and penalties assessed by its organizations are regulated byGovernment Decree 248/2001 (XII.18.).

 

TheCommunications Inspectorate and the Communications Regional Office supervisethe telecommunications market, may bring resolutions, start official proceduresor initiate procedures before the Communications Arbitration Committee or anyother competent authority. These bodies are responsible for licensing,identifier management and frequency management. Provision of service isregulated by Government Decree 252/2001 (XII.18.) on the “Notification of theProvision of Telecommunications Services”, which determines the rules relatingto the notification of market entries to the authorities.

 

*Universal Service. *According tothe Act on Communications, universal services are basic communications servicesthat should be available to all customers at an affordable price. Universalservices include access to fixed line voice telephony services of regulatedminimum quality, a regulated density of public payphones, a public register ofsubscribers, operator services and cost-free emergency calls. Access to voiceservices at an affordable price is provided through regulated tariff packages.

 

Accordingto Article 15 of Decree 29/1997 (XII. 20.) KHVM, the service provider isobliged to certify and attest that it meets the quality requirements set out inthe obligatory standards described in separate laws, authority licenses andtype certificates in addition to those standards that are undertaken in thebusiness rules or contractual conditions of the company. Matáv Rt. was grantedthe certificate first on August 27, 2001 for its concession telephony services.During the autumn of 2002 Matáv Rt. had Mátrix Kft. to certify its universaland publicly available telecommunications services as well. The certifyingorganization issued the certificate on the Company’s compliance on December 16,2002. This certificate is valid until November 10, 2005 with ongoing reviewsevery six months.

 

Universalservice providers are entitled to compensation for their loss of revenueresulting from the low price of the universal service package. MinisterialDecree 4/2002 (I.26.) MeHVM determines the detailed rules applicable to thepercentage of revenues payable to the Universal Telecommunication Support Fundand the compensation available for universal service providers from the fund.

 

Matávbecame a universal service provider as a consequence of the universal servicecontract that had been concluded between Matáv and the Minister on January 28,2002. Matáv’s Fixed Lines Concession Contracts have been superseded by theContract on Universal Service Provision, in such a way that the nationalconcession (which included the international and domestic long distance as wellas the local concessions) in 31 primary areas was terminated on January 31,2002, while the local concessions in the remaining five concession areas wereterminated on May 24, 2002. In the Contract on Universal ServiceProvision theMinister acknowledged that Matáv Rt. fully complied with all of its obligationsduring the concession period. The concession fee was duly paid by the companyregarding the first month of 2002 for the nationwide concession and regardingthe period until May 24 for the 5 primary areas. The Minister has nooutstanding claims against the company. Upon the termination of its concessioncontract in its three primary areas on November 1, 2002, Matáv’s subsidiary,Emitel has also concluded the contract on universal service provision with theMinister.

 

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*Subscriber Contracts. *The serviceproviders must prepare both general terms and conditions and subscribercontracts to be entered into with the subscribers. The Government Decree249/2001 (XII.18.) on “Telecommunications Subscriber Contract” contains thegeneral rules of agreements between subscribers and telecommunications serviceproviders for telecommunications services. In the subscriber contract, theparties can rephrase the provisions of the Government Decree 249/2001 (XII.18)only if they are more favorable to the subscribers. The service providersalready operating on the market were obliged to amend their existing generalterms and conditions and subscribers contracts in accordance with theGovernment Decree 249/2001 (XII.18.).

 

Thegeneral terms and conditions must contain, among other things, the process ofconcluding and amending subscribers contracts, the quality of thetelecommunications service, the conditions for restriction of the service, thefault-repair service and the method for handling subscriber complaints. Theindividual subscriber contract must contain at least the personal data of thesubscriber.

 

*Significant Market PowerRegulation. *All service providers with significant market power (“SMP”) in thevoice-telephony, mobile telecommunications, leased line or interconnection marketsare required to comply with certain obligations. An operator is identified ingeneral as an SMP when its market share in a specific market and in a specificgeographical area exceeds 25 percent. The Communications Arbitration Committee(“CAC”) designates the SMP carriers with a resolution. During the designationprocess the CAC may deviate from the predefined market share limit on the basisof an assessment of the circumstances defined by the law. Obligations of SMPoperators include accounting separation, operating a joint directory assistanceservice, publishing reference offers for interconnection services (which mustbe offered on cost-based prices), leased line services and unbundled localloops. Matáv has been designated as an SMP on the telephony and leased linesmarket by the power of the law on December 23, 2001.

 

*Retail Prices. *The Act onCommunications designates Matáv as an SMP operator in the voice telephonymarket. Consequently, the retail prices of fixed line voice telephony servicesprovided by Matáv will continue to be regulated. Details on the method of pricecalculation were determined in Decree 3/2002 (I.21.) MeHVM on “Charges forVoice Telephony Services Provided by Companies with Significant Market Powerand Tariff Packages Related to Universal Services” (“the 2002 Fixed Line TariffDecree”).

 

Matáv’sregulated access prices currently include an access deficit, i.e., Matáv’ssubscription fees do not cover the costs of access. According to the PricingAct and the relating ministerial decrees (3/2002 (I.21.) MeHVM and 4/2002(I.26.) MeHVM), the access deficit should be eliminated. Decree 3/2002 (I.21.)MeHVM deals with the access deficit problem by allowing an annual increase insubscription fees of universal tariff packages above annual inflation rate. Inaddition, Decree 1/2002 (I.11.) MeHVM on “Costing Methodology of NetworkServices” introduced an access deficit financing regime according to which anaccess deficit surcharge of HUF two per minute was applicable on all call originationand termination traffic. Decree 3/2003 (II.7.) IHM reduced the access deficitsurcharge to HUF one per minute as of February 15, 2003.

 

*Unbundled Local Loop. *According tothe Act on Communications and Government Decree 175/2001 (IX.26.) on “Unbundlingthe Local Loops and its Procedural Rules”, SMPs in the telephony market areobliged to unbundle twisted copper pair local loops and prepare referenceoffers for unbundled local loops (whether fully or partially unbundled) and toprovide these services when there is a request for them by othertelecommunications service providers.

 

The SMPsmay refuse the offer for unbundling if:

 

•                  the local loop inquestion does not have an appropriate length for the planned service of theother service provider;

 

•                  providing access to thelocal loop would endanger the unity of the SMPs’ network; or

 

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•                  the SMPs cannot providephysical connection to the local loop as a result of prior access having beengranted to another service provider.

 

An SMPdoes not have to grant access to the local loops if any of the subscribers whohave entered a pre-agreement with the intended new service provider haveoutstanding debts towards the SMP on the date on which it would be obliged togrant physical access. In addition, there is no obligation to provide unbundledlocal loops when an SMP requesting the service has a significant advantage infinancial status or in market power compared to the addressee of the request,therefore other local SMPs are not obliged to conclude unbundled local loopcontracts with Matáv.

 

The costbase for the price of these services has to be calculated using LRIC, althoughFully Allocated Costs (“FAC”) methodology can be used until December 31, 2002.Government Decree 175/2001 (IX.26.) provides for a transparent andnon-discriminatory calculation method, which the service providers must use.

 

The SMPsmust prepare a reference offer for the unbundling of the local loops in whichthey must regulate those matters listed in the Government Decree 175/2001(IX.26.). The reference offer forms the basis of the agreements to be concludedwith other service providers for unbundling the local loops. The referenceoffer of each SMP must be approved by the CAC. The CAC keeps a public, openregister. Matáv’s Reference Offer for the Unbundling of the Local Loop(“MARUO”) has been approved by the CAC on February 28, 2002. Matáv amended itsMARUO to be based on LRIC in November 2002 in compliance with the legalrequirements and submitted it to the CAC for approval. This procedure isongoing.

 

*Interconnection.*  According to the Act on Communications andGovernment Decree 251/2001 (XII. 18.) on “Network Interconnection Agreements”,SMPs are obliged to prepare reference offers for interconnection and to providethese services upon the reference offer when there is a request for them byother telecommunications service providers.

 

Accordingto the Government Decree 251/2001 (XII.18.), the SMPs are obliged to enter intoagreements for access to their networks on the basis of an offer put forward byanother service provider. If the provider is obliged to prepare a referenceinterconnection offer, such as Matáv, this offer must be in line with thereference offer. The CAC has the competence to arbitrate in dispute cases. Ifthe agreement is not entered into within 30-60 days of the offer because theservice provider owning or using the network has not responded to the offer orhas simply refused to enter into an agreement, the CAC may establish theagreement between the parties. The reference offer of the SMPs must be approvedby the CAC. Interconnection agreements concluded between service providersbefore the Act on Communications entered into force remain in effect, butmodifications may be initiated by either party in line with the new regulation.

 

A newinterconnection agreement on the basis of the provisions of the Act onCommunications was concluded between Matáv and Vivendi (the second mostsignificant fixed line telecommunications service provider in Hungary) onDecember 21, 2001 and between Matáv and Pantel on April 8, 2002. Matáv’sReference Offer for Interconnection (“MARIO”) was filed with the CAC forapproval, and it was approved on July 18, 2002. An interconnection agreement basedon MARIO was signed with GTS Datanet Kft. in December 2002, and with MonorTelefon Társaság, British Telecom and Emitel in March 2003. The price wasdefined according to the FAC method. Matáv amended its MARIO to be based onLRIC in November 2002 in compliance with the legal requirements and submittedit to the CAC for approval. This procedure is ongoing.

 

*Carrier Selection. *Since theexpiration of Matáv’s exclusive rights to provide domestic long distance andinternational telephony services on December 23, 2001, voice telephonycustomers have the right to select different service providers for domestic andinternational long distance fixed line calls and for international mobile callsby dialing a pre-selected number or by using a call-by-call pre-fixed number.The requirements for carrier selection are an interconnection agreement betweenthe affected service providers, a carrier selection number and the connectionof the calls to the desired end user.

 

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Carrier selectionagreements can be concluded in writing, orally or through an implied contract.Government Decree 250/2001 (XII.18.) on “Carrier Selection” obliges the chosenservice providers to inform the former service providers about any form of carrierselection, and the rules also provide that in the case of faulty performance,the risk is born by the actual service provider unless the parties agreeotherwise.

 

*Number Portability. *According tothe law, fixed line telecommunications service providers are obliged to providenumber portability on their networks from January 1, 2003, allowing subscribersto change service providers without changing their telephone numbers in thesame geographic location. The executive decree regulating the details is notfinalized yet. It is expected that a more simple version of number portabilitywill be implemented in 2003 as a transitional decree and from January 1, 2004an EU conform, central database based solution will replace the transitionaldecree. In case of geographical relocation the number can be retained uponrequest of the customer on a commercial basis.

 

*Telecommunications ServiceLicensing Requirements. *According to the Act on Communications, the provision of communicationsservices shall be notified to the Communications Regional Office forregistration 30 days before service commencement. The detailed rules of thenotification of services are laid out in Government Decree 252/2001 (XII. 18.)on “Notification of the Provision of Telecommunications Services”. Theauthority may reject the registration if the notifying entity does not fulfillthe conditions specified in the Act on Communications and other legislation.

 

Allcommunications service providers that have obtained the right to providecommunications services pursuant to license or notification before the Act onCommunications entered into force may pursue such activity according to suchright.

 

*Licensing and Allocation ofFrequencies*. With the exception of a program receiver device, radio equipment, radiostations and radio communication networks may be operated with a radio license.A radio license may be issued exclusively on the basis of a valid frequencyassignment license, except the cases specified by law. Radio equipment, radiostations, radio networks and radio communications systems may be installed witha frequency assignment license, with the exception of cases specified by law. Aregular fee specified by law shall be paid for the reservation and authorizeduse of the frequencies assigned for civil purposes, reservation of identifiersand use of the assigned identifiers.

 

Matáv Rt.pays a frequency license fee on the basis of Decree 6/1997 (IV.22) KHVM on“Frequency Reservation and Usage Fee” and Government Decree 120/1998 (VI.17.)on “Rules of Payment of Frequency Reservation and Usage Fee”. Additional rulesapplying to Matáv include Government Decree 284/2002 (XII.21.) on“Specification of the National Frequency Allocation Table” and GovernmentDecree 11/2003 (I.30.) on “Rules of the Auction and Tender to Obtain theFrequency Usage License”.

 

Matáv Rt.pays a number usage fee for those call numbers that are used by the Company,according to Decree 19/2001 (X.31.) MeHVM on “Fees of Engaging the Number andAddress Fields Necessary for the Provision of Public Telephony Services”.

 

Frequencyassignments must conform to the National Frequency Range Distribution Chart,which lays out the entire spectrum and the purpose and availability offrequency bands. Matáv’s frequencies are generally valid for periods of one tofive years. The frequency assignment for the Radio Local Loop system (“RLL”) isvalid through November 2003. Matáv has already started to replace those systemsby fixed GSM systems and will meet the relevant contract with the Ministry.

 

If atelecommunications service provider wishes to provide services that require afrequency assignment and appropriate frequencies are available, theTelecommunications General Inspectorate must hold a public auction or drawing.A public auction is held if the number of available frequencies is notsufficient to satisfy all requests. A drawing is held if the number ofavailable frequencies is sufficient to satisfy requests but the frequencieshave differing qualitative characteristics.

 

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The stateannounced a tender for the 3.5 GHz frequency, where Matáv’s bid was among thewinners. The frequency is used for the provision of new telecommunicationsservices.

 

*Rights of Way*.  According to the Act on Communications,communications service providers are entitled upon prior notification of theowner to install telecommunications equipment on private property and to enterprivate property where communications facilities (equipment, cables, antennas)are located for maintenance and fault elimination purposes. The publictelecommunications service provider has to enter into a contract with theproperty owner setting forth the conditions for the common use of the property.Owners of real property are also obliged to remove obstructions to publictelecommunications networks. Owners of real property have the right to claimcompensation for the nuisance suffered as a result of entry onto theirproperty.

 

Uponrequest, the competent inspectorate could establish easements in favor of apublic telecommunications service provider on real property for the purposes ofplacing communications facilities. Matáv is seeking easements over asubstantial number of real properties on which the Company or its predecessorsinstalled such facilities. If the placement of telecommunications equipmentprevents or materially hinders use of real property, the owner may request thepurchase or expropriation of the property after seeking an opinion from theInspectorate. The party that orders construction (installation) ofcommunications structures shall restore the initial conditions of theenvironment after the completion of construction works. If the communicationsstructure installed by the service provider provides for the customer residingor staying in the direct proximity of the structure better than average serviceor additional services, the service provider may not require compensation forit, neither in the subscriber contracts nor in any other way.

 

**Mobile Concession Contracts**

 

Hungarywas the first country in Central and Eastern Europe to introduce public mobiletelecommunications services. Westel 0660 began providing analog mobile radiotelephone service in October 1990 with an exclusive license and in 1994 enteredinto an exclusive concession contract with the Minister. In 1993, the Ministerawarded two concessions to provide nationwide cellular telephone services usingthe digital GSM 900 standard: one to Westel and the other to Pannon.

 

In March2000, Deutsche Telekom finalized the purchase of MediaOne’s interests in mobileoperations in Central and Eastern Europe including MediaOne International B.V.which owned 49 percent of Westel and 49 percent of Westel 0660. At the sametime the Company was granted an option to purchase the 49 percent holdings inWestel and Westel 0660 from Deutsche Telekom during the fifteen-month periodending September 2001. On December 21, 2001 the Company became a 100 percentowner of both Westel and Westel 0660. The final purchase price included HUF 226,750million (EUR 920 million), paid in December 2001, financed by a loan from DT,plus HUF 11,515 million paid in 2002, equal to 49 percent of the amount ofdividends declared by Westel for the year 2001.

 

**Westel**

 

Under theConcession Contract, dated November 4, 1993, as amended (the “900 ConcessionContract”), between the Minister and Westel, Westel has the right for 15 yearsfrom that date to provide public GSM mobile telephony services. Westel isauthorized to provide GSM service in the 906 to 914 and 951 to 959 MHzfrequency ranges in Hungary. The parties may agree to extend the Westelconcession for a period of seven and one-half years.

 

On February 25, 1999, the Ministry issued aninvitation to tender for the licensing in Hungary of DCS 1800 services, amobile telecommunications system operating in the 1800 MHz frequency band. Thetender was closed on May 7, 1999. On October 7, 1999 an amended 900 ConcessionContract was signed, allowing Westel and its GSM 900 competitor, Pannon, tostart commercial service in the 1800 MHz band for 15 years beginning 

 

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November26, 2000. At that time the Minister also signed a concession contract withV.R.A.M. Rt., the new entrant on the Hungarian digital cellular market, whichuses the Vodafone brand name.

 

Westel, simultaneously with Pannon, startedcommercial operation in the 1800 MHz band on November 16, 2000. Upon request byVodafone, the national roaming agreement between Westel and Vodafone wasterminated effective November 30, 2000, whereby Westel was released from theobligation to provide Vodafone with domestic roaming services on a nation-widebasis. Effective December 6, 2002 Pannon terminated its national roamingagreement with Vodafone. As Vodafone has no remedy available against such aunilateral decision, it has been forced to speed up its network roll-outcampaign to close the coverage gap vis-a-vis its competitors.

 

By the end of 2003, the three digital mobiletelecommunications service providers will have the same spectrum resourcesallocated to them both on the 900 and the 1800 MHz bands. By virtue of theConcession Contract amendment in 1999, the Minister agreed not to issue a newtender or otherwise license a new carrier for such services on these bandsbefore December 31, 2002. This was subsequently provided for accordingly by the2001 Act on Communication.

 

Westel isrequired to pay a HUF 11 billion concession fee, adjusted for changes in theHUF/USD exchange rate. The first installment of the concession fee, HUF 2,750million was paid eight days after the modification of the 900 ConcessionContract (November 1999). The second installment of HUF 2,750 million, adjustedfor changes in the HUF/USD exchange rate, was paid eight days after the commencementof 1800 MHz service (November 16, 2000). The third installment of HUF 1,830million, adjusted for the changes in the HUF/USD exchange rate, was paid onNovember 30, 2002. The remaining HUF 3,670 million, adjusted for the changes inthe HUF/USD exchange rate, payable towards the use of the last 6 MHz block, isexpected to be paid by December 31, 2003. Westel also pays an annual concessionfee of USD one million since the commencement of the 1800 MHz service.

 

*Frequency Fees.*  In accordance with the 900Concession Contract, the frequency fee payable to the Ministry consists of twoparts: a frequency reservation fee and a frequency usage fee. Westel must paythe Hungarian government a frequency reservation fee of HUF 256 million peryear for the nationwide reservation of one 8 MHz duplex frequency band (40 GSMduplex radio channel) in respect of the 900 MHz frequency band. This feedecreases in proportion to the percentage of the nationwide coverage of theservice. Westel must also pay a frequency usage fee of HUF 200,000 per year foreach GSM duplex channel and base station with a radio license. Pursuant to anew regulatory decree passed in December 2002, the former payment obligation,in respect of the frequency reservation fee, has been revoked. Westel also hadfrequency fee payment obligations for channels allocated in the 1800 MHz band.In 2002, based on a fairly complex calculation methodology set out in theConcession Contract, Westel paid HUF 60 million for the right to use the 6 MHzfrequency band, plus HUF 74,264 million for the actual use of channels withinthat band. Both amounts were adjusted for the changes in the HUF/USD exchangerate. In total, in 2002, Westel paid a HUF 2,405 million frequency usage feefor all frequency usage in both the 900 and the 1800 MHz bands, adjusted forthe changes in the HUF/USD exchange rate.

 

*Tariffs.*  Commencing January 1, 1998,Westel’s subscriber charges ceased to be regulated under the Pricing Act orministerial decree and consequently ceased to be subject to the previouslyapplicable price cap regime.

 

*Roaming Agreements.*  Westel may sign roamingagreements with other public mobile telecommunications service operatorsoutside of Hungary in accordance with the rules of the GSM Association, anassociation of digital mobile cellular telecommunications service providers.

 

*Interconnection*.  If Westel receives a requestfor interconnection (to provide either network access or networkinterconnection) from another telecommunications operator, it is required underthe Act on Communications and Government Decree 251/2001 (XII.18.) to enterinto a contract, provided that such request is justified on both technical andeconomic grounds and the meeting of such request is not rendered impossible dueto a scarce resource. The meeting of this obligation should be on anon-discriminatory basis.

 

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InNovember 2002, the CAC designated Westel as having SMP in the relevant marketof national interconnection. Westel, per statutory obligations, filed its costcalculation methodology and relevant cost/tariff data based on the mandatoryLRIC model, as provided for by the law. Pannon was also designated by the CACas having SMP in the same relevant market, but it chose to appeal the decisionand refused to submit its cost data and LRIC model. In order to avoid acompetitive disadvantage and to seek non-discriminatory treatment, Westel filedan official request with the CAC for a temporary staying order for theexecution of the decision regarding the implementation of its SMP obligationsuntil the final settlement of the judicial review initiated by Pannon. Thecourt of first instance put a staying order on the execution of the SMPdecision with respect to Pannon but this order was appealed successfully by theCAC. Assuming that Pannon will appeal the said decision at the Supreme Court,Westel filed a petition with the Municipality Court of Budapest, seekingremedies to restore the non-discriminative treatment by the CAC. Both abovereferenced cases are pending.

 

Westel haswithdrawn the LRIC model, which it originally filed in December 2002, becausethe legal situation is unclear and no valid regulation is in place regardingLRIC model guidelines. Lack of any such guidelines means that equal treatmentof market participants cannot be ensured. The Chairman of CAC informed Westelthat the CAC accepted the withdrawal, however, the CAC must officially continuewith the procedure as official one and gave Westel 30 days to file a new LRICmodel. Westel filed an appeal against such decision on procedural grounds asthe CAC has no right by law to continue the procedure as an official one.

 

*Domestic Goods and Services.*  Westel must use specifiedpercentages of Hungarian goods and services. Westel currently satisfies theserequirements.

 

*Non-concessionary Services.*  Westel is entitled to pursuethe following non-concessionary activities without obtaining any furtherlicense:

 

•             other telecommunicationsservices;

 

•             trade, repair andmaintenance related to media and computer technology;

 

•             computer applicationsservices;

 

•             measurement and securitytechnology services;

 

•             general technicaldevelopment services;

 

•             telecommunications researchand development;

 

•             organization, developmentand general construction activity related to investment programs and buildingmaintenance; and

 

•             telecommunications and othertraining courses.

 

Westel maynot sell mobile subscriber equipment that is manufactured by a company in whichWestel has an interest.

 

*Termination. *The Ministerhas notified Westel that for the years 2000 and 2001 it had met its concessionobligations. Westel also met its concession obligations for 2002, for whichnotification from the Minister is expected in the autumn of 2003. If an eventof default occurs under the 900 Concession Contract, the Minister may issue acure notice to Westel. Westel would then have 90 days to agree with theMinister on a plan of action for curing the default. If Westel does not reachan agreement with the Minister or if Westel does not cure any such defaultwithin an agreed period of between three to six months, the Minister may issuea notice terminating the 900 Concession Contract. Upon termination of the 900Concession Contract, Westel would be dissolved under the Concessions Act.

 

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**Westel 0660**

 

Pursuantto the concession contract, dated June 24, 1994 (the “0660 ConcessionContract”), between the Minister and Westel 0660, Westel 0660 has the right for15 years from October 15, 1990 to provide public NMT 0660 mobile telephonyservices in the 450 to 470 MHz frequency range in Hungary. The parties mayagree to extend the Westel 0660 concession for a period of seven and one-halfyears.

 

*Required Fees.* Westel 0660 currently pays frequency reservation fees to theTelecommunications General Inspectorate of HUF 7.4 million per year for the3.66 MHz duplex frequency range and HUF 20,000 per year for each 20 KHz duplexradio channel and base station with a radio license.

 

*Tariffs.  *CommencingJanuary 1, 1998, Westel 0660’s subscriber charges ceased to be regulated underthe Pricing Act or ministerial decree and consequently ceased to be subject tothe previously applicable price cap regime.

 

*Interconnection.*  If Westel 0660 receives arequest for interconnection (to provide either network access or networkinterconnection) from another telecommunications operator, it is required underthe Act on Communications and Government Decree 251/2001 (XII.18.) to enterinto a contract, provided that such request is justified on both technical andeconomic grounds and the meeting of such request is not rendered impossible dueto a scarce resource. The meeting of this obligation should be on anon-discriminatory basis.

 

*Domestic Goods and Services.*  Westel 0660 must use specifiedpercentages of Hungarian goods and services. Westel 0660 is currentlysatisfying these requirements.

 

*Non-concessionary Services.*  Westel 0660 is entitled topursue the following non-concessionary activities without obtaining any furtherlicense:

 

•             other telecommunicationsservices;

 

•             trade, repair andmaintenance related to media and computer technology;

 

•             computer applicationsservices;

 

•             measurement and securitytechnology services;

 

•             general technicaldevelopment services;

 

•             telecommunications researchand development;

 

•             organization, developmentand general construction activity related to investment programs and buildingmaintenance; and

 

•             telecommunications and othertraining courses.

 

Westel0660 may not sell mobile subscriber equipment that is manufactured by a companyin which Westel 0660 has an interest.

 

*Termination.*  The Minister may terminate allor part of the 0660 Concession Contract, if Westel 0660 does not fulfill itsobligations under the contract. The Minister is also entitled to terminate the0660 Concession Contract in the case of intentional and repeated violations ofthe contract. Termination could result from, among other things, Westel 0660’sfailure to meet quality requirements or to pay fees or its refusal to satisfyan 

 

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interconnection request of atelecommunications service provider. In addition, the Minister may terminatethe contract if liquidation proceedings are instituted against Westel 0660 orif Westel 0660’s inability to satisfy the claims of its creditors adverselyaffects its ability to fulfill its concession obligations. Upon termination ofthe 0660 Concession Contract, Westel 0660 would be dissolved under theConcessions Act. The Minister notified Westel 0660 that for the years 2000 and2001 it had met its concession obligations. Westel 0660 also met its concessionobligations for 2002, for which notification from the Minister is expected inthe autumn of 2003.

 

**Competition Law Restrictions**

 

Similarlyto the Concession Contract, the Act on Communications and the Contract onUniversal Service Provision in line with the Competition Act prohibit Matávfrom the abuse of its dominant position in the market for public voicetelephone services.

 

Under theCompetition Act, a market participant is considered to be in a dominantposition if, among other things, it may pursue economic activitiessubstantially independent of other market participants, i.e., without the needto consider the market behavior of its competitors, suppliers, customers andother business partners.

 

During theconcession period, until December 23, 2001, the Concession Contractspecifically prohibited several practices. Matáv could not unjustly orunreasonably discriminate between, or extend unjust or unreasonable preferencesto, similarly situated licensed operators or subscribers, including itsaffiliates. The rates and terms pursuant to which Matáv used the publictelephone network for providing its own services had to be the same as thosethat it offered to other providers. Matáv could supply terminal equipment tocustomers but could not make the purchase or lease of such equipment acondition to obtaining any public telephone service or include the charge orfee for such equipment as part of the rates, fees or charges for any publictelephone service.

 

Accordingto the Act on Communications and the Competition Act, the service provider withSMP status shall provide services to other telecommunications service providersbeing in the same position on the same commercial terms, and these terms maynot be less favorable than those offered to other service providers controlledby it or controlling it.

 

According to the Contract on Universal Service Provision, Matáv is obligedto provide subscribers in the same position reasonably similar treatment and torefrain from unfavorable distinction and/or unjustified advantage with respectto the conditions and fees of universal service provision.

 

TheCompetition Act generally prohibits the abuse of dominant position, including,among other things:

 

•             establishing purchase orsale prices unfairly in business relations, including the application ofgeneral contractual conditions, obtaining unjustified advantages in any manneror forcing another party to accept disadvantageous terms;

 

•             restricting production,distribution or technical development to the detriment of the consumer;

 

•             refusing withoutjustification to establish or maintain appropriate business relations;

 

•             establishing prices at alevel much lower than those of its competitors to force competitors out of orto prevent them from entering into a market;

 

•             hindering competitors fromentering a market in any other unjustified manner; and

 

•             creating an undulydisadvantageous market situation for competitors.

 

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**EU Association Agreement and European Directives**

 

InDecember 1991, Hungary signed an association agreement (the “AssociationAgreement”) with the members of the European Union. The Association Agreementwas enacted into law in Hungary on January 4, 1994, and in April of that yearHungary applied for full membership in the European Union. On July 17, 1997,the European Commission recommended that Hungary be named as one of sixcountries then invited to begin negotiations for membership.

 

TheAssociation Agreement provides for the harmonization of Hungarian legislation,including telecommunications and other legislation, with that of European Unionmember states. Hungary and the members of the European Union have agreed to:

 

•             exchange informationregarding telecommunications policy statements and technical and otherinformation;

 

•             organize seminars, workshopsand conferences;

 

•             provide training andadvisory services;

 

•             transfer technologies;

 

•             carry out mutual projects;

 

•             promulgate Europeanstandards, certificate systems and regulations; and

 

•             advance new communicationmethods, services and equipment.

 

Europeaninstitutions have enacted numerous directives providing for an open andseamless telecommunications market within and among EU member states throughliberalization and harmonization of member states’ laws. The seminalliberalization directive was adopted on June 28, 1990. It provided for theprogressive liberalization of telecommunications services other than voicetelephony, mobile telecommunications, telex and satellite communications. Otherdirectives were thereafter adopted to liberalize satellite telecommunicationsservices other than public fixed line voice services in October 1994, servicesprovided over cable television networks in October 1995 and mobile services inJanuary 1996. To complete the liberalization process, a March 13, 1996directive (1) required the full liberalization, as of July 1, 1996, of the useof alternative infrastructures, such as telecommunications infrastructures ofrailways, for the provision of all telecommunications services other than voicetelephony and (2) provided for complete liberalization of voice telephony andthe provision of public telecommunications infrastructure as of January 1,1998.

 

The EU New Regulatory Framework and its implementationinto Hungarian Telecommunications Law

 

Under the current timetable, Hungary is expected tojoin the European Union on May 1, 2004 and, after such date, will be a memberstate without transitional provisions following the accession date. Hungary isthus required to comply with the EU Acquis Communautair, which requires it toadopt EU legislation as domestic law and to take EU legislation into account inapplying its domestic law. EU legislation can take a number of forms.Regulations have general application, are binding in their entirety and aredirectly applicable to all member States. Directives are binding, but nationalauthorities may choose the form and method of implementation.

 

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Over the past fifteen years, the European Commissionhas opened the telecommunications markets to competition through a series ofliberalization directives that gradually abolished the monopoly rights ofstate-owned telecommunications operators. Public voice telephony servicesbecame open to full competition in the majority of EU member states fromJanuary 1, 1998 and had been open to full competition in the UnitedKingdom before that date.

 

The European Union has adopted a number of directivesand recommendations regarding open and efficient access to, and use of, publictelecommunications networks and services. These are intended to harmonize technicalinterfaces, usage conditions and mandatory minimum service standards for allfixed-line users and to provide general framework for tariffs throughout theEuropean Union. Specific measures have been adopted in a number of areasincluding licensing and interconnection. Additional obligations in relation tospecial network access, interconnection charging, accounting separation andcost accounting, publication and non-discrimination are imposed on operators,which are designated by the national regulatory authorities in thetelecommunications sector (the “NRAs”) as having significant market power in atelecommunications market. A European Union regulation on unbundled access tothe local loop entered into force in January 2001 and obligated telecommunicationoperators to provide full unbundled access to the copper paired wire and at thesame time unbundled access to the high frequency spectrum (line sharing).

 

At the endof 1999, the European Commission initiated a review of the EUtelecommunications regulatory framework that focused on the development ofcompetition in the European telecommunications sector and the increasingconvergence of media, telecommunications and information technology. In 2002,legislative measures were adopted. They consisted of a general frameworkdirective and specific directives regarding:

 

•                  access to andinterconnection of electronic communications networks;

 

•                  mandatory minimumservice standards for all users (“universal service”) and users’ rights;

 

•                  authorization and licensingregimes;

 

•                  data protection andprivacy; and

 

•                  decision on aregulatory framework for radio spectrum policy in the EU.

 

The new regulatory framework, in particular:

 

•                  Sets out the rights,responsibilities, decision-making powers and procedures of the NRAs and the EUCommission. This includes the NRAs’ obligation to submit to the Commission andthe NRAs of other EU member states in draft form the regulatory measures thatthey intend to take with respect to market definition and significant market powerand the EU Commission’s power to require NRAs to withdraw such drafts, if theEU Commission considers them to create a barrier to the single European marketor to be incompatible with EU law.

 

•                  Identifies specificpolicy objectives that NRAs have to achieve in carrying out theirresponsibilities (namely, to promote an open and competitive European marketfor communications services, to promote the interests of European citizens andto consolidate the EU’s internal market in a converging technological environment).

 

•                  Provides that operatorswith significant market power in relevant communications markets will besubject to certain obligations as set out in the directives on universalservice and access. Significant market power, a notion that includes caseswhere a company has market power individually or jointly with other companies,is defined on the basis of the concept of dominance as developed in the caselaw of the European Court of Justice and the Court of First Instance of theEuropean Communities.

 

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The European Commission issued a recommendation onrelevant product and services markets in February 2003. The recommendationidentifies certain markets having characteristics which may justify the impositionof regulatory obligations, e.g. relating to the cost-orientation of prices,transparency of information, non-discrimination between customers, accountingseparation and mandated access to, and use of, network facilities. The EUCommission Recommendation refers, among others, to:

 

•                    theretail markets for access to the public telephone network at fixed location andpublicly available local and/or national telephone services (both separatelyfor residential and non-residential customers);

 

•                    thewholesale markets for call origination as well as call termination and transitin the fixed public telephone network;

 

•                    unbundledaccess to the local loop; and

 

•                    wholesalebroadband access.

 

In the area of mobile communications, the frameworkdirective contains:

 

•                    thewholesale market for access and call origination on public mobile telephonenetworks;

 

•                    marketsfor call termination on individual public mobile telephone networks; and

 

•                    thenational wholesale market for international roaming services on public mobiletelephone networks.

 

The EU Commission will regularly carry out a review ofthe recommendation on relevant markets.

 

The Act on Communications and related executiveDecrees are subject to modification in relation to harmonization with the NewEU Regulatory Framework for Telecommunications. The regulatory review, the socalled “Tellex project”, ordered by the Ministry is focusing on the followingareas: EU harmonization and competition; Internet regulation; universal serviceobligation regulation; cost accounting and price regulation; carrier selection,unbundling, number portability regulation; and institutional issues. The Tellexproject started on January 15, 2003 and will end with proposals for thedecision makers by May 15, 2003. The government is planning to present the billfor voting in the fourth quarter of 2003 with the provisions of the billentering into force step by step from January 1, 2004.

 

Due to the early state of the implementationdiscussion it is yet not possible to predict the transformation of the new EUregulatory framework into the Act on Communications and thus foresee theregulatory consequences for Matáv’s business.

 

Whether any reduction or extension of regulatoryburdens, which could have a material negative impact on the financial positionor results of operation of Matáv, will occur will largely depend on the mannerin which the directives are implemented in member states, i.e. in Hungary andthe manner in which the concepts of the new framework are applied by the EU Commission,NRAs and the European Regulators Group. The European Regulators Group is anewly established body composed of representatives of NRAs, which will play animportant role in assisting the Commission in the process of harmonizing theapplication of the new EU regulatory framework in the EU member states.

 

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**Broadcasting and Transmission**

 

Broadcastingand transmission are governed by the Media Act, the Frequency Act, the Act onCommunications and the Concessions Act. Under the Media Act, the National Radioand Television Board (the “NRTB”) has primary authority for issuing tenders forbroadcasting contracts and registering other broadcasters and transmitters.

 

Nationaland regional television and radio broadcasting or broadcast “distribution” tolocal operators generally required concessions under the Telecommunications Actand could be carried out on the basis of a program distribution contract inaccordance with the Media Act between the NRTB and the distributor. The Act onCommunications does not change the former regulation. Frequencies are assignedunder the terms of the Frequency Act. Entities registered as programdistributors are permitted to transmit the broadcasts of third parties tosubscribers through a cable transmission network.

 

The MediaAct restricts Matáv’s further expansion in the program distribution sector.Under the Media Act, a party holding a controlling share in a programdistributor, including a cable television company, may not acquire acontrolling share in another program distributor. The Media Act defines a“controlling interest” in any entity to include a more than 25 percent economicor voting interest in the entity or contractual or other arrangements givingthe holder a controlling influence over the entity.

 

In its1999 amendments to the Telecommunications Act, the Hungarian Parliamentapproved restrictions on infrastructure relating to program distribution, whichis now reinforced in a more stringent way in the Act on Communications. As aresult, Matáv Rt. and its subsidiary MatávkábelTV, which was founded with theaim of providing program distribution services, can not establish, lease oracquire disposal rights over any cable network suitable for programdistribution parallel to Matáv Rt.’s public telecommunications network, exceptin settlements with populations of less than 30,000. This restriction onlyprevails until January 1, 2004.

 

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**Pricing**

 

***Regulatory Framework***

 

Inaccordance with the Pricing Act, as modified by the Act on Communications, theMinister, acting in agreement with the Minister of Finance, is responsible forregulating maximum tariffs for voice telephony services provided by companieswith SMP, maximum tariffs for PSTN access to the Internet and maximum tariffsfor universal services. Tariff regulation in Hungary is based on the price-capmethod in case of tariffs for voice telephony and universal services and thereare fixed maximized tariffs for PSTN access to the Internet.

 

As ofFebruary 1, 2002, fixed line tariffs and entrance fees are regulated by onecommon decree, the 2002 Fixed Line Tariff Decree. The 2002 Fixed Line TariffDecree extended the validity of tariffs set in 2001 until June 30, 2002, withthe exception of subscription fees, for the first time including fixed tomobile tariffs. Subscription fees were uniformly increased by four percent asof February 1, 2002. After June 30, 2002 fixed line tariffs were allowed to bechanged in accordance with the price cap rules stipulated by the 2002 FixedLine Tariff Decree. The only exceptions were the residential main linesubscription fees that could be increased by three percent and local usage feesthat could be increased by an average of five percent as of July 1, 2002.

 

The 2002Fixed Line Tariff Decree set forth price regulation rules for three years inadvance, from 2002 to 2004. The Decree determines the price cap formula thathas to be calculated by reducing the forward-looking CPI (set by theGovernment) with the three percent productivity factor set by the 2002 FixedLine Tariff Decree. An important change in price cap regulation stipulates thatthe aggregate price index includes all the prices and discounts set in thevarious tariff packages offered by Matáv to residential and business customers.In consequence, the changes in list prices alone are not relevant any more fordetermining whether Matáv has met the price cap regulation rules or not. Matávwill have to meet price cap regulations on an annual level as checked by theNational Regulatory Authority at the beginning of the following year.

 

*Tariffs for PSTN access tothe Internet. *As of January 1, 2002, tariffs for PSTN access to the Internet areregulated by the Decree 30/2001 (XII.23.) MeHVM on “Charges for PSTN Access tothe Internet and Share of Fee to be Transferred to ISP by TelecommunicationsService Provider in case of Providing PSTN Access to the Internet Service” (the“2002 Internet Tariff Decree”). By the 2002 Internet Tariff Decree, revenuesharing with ISPs also entered into force: a share of the fee billed to thecustomer –30 percent in peak time and 10 percent in off-peak time – has to betransferred to ISPs. In case of flat rate Internet access – if available – 13percent of the fee has to be transferred to ISPs.

 

*Interconnection Fees. *FromDecember 23, 2001 the interconnection tariffs are no longer regulated byitemized price regulation but according to the cost calculation methodology.According to the Act on Communications, the SMP operators could use FACmethodology for calculating interconnection tariffs until January 1, 2003.Since then the LRIC methodology has to be applied. The application of FACmethodology was regulated by Guidelines 1/2002 (I.11). The regulation aboutLRIC cost calculating methodology has not yet been published. The cost-basedunbundling and interconnection tariffs have to be approved by the ArbitrationCommittee. The reference offers must contain the approved tariffs.

 

*Network Access Fees.*  The network access fees arenot regulated. The Act on Communications only prescribes that network accessfees have to be set in a controllable way by objective criteria, following theprincipals of transparency and non-discrimination.

 

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***Fixed Line Tariffs***

 

Tariffsfor fixed line telephony services consist of a one-time entrance fee, monthlysubscription fees and usage charges.

 

*Entrance Fees*

 

Entrancefees are based upon costs of installation and the general development ofMatáv’s network. The 2002 Fixed Line Tariff Decree gives service providers theright to collect an additional fee for providing connections in rural areas ofup to 50 percent of the costs incurred, if the entrance fee does not cover thedirect costs of the service provider. Entrance fees and subscription charges,but not usage charges, are differentiated by customer type: business andresidential. Matáv may provide discounts from the published charges but may notexceed any published charge.

 

*Subscription Fees and UsageCharges*

 

Fixed linesubscription fees and usage charges are regulated under an aggregate price cap.In 2001, the aggregate price cap was set by reference to the forward-lookingconsumer price index as forecasted by the Government in the Budget Act for2001. After taking into account a 2.9 percent productivity factor to whichMatáv Rt. is subject and a 2.9 percent correction factor, Matáv Rt.’s aggregateprice cap for tariff increases in 2001 under the principles set forth in theDecree 1/2001 (I.26.) MeHVM (“the 2001 Fixed Line Tariff Decree”) was sixpercent. The correction factor was applied in order to compensate for theunder-estimated consumer price index defined by the government as six percentfor 2000, while the relevant October to October index was 10.9 percent. Thecorrection factor was two-thirds of the difference. At the same time the 2001Fixed Line Tariff Decree limited the residential consumer telephony priceindex, measured by the Central Statistical Office, to be six percent, equal tothe forecasted forward-looking consumer price index. It was also stipulatedthat in case the real August residential consumer telephony price index hadexceeded the permitted level (six percent), the tariffs would have had to bedecreased in order to fulfill the price index requirement.

 

Matáv Rt.complied with the residential price cap of six percent in 2001 as verified bythe Central Statistical Office, therefore it was not subject to any tariffreduction.

 

In the2002 Fixed Line Tariff Decree an aggregate price cap is set by reference to theforward-looking consumer price index forecasted by the Government, decreased bythe productivity factor, and is increased, if necessary, by the correctionfactor. The correction factor should only be applied in cases where the realconsumer price index differs from the estimated figure by at least one percent.In such a case the correction factor is two-thirds of the difference betweenthe estimated and the actual figure. The Minister increased the productivityfactor to three percent from 2002. For 2002 the aggregate price cap has beenset at four percent. The residential price cap is no longer distinguished.Tariff rebalancing is regulated by allowing a two-step increase of theresidential main line subscription fee in 2002 (four percent as of February 1and three percent as of July 1) and setting an annual increase of a maximum often percent in 2003 and 2004 as compared to the average rate of the base year.Tariff rebalancing is also restricted by setting a maximum of five percentincrease for local usage fees in 2002 as compared to the average rate of thebase year, which is lifted to six percent in 2003 and 2004. At the same time,Decree 1/2002 (I.11.) MeHVM on “Costing Methodology of Network Services”introduced an access deficit financing regime according to which an accessdeficit surcharge of maximum HUF two per minute could be applied on all callorigination and termination traffic until December 31, 2004. However, Decree3/2003 (II.7.) IHM reduced the access deficit surcharge for Matáv to maximumHUF one per minute as of February 15, 2003. According to the modified decreethe access deficit surcharge can be applied until December 31, 2003. Thisaccess deficit financing regime helps to reduce the potential losses due toincomplete rebalancing.

 

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Thefollowing table sets forth changes in public fixed line subscription fees andusage charges for 2002 as established under the 2002 Fixed Line Tariff Decree.

 
| **Basket**                                                        |   | **Percentage  Change** |   |
|-------------------------------------------------------------------|--------|------------------------|--------|
|                                                              |   |                   |   |
| Subscription fees                                                 |   | 4.64                   |   |
| Local and Zone 1 and Zone 2 (Budapest metropolitan  area) charges |   | 1.62                   |   |
| Zone 3 and international charges                                  |   | (0.13                  | )      |

 

As of July1, 2002 Matáv introduced a new international tariff structure as an importantstep of price changes within the liberalized market conditions. Matáv carriedout price increases allowed by price regulation on September 1, 2002. Theresidential main line subscription fee was increased by three percent (the maximumincrease allowed by regulation), while local usage list prices were changed(minute fees increased, the call set-up charge decreased) in such a way that,taking into consideration discount package prices, the overall increase wouldnot exceed the regulated limit of five percent. The list prices of national andinternational long distance fees as well as fixed to mobile tariffs were notchanged. As a result of the approval of varying termination fees in thereference interconnection offers of local telecommunications operators, Matávintroduced different long distance minute fees depending on which localoperator’s network the call is terminated.

 

AlthoughMatáv Rt. fixes local and national usage charges separately for each of twotime periods, it does not differentiate international charges by time of day.Decree 31/1998 (XII.23.) KHVM (“the 1999 Fixed Line Tariff Decree”) alsointroduced time-based billing. Under this system, the usage charge is composedof a call set-up and a second-based usage charge. In 2002, the list price ofthe call set-up charge changed from HUF 3.80 to 3.40 per call on September 1,exclusive of VAT, and is independent of the tariff zone or time period of thecall.

 

As ofFebruary 1, 2003, Matáv introduced price changes for 2003 based on the pricecap regulation included in the 2002 Fixed Line Tariff Decree. Matáv continuedrebalancing by increasing subscription and local fees even though, with dueregard to market conditions, it did not fully realize the price increaseallowed by regulation. The residential main line subscription fee and localusage fees could have been increased in 2003 by less than ten percent and by anaverage of six percent, respectively. Matáv, however, increased the residentialmain line subscription fee by 4.2 percent and local usage fees also by anaverage of 4.2 percent. The tariffs of Zone 2 peak time calls terminated in thenetworks of the various local telecommunications operators were increased by anaverage 19.6 percent. The list prices of national and international longdistance fees as well as fixed to mobile tariffs were not changed. However, dueto restructuring the international tariff zone structure, international usagefees experienced a significant reduction of 10.2 percent as many important countrieswere reallocated to a cheaper international tariff zone. The call set-up chargewas further reduced to HUF 3.20, exclusive of VAT.

 

The aboveprice indices have been calculated in line with the traditional historicalweighing methodology. The NRA has not yet, however, determined the price indexcontrol methodology. Therefore, future changes are possible in the abovefigures due to the possible modification of the methodology.

 

# ***Internet tariffs***

 

As of January 1, 2002, the maximized minute basedtariffs for PSTN access to the internet are HUF 4.88 in peak time and HUF 2.60in off-peak time exclusive of VAT. This represents 19 percent decrease in peaktime and 13 percent decrease in off-peak time compared to 2001 tariffs. Fromthese per minute fees 30 percent in peak time and 10 percent in off-peak timehas to be transferred to ISPs. Matáv withdrew its flat rate PSTN access to theInternet packages as of July and August 1, 2002 and introduced new ones as ofAugust 1, 2002. There is one package that contains 15 hours of off-peak timePSTN access to the Internet for HUF 1,240 exclusive VAT and another one thatcontains 40 hours of off-peak time PSTN access to the internet for HUF 3,200exclusive VAT.

 

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At the same time,Matáv introduced a special night-time PSTN access to the Internet tariff of HUF0.40 per minute exclusive VAT and valid every day from 0 to 7 a.m. As of March1, 2003, Matáv launched a new package that contains 100 hours of off-peak timePSTN access to the Internet for HUF 7,000 exclusive VAT.  At the same time, Matáv also introduced thewholesale version of these off-peak time PSTN access to the Internet packages:the 15 hour package for HUF 892.8 exclusive VAT, the 40 hour package for HUF 2,304exclusive VAT, the 100 hour package for HUF 5,040 exclusive VAT. New wholesalePSTN access to the Internet minute tariffs were also set at HUF 2.83 for peak,HUF 2.03 for off-peak and HUF 0.31 for night-time. State subsidy for consumerprices in above mentioned packages is secured for Matáv for every retail andwholesale 10, 40 or 100 hour package sold in a maximized total amount of HUF800 million exclusive VAT in 2002 and HUF 1.92 billion exclusive VAT in 2003.

 

*Leased Line Fees*

 

SinceMatáv’s concession ended in the area of leased lines required forinterconnection, leased lines that had formerly been regulated becameunregulated in 2002. On the leased line market, however, Matáv has beendeclared as a company with significant market power in 2002, and as a result,in line with the Telecommunication Act, submitted a Reference Leased Line Offer(as a modification of MARIO) for approval to the CAC on December 9, 2002. Theprices of the services to be included in the Reference Offer have to be basedon the LRIC methodology.

 

*Interconnection fees*

 

The Act onCommunication, the Ministerial Decree 1/2002 (I.11.) MeHVM on “CostingMethodology of Network Services”, the Government Decree 251/2001 (XII.18.) on“Network Interconnection Agreements” and the Government Decree 250/2001(XII.18.) on “Carrier Selection” have changed the principles of interconnectionand interconnection fees.

 

Interconnectionfees of an SMP on the interconnection market have to be cost-based. UntilDecember 31, 2002, FAC methodology of costing could be used. The methodologyand the cost of capital to be applied by the service provider for calculatingthe unit cost is set in the Decree 1/2002 (I.11.) MeHVM on “Costing Methodologyof Network Services”. In 2002 the regulated cost of capital rate was 19percent.  The cost of capital rate isexpected to be modified in May 2003.

 

SMPs areobliged to prepare reference offers for interconnection and local loopunbundling and to provide these services when there is a request for them byother telecommunications service providers. Matáv handed in its referenceunbundling offer first on October 4, 2001 and a second version on December 21,2001. The latter one was approved by the CAC on February 28, 2002. Matávsubmitted its first reference interconnection offer on January 22, 2002 and asecond version was submitted on April 26, 2002. The latter one was approved bythe CAC on July 18, 2002. The following table shows the approvedinterconnection usage fees.

 
| **Interconnection services *** |   | **peak  HUF/min** |   | **off peak  HUF/min** |   |
|--------------------------------|--------|-------------------|--------|-----------------------|--------|
|                           |   |              |   |                  |   |
| Local origination              |   | 5.44              |   | 2.03                  |   |
| Regional origination           |   | 6.46              |   | 2.41                  |   |
| National origination           |   | 8.32              |   | 3.11                  |   |
| Local termination              |   | 5.07              |   | 1.90                  |   |
| Regional termination           |   | 6.09              |   | 2.27                  |   |
| National termination           |   | 7.95              |   | 2.97                  |   |

 

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** exclusive VAT and accessdeficit surcharge*

 

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In 2002, asurcharge of maximum HUF 2 could be applied in cases of interconnection trafficservices in order to compensate for local access deficit. This extra chargecould be applied both for call origination and call termination. From February15, 2003 Matáv can apply a surcharge of HUF one, according to the Decree 1/2002(I.11.) MeHVM as modified by Decree 3/2003 (II.7.) IHM.

 

Existingnetwork interconnection contracts with LTOs and mobile operators remain inforce until modification that can be initiated by any of the contractingparties. Interconnection agreements signed before the approval of the 2002 RIOshould be modified retrospectively.

 

FromJanuary 1, 2003, the methodology of LRIC have to be used for determining thecost based prices of local loop unbundling and interconnection services. Inline with the Telecommunication Act, Matáv submitted its modified referencelocal loop unbundling (“LLU”) and interconnection (“IC”) offers for approval onNovember 5, 2002. The CAC rejected the reference IC offer on January 24, 2003and the reference LLU offer on February 3, 2003. Matáv filed the modifiedreference IC offer on February 28, 2003 and the modified reference LLU offer onMarch 12, 2003. The approval process is ongoing. After the approval of the LRICbased Reference Interconnection Offer (“RIO”) tariffs, the interconnectionagreements should be modified according to the CAC decision in line with theexisting bilateral agreements. The CAC decision is expected to take effectretrospectively as of January 1, 2003.

 

*Network access agreementsbetween Matáv and ISPs*

 

ISPs andMatáv have to sign network access contracts to secure access to ISPs servicesfor Matáv subscribers. Beside the already signed network access contracts,still existing subscriber contracts with ISPs remain in force until the newnetwork access contracts are signed if - according to the Government Decree251/2001 (XII.18.) on “Network Interconnection Agreements” modified byGovernment Decree 42/2003 (III.27.) - ISPs provide an offer to Matáv untilApril 30, 2003 to modify the subscriber contract for a new network accesscontract. Otherwise the subscriber contracts expire on June 30, 2003. Theconditions applied in the new access contracts have to be in line with legalrequirements (network access fees have to be set in a controllable way byobjective criteria, following the principals of transparency andnon-discrimination) and terms and conditions of the existing subscribercontracts.

 

*Reverse charging agreementsbetween Matáv and ISPs*

 

InNovember 2001, Matáv started to sign reverse charging agreements with a numberof ISPs. According to these agreements, customers pay their telecommunicationsbills for Internet usage to the ISPs instead of paying directly to Matáv. Thisnew scheme allows ISPs to form various fee-packages based on their customers’needs.

 

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**ORGANIZATIONAL STRUCTURE**

 

At December 31, 2002 the principal operatingassociates, joint ventures and subsidiaries of the Company were as follows:

 
| **Associates  / Joint ventures**                                                           |   | **Group  interest  in capital** |   | **Activity**                   |
|--------------------------------------------------------------------------------------------|--------|---------------------------------|--------|--------------------------------|
| Hunsat Magyar  Űrtávközlési Koordinációs Egyesülés |   | 50.00                           | %      | VSAT satellite  communications |
| Magyar RTL  Televízió Rt.                                                        |   | 25.00                           | %      | Television  broadcast company  |

 
| **Subsidiaries**                           |   | **Group  interest  in capital** |   | **Activity**                             |
|--------------------------------------------|--------|---------------------------------|--------|------------------------------------------|
| Axelero  Rt.                               |   | 100.00                          | %      | Internet  service and content provider   |
| Emitel  Rt.                                |   | 100.00                          | %      | Local  telecommunications operator       |
| InvesTel  Rt.                              |   | 100.00                          | %      | Cable TV  holding                        |
| Makedonski  Telekommunikacii AD (MakTel)   |   | 44.11                           | %      | Macedonian  telecommunications company   |
| Matávcom  Kft.                        |   | 100.00                          | %      | Solutions  for business customers        |
| MatávkábelTV  Kft.               |   | 100.00                          | %      | Cable  television operator               |
| Stonebridge  A.D.                          |   | 86.46                           | %      | Macedonian  holding company              |
| Westel  Rádiótelefon Kft         |   | 100.00                          | %      | Cellular  telephone services             |
| Westel  Mobil Távközlési Rt |   | 100.00                          | %      | GSM  digital cellular telephone services |

 

MakedonskiTelekommunikacii AD and Stonebridge AD are incorporated in Macedonia. All othercompanies listed are incorporated in Hungary.

 

## ***PROPERTY, PLANTS AND EQUIPMENT***

## *** ***

# ***Description of Property***

 

As ofDecember 31, 2002, Matáv’s property, plants and equipment had a total net bookvalue of HUF 645,087 million.

 

Matáv hasone of the largest real estate portfolios in Hungary with an aggregate net bookvalue at December 31, 2002 of HUF 95,392 million. The Company usessubstantially all of these properties for telecommunications installations,computer installations, research centers, service outlets and offices. Matávalso has a number of operating lease contracts for properties.

 

Due to the consolidation of various operations, the conversion todigital switches and ongoing staff reductions, Matáv anticipates that asubstantial portion of its owned and leased properties will not be necessary toits core business in the future. Consequently, the Company reduced its net realestate occupancy costs by terminating all of its real estate finance leasecontracts in 2000. The Company intends to sell or rent its surplus ownedproperties.

 

In thefourth quarter of 1999, the operations of Matáv’s total real estate portfoliowere outsourced to Trammell Crow-Wallis, a real estate management andconsulting company. On January 1, 2003, the operative

 

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part of real estate development, investmentand area management of Matáv was outsourced as well to Trammell Crow-Wallis.

 

The aggregatenet book value of Matáv’s technical equipment and machinery, which primarilyconsists of switches, communication towers, and other telecommunicationsequipment, at December 31, 2002 was HUF 486,539 million.

 

**INFRASTRUCTURE AND TECHNOLOGY**

 

Over thepast three years, Matáv has sought to rapidly build out and modernize itsnetwork to enable the Company to offer a broad portfolio of technologicallyadvanced products and services. Matáv expects gross additions to tangible andintangible assets to be approximately HUF 90 billion in 2003. The Companyexpects an increasing proportion of capital expenditures to be devoted tohigh-growth areas, such as mobile telecommunications, data transmissions andInternet.

 

*Modernization of Switchesand Exchanges.* The Company has rationalized its switching architecture to increase theoperational efficiency of its network. Due to the migration towards more valuableservices, the ratio of old type exchanges has been diminishing. The preparations for the liberalized telecommunications market includedthe major upgrading of Matáv’s PSTN/ISDN platform. As a result of thedevelopment Matáv subscribers can now use the telecommunications network ofother operators to make national and international calls, and the network ofMatáv can also be accessed by subscribers of other carriers for similar calls.The further upgrade of the platform is in the preparatory phase. When thedevelopment is completed, it will be possible for the subscribers to keep theiroriginal phone number even if they change their telecommunications carrier. Inaddition, the subscribers are allowed to use services offered by other carriersfor their domestic and international calls.

 

TheCompany continues to digitalize its local networks. At December 31, 2002, 87.1percent of Matáv’s exchange capacity was digital, compared to 79.0 percent atDecember 31, 1999. Each of the Matáv concession areas is served by a digitalprimary exchange. Digitalization permits a broader range of services andgenerates operational cost savings. Digitalization is also a prerequisite forproviding ISDN services. The number of local exchanges capable of providingISDN services has increased considerably and the number of ISDN channels grewfrom 114,466 at December 31, 1999 to 511,326 at December 31, 2002. On the basisof the ISDN infrastructure, Matáv’s network supports switched high qualityInternet access and packet switched data transmission for ISDN subscribers. The medium-term plans includemoderate ISDN capacity extensions and embody Matáv’s intention to respond tothe requirements of the liberalized market.

 

*Expansion of AccessNetworks.* In 2000, the market for new access lines had been largely saturated,although there has been an increase in demand for more valuable services. Atthe end of 2000, Matáv introduced its new broadband access services – based onADSL and ATM technologies – providing faster access to the Internet. The ADSLtransmission system provides high speed digital access to any data network overexisting copper wires without interruption of Plain Old Telephone System(“POTS”)/ISDN2 services. In 2002, Matáv enhanced broadband access services andintroduced new products based on ADSL and other xDSL technologies, such as webbased service selection. At the end of 2002, approximately 34 thousandcustomers were using ADSL lines for connection to the Internet. By the end of 2002, in principlemore than 1.4 million analog and ISDN2 Matáv subscribers could have had anaccess to ADSL service.

 

In 1996,the Company began to employ radio-linked subscriber lines (RLL) in the 900 MHzband. As part of the introduction of the DCS 1800 mobile system, in 1999 theMinistry required Matáv to exit part of its 900 MHz frequency bandwidth beforethe expiration of its license. In compliance, Matáv removed its analog RLLsystem from Budapest by August 31, 1999. At December 31, 2002, the Companystill provided services for approximately 22,000 RLL subscribers. Matávintroduced fixed GSM technology in March 2000 to replace the analog RLL system.The fixed GSM uses the existing GSM mobile network for PSTN service provisionby

 

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employing wall-mounted fixed GSM terminals.Matáv uses fixed GSM technology primarily for low-end customers in rural areaswithout fixed network access as well as to quickly provide services, on aninterim basis, when new subscriber demands cannot be satisfied immediately withexisting fixed line infrastructure. By the end of 2002, the number of fixed GSMsubscribers in Matáv’s access network was approximately 85,000.

 

Matáv usesfiber optic cables in its fixed line local loop networks, with approximately300,000 64 Kb/s equivalent channels connected to subscribers at the end of2002. The Company installed a substantial portion of the local network fiberoptic cable in Budapest, where segments of the old cable were in poor conditionand where Matáv believes the demand for high capacity and quality transmissionwill be the greatest (e.g. shopping malls, industrial parks, etc.). Matáv plansto extend its local fiber optic network both inside and outside Budapest tocover new, mainly business demands in existing areas.

 

*CityNet.*  CityNet is an overlay networkfor large cities that connects Matáv nodes and key business customers withoptical cables. It provides access to business communications services ofMatáv. By the end of 2002 more than 220 km of optical cable was installed inBudapest connecting 263 customers. Outside Budapest approximately 80 km ofoptical cable was also installed connecting 87 customers. This networktypically provides ISDN30, MLLN, HSLL and ATM-based services. By the end of 2002, Matáv hadinstalled approximately 50 km of optical cables in four cities, for datacommunication purposes, reaching more than 120 customers in LTO areas.

 

In thenext three years about 50 km of new optical cable is expected to be installedoutside Budapest to connect about 50 customers. In Budapest about 60 newcustomers are planned to be connected to the existing network. New CityNetproducts are also expected to be introduced. In 2003, the implementation of a newEthernet-based metropolitan core network will be launched.

 

*ManagedLeased Line Network (*“*MLLN”).*  Matáv has established itsn*64kbps speed digital managed telecommunications network in 1996. Thecontinuously growing network provides the platform for the managed leased lineservices (Flex-Com), frame relay services (Frame-Flex) and leased line accessfor the IP-VPN services as well as the X.25 (Datex-P) service of Matáv. MLLN isa homogeneous, very reliable network managed by a central management system.MLLN platform provides practically full coverage for business customers inMatáv areas. In 2003, Matáv plans to introduce cost efficient MLLN accessofferings.

 

*Backbone Network.* Matáv has a digital fiber opticnational long distance network that connects local primary area networks. TheCompany has implemented DWDM technology and SDH systems in both the nationallong distance and Budapest networks. The countrywide DWDM backbone network,installed in 2001, provides high capacity (maximum 64 times 10 Gb/s) in themost important nodes of Hungary, as well as in international directions. Inaddition to cost advantages, SDH systems provide a flexible transmissioninfrastructure with automatic transmission paths. Matáv installed additionalroutes of optical cable and SDH systems in the long distance network during2002, increasing both network availability and transmission capacity. As ofDecember 31, 2002, Matáv had 4,450 km of backbone optical cable network.

 

*Internet Core Network.*  Matáv introduced public Internet access servicein 1997. The underlying router network, which was initially based on MPLS overATM technology, has been upgraded to a multiservice MPLS backbone in 2000. Inorder to support traffic expansion driven by broadband growth, Gigabit SwitchRouters utilizing Wavelength Division Multiplexing (“WDM”) capacities have been deployed in2002 in the most critical locations. The network has several access options(dial-up, leased line, broadband /xDSL, CATV/) with PoPs in each primary areain Hungary. Available services include IP-VPN (scalable interconnection forcorporate sites), Virtual Private Dial-up Network and wholesale Internetservices for ISPs. Recent developments include IP-based Integrated Voice andData (“IVD”), IPSec and xDSL access to VPNs. Matáv plans to install additionalGigabit Switch Router nodes, thus creating a pure IP/MPLS over WDM/SDH backboneas well to support new capabilities and services and to increase the bandwidthavailable for IP services in the future.

 

*Intelligent Network.*  The Company launched the first set of INservices in 1998, including shared cost and toll free numbers, televoting andvirtual card calling. In 2000, Matáv introduced prepaid card calling servicesas

 

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well. In 2001, newfeatures were added to the prepaid application, thus a new tariff package wasintroduced for residential customers. Recharging of accounts can be done viabank automats. In 2002, we introduced new services such as Audiofix, to supportthe increasingly popular media games. We upgraded the existing Freephone Numberservices by user-specific routing trees. Matáv plans to develop new IN basedservices and to enhance and expand its existing services in the future.

 

*Asynchronous Transfer Mode.*  Matáv introduced the first public network inHungary based on ATM technology in 1999. Based on this technology, high speedLAN-Flex, Cell-Flex and WAN-Flex services are provided commercially. LAN-Flexoffers local area network interconnection service, while Cell-Flex offers ahigh-speed data transmission service. Both services provide flexible bandwidthdelivery. In addition WAN-Flex service provides 2 Mbit/s TDM link to connectPBXs of subscribers. ATM is also the connectivity network concentrating xDSLtraffic towards the IP backbone. Matáv intends to launch cost-effective ATMconcentrators and subscriber units.

 

*Network Quality.*  Investment in the network,particularly in modernization initiatives, has led to significant improvementsin network quality. For instance, Matáv has reduced the percentage of faultsper main line per year from 14.82 percent in 2000 to 10.75 percent in 2002 andhas reduced the call failure rate for national calls from 0.67 percent to 0.35percent over the same period. The Company has also cut downtime per main lineper year from 1.60 hours in 2000 to 1.07 hours in 2002. Modernization,particularly the digitalization and rationalization of Matáv’s switchingarchitecture, has also contributed to increases in the productivity of itsemployees.

 

**INFORMATION TECHNOLOGY**

 

Matáv hasdedicated significant resources to improving its information technologysystems. Matáv believes that the continuing development of these systems isessential to improving customer service and the efficiency and productivity ofits employees.

 

Matáv’snationwide operational support system integrates the following elements:

 

•                  billing;

 

•                  automated callcollection;

 

•                  network trafficmanagement;

 

•                  work force and workflow management;

 

•                  element, network andservice management (configuration, alarm management, SLA management); and

 

•                  process controlledtechnical inventories.

 

This operationalsupport system permits Matáv to offer itemized billing, to bundle products andservices in tariff packages and to generate a single bill for customers withmultiple locations. Automated call collection maintains customer billinginformation and improves tracking of traffic. Network traffic managementfacilitates to significantly reduce traffic (and revenue) losses caused byunexpected traffic situations or technical outages, and in this way keeping theservice level as near to the required values as possible.

 

Matáv hasembarked on a number of other information technology initiatives designed tomonitor and improve the efficiency of its network and increase employeeproductivity. A switched network operations and management system facilitatesthe centralized management of services, switches, network and signaling.

 

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In 1997, Matávbegan implementing the network repair and provisioning system to improve thequality of its service while reducing costs. The Company implemented a remedybased Work and Force Management System (“WFMS”), a new testing system for itsaccess network and for POTS and ADSL services, and a new Automatic CallDistributor (“ACD”) to establish call centers receiving customers’ requests andcomplaints. The deployment of the test system, the ACD and the call centers wascompleted in the second quarter of 1999. The countrywide roll out of the WFMSwas completed in 2000. Matáv has implemented a new technical inventory platform(Xng) for supporting the activities of network resources and capacitymanagement.

 

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**ITEM 5**— **OPERATINGAND FINANCIAL REVIEW AND PROSPECTS**

 

*The following discussionshould be read together with the consolidated financial statements, includingthe accompanying notes, included in this annual report. The consolidatedfinancial statements, the accompanying notes as well as the discussion ofresults presented below have been prepared in accordance with IFRS. IFRSdiffers in certain respects from U.S. GAAP. For a discussion of the principaldifferences between IFRS and U.S. GAAP as they relate to the Company, see Note32 to the consolidated financial statements. Revenues and operating expensesdiscussed under*“*— Results of Operations — By Segment*”*do notreflect intersegment eliminations.*

 

Matáv’sresults of operations and its medium-term prospects should be considered inlight of a number of rapid and fundamental changes occurring in both theCompany and the environment in which it operates:

 

•                  *Market Liberalization.* The Company’s exclusive rights to provide domestic and internationallong distance service throughout Hungary ended in December 2001. Its exclusiverights to provide fixed line local service in 31 local concession areas endedin December 2001 and in its five local concession areas ended in May 2002.Emitel, Matáv’s fully owned subsidiary, had exclusive rights in an additionalthree concession areas through November 2002.

 

•                  *Interconnection Fees.*  From December 23, 2001 theinterconnection tariffs are no longer regulated by itemized price regulationbut according to the cost calculation methodology. The cost-based unbundlingand interconnection tariffs have to be approved by the CAC. The referenceoffers contain the approved tariffs. See “Item 4 - Regulation and Pricing”.Matáv is in the process of concluding interconnection agreements with otherfixed line and mobile service providers based on its approved reference offers.

 

•                  *Taxation.*  The Company benefits from reduced corporateincome tax. Through 1998, Matáv Rt. and Westel qualified for a 100 percentallowance. From January 1, 1999, Matáv Rt. has been utilizing a reducedallowance of 60 percent for a maximum possible five years (resulting in aneffective tax rate of 7.2 percent). From January 1, 1996 through December 31,1999, Westel 0660 utilized a reduced allowance of 60 percent. Managementbelieves that the conditions underlying the reduction in income tax willcontinue to be met by Matáv Rt. As a result of Matáv’s acquisition of theremaining 49 percent of Westel, foreign ownership fell below 30 percent, henceWestel lost its 60 percent reduction in income tax as of December 21, 2001.

 

•                  *Inflation.*  Annual inflation in Hungary, as measured bychanges in the consumer price index, averaged 9.8 percent in 2000, 9.2 percentin 2001 and 5.3 percent in 2002. The nominal increase in Matáv’s revenues overthis period is partly due to the effects of inflation and correspondingadjustments in tariffs, although many of Matáv’s tariffs have fallen in realterms and are beginning to decline in nominal terms as well. The increase innominal terms of many of the Company’s costs is also attributable to inflation.

 

•                  *Devaluation.*  In recent years, the Hungarian Forint hasbeen subject to significant devaluation. Until October 2001, the HungarianForint was devalued by a fixed monthly percentage against a currency basket.Devaluation can result in both realized and unrealized foreign exchange lossesrelating to non-Hungarian Forint denominated liabilities. These losses are includedin net interest and other charges relating to the Company’s foreign currencydenominated indebtedness.

 

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**OPERATING RESULTS**

 

**Resultsof Operations****— Total**

 

***Basis of presentation***

 

In March 2000, Deutsche Telekom finalized thepurchase of MediaOne’s interests in mobile operations in Central and EasternEurope including MediaOne International B.V. which owned 49 percent of Westeland 49 percent of Westel 0660. At the same time the Company was granted an optionto purchase the 49 percent holdings in Westel and Westel 0660 from DeutscheTelekom during the fifteen-month period ending September 2001. On December 21,2001 the Company became a 100 percent owner of both Westel and Westel 0660. Thefinal purchase price included HUF 226,750 million (EUR 920 million), paid inDecember 2001, financed by a loan from DT, plus HUF 11,515 million paid in2002, equal to 49 percent of the amount of dividends declared by Westel for theyear 2001.

 

The Company wascontrolled by DT so this was a transaction between parties under commoncontrol. The financial statements have been restated as if the Westels werewholly owned subsidiaries of Matáv since March 23, 2000, the date when DTacquired 49 percent of the Westels. The consideration for the Company’sacquisition of the Westels was financed by a loan from DT. The loan agreementwas completed on December 20, 2001. The book value of the Company’s additionalshare of net assets (including goodwill and other intangibles) of the Westelson March 23, 2000 has been presented as an increase in equity at December 31,2000 (HUF 252,408 million).

 

The impactof the restatement was to increase the amortization of intangibles by HUF16,780 million in 2000 and HUF 16,411 million in 2001, increase deferred taxcredit by HUF 456 million in 2000 and reduce deferred tax charge by HUF 26million in 2001 and decrease minority interest in the income statement by HUF14,213 million in 2000 and HUF 23,738 million in 2001. The minority interest inWestel and Westel 0660 was eliminated and considered as part of group netincome both for 2000 and 2001.

 

Matáv hasreviewed the classification of its data transmission products and based on thisreview, the leased lines and data transmission category has been redefinedeffective January 1, 2002. International incoming revenues relating to datatransmission products, reported in international traffic revenues earlier, havebeen reclassified into data transmission. Cable television revenues, reportedin data transmission earlier, have been reclassified into other services.Various ISDN charges, reported in data transmission in prior year reports, havebeen reclassified into subscriptions, connections and other charges. TheCompany has reclassified prior period revenue lines as well according to thesenew definitions.

 

***Total Revenues***

 

Matáv’s totalrevenues grew by 32.4 percent from 2000 to 2002. Matáv’s total revenuesamounted to HUF 445,945 million in 2000, HUF 547,735 million in 2001 and HUF590,585 million in 2002. Increases in revenues from fixed linetelecommunications services have been driven by increases in monthlysubscriptions tariffs, growth in leased line and data transmission revenues andthe introduction of new products and services. Revenues from mobiletelecommunications services grew by 63.9 percent from 2000 through 2002**drivenby a rapid increase in the mobile subscriber base. Total revenues of theCompany also grew through international expansion.

 

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***Total Operating Expenses***

 

TheCompany’s total operating expenses increased by 33.9 percent from 2000 to 2002.Operating expenses amounted to HUF 349,854 million in 2000, HUF 428,335 millionin 2001 and HUF 468,345 million in 2002. Matáv’s total operating expenses as apercentage of total revenues increased from 78.5 percent in 2000 to 79.3percent in 2002.

 

Depreciationand amortization and employee-related expenses are Matáv’s most significantoperating expenses.

 

Depreciationand amortization increased throughout the period as a result of Matáv’s ongoinginvestment in its networks. The increase is also a result of the increase inimpairment losses charged to tangible and intangible fixed assets in 2002, ascompared to 2001. The HUF 2,311 million impairment losses charged in 2001mostly related to analog cellular and security monitoring equipment. The HUF4,286 million impairment losses charged in 2002 mainly related to the publicpayphone assets and certain assets using 3.5 GHz technology and the relatedlicense.

 

In thefourth quarter of 2001, the analog mobile services became loss making after therapid development of the GSM services. This made it clear that cash generationpotential of the analog service had deteriorated so severely that it could notbe restored, therefore impairment charges had to be recognized.

 

Afterseveral years of significant losses in security monitoring services, managementdecided to transfer this service into a newly set up associated company, inwhich the controlling owner is a professional investor (Group 4). A certainpart of the assets was retained by Matáv. The future revenues of the Companywould consist of the rental fee for these assets, which does not providerecovery for the net book value of these assets, therefore impairment chargeshad to be recognized.

 

From 2000to 2002 the revenues generated by the public payphone business decreased by 18percent, which made the Company’s management reconsider the future operationsof the business unit. The Company decided to eliminate a number of loss-makingpublic payphones. The remaining infrastructure was also assessed to be able togenerate less cash in the future than would substantiate the book value ofthese assets. This resulted in an impairment charge.

 

In June2001 the Company acquired a license for the use of the 3.5 GHz bandwidth,through which Matáv planned to provide ISDN, leased line and IP based datacommunication services. Over the past 18 months Matáv has not utilized thepotential of the license, and the future cash generation capacity of thelicense and related assets was assessed and found to be inadequate. As aresult, the Company’s management recognized impairment losses for the licenseand the tangible assets installed for the utilization of the license.

 

Employee-relatedexpenses increased throughout the period as the effect of average wageincreases in nominal terms has more than offset the effect of reductions in thenumber of employees. In addition, with respect to the involuntary headcountreduction in 2003 and 2004, HUF 8,623 million provision was recorded in 2002 ontop of the expense related to the 2002 redundancies that amounted to HUF 1,442million. The employees impacted by the headcount reduction in 2003 and 2004include mostly network (in terms of nominal headcount) and logistics (inproportional terms) personnel. The reason for the headcount reduction was thatthe fixed line operations of the Company reached a point over the last yearswhere extensive growth had significantly slowed down, which thus required asmaller amount of workforce. In addition to the above, the technicaldevelopment in all areas of the Company, as well as the organizational changesimplemented in the Group, have resulted in increased efficiencies leading tosmaller headcount requirements. Approximately half of the redundancies providedfor were made in the first quarter of 2003. Headcount reduction planned in thefirst quarter of 2004 is expected to cost HUF 1,040 million, while the rest ofthe provision will be utilized in the remaining three-quarters of 2003. Thecash utilized for the severance payments are financed from the operatingcashflows of the Company.

 

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Otheroperating expenses increased during the period due primarily to increases inexpenses related to materials, agency fees, outsourcing of real estatemanagement and IT activities and contributions payable to the UniversalTelecommunication Support Fund.

 

## ***Total OperatingProfit***

 

Matáv’s totaloperating profit increased by 27.2 percent from HUF 96,091 million in 2000 toHUF 122,240 million in 2002, as the increase in total revenues was larger thanthe increase in operating expenses.

 

***Trend Information***

 

Matáv anticipatesthat growth rates of fixed line services will slow down or decline in the nearfuture because of the saturated market, the effect of liberalization of theHungarian telecommunications market and continuing tariff decreases. At thesame time, demand for mobile communications, data transmission, Internet accessand related services is expected to grow. As a result of these changes, theCompany’s traditional reliance on fixed line telecommunications revenues isexpected to shift gradually, and Matáv’s future growth is likely to bedependent largely on revenues from mobile telecommunications, datatransmission, Internet access and related services.

 

***Revenue and EBITDA margin targets***

 

In light ofMatáv’s refocused activities and increased operating expenses, we expect toachieve low single digit percent revenue growth and an EBITDA margin ofapproximately 40 percent in 2003.

 

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**Results of Operations — By Segment**

 

The followingtable sets forth revenues, operating expenses and operating profit by segment:

 
|                          |   | **Year  ended December 31,** |   |
|-------------------------------|--------|------------------------------|--------|
|                          |   | **2000**                     |   | **2001** |   | **2002** |   |
|                          |   | **(in  HUF millions)**       |   |
| Revenues:                     |   |                         |   |   |   |   |   |
| Fixed line                    |   | 326,280                      |   | 333,685 |   | 336,306 |   |
| Mobile                        |   | 159,345                      |   | 198,947 |   | 232,612 |   |
| International                 |   | n.a.                         |   | 60,034 |   | 67,562 |   |
| Intersegment eliminations (1) |   | (39,680                      | )      | (44,931 | ) | (45,895 | ) |
| Total                         |   | 445,945                      |   | 547,735 |   | 590,585 |   |
|                          |   |                         |   |   |   |   |   |
| Operating expenses:           |   |                         |   |   |   |   |   |
| Fixed line                    |   | 255,443                      |   | 273,542 |   | 292,642 |   |
| Mobile                        |   | 134,091                      |   | 163,154 |   | 180,222 |   |
| International                 |   | n.a.                         |   | 36,570 |   | 41,376 |   |
| Intersegment eliminations (1) |   | (39,680                      | )      | (44,931 | ) | (45,895 | ) |
| Total                         |   | 349,854                      |   | 428,335 |   | 468,345 |   |
|                          |   |                         |   |   |   |   |   |
| Operating profit:             |   |                         |   |   |   |   |   |
| Fixed line                    |   | 70,837                       |   | 60,143 |   | 43,664 |   |
| Mobile                        |   | 25,254                       |   | 35,793 |   | 52,390 |   |
| International                 |   | n.a.                         |   | 23,464 |   | 26,186 |   |
| Total                         |   | 96,091                       |   | 119,400 |   | 122,240 |   |

 

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(1)       Intersegmenteliminations include primarily interconnection fees between the fixed line andmobile networks.

 

***Fixed Line Telecommunications Segment***

 

Matáv’s fixedline telecommunications segment includes local, domestic and international longdistance telephone services as well as value added digifon services such ascall waiting, itemized billing and telephone and private branch exchangeequipment rental. This segment also consists of revenues from related services,such as leased lines, data transmission, Internet, equipment sales and cabletelevision.

 

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*Revenues*

 

The followingtable sets forth information regarding revenues for the fixed linetelecommunications segment:

 
|                                         |   | **Year  ended December 31,** |   | **Year  ended  December 31,** |   |
|----------------------------------------------|--------|------------------------------|--------|-------------------------------|--------|
|                                         |   | **2000**                     |   | **2001**                      |   | **2002** |   | **2001/2000** |   | **2002/2001** |   |
|                                         |   | **(in  HUF millions)**       |   | **(%  change)**               |   |
| Revenues:                                    |   |                         |   |                          |   |   |   |   |   |   |   |
| Subscriptions, connections and other charges |   | 84,016                       |   | 97,942                        |   | 98,797 |   | 16.6 |   | 0.9 |   |
| Domestic traffic revenues                    |   | 129,517                      |   | 123,366                       |   | 118,839 |   | (4.7 | ) | (3.7 | ) |
| Other usage                                  |   | 26,679                       |   | 24,276                        |   | 20,885 |   | (9.0 | ) | (14.0 | ) |
| International traffic revenues               |   | 39,008                       |   | 32,339                        |   | 27,274 |   | (17.1 | ) | (15.7 | ) |
| Leased lines                                 |   | 16,453                       |   | 18,010                        |   | 20,377 |   | 9.5 |   | 13.1 |   |
| Data transmission and related services       |   | 11,241                       |   | 15,184                        |   | 17,597 |   | 35.1 |   | 15.9 |   |
| Telecommunications equipment sales           |   | 4,810                        |   | 3,582                         |   | 3,671 |   | (25.5 | ) | 2.5 |   |
| Other revenues                               |   | 14,556                       |   | 18,986                        |   | 28,866 |   | 30.4 |   | 52.0 |   |
| Total                                        |   | 326,280                      |   | 333,685                       |   | 336,306 |   | 2.3 |   | 0.8 |   |

 

*Subscriptions, Connectionsand Other Charges. *Revenues from subscriptions, connections and other charges consist ofrevenues from monthly subscription fees, entrance fees, fees for digifonservices and rental charges for telephones and private branch exchanges.Revenues from subscriptions, connections and other charges are principally afunction of the number and mix of residential, business and ISDN access linesand corresponding charges.

 

Revenues fromsubscriptions, connections and other charges increased in both 2001 and 2002principally as a result of nominal increases in standard monthly subscriptionfees and increases in usage of digifon services.

 

Monthlysubscription fees for analog lines increased in nominal terms by 27.2 percenton February 1, 2001, by 3.9 percent on February 1, 2002 and by an additional3.0 percent on September 1, 2002*.*

 

The table belowsets forth information regarding average access lines in Matáv’s localconcession areas:

 
|                                                 |   | **Year  ended December 31,** |       | **Year  ended  December 31,** |       |
|------------------------------------------------------|--------|------------------------------|------------|-------------------------------|------------|
|                                                 |   | **2000**                     |       | **2001**                      |       | **2002** |   | **2001/2000** |   | **2002/2001** |   |
|                                                 |   |                         |       |                          |       |   |   | **(%  change)** |   |
| Average access lines in Matáv Rt.’s areas: |   |                         | ** ** |                          | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Residential                                          |   | 2,333,127                    |       | 2,213,601                     |       | 2,102,305 |   | (5.1 | ) | (5.0 | ) |
| Business                                             |   | 357,588                      |       | 306,778                       |       | 291,154 |   | (14.2 | ) | (5.1 | ) |
| Public payphones                                     |   | 36,448                       |       | 37,145                        |       | 36,908 |   | 1.9 |   | (0.6 | ) |
| Total                                                |   | 2,727,163                    |       | 2,557,524                     |       | 2,430,367 |   | (6.2 | ) | (5.0 | ) |
| ISDN channels                                        |   | 192,468                      |       | 382,859                       |       | 488,455 |   | 98.9 |   | 27.6 |   |
| Total                                                |   | 2,919,631                    |       | 2,940,383                     |       | 2,918,822 |   | 0.7 |   | (0.7 | ) |
|                                                 |   |                         |       |                          |       |   |   |   |   |   |   |
| Average access lines in Emitel’s areas:         |   | n.a.                         |       | 81,346                        |       | 80,212 |   | n.a. |   | (1.4 | ) |

 

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The number ofanalog lines decreased in 2001 and 2002, partly as a result of migration ofcustomers to ISDN lines as well as to mobile services. At the same time, thenumber of ISDN channels shows a significant growth over the period.

 

*Domestic Traffic Revenues.* Domestic traffic revenuesconsist of traffic charges for local and domestic long distance calls placed byMatáv’s subscribers. Domestic traffic revenues are a function of tariffs, thetotal number of telephone calls, the distribution of call duration, the time ofday and the mix between more costly domestic long distance calls and lessexpensive local calls.

 

Domestic trafficrevenues decreased in 2001 compared to 2000 mainly as a result of tariffdecreases. On February 1, 2001, Matáv decreased its local tariffs by 6.4percent and long distance tariffs by 11.9 percent, while tariffs for calls fromfixed line to mobile telephone did not change. These tariff decreases werepartly offset by increases in usage per line. Changes in tariffs did not have asignificant effect on call patterns. Domestic traffic revenues decreased in2002 compared to 2001 mainly as a result of decreased usage, partly offset byincreases in tariffs. On September 1, 2002, Matáv increased its local tariffsby 5.2 percent and long distance tariffs by 1.4 percent, while tariffs fromfixed line to mobile telephone did not change.

 

*Other Usage.* Revenues from other usageinclude amounts related to domestic and international long distance servicesthat Matáv provides to customers in non-Matáv Local Primary Areas or to mobilecustomers. Revenues from other usage decreased in 2001 and 2002 due todecreases in rates Matáv receives from other local telephone operators andmobile service providers.

 

*International TrafficRevenues. *Revenues from international traffic consist of revenues from outgoingand incoming international services. The following table sets forth informationconcerning international traffic revenues and outgoing and incominginternational traffic:

 
|                                        |   | **Year  ended December 31,**                    |       | **Year  ended  December 31,** |       |
|---------------------------------------------|--------|-------------------------------------------------|------------|-------------------------------|------------|
|                                        |   | **2000**                                        |       | **2001**                      |       | **2002** |   | **2001/2000** |   | **2002/2001** |   |
|                                        |   | **(in  HUF millions,  except traffic figures)** |       | **(%  change)**               |       |
| Revenues:                                   |   |                                            | ** ** |                          | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Outgoing international traffic revenue (1)  |   | 17,490                                          |       | 13,843                        |       | 12,018 |   | (20.9 | ) | (13.2 | ) |
| Incoming international traffic revenue (2)  |   | 21,518                                          |       | 18,496                        |       | 15,256 |   | (14.0 | ) | (17.5 | ) |
| Total                                       |   | 39,008                                          |       | 32,339                        |       | 27,274 |   | (17.1 | ) | (15.7 | ) |
|                                        |   |                                            |       |                          |       |   |   |   |   |   |   |
| Traffic in thousand of minutes:             |   |                                            | ** ** |                          | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Outgoing international at Matáv Rt.(3) |   | 182,479                                         |       | 166,649                       |       | 150,999 |   | (8.7 | ) | (9.4 | ) |
| Outgoing international at Emitel (4)        |   | n.a.                                            |       | 1,370                         |       | 2,545 |   | n.a. |   | n.a. |   |
| Incoming international (5)                  |   | 474,388                                         |       | 405,094                       |       | 369,054 |   | (14.6 | ) | (8.9 | ) |

 

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(1)              Excludesrevenues from calls placed by subscribers of other local telephone operatorsand mobile service providers. Matáv’s revenues relating to these calls areincluded in revenues from other usage.

(2)              Includesrevenues from calls transited by Matáv Rt. and terminating with subscribers ofMatáv, other local telephone operators and mobile service providers, transittraffic via Hungary and other international services.

(3)              Excludesminutes from calls placed by subscribers of other local telephone operators andmobile service providers. Matáv’s revenues relating to these calls are includedin revenues from other usage.

(4)              Trafficgenerated since July 1, 2001, the date when Emitel became a fully consolidatedsubsidiary of the Company.

(5)              Includesminutes from calls transited by Matáv Rt. and terminating with subscribers ofMatáv, other local telephone operators and mobile service providers. Does notinclude transit traffic and other international services via Hungary.

 

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Revenuesfrom outgoing international traffic are a function of tariffs and the number,duration and mix of calls to destinations outside Hungary placed by Matáv’sfixed line subscribers. In 2001, revenues from outgoing international trafficdecreased principally as a result of tariff decreases. Matáv decreased itsinternational tariffs by 15.0 percent on February 1, 2001. In 2002, revenuesfrom outgoing international traffic decreased primarily as a result ofdecreased usage due to the relatively high number of international calls placedby mobile subscribers and the rapid growth of private leased lines.

 

Revenues fromincoming international traffic consist of amounts paid by foreign carriers forthe use of Matáv’s network to carry calls placed by their customers. Revenuesfrom incoming international traffic decreased in 2001, principally as a resultof the decrease in international incoming traffic minutes. Revenues fromincoming international traffic further decreased in 2002, principally as aresult of the decrease in international incoming traffic minutes and thestrengthening of the Hungarian Forint against the SDR, in which internationalsettlement payments between telecommunications providers are generallydenominated.

 

*Leased Lines*.  Revenues from leased linesincreased in both 2001 and 2002 principally as a result of growth in the numberof leased line connections, which increased from 8,920 at December 31, 2000 to12,716 at December 31, 2002.

 

*Data Transmission andRelated Services.*  Revenues from data transmission and related services increased inboth 2001 and 2002 as a result of growth in the number of ISDN connections,Internet subscribers and ADSL customers. The number of ISDN channels has grownsignificantly, from 305,882 channels at the end of 2000 to 511,326 channels atthe end of 2002. The number of dial-up Internet subscribers increased by 34.4percent from December 31, 2000 to December 31, 2002. The number of ADSLcustomers has grown significantly, reaching 33,951 by the end of 2002.

 

*Telecommunications EquipmentSales.* Revenues from telecommunications equipment sales decreased in 2001compared to 2000 as a result of decreased equipment sales activity of MatávcomKft. A slight increase in telecommunications equipment sales revenue in 2002 isdue to the higher equipment sales activity at Matáv Rt.

 

*Other Revenues.*  Other revenues increased bothin 2001 and 2002 as a result of increased number of cable television customersand higher advertising revenue at Matáv Rt. from phonebook publishing. Throughnetwork development and acquisitions, the number of cable customers grewsignificantly, reaching 338,625 subscribers by the end of 2002 compared to300,857 at the end of 2001 and 267,246 at December 31, 2000. In 2002, theincrease in other revenues was also due to the subsidy receivable from theUniversal Telecommunication Support Fund. These increases were partly offset bylower construction and maintenance activities of Matávcom Kft. in 2001 comparedto 2000.

 

*Operating Expenses*

 

Operatingexpenses consist of employee-related expenses, depreciation and amortizationand other operating expenses. The following table sets forth informationregarding operating expenses:

 
|                                |   | **Year  ended December 31,** |   | **Year  ended  December 31,** |   |
|-------------------------------------|--------|------------------------------|--------|-------------------------------|--------|
|                                |   | **2000**                     |   | **2001**                      |   | **2002** |   | **2001/2000** |   | **2002/2001** |   |
|                                |   | **(in  HUF millions)**       |   | **(%  change)**               |   |
| Operating expenses:                 |   |                         |   |                          |   |   |   |   |   |   |   |
| Employee-related expenses           |   | 51,595                       |   | 53,775                        |   | 63,973 |   | 4.2 |   | 19.0 |   |
| Depreciation and amortization       |   | 60,932                       |   | 65,948                        |   | 76,664 |   | 8.2 |   | 16.2 |   |
| Payments to other network operators |   | 71,641                       |   | 74,560                        |   | 71,899 |   | 4.1 |   | (3.6 | ) |
| Cost of telecomm. equipment sales   |   | 5,071                        |   | 4,070                         |   | 3,706 |   | (19.7 | ) | (8.9 | ) |
| Other operating expenses            |   | 66,204                       |   | 75,189                        |   | 76,400 |   | 13.6 |   | 1.6 |   |
| Total                               |   | 255,443                      |   | 273,542                       |   | 292,642 |   | 7.1 |   | 7.0 |   |

 

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*Employee-related Expenses.* Employee-related expensesconsist of wages and salaries, social security and other expenses.Employee-related expenses increased in 2001 and 2002 due to wage increases andan increase in the relative proportion of higher paid skilled and managerialemployees, partly offset by a reduction in headcount. The official wageincrease for Matáv Rt.’s employees was 12.5 percent in April 2001 and 9.0percent in April 2002. Required social security contributions and bonus,welfare and pension payments rose in line with wages. Employee related expensesin 2000 include a HUF 8.6 billion severance provision made in connection withheadcount reduction in 2001. The growth in employee-related expenses in 2002 ispartially due to a HUF 8.2 billion severance provision made in the fixed linesegment in connection with headcount reductions in 2003 and 2004. The headcountis expected to be reduced by 1,100 in 2003 and 250 in 2004 at Matáv Rt.

 

The averagenumber of employees in the fixed line telecommunications segment decreased by1,686 employees or 12.8 percent in 2001 and by 575 employees or 5.0 percent in2002**asa result of a streamlining of the organizational structure, natural attritionand improved efficiency.

 

*Depreciation andAmortization.* Depreciation and amortization expenses increased in both 2001 and2002 as a result of continued investment in Matáv’s fixed linetelecommunications network*.*In preparation for the liberalizedmarket, Matáv carried out a review of its assets and organizational structurein the last quarter of 2000. This review resulted in accelerated depreciationand scrapping of certain fixed assets in an amount of HUF 3,442 million.Depreciation and amortization also increased in 2002 due to HUF 4.3 billionimpairment losses recorded in the fourth quarter. Impairment losses mainlyrelate to the public payphone assets and certain assets using 3.5 GHztechnology, accounted for due to changes in market conditions.

 

*Payments to Other NetworkOperators*. Payments to other network operators include amounts paid to mobileoperators, other local fixed line telephone operators and to foreign telephoneoperators for calls terminated on their network. Payments to other networkoperators increased in 2001 as a result of increased penetration of mobilecustomers. Payments to other network operators decreased in 2002 due to lowerinternational outpayments resulting from decreased international traffic ofMatáv Rt.

 

*Other Operating Expenses.* The majority of the increases in other operating expenses in 2001related to materials and maintenance, frequency and service fees, legal andother consulting fees, marketing fees, outsourcing of real estate and IToperations and provisions. In 2002, other operating expenses mainly increaseddue to higher agency fees resulting from the increased number of Internet andcable television customers and higher fees and levies due to contributionspayable to the Universal Telecommunication Support Fund.

 

# ***Operating Profit***

 

The followingtable sets forth information concerning operating profit and operating marginfor the fixed line telecommunications segment:

 
|                               |   | **Year  ended December 31,** |   | **Year  ended  December 31,** |   |
|------------------------------------|--------|------------------------------|--------|-------------------------------|--------|
|                               |   | **2000**                     |   | **2001**                      |   | **2002** |   | **2001/2000** |   | **2002/2001** |   |
|                               |   |                         |   |                          |   |   |   | **(%  change)** |   |
| Operating profit (in HUF millions) |   | 70,837                       |   | 60,143                        |   | 43,664 |   | (15.1 | ) | (27.4 | ) |
| Operating margin (%)(1)            |   | 21.7                         |   | 18.0                          |   | 13.0 |   | n.a. |   | n.a. |   |

 

----

(1)       Operatingmargin is the ratio of operating profit to revenue, expressed as a percentage.

 

In 2001,operating profit decreased by 15.1 percent partly as a result of tariffdecreases for fixed line telecommunication services. In 2002, operating profitdecreased by 27.4 percent partly as a result of the HUF 8.2 

 

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billion provision recorded in the fourth quarter of2002 for the severance payments expected to be incurred in 2003 and 2004 andHUF 4.3 billion impairment losses recorded in the fourth quarter of 2002.

 

***Mobile Telecommunications Segment***

 

*Revenues*

* *
|     |   | **Year  ended December 31,** |   | **December  31,** |   |
|----------|--------|------------------------------|--------|-------------------|--------|
|     |   | **2000**                     |   | **2001**          |   | **2002** |   | **2001/2000** |   | **2002/2001** |   |
|     |   | **(in  HUF millions)**       |   | **(%  change)**   |   |
|     |   |                         |   |              |   |   |   |   |   |   |   |
| Revenues |   | 159,345                      |   | 198,947           |   | 232,612 |   | 24.9 |   | 16.9 |   |

 

Revenuesfrom the mobile telecommunications segment consist of one-time connection fees,monthly subscription fees (only payable by postpaid customers), trafficcharges, including fees for value added services, and equipment sales. Revenuesincreased in 2001 and 2002 principally as a result of rapid growth in thenumber of subscribers. Within the mobile telecommunications segment, valueadded services show the highest increase, with nearly a 100 percent growth in2002 compared to 2001. Value added services represented approximately 10percent of revenues from mobile telecommunications services in 2002. Thisrevenue is primarily from fees charged for short message services.

 

The followingtable provides information concerning subscribers of mobile telecommunicationsservices and monthly usage of the network:

 
|                           |   | **Year  ended December 31,** |       | **Year  ended  December 31,** |       |
|--------------------------------|--------|------------------------------|------------|-------------------------------|------------|
|                           |   | **2000**                     |       | **2001**                      |       | **2002** |   | **2001/2000** |   | **2002/2001** |   |
|                           |   |                         |       |                          |       |   |   | **(%  change)** |   |
| Average number of subscribers: |   |                         | ** ** |                          | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Westel                         |   | 1,186,293                    |       | 2,008,667                     |       | 2,928,075 |   | 69.3 |   | 45.8 |   |
| Westel 0660                    |   | 87,411                       |       | 60,087                        |       | 33,827 |   | (31.3 | ) | (43.7 | ) |
|                           |   |                         |       |                          |       |   |   |   |   |   |   |
| Average monthly usage per      |   |                         | ** ** |                          | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Westel subscriber (minutes):   |   | 184                          |       | 146                           |       | 118 |   | (20.7 | ) | (19.2 | ) |

 

Westel’srevenues from mobile telecommunications services increased from 2000 through2002, primarily as a consequence of the continued growth in the Westelsubscriber base. The average number of Westel subscribers grew by 45.8 percentin 2002 compared to 2001. Within the Westel customers, the prepaid group showsa significant 51.8 percent increase. Prepaid customers accounted forapproximately 89.4 percent of gross additions in the year ended December 31,2002 and represented 75.0 percent of total Westel customers at December 31,2002. The churn rate of Westel is low compared to international benchmarks.Westel continuously monitors its churn rates and proactively offers tailor-madediscounts in order to retain valuable customers.

 

Theeffects of subscriber-base growth were partially offset by declines in averagemonthly minutes per subscriber, which management believes reflected the growthof the overall mobile telecommunications market to include more low-volumeusers. The decreasing MoU is also due to the increasing proportion of theprepaid customer base, which has lower minutes of usage than regularsubscribers. In addition, per minute charges also decreased in 2001 due toincreasing competition and to changes in call patterns, whereby the proportionof lower tariff calls (such as within network and off-peak period) hasincreased in the call distribution. In 2002, however, per minute chargesincreased slightly, resulting from the growing proportion of value addedservices used by mobile customers. As a result of lower MoU, ARPU decreasedfrom HUF 6,946 in 2001 to HUF 5,732 in 2002.

 

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Increases inmobile telecommunications services were partly offset by lower revenues fromWestel 0660 resulting from their significantly decreasing customer base.

 

*Operating Expenses*

 

Operatingexpenses consist of employee-related expenses, depreciation and amortizationand other operating expenses. The following table sets forth informationregarding operating expenses for the mobile telecommunications segment:

 
|                                |   | **Year  ended December 31,** |   | **Year  ended  December 31,** |   |
|-------------------------------------|--------|------------------------------|--------|-------------------------------|--------|
|                                |   | **2000**                     |   | **2001**                      |   | **2002** |   | **2001/2000** |   | **2002/2001** |   |
|                                |   | **(in  HUF millions)**       |   | **(%  change)**               |   |
| Operating expenses:                 |   |                         |   |                          |   |   |   |   |   |   |   |
| Employee-related expenses           |   | 14,429                       |   | 15,964                        |   | 17,457 |   | 10.6 |   | 9.4 |   |
| Depreciation and amortization       |   | 33,788                       |   | 40,282                        |   | 35,423 |   | 19.2 |   | (12.1 | ) |
| Payments to other network operators |   | 21,164                       |   | 30,456                        |   | 43,929 |   | 43.9 |   | 44.2 |   |
| Cost of telecomm. equipment sales   |   | 29,269                       |   | 32,863                        |   | 33,494 |   | 12.3 |   | 1.9 |   |
| Other operating expenses            |   | 35,441                       |   | 43,589                        |   | 49,919 |   | 23.0 |   | 14.5 |   |
|                                |   | 134,091                      |   | 163,154                       |   | 180,222 |   | 21.7 |   | 10.5 |   |

 

*Employee-related Expenses.* Employee-related expensesincreased in 2001 and 2002, principally as a result of higher workforce levelsand nominal increases in wages. The average number of mobile employees grew by44 or 2.7 percent in 2001 and by 58 or 3.4 percent in 2002, principally as aresult of increased sales and service personnel to accommodate the expandedsubscriber base. Employee-related expenses also include an approximately HUFone billion provision charge in 2000 and approximately HUF 0.4 billionprovision charge in 2002 that Westel 0660 took in the fourth quarter of 2000and 2002, respectively, for anticipated severance expenses.

 

*Depreciation andAmortization.* Depreciation and amortization expenses were restated in relationto the Westel acquisition. The restatement resulted in an additionalamortization of goodwill and intangible assets of HUF 16,780 million in 2000and HUF 16,411 million in 2001. Depreciation and amortization expenses also increasedin 2001 due to increases in property, plant and equipment and investment in themobile network. The restated numbers included amortization of goodwill over 15years in accordance with Deutsche Telekom’s policy. On acquisition by Matáv theremaining goodwill is amortized based on an original life of 20 yearsconsistent with Matáv’s policy and the treatment of the goodwill alreadyexisting in relation to Westel. As a results depreciation and amortizationdecreased in 2002 compared to 2001.

 

*Payments to Other NetworkOperators. *Payments to other network operators include amounts paid by Westel andWestel 0660 to other mobile telephone operators and to the fixed line telephoneoperators as well as to the foreign mobile telephone operators for terminatingtheir calls. Payments to other network operators increased in both 2001 and2002 as a result of the significantly higher subscriber base of Westel.

 

*Cost of TelecommunicationsEquipment Sales. *Cost of telecommunications equipment sales increased in both 2001 and2002 as a result of a significantly higher number of mobile handsets sold. In2002, this increase was largely offset by the lower average cost of the mobilephonesets.

 

*Other OperatingExpenses. *Other operating expenses increased in both 2001 and 2002, principallydue to marketing expenses, SIM costs, maintenance of base stations, upgradingsoftware and hardware support to accommodate the needs of the increasedsubscriber base and higher local taxes and frequency fees. In addition, in

 

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2002 other operating expenses also increased due tocontributions payable to the Universal Telecommunication Support Fund.

 

*Operating Profit*

 

The followingtable sets forth information concerning operating profit and operating marginfor the mobile telecommunications segment:

 
|                               |   | **Year  ended December 31,** |   | **Year  ended  December 31,** |   |
|------------------------------------|--------|------------------------------|--------|-------------------------------|--------|
|                               |   | **2000**                     |   | **2001**                      |   | **2002** |   | **2001/2000** |   | **2002/2001** |   |
|                               |   |                         |   |                          |   |   |   | **(%  change)** |   |
|                               |   |                         |   |                          |   |   |   |   |   |   |   |
| Operating profit (in HUF millions) |   | 25,254                       |   | 35,793                        |   | 52,390 |   | 41.7 |   | 46.4 |   |
| Operating margin (%)(1)            |   | 15.8                         |   | 18.0                          |   | 22.5 |   | n.a. |   | n.a. |   |

 

----

(1)       Operatingmargin is the ratio of operating profit to revenue, expressed as a percentage.

 

Operating profitincreased by 41.7 percent in 2001 and by 46.4 percent in 2002 mainly as aresult of significant growth in the number of mobile customers.

 

***International Segment***

 

The internationalsegment includes the four Macedonian companies:

 

•             Stonebridge, the holdingcompany through which Matáv controls MakTel;

 

•             MakTel, Macedonia’sexclusive fixed line telecommunications company;

 

•             Mobimak, MakTel’ssubsidiary, a cellular telecommunications service provider in Macedonia; and

 

•                  Telemacedonia A.D.through which Matáv provides management and consultancy services to MakTel,Mobimak A.D. and Stonebridge.

 

Inaddition, the results of the international segment also include the goodwillamortization arising from the consolidation of MakTel.

 

MakTel hasbeen a consolidated company of Matáv since January 15, 2001. MakTel had 594,213fixed lines (including ISDN channels), 366,348 mobile subscribers and 34,222Internet subscribers at December 31, 2002.

 

In 2002,revenues in the international segment increased by 12.5 percent compared to2001. The majority of the increase relates to higher mobile revenues resultingfrom nearly doubling the average mobile subscriber base. The number of mobilesubscribers reached 366,348 by the end of 2002 compared to 221,336 at the endof 2001. Within the mobile customer base, the number of prepaid subscribersshows more significant growth, which represented approximately 75 percent oftotal mobile customers by December 31, 2002 compared to 61 percent at the endof 2001. The significant growth of mobile customer base was partially offset bylower mobile ARPU.

 

Domesticfixed line traffic revenues also increased in 2002 as a result of highertariffs. International fixed line traffic revenues declined in 2002, due tolower international usage (both outgoing and incoming) as well as tariff 

 

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decreases. The number of fixed line customersincreased to 594,213 at December 31, 2002 compared to 549,988 at the end of2001, representing an eight percent growth.

 

Leasedline and data transmission revenues grew dynamically in 2002, but stillrepresent only three percent of total revenues in the international segment.The increase in data transmission revenues was due to the higher number ofInternet customers, which reached 34,222 by the end of 2002 from 21,674 at theend of 2001.

 

Totaloperating expenses increased by 13.1 percent in 2002 mainly because ofincreases in employee related expenses, cost of telecommunications equipmentsales, debtor provision and marketing expenses.

 

Theinternational segment has a strong, 54.5 percent EBITDA margin and 38.8 percentoperating margin for the year ended December 31, 2002.

 

Minorityinterests of HUF 13,973 in 2001 and HUF 13,632 million in 2002 mainly representthe share of income accruing to the minority owners of MakTel and Stonebridge.Minority interest is not calculated on the amortization relating to thegoodwill acquired by Matáv Rt.

 

***Net Interest and Other Charges — Total***

 

Thefollowing table sets forth information concerning net interest and othercharges:

 
|                                      |   | **Year ended December 31,** |   | **Year ended  December 31,** |   |
|-------------------------------------------|--------|-----------------------------|--------|------------------------------|--------|
|                                      |   | **2000**                    |   | **2001**                     |   | **2002** |   | **2001/2000** |   | **2002/2001** |   |
|                                      |   | **(in HUF millions)**       |   | **(% change)**               |   |
| Interest expense:                         |   |                        |   |                         |   |   |   |   |   |   |   |
| Hungarian Forint                          |   | 11,490                      |   | 11,592                       |   | 14,173 |   | 0.9 |   | 22.3 |   |
| Foreign currency                          |   | 5,318                       |   | 9,149                        |   | 12,459 |   | 72.0 |   | 36.2 |   |
| (Gains)/losses on swap agreements         |   | 0                           |   | (582                         | )      | 9,435 |   | n.m. |   | n.m. |   |
| Net foreign exchange losses/(gains)       |   | 4,835                       |   | (6,930                       | )      | (10,948 | ) | n.m. |   | 58.0 |   |
| Bank charges and other financial expenses |   | 2,042                       |   | 2,420                        |   | 3,686 |   | 18.5 |   | 52.3 |   |
| Total interest payable and other charges  |   | 23,685                      |   | 15,649                       |   | 28,805 |   | (33.9 | ) | 84.1 |   |
| Interest capitalized                      |   | (626                        | )      | (404                         | )      | (226 | ) | (35.5 | ) | (44.1 | ) |
| Interest and other financial income       |   | (2,067                      | )      | (2,141                       | )      | (660 | ) | 3.6 |   | (69.2 | ) |
|                                      |   | 20,992                      |   | 13,104                       |   | 27,919 |   | (37.6 | ) | 113.1 |   |

 

Netinterest and other charges decreased in 2001 primarily as a result of adecrease in net foreign exchange loss. Net foreign exchange loss decreased in2001 due to the reduced rate of monthly devaluation and better performance ofthe Hungarian Forint within the intervention band in relation to the currencybasket. In addition, in 2001 foreign exchange loss also decreased due tosignificant strengthening of the Hungarian Forint following the widening of theintervention band. In 2001, in shifting the loan portfolio to Hungarian Forintdenominated loans, Matáv benefited from decreasing Hungarian Forint interestrates. In 2001, interest expense on foreign currency loans increasedsignificantly because of the foreign exchange denominated loans taken from DTto finance the acquisitions of MakTel and the remaining 49 percent of Westel.

 

Net interest andother charges increased in 2002 primarily as a result of an increase in theaverage amount of loans resulting from the foreign exchange denominated loans takenfrom DT to finance the acquisitions of the remaining 49 percent of Westel onDecember 20, 2001. The interest expense in Hungarian Forint increased as wellin 2002 because Matáv has been gradually shifting the loan portfolio toHungarian Forint denominated loans. Due to the strengthening of the HungarianForint against the Euro in 2002, losses on swap agreements increasedsignificantly, which was partially compensated by the significant increase ofthe foreign exchange gains 

 

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on the foreign exchange denominatedloans.  See Item 11 for certainquantitative and qualitative information about financial instruments.

 

***Income Tax — Total***

 

Thefollowing table sets forth information concerning income tax expense incurredby the Company:

 
|                          |   | **Year ended December 31,** |   | **Year ended  December 31,** |   |
|-------------------------------|--------|-----------------------------|--------|------------------------------|--------|
|                          |   | **2000**                    |   | **2001**                     |   | **2002** |   | **2001/2000** |   | **2002/2001** |   |
|                          |   | **(in HUF millions)**       |   | **(% change)**               |   |
|                          |   |                        |   |                         |   |   |   |   |   |   |   |
| Income tax expense /(benefit) |   | 7,752                       |   | 11,733                       |   | 13,245 |   | 51.4 |   | 12.9 |   |

 

The Companyand the Westels qualified for a reduction in income tax payable on meetingcertain conditions. These conditions include (1) that one half of the company’sannual revenues originate from public telecommunications services; (2) that thecompany’s initial share capital exceeds HUF 50 million; and (3) that at least30 percent of the company’s initial share capital is held by non-Hungarians.

 

Thereductions in the tax payable amounts are a 100 percent allowance for fiveyears from the date of qualification and a 60 percent allowance for a furtherfive years. Through 1998, Matáv Rt. and Westel qualified for the 100 percentallowance. Through 1995, Westel 0660 utilized the 100 percent allowance. SinceJanuary 1, 1999, Matáv Rt. has been utilizing the reduced allowance of 60percent, which is allowed for a total of five years (resulting in an effectivetax rate of 7.2 percent). From January 1, 1996 through December 31, 1999,Westel 0660 utilized the reduced allowance of 60 percent.

 

Managementbelieves that the conditions underlying the reduction in income tax willcontinue to be met by Matáv Rt. As a result of Matáv’s acquisition of theremaining 49 percent of Westel, foreign ownership fell below 30 percent, henceWestel lost its 60 percent reduction in income tax as of December 21, 2001.This resulted in a deferred tax credit of approximately HUF 1,600 million in2001. All other Hungarian subsidiaries were subject to income tax of 18percent, while the Macedonian companies are subject to income tax of 15 percent.

 

Differences intiming between tax regulations and financial reporting generate deferred taxassets and liabilities in the consolidated financial statements. The Companyrecords these temporary differences according to the liability method in thecurrent period.

 

Deferred taxassets are recognized for tax loss carry forwards only to the extent thatrealization of the related tax benefit is probable. Recognized tax losses ofHUF 1,615 million will expire in 2003, HUF 100 million will expire in 2005, HUF5,842 million will expire in 2006 and HUF 5,112 million will expire in 2007. Ofthe recognized tax losses, HUF 4,949 million is not subject to statutorylimitations.

 

Income taxexpense increased in 2001 compared to 2000 mainly due to higher taxable profitof Westel, higher deferred tax expense to cover the tax impact of futurenon-deductible depreciation expenses and deferred tax expense relating tonon-taxable release of severance provisions. In addition, income tax expenseincreased both in 2001 and 2002, because Westel lost its 60 percent reductionin income tax as of December 21, 2001 as its foreign ownership fell below 30percent.

 

Accordingto the Act LXXXI/1996 on Profit Taxation as modified by Act XLII/2002,corporate tax allowances are available for companies investing in broadbandInternet service provision effective January 1, 2003. Depending on thegeographic area of the investments, between 30 and 50 percent of the broadbandaccess buildout related capital expenditure with a minimum amount of HUF 100million can be deducted from the 

 

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income tax for a maximum of five yearsstarting either in the year of completing the investment or in the followingyear. As a result of this allowance, Matáv Rt. expects its income tax expenseto decrease significantly from 2003.

 

**SIGNIFICANT ACCOUNTINGPOLICIES**

 

Matáv’sdiscussion and analysis of its financial condition and results of operationsare based upon Matáv’s consolidated financial statements, which have beenprepared in accordance with IFRS. Reported financial conditions and results ofoperations of Matáv are sensitive to accounting methods, assumptions andestimates that underlie the preparation of the financial statements. Matávbases its estimates on historical experience and on various other assumptions,the results of which form the basis for making judgments about the carryingvalues of assets and liabilities that are not readily apparent from othersources.

 

Theselection of critical accounting policies, the judgments and otheruncertainties affecting application of those policies and the sensitivity ofreported results to changes in conditions and assumptions are factors to beconsidered when reviewing Matáv’s financial statements. Matáv believes thefollowing critical accounting policies involve the most significant judgmentsand estimates used in the preparation of its consolidated financial statements.

 

***Depreciable lives of assets***

 

Property,plant and equipment and purchased intangible assets other than goodwill arerecorded at acquisition cost. If such assets are acquired in a businesscombination, the purchase price is allocated to the estimated fair value of theacquired property, plant and equipment and intangible assets. Property, plant,equipment and intangible assets are depreciated or amortized on a straight-linebasis over their estimated useful lives.

 

Thedetermination of the useful lives of assets is based on historical experiencewith similar assets as well as any anticipated technology evolution and changesin broad economic or industry factors. The appropriateness of the estimateduseful lives is reviewed annually, or whenever there is an indication ofsignificant changes in the underlying assumptions.

 

Matávbelieves that the accounting estimate related to the determination of theuseful lives of assets is a critical accounting estimate since it involvesassumptions about technology evolutions in an innovative industry. Further, dueto the significant weight of long-lived assets in the asset base of Matáv, theimpact of any changes in these assumptions could be material to the Company’sfinancial position, as well as the results of operations.

 

As ofJanuary 1, 2002, the Company revised and changed the useful lives of certaintangible fixed assets considering their technical obsolescence (e.g. network,servers and routers). This change resulted in additional planned depreciationin an amount of HUF 4,202 million.

 

##### ***Impairment of property, plant andequipment and intangibles***

 

Matávassesses the impairment of identifiable property, plant, equipment andintangibles whenever there is reason to believe that the carrying value maymaterially exceed the fair value and where a permanent impairment in value isanticipated. When an impairment in the value of assets occurs, nonscheduledwrite-downs are made. Impairment is based on a broad measure of factors, thedetermination of impairment of property, plant, equipment and intangible assetsalso involves the use of estimates which include but are not limited to thecause, the timing and the amount of the impairment. Among others, the Companytypically considers future revenues and expenses, technological obsolescence,discontinuance of services and other changes in circumstances that may indicatean impairment.

 

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The needfor the above assumptions and the fact that recognizing an impairment couldhave a material impact on the financial position and operating results of theCompany make the management believe that the accounting estimate related toasset impairment is a critical accounting estimate.

 

Impairmentlosses charged in 2002 mainly relate to the public payphone assets and certainassets using 3.5 GHz technology and the related license, accounted for due tochanges in market conditions. The recoverable amount, determined at the cashgenerating unit level, represents the value in use determined using discountedcash flow analysis.

 

**Allocation of purchase price**

 

Accountingfor property, plant, equipment and intangible assets involves the use ofestimates for determining fair value at the acquisition date and the usefullives of the assets over which the costs of acquiring these assets are chargedto the income statement.

 

Theallocation of the purchase price is highly judgmental and requires extensiveuse of estimates and fair value assumptions. Further, the depreciation andimpairment of the purchase price allocated to long-lived assets can have animpact on the financial position and operating results of the Company. Based onthis management believes that the accounting estimate related to purchase priceallocation is a critical accounting estimate.

 

**Valuation of goodwill**

 

UnderIFRS, goodwill resulting from business combinations is amortized on a straight-linebasis over its useful life. The determination of goodwill is dependent on theallocation of the purchase price to individual assets acquired and theliabilities assumed. Such an allocation is based on management’s judgment. Inaddition, the useful life assigned to goodwill is an estimate based on thejudgement of management at the time of acquisition.

 

Matávreviews the performance of its subsidiaries regularly and the fair value of therelated goodwill is determined if indicators of impairment exist. When there isreason to believe that the goodwill arising from acquisitions is impaired,Matáv records an impairment charge in the depreciation and amortization line ofthe income statement. Matáv uses estimates in determining fair values and the amountof any goodwill impairment.

 

For U.S.GAAP purposes, on January 1, 2002, Matáv adopted Statement of FinancialAccounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets”. Onadoption of SFAS 142, Matáv stopped amortizing goodwill. According to SFAS 142goodwill has to be tested at least annually for impairment. After initialadoption of the statement, any future impairment has to be recorded inamortization expense.

 

Matávcompleted the impairment tests first in the first half of 2002 for January 1,2002, then in November 2002. As a result, no impairment was recorded under U.S.GAAP.

 

Matávbelieves that the accounting policies related to goodwill are criticalaccounting policies. Under U.S. GAAP, the determination of the value of goodwillinvolves assumptions about fair values, and the impact of recognizing animpairment could be material to the financial statements and operating results.In case of IFRS financial statements, the useful lives of goodwill aredetermined based on assumptions made on the expected economic life of theentities they relate to. The impact of changes in these assumptions could besignificant to the result of operations.

 

As none ofthe subsidiaries of Matáv Group are listed companies, the fair values of thebusiness units and reportable segments are calculated based on the discountedcash flows to be generated by these units.

 

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**Revenue recognition**

 

Revenuesfor all services, shown net of VAT**and discounts and after eliminated saleswithin Matáv, are recognized when products and services are provided.

 

Aproportion of the revenue received is paid to other operators for the use oftheir networks, where appropriate. These revenues and costs are stated gross inthese consolidated financial statements.

 

Revenuesearned from connecting subscribers to the mobile network are recognized uponservice activation. Revenues and costs from sale of telephone sets arerecognized upon delivery.

 

Revenuesfrom sale of public phone cards, prepaid mobile cards and prepaid Internetcards are recognized when used by the customers or when expire unused.

 

A portionof the fees charged to Matáv customers upon connection to the fixed linenetwork prior to October 15, 1997 represented contributions to the cost ofnetwork construction. The capital contribution element of such fees wasdeferred and is amortized to revenue over the life of the related assets in theIFRS financial statements. Legislation was enacted effective October 15, 1997 eliminatingrefunds of such fees and signaling the removal of any capital contributionelement of future customer fees. Since October 1997, these connection fees arerecognized in the income statement upon connection, reflecting the change inrelated legislation and the advanced development of the network.

 

Under U.S.GAAP, Matáv defers the recognition of customer activation revenues and relatedincremental customer activation costs and amortizes them over the expectedduration of the customer relationship. Matáv assesses the estimated averageduration of the relationship based on historical customer churn. Ifmanagement’s estimates are revised, differences may result in the amount andtiming of Matáv’s revenue for any period. Although this estimate does not haveany impact on the future cashflows of the company, the timing and the amount ofthe recognition of these revenues can have a significant impact on the revenuesand consequently on net income.

 

**Deferred taxes**

 

Matáv isrequired to estimate its actual current tax exposure and to assess thetemporary differences resulting from differing treatment of items for tax andfinancial reporting purposes. The principal temporary differences arise fromdepreciation on property, plant and equipment, intangible assets, deferredrevenue and unrealized foreign exchange gains, impairment of receivables andinventory, provisions for liabilities and charges, government loans and taxlosses carried forward. These differences result in deferred tax assets andliabilities, which are included in Matáv’s consolidated balance sheet. Matávmust assess in the course of its tax planning procedures the fiscal year of thereversal of its deferred tax assets and liabilities. The actual reversal ofthese timing differences may be different from initial expectations.

 

Matávbelieves that the accounting estimate related to establishing deferred taxasset balances is a critical accounting estimate since it involves judgmentalassumptions about the probability of future taxable income to realize the taxbenefit of tax loss carry forwards, and involves assumptions on the timing ofreversing differences.

 

**Impairment loss for doubtfulaccounts**

 

Managementcalculates impairment for doubtful accounts for estimated losses resulting fromthe inability of Matáv’s customers to make required payments. Management basesits estimates on the aging of Matáv’s accounts receivable balances and Matáv’shistorical write-off experience, customer credit-worthiness and changes inMatáv’s customer payment terms when evaluating the adequacy of the impairmentloss for doubtful accounts.

 

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Matávbelieves that the accounting estimate related to impairment of doubtfulreceivables is a critical accounting estimate since it involves assumptionsabout future customer behavior and the resulting future cash collections. Ifthe financial condition of Matáv’s customers were to deteriorate, actualwrite-offs of currently existing receivables may be higher than expected andmay exceed the level of the impairment losses recognized so far.

 

**Fair value of financialinstruments**

 

In assessing thefair value of non-traded derivatives and other financial instruments, Matávmakes assumptions that are based on market conditions existing at each balancesheet date. Matáv uses the discounted value of future estimated cashflowsmethod to determine the fair value of derivatives and other financialinstruments.

 

**LIQUIDITY AND CAPITALRESOURCES**

 

Thefollowing table sets forth information concerning the Company’s cash flows:

 
|                                                                  |   | **Year ended December 31,** |   |
|-----------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                  |   | **2000**                    |   | **2001** |   | **2002** |   |
|                                                                  |   | **(in HUF millions)**       |   |
| Net cash flows:                                                       |   |                        |   |   |   |   |   |
| From operating activities                                             |   | 156,449                     |   | 196,545 |   | 199,043 |   |
| From investing activities                                             |   | (145,805                    | )      | (429,550 | ) | (119,941 | ) |
| From financing activities                                             |   | (3,932                      | )      | 230,197 |   | (80,054 | ) |
| Effect of foreign exchange rate changes on cash and  cash equivalents |   | 0                           |   | (371 | ) | (314 | ) |
| Change in cash and cash equivalents                                   |   | 6,712                       |   | (3,179 | ) | (1,266 | ) |
| Cash and cash equivalents, beginning of period                        |   | 6,584                       |   | 13,296 |   | 10,117 |   |
| Cash and cash equivalents, end of period                              |   | 13,296                      |   | 10,117 |   | 8,851 |   |

 

*Net Cash Flows fromOperating Activities.* Matáv’s primary source of liquidity is cashflows from operating activities.

 

Net cash flowsfrom operating activities increased by HUF 40,096 million in 2001 compared to2000, primarily due to higher operating profit, which increased by HUF 23,309million. In 2001, the change in receivables decreased by HUF 6,546 million, andthe change in payables increased by HUF 6,250 million, both of which led to acorresponding increase in net cash flows from operating activities. These cashinflows were partly offset by the increase of HUF 5,233 million in income taxpaid.

 

Net cash flowsfrom operating activities increased by HUF 2,498 million in 2002 compared to2001, primarily due to higher operating profit, which increased by HUF 2,840million. In 2002, the change in receivables decreased by HUF 4,495 million,which led to a corresponding increase in net cash flows from operatingactivities. In 2002, the change in payables decreased by HUF 18,432 million,which led to a corresponding decrease in net cash flows from operatingactivities.

 

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*Net Cash Flows fromInvesting Activities*.  Net cash flows from investing activities are primarily driven bythe purchase of subsidiaries and capital expenditures. Matáv invested HUF324,813 million in the purchase of subsidiaries in 2001, mainly for the acquisitionof MakTel in January 2001 and the remaining 49 percent of Westel in December2001. The HUF 13,230 million spent on purchase of subsidiaries in 2002represents mainly the additional HUF 11.5 billion paid to DT in connection withthe Westel acquisition. Capital expenditures were HUF 152,784 million in 2000,HUF 127,747 million in 2001 and HUF 109,988 million in 2002.

 

*Net Cash Flows fromFinancing Activities*.  Net cash flows from financing activities are primarily driven bythe Company’s borrowing activities. Matáv received net proceeds from loans ofHUF 4,915 million in 2000, HUF 249,164 million in 2001 and had a net repaymentof loans of HUF 69,358 million in 2002. The net proceeds of HUF 249,164 millionin 2001 were received to finance the acquisition of subsidiaries.

 

*Net Working Capital.* Although the Company’s current liabilities exceeded current assets atDecember 31, 2000, 2001 and 2002, Matáv was capable of meeting payables as theyfell due from its positive operating cash flow. In addition, Matáv has built upand maintains a significant level of undrawn committed credit facilities whichit uses, when necessary, to meet current liabilities as they fall due.Management believes it has adequate working capital to finance the Company’soperations.

 

At December 31,2002, Matáv had undrawn committed credit facilities of HUF 14,227 million.These credit facilities, should they be drawn down, are subject to an interestrate of LIBOR, BUBOR and commercial floating bank prime rates plus a margindepending on the currency and institution providing the facilities. There arepledges on receivables for loans totaling HUF 1,004 million.

 

*Indebtedness*.  The Company’s totalindebtedness analyzed by currency is as follows:

 
|             |   | **At December 31,**   |   |
|------------------|--------|-----------------------|--------|
|             |   | **2001**              |   | **2002** |   |
|             |   | **(in HUF millions)** |   |
|             |   |                  |   |   |   |
| Hungarian Forint |   | 113,554               |   | 193,404 |   |
| EURO             |   | 318,796               |   | 172,497 |   |
| U.S. Dollar      |   | 21,020                |   | 8,106 |   |
|             |   | 453,370               |   | 374,007 |   |

 

HUF228,340 million is scheduled for repayment in 2003, HUF 40,660 million isscheduled for repayment in 2004 and HUF 15,733 million is scheduled forrepayment in 2005. Matáv expects scheduled repayments of indebtedness to befinanced through refinancing by DT, from cash flows from operating activitiesand from undrawn committed credit facilities. DT has pledged its support forMatáv’s financing needs through to June 30, 2004.

 

As ofDecember 31, 2002, approximately 66.7 percent of the Company’s indebtednessbore interest at variable rates. The Company’s Hungarian Forint denominatedfloating rate indebtedness is subject to interest rates between 8.36 percentand 10.28 percent based on various reference rates, including BUBOR and therate quoted by the National Bank of Hungary. The Company’s foreign currencydenominated floating rate indebtedness is subject to a 3.84 percent interestrate, which is based on EURIBOR plus a margin.

 

On March 24,1998, the Company completed two domestic bond offerings. A one-year bondoffering in the total amount of HUF five billion was fully subscribed andsubsequently repaid on March 26, 1999. The other transaction included five-yearbonds with a total amount of HUF 10 billion with interest payable semi-annuallyat an interest rate of 50 basis points over the average yield of the last threeauctions of six-month Hungarian Treasury Bills. These five-year bonds werefully repaid on the maturity date of March 25, 2003.

 

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On June22, 2000, Matáv launched a HUF 45 billion bond program. This program allowsMatáv to issue fixed, floating or zero coupon bonds with maturities of between1 and 10 years. On July 12, 2000, Matáv issued a three-year, fixed rate tranchein the nominal amount of HUF 10 billion. The bonds were sold at an averageprice of 51 basis points over three-year Hungarian Treasury Bills. On March 21,2001, Matáv issued a 2.5-year fixed rate 9.25 percent bonds in a nominal amountof HUF three billion. The bonds were sold at an average price of 74 basispoints over the three-year Hungarian Treasury Bills.

 

Matáv’soperating revenues and expenses are denominated almost entirely in HungarianForints. Amounts payable to and receivable from other international carriers,which are denominated in a basket of currencies known as SDRs, are nettedagainst one another and settled primarily in U.S. dollars and Euros. Capitalexpenditures are denominated partly in foreign currencies, principally U.S.dollars and Euros.

 

Certainloan agreements contain covenant restrictions that require the maintenance ofpre-defined financial ratios. Breach of those covenants would make HUF 54,882million due and payable in 30 days if not remedied.  At December 31, 2002 the Company was in compliance with thesecovenants. One of the covenants allows a debt to EBITD (earnings beforeinterest, tax and depreciation) ratio of maximum 2.5 and 3.0 (in the differentagreements), while the actual ratio was 1.53. The other covenant requires themaintenance of an EBITD to interest expense ratio of minimum 2.0, while theactual ratio was 8.8.

 

For theacquisition of a 44 percent stake in MakTel, Matáv received a loan of EUR 301.5million (HUF 79,985 million) from Deutsche Telekom Finance B.V. on January 15,2001. The loan is based on a variable rate of EURIBOR plus 30 basis points andrepayable in one amount on January 31, 2006. Interest payments are duesemi-annually.

 

For theacquisition of the remaining 49 percent stake in Westel, Matáv received a loanof EUR 920 million (HUF 226,750 million) from Deutsche Telekom Finance B.V. onDecember 20, 2001. The loan is based on a variable rate of EURIBOR plus 50basis points and repayable in one amount on August 14, 2003. Interest paymentsare due quarterly.

 

Foradditional information about market risk sensitive instruments see “Item 11 —Quantitative and qualitative disclosures about market risk”.

 

In 2000,Matáv approached both Moody’s and S&P to initiate rating coverage.

 

Moody’sinitial credit rating for the long-term senior unsecured foreign and domesticcurrency ratings, announced on November 14, 2000, was Baa1, with a stableoutlook.

 

OnDecember 7, 2000, S&P announced a local corporate credit rating of A- withnegative outlook, and a foreign currency corporate credit rating of BBB+ withpositive outlook. The local currency rating took into account the DT influence,whereas for the foreign currency rating, the positive outlook of the Hungariansovereign was factored in. On January 3, 2001, S&P raised the long-termforeign currency corporate rating of Matáv to A- from BBB+, and revised theoutlook to negative from positive. The rating actions reflected the upgrade ofthe long-term foreign currency issuer credit rating on the Republic of Hungary.

 

OnFebruary 25, 2002 both Moody’s and S&P put DT on negative watch and stateda possible one-notch downgrade of DT referring to pressure to reduce debt anddoubts over asset sales. Following this step Standard & Poor’s placed Matávon negative watch as well quoting the correlation with DT as the solejustification for a possible downgrade, while emphasizing the satisfying ownperformance of Matáv.

 

S&Pplaced DT off credit watch and downgraded its rating by one notch to BBB+ withstable outlook on April 8, 2002. In line with S&P’s methodology, Matáv, asa strategically owned subsidiary of DT, was downgraded to BBB+ with stableoutlook as well on the same day. S&P quoted DT’s downgrade as the rationalefor the downgrade of Matáv and emphasized its good 2001 results again.

 

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Despiteputting DT on negative watch and downgrading DT to Baa1 with stable outlookfrom A3 on March 28, 2002, Moody’s maintained Matáv’s rating of Baa1 withstable outlook and did not place the Company on credit watch.

 

Matáv’scontractual obligations, including commitments for future payments undernon-cancelable lease arrangements and short and long term debt arrangements,are summarized below and are disclosed in more details in Notes 14 and 26 toMatáv’s Consolidated Financial Statements. Matáv does not participate in, norsecure, financings for any unconsolidated, limited purpose entities.

 
|                                                      |   | **Payments Due by Period** |       |
|-----------------------------------------------------------|--------|----------------------------|------------|
|                                                      |   | **Total**                  |       | **Less than  one year** |   | **1-2 years** |   | **3-4 years** |   | **Over four  years** |   |
|                                                      |   | **(in HUF millions)**      |       |
|                                                      |   |                       | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Loans and borrowings including finance lease  commitments |   | 374,007                    |       | 228,340 |   | 56,393 |   | 81,801 |   | 7,473 |   |
| Operating leases                                          |   | 9,264                      |       | 2,065 |   | 2,903 |   | 2,763 |   | 1,533 |   |
| Unconditional purchase agreements                         |   | 7,504                      |       | 7,504 |   |   |   |   |   |   |   |
| Trade payables                                            |   | 101,857                    |       | 101,857 |   |   |   |   |   |   |   |
| Total contractual cash obligations                        |   | 492,632                    |       | 339,766 |   | 59,296 |   | 84,564 |   | 9,006 |   |

 

**CAPITAL EXPENDITURES**

 

The Company’s capitalexpenditures on tangible and intangible assets totaled HUF 152,784 million in2000, HUF 127,747 million in 2001 and HUF 109,988 million in 2002, including ineach year changes in capital expenditure creditors. Capital expendituresincluded expenditures for (1) the fixed line network, including networkoperations systems, (2) mobile telecommunications and (3) new products,corporate infrastructure and other assets.

 

Capitalexpenditures for the fixed line segment accounted for 73 percent of total capitalexpenditures in 2000, 59 percent of total capital expenditures in 2001 and 45percent of total capital expenditures in 2002. Capital expenditures for themobile segment totaled 27 percent of total capital expenditures in 2000, 28percent of total capital expenditures in 2001 and 38 percent of total capitalexpenditures in 2002. The remaining 13 percent and 17 percent of capitalexpenditures for 2001 and 2002, respectively, related to the internationalsegment.

 

TheCompany expects gross additions to tangible and intangible assets to beapproximately HUF 90 billion in 2003. The Company expects to be able to financecapital expenditures over the next several years from net cash flows fromoperations and from borrowings. The Company’s actual future capital expenditureswill depend on a variety of factors, such as the development of its businessand of the Hungarian economy and whether Matáv enters into any new lines ofbusiness. As a result, the Company’s actual future capital expenditures may besignificantly different.

 

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**RECONCILIATION TO U.S. GAAP**

 

Thefollowing table reconciles net income and shareholders’ equity under IFRS toU.S. GAAP for the periods indicated:

 
|                       |   | **Year ended December 31,** |   |
|----------------------------|--------|-----------------------------|--------|
|                       |   | **2000**                    |   | **2001** |   | **2002** |   |
|                       |   | **(in HUF millions)**       |   |
| Net income:                |   |                        |   |   |   |   |   |
| IFRS                       |   | 66,652                      |   | 82,560 |   | 68,128 |   |
| U.S. GAAP                  |   | 64,508                      |   | 82,231 |   | 78,153 |   |
|                       |   |                        |   |   |   |   |   |
| Shareholders’ equity: |   |                        |   |   |   |   |   |
| IFRS                       |   | 637,281                     |   | 460,300 |   | 516,144 |   |
| U.S. GAAP                  |   | 622,941                     |   | 445,167 |   | 511,036 |   |

 

Reconcilingadjustments relate principally to the different treatment under U.S. GAAP ofdeferred revenue, including the adoption of SAB 101, post-retirement benefits,management incentive plan bonds and recognition and amortization of intangibleassets. See Note 32 to the consolidated financial statements.

 

**Recent AccountingPronouncements**

 

On January1, 2003 Matáv is required to adopt Statement of Financial Accounting Standards(SFAS) No. 143, “Accounting for Asset Retirement Obligations”. SFAS 143requires that the fair value of a liability for an asset retirement obligationbe recognized in the period in which it is incurred if a reasonable estimate offair value can be made. The associated asset retirement costs are capitalizedas part of the carrying amount of the long-lived asset.  The Company is currently evaluating theimpact of SFAS 143 on its financial statements.

 

SFAS 146“Accounting for Costs Associated with Exit or Disposal Activities” was issuedin June 2002, and is effective for exit or disposal activities that areinitiated after December 31, 2002. The provisions of the statement change thedate of recognition of a liability for a cost associated with an exit ordisposal activity from the date of an entity’s commitment to an exit plan tothe date when the liability is incurred. The statement also establishes thatthe fair value is the objective for initial measurement of the liability. Matávcurrently does not plan to exit or dispose of any of its significantactivities.

 

SFAS 148“Accounting for Stock-Based Compensation” is an amendment of SFAS 123 and is tobe applied for financial statements for fiscal years beginning after December15, 2003. The statement was issued to provide alternative methods of transitionfor a voluntary change to the fair value based method of accounting forstock-based employee compensation. In addition, this statement amends thedisclosure requirements of the preceding statement to require more prominentdisclosures in the financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on thereported results. The Company is currently evaluating the impact of SFAS 148 onits financial statements.

 

**RESEARCH AND DEVELOPMENT**

 

Matáv hasa separate organization called PKI Telecommunications Development Institute forthe performance of research and development (“R&D”) tasks needed formeeting the demands of the rapidly changing market through development of itstelecommunications networks and service platforms. The institute is in closecooperation with strategic partners, domestic and international developmentorganizations.

 

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TheR&D field of Matáv is facing new challenges due to the convergence oftelecommunications, media and information technology.

 

Significantresources are devoted to upgrading Matáv’s digital backbone network. The DWDMtechnology was introduced in order to be able to satisfy the backbone networkdemands raised in connection with broadband services, for example quickInternet access and broadband IP-VPN. In the last two years Matáv rolled out awide range of broadband access technologies (ADSL, cable television, opticalaccess network, 3.5 GHz point to multipoint systems, managed leased line technologies)to satisfy the increased bandwidth demand. The Company is making preparationsfor interconnection and convergence of the currently separate voice and datanetworks.

 

Matáv iscontinuously developing its data communications and IP network and services tobe able to satisfy broadband demands. The Company developed its first conceptof a national, high speed IP network built on DWDM and Gigabit Ethernet. Matávhas also developed European Union conform solution products (Intelligent City,etc.). The Company has laid the foundations of establishing city networks(“CityNets”) to satisfy special demands of our key customers. In addition tobasic IN services, such as toll free, shared cost and premium rate services,Matáv has developed new services, such as televoting, world card, drop charge(access to information for one off fee) and virtual private network. As anupgrade of the existing voice mail platform the subscribers of the fixednetwork can be informed about the receipt of a message through an SMS sent totheir GSM set. In 2002 Matáv introduced the fixed-SMS service, which allowsfixed line subscribers to use the popular SMS. PKI developed a public Internetterminal where payment is realized by chip cards. In addition to itstraditional telephony and Internet browser function, the terminal is capable ofsupporting almost all existing multimedia forms of data transfer, such asInternet telephony, video telephony and the downloading of data even to mobilephones. Matáv also developed a system supporting remote reading of meters,which is able to provide information services essential for companies operatingin the energy sector. Matáv made preparations to introduce the WLAN technologyin the access network for hot spot applications.

 

On April1, 2002 DT, T-Systems International, T-Systems Hungary and Matáv founded theT-Systems Regional Innovation Center (“RIC”) in Budapest.

 

RIC’smission is to become a regional competence center for the development ofT.I.M.E.S (Telecommunications, Information Technology, Multimedia,Entertainment, Security Services) market business ideas.

 

RIC isdesigned to increase the success of DT as well as Matáv in developingtechnologically innovative solutions, technology and/or knowledge basedbusiness performance. Its main goals are to

 

•                  exploit  the innovation networking potential of DT;

 

•                  establish an R&Dcompetency center to provide state of the art technical support and assistancefocusing on key new areas;

 

•                  provide careeropportunities for young engineers in Hungary;

 

•                  benefit from thecompetitive advantage of Hungarian human resource cost;

 

•                  strengthen therelationship with universities and international development centers; and

 

•                  increase the efficiencyof recruiting activities from Hungarian universities to DT, Matáv andinternational markets.

 

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Being anenvironment conscious company, Matáv is continuously working to reduce theenvironmental impacts of its products and services and to preserve resources.The first special info-communication system to be applied in the domain ofenvironment protection was worked out for Aggtelek National Park in the frameof an environment protection development project. The first phase of theproject was completed in the spring of 2002, while the termination of thesecond phase is expected at the end of 2003. The national park authorities showgreat interest in the system.

 

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**ITEM 6****— DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES**

 

**Board of Directors**

 

Under Hungarianlaw, the Board of Directors is responsible for the Company’s management anddecides on matters other than those that must be determined by shareholders.The Board of Directors is required to report to the shareholders at the annualgeneral meeting of the shareholders and quarterly to the Supervisory Board onthe business administration, state of assets and business policy of theCompany.

 

Pursuant to theCompany’s amended Articles of Association, the Board of Directors consists of aminimum of six and a maximum of 11 members elected at the annual generalmeeting of the shareholders for a term of one year. One current director wasnominated by the holder of the Series “B” share pursuant to the Articles ofAssociation; six of the current directors were nominated by MagyarCom and twoof the current directors were elected upon proposal by other shareholders ofthe Company.

 

Meetingsof the Board of Directors are held at least four times a year. Meetings of theBoard of Directors require the presence of six members for a quorum. Eachmember has one vote. The Board of Directors passes resolutions by simplemajority vote.

 

OnDecember 31, 2002, the members of the Board of Directors, their principaloccupations and the years of their original election were as follows:

 
| **Name**                     |   | **Age** |   | **Principal Occupation**                                                                           |   | **Member  since** |
|------------------------------|--------|---------|--------|----------------------------------------------------------------------------------------------------|--------|-------------------|
|                         |   |    |   |                                                                                               |   |              |
| Elek Straub                  |   | 58      |   | Chairman and  Chief Executive Officer of Matáv                                                |   | 1995              |
| Michael Günther         |   | 58      |   | Head of  Corporate Finance of T-Mobile International                                               |   | 2002              |
| Dr. Sándor  Csányi |   | 49      |   | Chairman and  Chief Executive Officer of OTP Bank                                                  |   | 2000              |
| Gyula  Gansperger*           |   | 39      |   | N.a.                                                                                               |   | 2000              |
| Fridbert  Gerlach            |   | 45      |   | Vice President  Regional Build-up and Integration, Central and Eastern Europe and Middle  East, DT |   | 2001              |
| Jan Geldmacher               |   | 41      |   | Director of  Telecommunications Services, T-Systems International                                  |   | 2002              |
| Dr. Klaus  Hartmann          |   | 41      |   | Chief Financial  Officer of Matáv                                                             |   | 2000              |
| Hans Albert  Aukes           |   | 53      |   | Member of the  Board of Management T-Com, International Business                                   |   | 2002              |
| Dr. Mihály  Patai       |   | 49      |   | Chairman and  Chief Executive Officer of Hungária Biztosító                         |   | 1998              |

 

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* Representative of the holder of the Series “B”Share.

 

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**Other Principal Directorshipsof Members of the Board of Directors**

 
| **Name**                     |   | **Position held**                        |   | **Company**                                       |
|------------------------------|--------|------------------------------------------|--------|---------------------------------------------------|
|                         |   |                                     |   |                                              |
| Elek Straub                  |   | Chairman of the  Board of Directors      |   | Westel                                            |
| Michael Günther         |   | Member of the  Board of Management       |   | T-Mobile  International AG, Germany               |
|                         |   | General Manager                          |   | Smaragd  Telekommunikationsdienste GmbH           |
|                         |   | Chairman of the  Board of Directors      |   | RadioMobil  a.s., Czech Republic                  |
|                         |   | Chairman of the  Board of Directors      |   | EuroTel  Bratislava, a.s., Slovak Republic        |
|                         |   | Vice-Chairman  of the Board of Directors |   | Westel                                            |
|                         |   | Vice-Chairman  of the Supervisory Board  |   | Polska  Telefonia Cyfrowa Sp. Z. o.o., Poland     |
|                         |   | Member of the  Board of Directors        |   | Mobile  Telecommunications Systems (MTS), Russia  |
|                         |   | Member of the  Supervisory Board         |   | Hrvatske  Telekomunikacije d.d. Zagreb, Croatia   |
|                         |   | Member of the  Supervisory Board         |   | Zeta GmbH,  Germany                               |
|                         |   | Member of the  Board of Directors        |   | Cmobil B.V.,  The Netherlands                     |
| Dr. Sándor  Csányi |   | Chairman of the  Board of Directors      |   | OTP Bank Rt.                                      |
|                         |   | Member of the  Board of Directors        |   | MOL Rt.                                           |
|                         |   | Chairman of the  Supervisory Board       |   | OTP Garancia  Biztosító Rt.             |
|                         |   | Chairman of the  Supervisory Board       |   | Gyulaj Erdészeti  és Vadászati Rt. |
|                         |   | Chairman of the  Supervisory Board       |   | Csányi  Pincészet Rt.                   |
| Gyula  Gansperger            |   | None                                     |   |                                              |
| Fridbert  Gerlach            |   | Member of the  Board of Directors        |   | RadioMobil,  a.s., Czech Republic                 |
|                         |   | Member of the  Board of Directors        |   | Slovenske  Telekomunikacie, a.s., Slovak Republic |
|                         |   | Member of the  Supervisory Board         |   | Polska  Telefonia Cyfrowa z.o.o, Poland           |
|                         |   | Member of the  Board of Directors        |   | EuroTel  Bratislava, a.s., Slovak Republic        |
|                         |   | Member of the  Board of Directors        |   | PragoNet, a.s.,  Czech Republic                   |
|                         |   | Member of the  Board of Directors        |   | Westel                                            |
|                         |   | Member of the  Supervisory Board         |   | T-Mobile  Netherlands                             |
|                         |   | Member of the  Supervisory Board         |   | T-Mobile  Austria                                 |
| Jan Geldmacher               |   | Head of the  Supervisory Board           |   | Infonet  Deutschland GmbH                         |
|                         |   | Member of the  Supervisory Board         |   | T-Systems Japan                                   |
|                         |   | Member of the  Supervisory Board         |   | T-Systems Siris                                   |
| Dr. Klaus  Hartmann          |   | Member of the  Board of Directors        |   | Westel                                            |
| Hans Albert  Aukes           |   | Chairman of the  Supervisory Board       |   | Hrvatske  Telekomunikacije d.d. Zagreb, Croatia   |
|                         |   | Member of the  Board of Directors        |   | Slovenske  Telekomunikacie, a.s.,Slovak Republic  |
| Dr. Mihály  Patai       |   | Chairman of the  Board of Directors      |   | Allianz  Hungária Biztosító Rt.    |
|                         |   | Member of the  Supervisory Board         |   | Siemens Rt.                                       |

 

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***Biographies of Members of the Board of Directors***

 

*Elek Straub. *Mr. Straubgraduated in electrical engineering and business administration from theBudapest Technical University. He has served as Chairman of the Board ofDirectors since January 1996. He served as the Head of the IT Department of theMinistry of Labor from 1970 through 1980. From 1980 through 1990, he was firstthe Head and later the Vice President of the IT Division of the CentralStatistical Office of the Hungarian government. From 1990 to 1995, he was theGeneral Manager of IBM Hungary. In 1995, he joined Matáv. Mr. Straub became amember of the Operating Committee in 1995, Chairman of the Executive Committeein 1996 and Chairman of the Management Committee in 2000.

 

*Michael Günther*.  Mr. Günther has been ChiefOfficer of T-Mobile International AG responsible for Joint Venture Managementsince June 2001. He was there Chief Financial Officer since February 2000.After an internship at Osram GmbH in Berlin in the commerce area Mr. Güntherstudied business administration at the universities of Berlin and Hamburg. In1971 he started his carrier at Philips-Konzern where he was a commercialexecutive. From 1987 to 1993 Mr. Günther was member of the Board of Directorsof Philips Kommunikations Industrie AG in Nuremberg. In 1994 he joinedDeTeSystems, a DT subsidiary, as commercial director. In 1996 Mr. Güntherjoined DT where he acted as head of financial and controlling divisionresponsible for business customers. From September 1997 to August 2000, Mr. Güntherhas served as the financial and controlling director at T-Mobil*.*

 

*Dr. Sándor Csányi.*  Dr. Csányi Ph.D. is Chairmanand CEO of OTP Bank (National Savings and Commercial Bank Ltd.). He has adegree in finance from the University of Economics, and he is a certified priceanalyst and a chartered accountant. He started his career at the Ministry ofFinance in 1974 and worked for the Ministry of Agriculture between 1983 and1986. He became Head of Department at Magyar Hitelbank in 1986 and served asDeputy CEO of the Kereskedelmi és Hitelbank between 1989 and 1992. He has beenChairman and CEO of OTP Bank since 1992.

 

*Gyula Gansperger. *Mr.Gansperger graduated from the University of Economics as an economist majoringin finance in 1986. He served as chief accountant in several firms. In 1990, hebecame owner and managing director of Taxorg Tax Consultants and AccountingLtd., which developed complete accounting and controlling systems for domesticand foreign companies. He served as a member of the Supervisory Board of ÁPVbetween 1995 and 1998, headed audits and controlled the company’s business andfinancial reports. After Mr. Gansperger became CEO of ÁPV in 1998, herestructured the company and prepared it for its new primary function of assetmanagement.

 

*Fridbert Gerlach.*  Mr. Gerlach joined DT in 1999as Vice President Regional Build-up and Integration in the Region Central andEastern Europe and Middle East. After his graduation in telecommunications fromAachen University in 1983, he worked there as an electrical engineer until 1987and, during that time, completed his studies in business administration. From1987 to 1997 he held several management positions within the internationaldivision of Alcatel SEL AG in Stuttgart, Germany. Before joining DT in 1999, heworked as director for international joint ventures at T-Mobil.

 

*Jan Geldmacher.*  Mr. Geldmacher is Director ofT-Systems International GmbH, Telecommunications Services.  After his graduation at the University ofCologne in business administration Mr. Geldmacher started his professionalcareer at NCR/AT&T in Augsburg and Hannover in various sales executivepositions, and later worked at AT&T in San Diego, California, USA. Afterhis return in 1996 he held various executive positions in sales areas atMeganet, Vebacom and o.tel.o. In 1999 he joined debis Systemhaus where he wasresponsible for Network Operations & International Support in theTelecommunications Services area. On August 1, 2000 he took over theInternational Networks and Portfolio area of DT. Since October 1, 2001 Mr.Geldmacher has been Director of Telecommunications Services at T-SystemsInternational GmbH.

 

*Dr. Klaus Hartmann. *Dr. Hartmanngraduated with a Ph.D. in Economics. He also holds an MBA from the Universityof Birmingham. Prior to his employment with DT, he worked for Arthur Andersenin Germany and as

 

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treasurer andoperational controller for a subsidiary of the BICC Group. He joined DT in 1995as Manager of International Capital Markets and became Corporate Treasurer ofGlobal One, a joint venture of DT, France Telekom and Sprint in 1997. Hereturned to DT’s Bonn Headquarters as Senior Advisor to the CFO in April 2000*.*Hewas appointed CFO of Matáv and Vice-Chairman of its Management Committee inNovember 2000.

 

*Hans Albert Aukes*.  Within the framework of the“T-Com” pillar of DT, Mr. Aukes is serving as the temporary head of NationalBusiness and as the head of International Business. He plays a significant partin the management of this Telekom pillar, which combines the communicationsoffers for residential customers and small and medium-sized companies. Hepreviously served as Chief Operating Officer. From September 1999, Mr. Aukesheld the position of senior executive vice president, network communications,DT’s largest business segment. Prior to that Mr. Aukes was head of strategicGroup management in the Division for Corporate Group Strategy, Communication,Auditing and Organization of DT. In 1994 Mr. Aukes was head of commercial Grouprelations at T-Mobil. In the years 1990 to 1993 he managed the SupervisoryBoard office of DT and was at the same time personal assistant to the Chairmanof the Supervisory Board. Before Deutsche Bundespost Telekom was founded on January1, 1990, Mr. Aukes was responsible for telecommunications policy at theBundesministerium für Post- und Telekommunikation (Federal Ministry of Postsand Telecommunications) from 1979 until the end of 1989.

 

*Dr. Mihály Patai.* Dr. Patai started to work atthe National Bank of Hungary in 1976 and joined the Financial ResearchInstitute in 1978. Between 1982 and 1988, he served at the Ministry of Finance,Department of International Finances. He became Chairman of the Board atGeneral Banking and Trust Company Ltd. In 1988, he joined the World Bank,Washington DC, then worked as Bank and IFC alternate executive director. Hebecame managing director of Kereskedelmi Bank Rt. in charge of Internationaland Foreign Exchange Operations in 1993 and was appointed Chairman and CEO atBudapest Investment International Inc. in 1996. He has been Chairman of theBoard and CEO of Hungária Biztosító since 1996.

 

**Management Committee**

 

Pursuantto the Company’s amended Articles of Association and the amended Rules ofProcedure of the Board of Directors, the Board of Directors established aManagement Committee in 2000, which is empowered to carry out the day-to-dayoperations in accordance with the annual business plan. At the end of 2002, theManagement Committee consisted of eight members who were the eight chiefofficers of Matáv. The eight members are as follows:

* *
| **Name**                      |   | **Age** |   | **Position**                                     |   | **Member  since** |
|-------------------------------|--------|---------|--------|--------------------------------------------------|--------|-------------------|
|                          |   |    |   |                                             |   |              |
| Elek Straub                   |   | 58      |   | Chairman and  Chief Executive Officer            |   | 2000              |
| László Bodnár  |   | 54      |   | Chief Services  and Logistics Officer            |   | 2000              |
| Dr. Klaus  Hartmann      |   | 41      |   | Vice-Chairman  and Chief Financial Officer       |   | 2000              |
| Horst Hermann                 |   | 47      |   | Chief  Strategic and International Officer  |   | 2002              |
| Christopher  Mattheisen       |   | 41      |   | Chief Officer,  Head of Residential Services LoB |   | 2002              |
| Manfred Ohl                   |   | 55      |   | Chief Technical  Officer, Head of Network LoB    |   | 2000              |
| Dr. Tamás  Pásztory |   | 51      |   | Chief Human  Resources and Legal Officer         |   | 2000              |
| Zoltán Tankó        |   | 45      |   | Chief Officer,  Head of Business Services LoB    |   | 2000              |

 

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**Other Principal Directorshipsof Members of Management Committee**

 
| **Name**                      |   | **Position held**                   |   | **Company**                                         |
|-------------------------------|--------|-------------------------------------|--------|-----------------------------------------------------|
|                          |   |                                |   |                                                |
| Elek Straub                   |   | Chairman of the  Board of Directors |   | Westel                                              |
| László Bodnár  |   | Member of the  Board of Directors   |   | TCW Rt.                                             |
|                          |   | Member of the  Supervisory Board    |   | Matáv Futball  Sportszolgáltató Kft. |
| Dr. Klaus  Hartmann           |   | Member of the  Board of Directors   |   | Westel                                              |
| Horst Hermann                 |   | Chairman of the  Board of Directors |   | Stonebridge AD                                      |
|                          |   | Member of the  Board of Directors   |   | MakTel,  Macedonia                                  |
|                          |   | Member of the  Board of Directors   |   | Mobimak, Macedonia                                  |
| Christopher  Mattheisen       |   | None                                |   |                                                |
| Manfred Ohl                   |   | Member of the  Board of Directors   |   | Westel                                              |
|                          |   | Member of the  Board of Directors   |   | DeTeLine  Budapest                                  |
| Dr. Tamás  Pásztory |   | Chairman of the  Supervisory Board  |   | Investel Rt.                                        |
|                          |   | Member of the  Board of Directors   |   | Axelero Rt.                                         |
|                          |   | Member of the  Board of Directors   |   | Magyar Posta  Rt.                                   |
|                          |   | Member of the  Board of Directors   |   | Westel                                              |
| Zoltán Tankó        |   | Chairman of the  Supervisory Board  |   | Linum  Foundation                                   |

 

***Biographies of Chief Officers***

 

*Elek Straub,* Chairman and Chief Executive Officer. See “Biographies of Members of the Board of Directors” above.

 

*László Bodnár,* Chief Services and Logistics Officer. Mr. Bodnár is responsible for the coordination of Matáv’s InformationTechnology activities. He joined the Miskolc Post Directorate in 1971 andserved in positions with increasing responsibilities. He was Director of theSopron Post Directorate from 1989 until 1990 and Head of the SopronTelecommunications Directorate from 1990 until 1999. In 1998 and 1999, hesupervised the modernization of Matáv’s organization. Since January 1, 1999, heserved as Director of the West Hungary Technical Directorate.

 

*Dr. Klaus Hartmann,*Chief Financial Officer.  See“Biographies of Members of the Board of Directors” above.

 

*Horst Hermann*, Chief Strategic and International Officer.  Mr. Hermann joined DT as an operations manager in 1978. In 1990he joined DT Headquarters, Corporate Strategy and Regulatory Policy. From 1994he was Assistant Managing Director for Business Development and Finance in DT’sregional headquarters in Singapore. From 1996 he was responsible for StrategicPlanning in the DT’s Bonn headquarters. In April 1998 he joined Matáv to takein charge of Strategy and Business Development. On January 1, 2002 he waspromoted to Chief Strategy and International Officer, and is also responsiblefor Portfolio Management and Matáv’s Group policy on content and media

 

*Christopher Mattheisen*, Chief Officer, Head of Residential Services LoB.  Mr. Mattheisen studied economics and financeat Indiana University of Bloomington and at Columbia University, New York. Hefirst came to Hungary in 1990 to start a strategic planning and businessconsulting company. In 1993, in his capacity as a marketing manager of US WestInternational, Mr. Mattheisen helped to launch the Hungarian, Polish and Czechmobile service operators. He worked as marketing and sales director of Westelbetween 1993 and 1996. In 1997, he ran the sales and marketing activities ofMediaOne in London and later worked in Britain as the

 

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business, salesand marketing director of BT’s Cellnet. On September 1, 2002 Mr. Mattheisentook up the job of chief officer of Matáv’s Residential Services LoB.

 

*Manfred Ohl,* Chief Technical Officer, Head of Network LoB.  DT appointed Mr. Ohl Chief Technical Officerof Matáv in January 1999. He was Head of the Technical and Network BusinessUnit of DT in Frankfurt am Main, which is a business unit serving thetelecommunications demand of international companies. During the constructionof the telecommunications infrastructure in the new federal states of Germany,Mr. Ohl worked for the Headquarters of DT and was responsible for turn-keycable network construction. Then Mr. Ohl was responsible for reconciliation ofthe Business Plan with the investment demand for network infrastructure in thearea of DT and for central coordination of investments.

 

*Dr. Tamás Pásztory,* Chief Human Resources and Legal Officer.  Dr. Pásztory graduated in law and organization engineering. Hehas been the Executive Director of the Human Resources Branch since Matáv’sestablishment. He was appointed Deputy Chief Officer of Matáv in July 1995 andChief Human Resources and Legal Officer of Matáv in February 1996. He joinedMatáv’s predecessor in 1969 and has been in various positions in the humanresources area since 1980.

 

*Zoltán Tankó,* Chief Officer, Head of Business Services LoB.  Mr. Tankó graduated at the BudapestTechnical University in electrical engineering. He started as an IT developmentengineer for Budapest Radio Technology Enterprise in 1980 and for KőbányaPharmaceuticals in 1982. He had several positions at Műszertechnika(Instrument technology) starting in 1984, including Chief TelecommunicationsOfficer starting in 1990. He became Director of Matáv’s Business CommunicationsBranch in February 1996.

 

**Supervisory Board**

 

TheSupervisory Board is responsible for supervising the administration and controlof the Company and for assuring that the Company meets Hungarian legalrequirements and the provisions set out in its governing instruments. TheSupervisory Board reviews every significant report delivered at the generalmeeting of the shareholders, proposals by the Board of Directors, financialstatements and proposals regarding profit distribution. The Supervisory Boardalso prepares a report on these topics for the general meeting of shareholdersat which the annual report is discussed.

 

Pursuantto the Articles of Association, the Supervisory Board consists of nine memberselected by the shareholders for terms of one year each. The Works Councilnominates one third of the Supervisory Board members in accordance with therules set out to guide the election of employee members. The holder of theSeries “B” share has the right to nominate one member of the Supervisory Board.Meetings of the Supervisory Board require a quorum of six members.

 

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OnDecember 31, 2002, the members of the Supervisory Board, their principaloccupation and the years of their original election were as follows:

 
| **Name**                    |   | **Age** |   | **Principal Occupation**                                                                                                                      |   | **Member  since** |
|-----------------------------|--------|---------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|
|                        |   |    |   |                                                                                                                                          |   |              |
| Dr. Klaus  Nitschke         |   | 42      |   | Head of  International Marketing, T-Com                                                                                                       |   | 2002              |
| Dr. Erbil Kurt              |   | 37      |   | Member of the  Board of Management T-Com, Corporate Function                                                                                  |   | 2002              |
| Dr. Ralph  Rentschler       |   | 42      |   | Member of the  Board Management T-Com, Finance and Controlling Function                                                                       |   | 2002              |
| Géza Böhm         |   | 50      |   | Chairman of  Hungarian Telecommunications Trade Union                                                                                         |   | 2002              |
| Joachim Kregel              |   | 49      |   | Head of Group  Auditing at DT in Bonn, and member of the Group Committee for Organizational  Projects and of the Central Consulting Committee |   | 2000              |
| Dr. László Pap    |   | 59      |   | Budapest  University of Technology, Professor, Strategic Vice-rector                                                                          |   | 1998              |
| Dr. Árpád  Herbst |   | 45      |   | Chairman of the  Századvég Political School Foundation                                                                              |   | 2002              |
| Gellért Kadlót    |   | 53      |   | Chairman of the  Workers’ Council of  Domestic Carriers  Division, Member of the Central Workers’ Council                      |   | 2002              |
| Péter Vermes           |   | 55      |   | Chairman of  Matáv’s  Central Workers’ Council                                                                            |   | 1995              |

 

**Other Principal Directorshipsof Members of the Supervisory Board**

 
| **Name**                   |   | **Position  held**                                                                                          |   | **Company**                                                                 |
|----------------------------|--------|-------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------|
|                       |   |                                                                                                        |   |                                                                        |
| Dr. Klaus Nitschke         |   | Member of the  Supervisory Board                                                                            |   | Slovenske  Telekomunikacie, a.s.                                            |
| Dr. Erbil Kurt             |   | Vice-Chairman  of the Supervisory Board  Member of the Supervisory Board  Member of the Board of Management |   | GmG  Generalmietgesellschaft mbH  T-Telmatik Venture Holding GmbH.  T-Com   |
| Dr. Ralph Rentschler       |   | Member of the  Board of  Management  Member of the Supervisory Board  Member of the Supervisory Board  |   | T-Com  Slovenske Telekomunikacie, a.s.  Cap Customer Advantage Program GmbH |
| Géza Böhm        |   | None                                                                                                        |   |                                                                        |
| Joachim Kregel             |   | None                                                                                                        |   |                                                                        |
| Dr. László Pap   |   | None                                                                                                        |   |                                                                        |
| Dr. Árpád Herbst |   | Chairman of the  Supervisory Board  Member of the Supervisory Board  Member of the Supervisory Board        |   | Duna TV Rt.  Elmű Rt.  Agrárközpont Kht.                     |
| Gellért Kadlót   |   | None                                                                                                        |   |                                                                        |
| Péter Vermes          |   | None                                                                                                        |   |                                                                        |

 

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**Biographies of Members of theSupervisory Board**

 

*Dr. Klaus Nitschke.* Mr. Nitschke is Headof International Marketing T-Com. He is responsiblefor  improving the operationalperformance of the Central European affiliate companies of T-Com. Afterfinishing his studies he gained professional experience at consulting companiesin the fields of value based company management, strategic development, companymergers and acquisitions. Between September 2000 and March 2002 he was ChiefOperating Officer at Bertelsmann eCommerce Group.

 

*Dr. Erbil Kurt*.  Mr. Kurt joined DeutscheTelekom as Head of New Business in 1997. Prior to that he worked as ajournalist for Der Spiegel, the Neue Zürcher Zeitung and the Cable andSatellite. In 1994 he obtained his PhD and worked in the management of TVSpielfilm. In 1995 he became the Chief Editor of CLT-Digital TV.

 

*Dr. Ralph Rentschler*.  Mr. Rentschler became head ofGroup Controlling in February 2001. After studying economics and gaining adoctorate he worked for four years for Robert Bosch GmbH as an expert advisoron business principles and methods. His areas of responsibility includedinvestment analysis and cost accounting. Later he was Commercial Manager of theBrand Optics Division at Carl Zeiss, where he managed Accounting, Controlling,Data Processing and Purchasing. Mr. Rentschler was head of Group Controllingand the Planning and Reporting Departments at Carl Zeiss from 1992 to 1997. Hisarea of responsibility included production and investment controlling,controlling of affiliated companies, M&A as well as strategic planning. Hewas also responsible for the accounting of various factories.

 

*Géza Böhm*.  Mr. Böhm has been workingwith Matáv and its legal predecessor since 1970. His functions have beenforeman, administrator in charge of transmission investment and SDH projectleader. He has been officer of the Workers’ Council since 1993. Since March2002, he has been the Chairman of the Trade Union of HungarianTelecommunications Employees.

 

*Joachim Kregel.*  Mr. Kregel is an economist. Hestudied economics and business administration at the University of Bochum.Subsequently, he held various positions at Deutsche Unilever GmbH and OttoVersand GmbH & Co. in Hamburg. Between 1992 and 1995, he headed the AuditDepartment of Kaufhof Holding AG in Cologne. He has been head of Group Auditingat DT in Bonn since 1996. He is also a member of the Group Committee forOrganizational Projects and the Central Advisory Committee. Mr. Kregel is alsoa member of various committees within the German Institute of Internal Audit.

 

*Dr. László Pap.*  Mr. Pap graduated from theTechnical University of Budapest as a Telecommunications major. He earned hisPh.D. in 1980 and Doctor of Sciences (the highest degree awarded by theHungarian Academy of Sciences) in 1992. He has been a professor of theElectrical Engineering Department and Head of the Department of Telecommunicationsat the Budapest Technical University since 1967. He has obtained numerouspatents for his inventions.

 

*Dr. Árpád Herbst*.  Mr. Herbst is a universitydocent at GATE University, Department of Economic Law. He is member of theBoard of Directors of ÁPV Rt. and senior advisor of the Minister leading thePrime Minister’s Office since 1998. He is the president of the SzázadvégPolitical School Foundation. He is the author and co-author of several books,schoolbooks and university books on economic constitutionalism and economiclaw.

 

*Gellért Kadlót*.  Mr. Kadlót has been workingwith Matáv since 1970, focusing first on operations, and later on development.Currently, he coordinates the cooperation between the local telecommunicationsoperators and Matáv within the Domestic Carriers Division. Since 1996, he hasbeen the Chairman of the Workers’ Council of the Domestic Carriers Division.

 

*Péter Vermes.* Mr. Vermes became a qualified technician in 1972, graduated as atelecommunications engineer in 1975 and as teacher of technical sciences in1978. Between 1972 and 1986, he worked for the Budapest Regional Directorateand between 1986 and 1997 for the Long-Distance Telecom Directorate. Hecurrently works for the Operations and Maintenance Directorate. He has been Chairmanof Matáv’s Central

 

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Workers’ Councilsince 1993. He was elected as the employees’ representative on the SupervisoryBoard in 1995 for the first time.

 

**Indemnification of the Board of Directors and theSupervisory Board**

 

Pursuantto the Company’s amended Articles of Association, to the extent permitted bylaw, the Company is required to indemnify each current and former member of theBoard of Directors and the Supervisory Board in certain circumstances.Generally, if such an individual is liable for certain costs or damages inconnection with his board position and has acted in good faith, the Companymust indemnify him. The Company may maintain insurance on behalf of any memberof the Board of Directors or the Supervisory Board against any liabilityasserted against him and incurred by him in any such capacity, whether or notthe Company would have the right to indemnify him against such liability.

 

**Statement of the Board ofDirectors**

 

“The role of theBoard of Directors is to act on behalf of the shareholders in insuring thatMatáv operates in a manner that safeguards the interests of shareholders allover the world. Our conduct as Matáv’s governing body will be continuouslyconsistent with performing our fiduciary responsibility and the followingvalues:

 

•                  accountability to ourshareholders;

 

•                  openness to scrutiny;

 

•                  transparency of alldecisions taken; and

 

•                  deliberation that willbe fair and open but also efficient, timely and orderly.

 

By accepting toserve on Matáv’s Board we have committed ourselves not to spare neither timenor effort in order to earn the trust of those who have invested in the futureof this Company.”

 

**Compensation of Directors andOfficers**

 

For theyear ended December 31, 2002, the aggregate compensation of the Board ofDirectors was HUF 7.0 million.

 

For theyear ended December 31, 2002, the aggregate compensation of the members of theSupervisory Board was HUF 7.0 million.

 

For theyear ended December 31, 2002, the aggregate compensation of the members of theManagement Committee was HUF 527 million.

 

**Board Practices**

 

Members ofthe Board of Directors and the Supervisory Board are elected for a term of oneyear. Members of the Management Committee are elected for an indefinite period.

 

Workcontracts of management employees of the Company contain special provisionsregarding entitlements after termination of employment; therefore, the amountof severance is higher than the amount regulated by the applicable provisionsof the Labor Code.

 

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AuditCommittee members are appointed from the Supervisory Board, and RemunerationCommittee members are appointed from the Board of Directors.

 

The AuditCommittee assists in the appointment of independent auditors to be elected bythe annual general meeting and reviews the scope of external audit services.The Audit Committee also reviews the annual financial statements of Matáv,taking into account the results of the audits and reviews performed by theindependent auditors. The Audit Committee also reviews financial reportssubmitted to the stock exchanges, banks and regulatory bodies as well asreports prepared by the Company’s internal auditors. Members of the AuditCommittee are Dr. Ralph Rentschler, Joachim Kregel and Dr. László Pap. TheAudit Committee holds at least three meetings each year.

 

TheRemuneration Committee makes proposals to the Board of Directors regardingremuneration of executive officers, including setting and evaluating bonustargets. Members of the Remuneration Committee are Hans Albert Aukes, FridbertGerlach and Dr. Mihály Patai. The Remuneration Committee holds at least twomeetings each year.

 

**Employees**

 

Matávemployed 16,114 persons as of December 31, 2002. The following table providesinformation concerning the number of full-time employees, including full-timeequivalents, of Matáv Rt. and its consolidated subsidiaries:

* *
|                                              |   | **2000** |   | **2001** |   | **2002** |   |
|---------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Matáv Rt.:                                   |   |     |   |     |   |     |   |
| Average number of employees                       |   | 11,573   |   | 9,864    |   | 9,242    |   |
| Number of employees at period end                 |   | 11,227   |   | 9,298    |   | 9,153    |   |
|                                              |   |     |   |     |   |     |   |
| Matáv Rt. and its consolidated subsidiaries: |   |     |   |     |   |     |   |
| Average number of employees                       |   | 14,841   |   | 16,914   |   | 16,385   |   |
| Number of employees at period end                 |   | 14,380   |   | 16,633   |   | 16,114   |   |

 

Thefollowing table provides information on the breakdown of Matáv Rt.’s employeesby activity at December 31, 2002.

 
| **Branches**              |   | **Number of employees** |       |
|---------------------------|--------|-------------------------|------------|
|                      |   |                    | ** ** |
| Operation and maintenance |   | 4,607                   |       |
| Business services         |   | 558                     |       |
| Residential services      |   | 1,615                   |       |
| Logistics                 |   | 897                     |       |
| Finance                   |   | 586                     |       |
| Research and development  |   | 183                     |       |
| Human Resource and Legal  |   | 542                     |       |
| Other support             |   | 165                     |       |
| Total                     |   | 9,153                   |       |

 

*Workforce Reduction andRedeployment.* Centralization, technological improvements and attrition havepermitted the Company to reduce the size of its workforce. While overallpersonnel levels are falling, the number of highly skilled employees isincreasing. Matáv expects to further reduce its number of employees. Accesslines per fixed line employee increased from 201 at December 31, 1998 to 313 atDecember 31, 2002. In 2001, Matáv Rt. carried out a restructuring programincluding a 16 percent headcount reduction. The objective of the

 

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restructuringprogram was to redefine the focus of the Company’s operation and consumptionpatterns. Matáv reallocated substantial human and financial resources to themobile communications, data communication and Internet areas.

 

*Employee Representation andLabor Relations.*  Matáv Rt. has entered into a collective bargaining agreement withthe Hungarian Telecommunications Trade Union. The agreement, which can beterminated by either party with three months’ notice, applies to all Matáv Rt.employees except for the Chief Executive Officer, regardless of their unionmembership status. Wage terms in the agreement must be renegotiated annually.Under the agreement, employees are generally entitled to specific periods ofnotice before termination. Furthermore, employees are entitled to a specific amountof severance pay, which depends on the tenure of the employee. Employees arealso entitled to welfare benefits as discussed below.

 

Inaddition to the collective bargaining agreement, Matáv’s employees aregenerally covered by the Hungarian Labor Code, Law XXII of 1992, as amended,which imposes various restrictions on the involuntary termination ofemployment. The Hungarian Labor Code protects employee interests through twodifferent labor organizations: the Trade Union and the Works Council. The TradeUnion, as the official representative of employee interests in negotiationsrelating to the terms of employment, has the right to be informed of allcorporate measures that may significantly affect the interests of employees andto commence legal action against the Company for employment-related conductthat infringes an employment rule. In addition, the Works Council directlyrepresents employee interests in dealings with management and decides jointlywith the employer on matters involving employee welfare funds and institutions.The Works Council must be informed in semi-annual reports on issues affectingthe Company’s economic performance and changes in wages, employment conditionsand working hours. The Works Council must also be consulted regarding corporatemeasures affecting employees. The Works Council elects one-third of the membersof the Company’s Supervisory Board.

 

Under theHungarian Companies Act, employee representatives on the Supervisory Board arenominated by the Works Council in cooperation with the Trade Union. Thecomposition of the Supervisory Board is approved by the annual general meeting.At least one third of the members of the Supervisory Board must be employeerepresentatives. Currently, three members of the Supervisory Board are employeerepresentatives. These members are Géza Bőhm, Gellért Kadlót and PéterVermes.

 

Matávbelieves that its relations with its employees are good. Matáv has notexperienced any labor strikes or disruptions since its formation.

 

*Pensions and BenefitPrograms. *Matáv provides employees with discounted telephone services, subsidizedmeals, interest-free loans to purchase real estate, discount holiday facilitiesand other in-kind benefits. In addition to its statutory contributions togovernmental health, retirement and unemployment schemes, Matáv contributes tothe employees’ voluntary pension fund and supplementary benefits fund, whichprovide private pension and health insurance benefits supplementing governmentpension and health benefits. The Company does not, however, guarantee paymentby the benefits fund to its members. In 2002, approximately 92 percent of allemployees participated in the pension plan and self-help plans. Matávestablished a health fund in 1998 that had a membership of 7,738 at the end of2002.

 

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**Share Ownership of Management**

 

Thefollowing table sets out information relating to holdings of ordinary shares bythe directors and executive officers of Matáv at December 31, 2002:

 
| **Name**                     |   | **Title**                                 |   | **No. of Shares Owned** |   |
|------------------------------|--------|-------------------------------------------|--------|-------------------------|--------|
|                         |   |                                      |   |                    |   |
| Elek Straub                  |   | Chairman-CEO                              |   | 76,338                  |   |
| Dr. Klaus Hartmann           |   | Board Member,  CFO                        |   | 5,000                   |   |
| Dr. Mihály Patai        |   | Board Member                              |   | 58,190                  |   |
| László Bodnár |   | Chief Services  and Logistics Officer     |   | 881                     |   |
| Horst Hermann                |   | Chief Strategy  and International Officer |   | 400                     |   |
| Gellért Kadlót     |   | Supervisory  Board Member                 |   | 700                     |   |
| Péter Vermes            |   | Supervisory  Board Member                 |   | 8,800                   |   |

 

*Convertible bonds*

 

From June29, 1998 to July 1, 1998, Matáv Rt. issued 7 million convertible bearer bonds,known as the “Management Incentive Program Bond” each with a face value of HUF1. The holder of a bond could convert it into one newly issued Matáv Series “A”registered common stock with a face value of HUF 100, in accordance with theallocation and conversion rules. On July 1, 1998, 4,231 thousand bonds were allocatedto management. In 1999, 402 thousand bonds were forfeited. In 2000 anadditional 876 thousand bonds were allocated to management and 283 thousandbonds were forfeited. In 2001, 242 thousand bonds were forfeited.

 

The Bondscould be converted into newly issued Matáv Series “A” registered common stockover a three year period with one third vesting each year beginning July 1,1999. Bonds could not be converted after the end of the bond’s term, June 2002.None of the bonds was converted into shares and so all outstanding bonds wereforfeited in 2002.

 

Theconversion price of the bonds was the Hungarian Forint equivalent of USD 5.75per bond, calculated based on the USD/HUF exchange rate quoted by the HungarianNational Bank on the day of conversion, less the face value of the bond, butnot less than the initial public offering price of HUF 730 per share.

 

Compensationcosts were not recognized in Matáv’s financial statements for the fair value orthe intrinsic value of the bonds granted.

 

*Share options*

 

On April26, 2002, the annual Shareholders’ Meeting approved the introduction of a newmanagement share option plan and authorized the Company’s Board of Directors topurchase 17 million Series “A” registered ordinary shares, each having anominal value of HUF 100 as treasury shares.

 

On July 1,2002, the Company granted 3,964,600 options to participants of the stock optionplan at an exercise price of HUF 933 for the first tranche (exercisable in2003) and HUF 950 for the second and third tranches (exercisable in 2004 and2005). The Company’s share price as quoted on the BET (Budapest Stock Exchange)on the grant date was HUF 833 per share. The options have a life of five yearsfrom the grant date, meaning that the options are forfeited without replacementor compensation on June 30, 2007.

 

The optionwith respect to the maximum of one-third of the shares that can be purchasedunder the relevant option (first tranche) may be exercised from July 1, 2003until the end of the term.

 

The optionwith respect to the maximum of a further one-third of the shares that can bepurchased under the option (second tranche) may be exercised from July 1, 2004until the end of the term.

 

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The optionwith respect to the rest of the shares that can be purchased under the option(the third tranche) may be exercised from July 1, 2005 until the end of theterm.

 

Compensationcosts were not recognized in Matáv’s financial statements for the fair value ofthe options granted.

 

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**ITEM 7****— MAJOR SHAREHOLDERS AND RELATEDPARTY TRANSACTIONS**

 

***Major Shareholders***

 

The issuedshare capital of the Company is HUF 104,281,170,000, consisting of1,042,811,600 Series “A” ordinary shares and one Series “B” voting preferenceshare. All Series “A” ordinary shares have a nominal value of HUF 100 and theSeries “B” Share has a nominal value of HUF 10,000. The holder of the Series“B” Share enjoys certain preferential voting and other rights. See “Item 10 —Additional Information — Voting Rights and Voting — Series “B” Share” and“Transfer of Shares”.

 

Ordinaryshares outstanding as of December 31, 1999 amounted to 1,037,281,600 shares. InJune 2000, 630,000 ordinary shares of the Company were registered, whichincreased Matáv Rt.’s number of registered ordinary shares to 1,037,911,600. Ofthe newly issued shares, 77,270 ordinary shares were issued outside Matáv.Consequently, the number of shares outstanding increased to 1,037,358,870shares.

 

In 2002,the remaining 552,730 shares from the June 2000 transaction issue were issuedoutside Matáv. In addition, as a result of the new management stock ownershipprogram launched in 2002, the Company issued 4,900,000 shares of common stock,which were repurchased immediately. As a result, the number of registeredshares increased to 1,042,811,600.

 

MagyarCompurchased a 30.1 percent interest in Matáv from the ÁPV on December 22, 1993.On December 22, 1995, MagyarCom acquired from the ÁPV an additional 37.2 percentinterest, raising its stake to 67.3 percent. In connection with the Company’sinitial public offering, both MagyarCom and the ÁPV collectively sold272,861,367 shares. In June 1999, the ÁPV sold its remaining 5.75 percent stakein Matáv during a secondary offering. The total number of shares sold was60,096,515, out of which MagyarCom sold 581,319 shares in connection with agreenshoe option. Information concerning Matáv’s ownership structure as ofDecember 31, 2002 is set out in the following table:

 
| **Shareholder**                          |   | **Number of shares** |   | **Percentage of  share capital** |   |
|------------------------------------------|--------|----------------------|--------|----------------------------------|--------|
|                                     |   |                 |   |                             |   |
| MagyarCom                                |   | 617,478,081          |   | 59.21                            |   |
| Publicly traded(1)                       |   | 420,433,519          |   | 40.32                            |   |
| Treasury shares                          |   | 4,900,000            |   | 0.47                             |   |
|                                     |   | 1,042,811,600        |   | 100.00                           |   |
| Holder of Series “B” Shares(2) |   | 1                    |   |                             |   |
|                                     |   | 1,042,811,601        |   |                             |   |

 

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(1)      Of Matáv’s publicly traded shares,JP Morgan Chase Bank had 29,829,244 ADRs, evidencing 149,146,220 shares on itsaccounts as of December 31, 2002, for registered holders, such amountrepresenting 14.38 percent of the total shares outstanding. Matáv does not knowwhether this percentage may be indicative of the percentage of its ordinaryshares held by U.S. persons. Also, the members of the Board of Directors,Supervisory Board and the management own a total of 150,309 shares.

(2)      Par value of Series “B” Share isHUF 10,000.

 

Onecurrent director was nominated by the holder of the Series “B” Share pursuantto the Articles of Association, six of the current directors were nominated byMagyarCom and two of the current directors were elected upon proposal of othershareholders of the Company. MagyarCom therefore controls Matáv.

 

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SBC and DTmanaged and operated MagyarCom jointly until SBC’s 50 percent ownership inMagyarCom was transferred to DT in a transaction with a value based on MatávRt.’s share price as of market closing on June 30, 2000 in accordance with theterms of the shareholders’ agreement between DT and SBC.

 

*The Hungarian State.* The Hungarian State hassignificant influence over Matáv’s activities as the holder of the Series “B”Share through the Minister, as the regulator of the Hungariantelecommunications sector and as Matáv’s largest customer. Ownership of theSeries “B” Share gives the Hungarian state, through the Minister, certainspecial rights in the election of one member of each of the Board of Directorsand the Supervisory Board and the right to require the Ministry’s consent forcertain other decisions taken at the general shareholders’ meeting. TheHungarian State, acting through the Ministry and various regulatory bodiesunder its supervision, also exercises regulatory control over Matáv’stelecommunications activities.

 

**Related party transactions**

 

*MagyarCom GmbH*

 

TheCompany is majority owned by MagyarCom GmbH (59.49 percent), which is owned byDeutsche Telekom AG. Matáv paid dividends of HUF 6,792 million to MagyarComGmbH in 2002 and HUF 6,174 million in 2001.

 

Matávincurred no revenues or expenses for the three-year period ending December 31,2002 nor receivables and payables at the end of 2001 or 2002.

 

*MagyarCom Services Kft.*

 

MagyarComServices Kft., a Hungarian company owned by DT, provides Matáv with managementand consultancy services. The total service fees charged in 2000, 2001 and 2002amounted to HUF 2,478 million and HUF 1,563 million and HUF 2,028 million,respectively. Matáv had outstanding payables to MagyarCom Services Kft. of HUF573 million at December 31, 2002 (HUF 515 million at December 31, 2001). Matávhad no amounts receivable from MagyarCom Services Kft. as of the same dates.

 

*Deutsche Telekom Group*

 

Matáv hadtelecommunications revenues amounting to HUF 7,589 million, HUF 5,992 millionand HUF 5,168 million in 2002, 2001 and 2000, respectively, from other DeutscheTelekom Group members. Operating expenses to Deutsche Telekom Group membersamounted to HUF 4,852 million in 2002, HUF 5,900 million in 2001 and HUF 4,658million in 2000.

 

Matáv hadoutstanding payables to other Deutsche Telekom Group members of HUF 833 millionat December 31, 2002  and HUF 344million at December 31, 2001. Matáv had amounts receivable from other DT Groupmembers amounting to HUF 1,731 million in 2002 and HUF 644 million in 2001.

 

Includedin loans from related parties is a HUF denominated loan in an amount of HUF73,675 million received from Deutsche Telekom Finance B.V. The loan is subjectto fixed 9.36 percent interest rate, repayable in one amount on January 31,2006. Interest payments are due semi-annually.

 

Includedin loans from related parties is a EUR denominated loan in an amount of HUF162,771 million (EUR 690 million) received from Deutsche Telekom Finance B.V.The loan is based on a variable rate of EURIBOR plus 50 basis points andrepayable in one amount on August 14, 2003. Interest payments are duequarterly. EUR 525 million of the loan is subject to various cross-currencyinterest rate swap agreements.

 

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Related tothe swap agreements concluded with DT, Matáv had interest expense of HUF 5,040million in 2002 included in the gains and losses on swap agreements. Accruedinterest at December 31, 2002 amounted to HUF 1,041 million included in thefair value of the swap agreements in other non current liabilities.

 

Related tothe loan agreement concluded with Deutsche Telekom Finance B.V., Matáv hadinterest expense of HUF 13,654 million in 2002 and HUF 3,846 million in 2001.Accrued interest at December 31, 2002 amounted to HUF 4,298 million  and HUF 1,918 million in 2001, which wereincluded in accrued expenses.

 

DeutscheTelekom has pledged its support for Matáv’s financing needs through to June 30,2004.

 

*Governments*

 

Matávprovides services to Government departments and businesses in Hungary andMacedonia on arm’s length basis; however, individually none of these customersrepresent a significant source of revenue.

 

*Associates*

 

Hunsat isa joint venture founded by the Company (50 percent) and Antenna Hungária Rt.The revenues of Hunsat include membership fees paid by the establishing ownersand subsidies received from an international space communications organization.Costs incurred by Matáv including payment of these membership fees amounted toHUF 160 million in 2002, HUF 269 million in 2001 and HUF 324 million in 2000.Any profits made by Hunsat are repaid to the joint venture partners.

 

As MRTL,the Hungarian television broadcast company, in which Matáv has a 25 percentshare of ownership, operates mostly through production agencies, thetransactions between MRTL and Matáv are insignificant.

 

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**ITEM 8 — FINANCIALINFORMATION**

 

**CONSOLIDATED FINANCIALSTATEMENTS**

 

See “Item 17.Financial Statements” and pages F-1 through F-43.

 

**OTHER FINANCIAL INFORMATION**

 

**Legal proceedings**

 

***Legal proceedings at the competent court, affectingMatáv in excess of 60 Million HUF***

 

Forum-TelKft. (Pismányi Portfolió Kezelő Kft.) has a claim for HUF 2,313 millionagainst Matáv Rt. for breach of contract. The Procurement Directorate of Matáv Rt. declared on September 17, 1999,that its tender of May 5, 1999 for the procurement of coax cables andconnectors was terminated.  The Claimantargues that the contract with the content specified in the tender had beenconcluded so that Matáv would be obligated to ship cable televisionmaterials.  The court refused the claimwith its first instance judgment due to the fact that the terms and conditionsof establishing a contract were not realized. The Claimant has submitted anappeal, and Matáv expects the court to hear the appeal.

 

PG IngatlanforgalmazóKft. has a claim for HUF 869 million against Matáv Rt. for breach ofcontract.  The Claimant argues that theyestablished with Matáv a sale and purchase contract for the purchase ofproperty at Budapest, VI Nagymező str. 54-56.  It is expected that the court will rule for the Claimant.  The parties have jointly requested anadjournment of the hearing on December 17, 2002 and are in the process ofnegotiating an out of court settlement. The first instance court refused the claim on May 6, 2003.

 

V.R.A.M.Távkozlési Rt. (Vodafone) has a claim for HUF 75 million against Matáv forbreach of contract.  The Claimant arguesthat Matáv breached an interconnection contract between the parties, datedNovember 15, 1999 by failing to collect and transfer the sum collected from thelocal carriers to the Claimant. According to Matáv’s position, the claim isill-founded, and Matáv has filed its defense. The first instance hearings arecurrently being held.

 

JózsefCzifra and Ferenc Nagy, Hungarian Receivables Management Rt. and KELMISFinancial Consulting and Services Kft. have a claim for HUF 405 million againstEmitel and Telekábel for breach of contract. Emitel concluded a frameworkagreement with Telekábel in 1995 under which Telekábel would construct atelecommunications network. Based on this framework contract, Emitel enteredinto separate individual contracts to building the telecommunications networkof six localities. In July 1997, Emitel and Telekábel amended the contract. Thecreditors of Telekábel, now under liquidation, are now challenging theamendment and have filed this claim for compensation of damages. The originalclaim is comprised of three items:

 

•                  late payment interestof the capital deductions, which the Claimants argue is unlawful;

 

•                  late payment interestof the allegedly late payment of Emitel; and

 

•                  subscription feescollected from connected subscribers prior to the technical transfer-receiptprocedure.

 

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Accordingto Emitel, the amendment is valid and does not detract from the creditors’rights.  The first instance courtrefused the claim.  Upon appeal, theSupreme Court made a partial decision - it partially annulled and partiallyapproved the first instance judgment - and has ordered a new hearing regardingthe annulled part.

 

NET VOICEKft. has a claim for HUF 174 million against Westel for breach ofcontract.  Westel and the Claimantagreed in a service contract, dated January 9, 2001, that Westel would providethe Claimant with IP based dedicated business service network service.  Westel argues that the Claimant materiallybreached the contract while using the service by reselling the service forprofit, which is contrary to the terms of the contract. Westel terminated the contractwith immediate effect on January 29, 2002 and ceased to provide the service.The Claimant argues that the Undertaking Conditions of the contract were sounfair that they were able to cause damage to the Claimant besides providingunjustified and unilateral advantages to Westel. Westel has requested that thecourt refuse the claim and is supported by the opinion of theTelecommunications Authority.

 

Vivendi Rthas a claim against a CAC’s decision. This decision relates to all of mobiletelephone service providers in Hungary, including Westel, for unlawfultermination fees offered by the providers. The CAC:

 

•                  declared that the feeswere unlawful because Westel did not calculate its network fees as required bythe Communication Act and required Westel to apply lawful prices;

 

•                  dismissed the claim ofVivendi to oblige Westel to return the extra revenue gained by its unlawfulbehavior; and

 

•                  required Westel toconclude the relevant interconnection contract.

 

Westel haschallenged the decision in court, the hearing of the court of appeal isexpected. According to Westel’s position, the claim is ill-founded and Westelhas filed its defense.

 

InNovember 2002, the CAC designated Westel as having SMP in the relevant marketof national interconnection. Westel, per statutory obligations, filed its costcalculation methodology and relevant cost/tariff data based on the mandatoryLRIC model, as provided for by the law. Pannon was also designated by the CACas having SMP in the same relevant market, but it chose to appeal the decisionand refused to submit its cost data and LRIC model. In order to avoid acompetitive disadvantage and to seek non-discriminatory treatment, Westel filedan official request with the CAC for a temporary staying order for the executionof the decision regarding the implementation of its SMP obligations until thefinal settlement of the judicial review initiated by Pannon. The court of firstinstance put a staying order on the execution of the SMP decision with respectto Pannon but this order was appealed successfully by the CAC. Assuming thatPannon will appeal the said decision at the Supreme Court, Westel filed apetition with the Municipality Court of Budapest, seeking remedies to restorethe non-discriminative treatment by the CAC. Both above referenced cases arepending.

 

Westel haswithdrawn the LRIC model, which it originally filed in December 2002, becausethe legal situation is unclear and no valid regulation is in place regardingLRIC model guidelines. Lack of any such guidelines means that equal treatmentof market participants cannot be ensured. The Chairman of CAC informed Westelthat the CAC accepted the withdrawal, however, the CAC must officially continuewith the procedure as official one and gave Westel 30 days to file a new LRICmodel. Westel filed an appeal against such decision on procedural grounds asthe CAC has no right by law to continue the procedure as an official one.

 

Legaldispute over alleged tapping in the service area of MakTel with the value of3,328,410 EUR. The claimants (who are private individuals) claim that theirpersonal rights were violated by the tapping and recording of their telephoneconversations. In January 2001 the leader of the opposition (the present PrimeMinister) published his accusations about widespread tapping of phone linesacross Macedonia. He published shorthand written texts of telephoneconversations as proof of the allegation. The claimants, among other things,claim compensation for damages. This is the first case of this type, there isno precedent so far, therefore we can not forecast the outcome of the case.

 

***Procedures at the Competition Office affecting Matáv inexcess of 60 million HUF***

 

TheCompetition Office initiated a procedure against Matáv Rt., Westel, Westel0660, Pannon and V.R.A.M Rt. (Vodafone) for concerted market practicesregarding fixed-to-mobile and mobile-to-mobile call termination on February 7,2002. The report closing the investigation procedure suggests that theCompetition Council:

 

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•                  states that Westel’sand Pannon’s fixed-to-mobile terminating fees breach the prohibition of abuseof dominant position;

 

•                  states that thestrategy of Westel and Pannon to set prices at the same level breaches theprohibition of abuse of dominant position; and

 

•                  states that certainprovisions of the network contracts concluded by all mobile telephone serviceproviders breach the prohibition on concerted market practices.

 

Theinvestigation report proposes to impose a penalty in the amount of HUF 1,932million for Westel and HUF 33 million for Westel 0660.

 

Theinvestigation report proposes to terminate the procedure against Matáv Rt.Westel claims that the Competition Council investigation must end with liftingall charges against Westel. Westel expressed in its submission to theCompetition Council, dated on December 2, 2002, that the investigation reportis groundless in several points. It is expected that the Competition Councilwill hold a hearing. The affected parties may submit their appeal against thedecision of the Competition Council at the Court, and the Court has theauthority to change the resolution of the Competition Council.

 

***Procedures at thetax authority affecting Matáv in excess of 60 million HUF***

 

Westel isinvolved in a legal dispute regarding the refund of the VAT paid to Austrianroaming partners. Westel concluded a contract with Cash Back Hungary Kft. in1995 to administer the VAT refund from the invoices of the roaming partners.According to the claim of Westel, the sum in question is ATS 16,611,140 for1995 to 2000 and EUR 832,507 for 2001. On January 21, 2002, Cash Back Kft.informed Westel that the Austrian Tax Authority refused to refund the VAT andstated that Westel would have to pay taxes in Austria to claim the VAT refundsince the tax of the roaming traffic of Westel customers using the service inAustria has to be paid in Austria. The Austrian Tax Authority claims that theVAT refund to the foreign tax payer is unlawful. Westel finds it necessary toinitiate an interstate harmonization and the revision of EU principles due tobeing double taxed. According to the legal standpoint of Matáv, the outcome ofthe case heavily depends on the first instance resolution of the Austriancourt, since the basis of the legal dispute is the interpretation of the EUdirectives and the revision of the directives will finally have to be requestedfrom Brussels. This may result in lengthy procedures.

 

**Dividend Policy**

 

Theshareholders have approved the payment of cash dividends of HUF 18,682 million,equal to HUF 18 per share, from the Company’s consolidated net income for 2002.This amount corresponds to 27.4 percent of 2002**net income. The record datefor payment of the dividends is May 27, 2003.

 

UnderHungarian law, the Company is permitted to pay annual dividends out of profitsand profit reserves, determined on the basis of the annual unconsolidatedaccounts prepared in accordance with Hungarian Accounting Regulations,following a declaration at the annual general meeting of shareholders. Prior tothe approval of the annual unconsolidated accounts, the Company’s shareholdersat a general meeting may also declare a dividend advance on the basis of aninterim set of financial statements. Under Hungarian law, the general meetingof shareholders may decide to declare a higher or lower dividend than thatrecommended by the Board of Directors, provided that the Company’sshareholders’ equity under Hungarian Accounting Rules would still meet thestatutory requirements following the dividend. The general meeting ofshareholders may also decide not to declare a dividend, even if the Board ofDirectors recommends one. The Company distributes dividends to holders ofshares duly registered in the shareholders’ register as the legal owners ofshares on the date determined by the general meeting to be the dividend recorddate.

 

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Thedetermination of whether to pay dividends and of the amount of dividends paid,depends upon, among other things, the Company’s earnings, financial conditionand cash requirements, applicable restrictions on the payment of dividendsunder Hungarian law and any other factors the Board of Directors may considerrelevant. As of December 31, 2002*,*the profit reserves available fordistribution were approximately HUF 260,000 million.

 

TheCompany will declare any cash dividends in Hungarian Forints. In the case ofshares represented by ADSs, the cash dividends are paid to the depository andconverted into and paid in U.S. dollars at the prevailing rate of exchange, netof conversion expenses of the depository and applicable Hungarian withholdingtax. Fluctuations in exchange rates will affect the amount of dividends thatADS holders receive. Dividends paid to non-Hungarian holders, including U.S.holders, of shares or ADSs may be converted into foreign currency andrepatriated, subject to Hungarian withholding tax.

 

In themedium term, Matáv’s strategic priority further remains that of findingvalue-creating acquisitions. These potential future transactions require thatbalance sheet flexibility be maintained. According to Matáv’s currentestimation, this would be achievable with a net debt ratio (net debt to netdebt plus equity plus minority interest) in the range of 30-40 percent. Matávwill aim to further increase the dividend payment in Hungarian Forint terms,while keeping within the aforementioned net debt ratio range. This new dividendpolicy is not only dependent on the acquisition opportunities that may arise,but also on the future financial position of the Matáv as well as generalmarket conditions.

 

**Significant changes**

 

Nosignificant change has occurred since the date of the annual financialstatements included in this annual report.

 

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**ITEM 9****— THE OFFER AND LISTING**

 

InNovember 1997, shareholders of Matáv completed a Hungarian and internationalinitial public offering of shares. Matáv shares were listed in the “A” categoryof the Budapest Stock Exchange, and Matáv ADSs, each representing five ordinaryshares, were listed on the New York Stock Exchange. The total number of sharessold in the initial public offering was 272,861,367, or 26.31 percent of thetotal outstanding shares, for an aggregate offering price of over U.S. dollar1.0 billion. The offer price was HUF 730 per share and U.S. dollar 18.65 perADS.

 

In June1999, the ÁPV sold its remaining 5.75 percent stake in Matáv through asecondary offering. The total number of shares sold was 60,096,515, out ofwhich MagyarCom sold 581,319 shares in connection with a greenshoe option. Theoffer price was HUF 1,273 per share and U.S. dollar 26.50 per ADS. The ADSs areeligible for quotation and trading on SEAQ International.

 

**Trading on the New York StockExchange**

 

The tablebelow sets forth the high and low closing sales prices for the ADSs on the NewYork Stock Exchange for the periods indicated:

 
|           |   | **Price per ADS** |   |
|----------------|--------|-------------------|--------|
|           |   | **High**          |   | **Low** |   |
|           |   | **(U.S.$)**       |   |
|           |   |              |   |   |   |
| **1998**       |   | 33.25             |   | 19.00 |   |
| **1999**       |   | 36.50             |   | 24.94 |   |
| **2000**       |   | 49.00             |   | 15.94 |   |
| **2001**       |   | 23.75             |   | 11.32 |   |
| First Quarter  |   | 23.75             |   | 13.95 |   |
| Second Quarter |   | 17.35             |   | 13.37 |   |
| Third Quarter  |   | 14.80             |   | 11.32 |   |
| Fourth Quarter |   | 17.03             |   | 13.35 |   |
| **2002**       |   |              |   |   |   |
| First Quarter  |   | 19.02             |   | 16.12 |   |
| Second Quarter |   | 19.83             |   | 15.75 |   |
| Third Quarter  |   | 17.79             |   | 14.99 |   |
| Fourth Quarter |   | 19.34             |   | 13.89 |   |
| October        |   | 15.94             |   | 13.89 |   |
| November       |   | 18.98             |   | 15.69 |   |
| December       |   | 19.34             |   | 17.68 |   |
| **2003**       |   |              |   |   |   |
| January        |   | 19.55             |   | 17.52 |   |
| February       |   | 17.68             |   | 16.29 |   |
| March          |   | 16.98             |   | 15.89 |   |

 

Source: Bloomberg

 

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**Trading on the Budapest StockExchange**

 

The tablebelow sets forth the high and low closing sales prices for the shares on theBudapest Stock Exchange for the periods indicated:

 
|           |   | **Price per Share** |   |
|----------------|--------|---------------------|--------|
|           |   | **High**            |   | **Low** |   |
|           |   | **(HUF)**           |   |
|           |   |                |   |   |   |
| **1998**       |   | 1,411               |   | 859 |   |
| **1999**       |   | 1,791               |   | 1,150 |   |
| **2000**       |   | 2,655               |   | 958 |   |
| **2001**       |   | 1,318               |   | 571 |   |
| First Quarter  |   | 1,318               |   | 858 |   |
| Second Quarter |   | 1,039               |   | 792 |   |
| Third Quarter  |   | 835                 |   | 571 |   |
| Fourth Quarter |   | 975                 |   | 735 |   |
| **2002**       |   |                |   |   |   |
| First Quarter  |   | 1,056               |   | 905 |   |
| Second Quarter |   | 1,052               |   | 775 |   |
| Third Quarter  |   | 870                 |   | 750 |   |
| Fourth Quarter |   | 924                 |   | 685 |   |
| October        |   | 778                 |   | 685 |   |
| November       |   | 897                 |   | 755 |   |
| December       |   | 924                 |   | 808 |   |
| **2003**       |   |                |   |   |   |
| January        |   | 868                 |   | 791 |   |
| February       |   | 800                 |   | 736 |   |
| March          |   | 785                 |   | 711 |   |

 

Source: Bloomberg

 

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**ITEM10****– ADDITIONALINFORMATION**

 

**ShareCapital**

 

The issuedshare capital of the Company is HUF 104,281,170,000, consisting of1,042,811,600 Series “A” ordinary shares and one Series “B” voting preferenceshare. All Series “A” ordinary shares have a nominal value of HUF 100 and theSeries “B” Share has a nominal value of HUF 10,000. The holder of the Series“B” Share enjoys certain preferential voting and other rights described below.

 

Ordinaryshares outstanding as of December 31, 1999 amounted to 1,037,281,600 shares. InJune 2000, 630,000 new ordinary shares of the Company were registered, relatingto the 7,000,000 convertible management bond program. These new sharesincreased Matáv Rt.’s number of registered ordinary shares to 1,037,911,600. Ofthe newly issued shares, 77,270 ordinary shares were issued outside Matáv;therefore, the number of shares outstanding increased to 1,037,358,870 shares.This amount included 96,097 treasury shares held by Matáv as of December 31,2001.

 

In 2002,the remaining 552,730 shares from the June 2000 transaction issue were issuedoutside Matáv. In addition, as a result of the new management stock ownershipprogram launched in 2002, the Company issued 4,900,000 shares of common stock,which were repurchased immediately. As a result, the number of registeredshares increased to 1,042,811,600. This amount includes 4,900,000 treasuryshares held by Matáv as of December 31, 2002.

 

**Option to Purchase Securitiesfrom Registrant or Subsidiaries**

 

**(a) Convertible bonds**

 

From June29, 1998 to July 1, 1998, Matáv Rt. issued seven million convertible bearerbonds, known as the “Management Incentive Program Bond”, each with a face valueof HUF 1. The holder of a bond could convert it into one newly issued MatávSeries “A” registered common stock with a face value of HUF 100, in accordancewith the allocation and conversion rules. On July 1, 1998, 4,231 thousand bondswere allocated to management. In 1999, 402 thousand bonds were forfeited. In2000 an additional 876 thousand bonds were allocated to management and 283thousand bonds were forfeited. In 2001, 242 thousand bonds were forfeited.

 

The Bondscould be converted into newly issued Matáv Series “A” registered common stockover a three year period with one third vesting each year beginning July 1,1999. Bonds could not be converted after the end of the bond’s term, June 2002.None of the bonds was converted into shares and so all outstanding bonds wereforfeited in 2002.

 

Theconversion price of the bonds was the Hungarian Forint equivalent of USD 5.75per bond, calculated based on the USD/HUF exchange rate quoted by the HungarianNational Bank on the day of conversion, less the face value of the bond, butnot less than the initial public offering price of HUF 730 per share.

 

Compensationcosts were not recognized in Matáv’s financial statements for the fair value orthe intrinsic value of the bonds granted.

 

**(b) Share options**

 

On April26, 2002, the annual Shareholders’ Meeting approved the introduction of a newmanagement share option plan and authorized the Company’s Board of Directors topurchase 17 million Series “A” registered ordinary shares, each having anominal value of HUF 100 as treasury shares.

 

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Theobjective of issuing the convertible bonds was to establish a closer tiebetween the interests of shareholders and management in the performance of theCompany. The new stock option plan is modeled on the principles of the plancurrently in place at DT however its parameters have been tailored to operatewithin local market conditions and legal constraints.

 

Main parametersof the program:

 

•                  320 senior andmiddle-level managers are eligible to participate in the program. Eligibilityand the number of options granted are determined on the employees’ positionwithin the organization. Toobtain the total amount of options a manager has to have atleast one year’s employment in the appropriate position, otherwise he gets apro-rated amount. The size of grants is established in proportion to the annualgross income, as follows:

 
| 1.     |   | Chief Executive Officer and Chief Officers |   | 45 percent |   |
|--------|--------|--------------------------------------------|--------|------------|--------|
|   |   |                                       |   |       |   |
| 2.     |   | Directors and  Deputy directors            |   | 22 percent |   |
|   |   |                                       |   |       |   |
| 3.     |   | Heads of  Department                       |   | 11 percent |   |

 

•                      The options will beissued annually, in three installments in three consecutive years until thethird anniversary of the start of the program.

 

•                      For the totalduration of the program, the total number of shares potentially attainablethrough the exercise of the options will be 17 million. The breakdown for thethree years is as follows: 4.9 million in 2002, 5.6 million in 2003 and 6.5million in 2004.

 

•                      Options have a lifeof five years and options not exercised after five years from the date of grantwill expire.

 

•                      The options issuedare subject to a graded vesting provision under which the employee may notexercise any options until the first anniversary of the grant, at which timeone third of the options will vest. The remaining options will vest over thenext two years in equal installments such that all options will be exercisableas of the third anniversary of the grant date.

 

•                      The option price isthe lower of the closing market price on the date of the grant or the weightedaverage stock exchange price of the month preceding the grant. The optionexercise price is the option price plus a 10 percent premium plus a certainpercentage to eliminate the inflation effect. The exercise price in eitherinstance will equal or exceed the fair market value on the grant date.

 

•                      Matáv funds theoption exercises by transferring from Treasury the appropriate number of sharesacquired through exercise to the respective employee upon receipt of thenecessary funds. Once the shares are delivered, Matáv will not undertake anyresponsibility with respect to the employees’ sale of those shares.

 

On July 1,2002, the Company granted 3,964,600 options to participants of the stock optionplan at an exercise price of HUF 933 for the first tranche (exercisable in2003) and HUF 950 for the second and third tranches (exercisable in 2004 and2005). The Company’s share price as quoted on the BET (Budapest Stock Exchange)on the grant date was HUF 833 per share. The options have a life of five yearsfrom the grant date, meaning that the options are forfeited without replacementor compensation on June 30, 2007.

 

The optionwith respect to the maximum of one-third of the shares that can be purchasedunder the relevant option (first tranche) may be exercised from July 1, 2003until the end of the term.

 

The optionwith respect to the maximum of a further one-third of the shares that can bepurchased under the option (second tranche) may be exercised from July 1, 2004until the end of the term.

 

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The optionwith respect to the rest of the shares that can be purchased under the option(the third tranche) may be exercised from July 1, 2005 until the end of theterm.

 

Compensationcosts were not recognized in Matáv’s financial statements for the fair value ofthe options granted.

 

The financingstructure of the program:

 

To start the program, the annual Shareholders’ Meetingauthorized the Company’s Board of Directors to purchase 17 million Series “A” registeredordinary shares and empowered the Board of Directors to decide on the timing ofthe capital raises as needed for the plan’s operations when the granted optionsbecome exercisable.

 

In 2002 the Board of Directors raised the capital by4.9 million shares in the framework of a closed-circle capital raise incompliance with take-over regulations set forth in the Act on Equity Markets.

 

Matáv will purchase treasury shares equal to theamount of vested options in order to provide physical shares to the employeesupon the exercise of their options. The General Meeting empowered the Board ofDirectors to authorize the repurchase of the necessary shares into thetreasury.

 

Expected EPS dilution:

 

The number of the shares will increase during theprogram as described above and assuming a given earnings figure, it will resultin the following maximal EPS dilution: 0.47 percent in 2002, 0.53 percent in2003 and 0.62 percent in 2004, resulting in a cumulative EPS dilution of 1.61percent for the three years.

 

**Memorandum and Articles of Association**

 

Matáv is acompany limited by shares. As an association, it is organized by the Act CXLIVof 1997 on Business Associations and registered in the Court of Registration inBudapest, under the entry number 01-10-041928. The purpose of the Company isidentified in paragraph 1.6 in its Articles of Association as follows: The Company isauthorized to provide public telephony services within the entire territory ofthe Republic of Hungary, along with certain closely related auxiliary services.

 

**Corporate Governance**

 

Hungarianstock corporations are governed by three separate bodies: the general meetingof shareholders, the supervisory board and the board of directors. Their rolesare defined by Hungarian law and by the Company’s memorandum and articles ofassociation and may be described generally as follows:

 

**General Meeting of theShareholders**

 

Thesupreme decision making body of the Company is the general meeting ofshareholders. If required, extraordinary general meetings may be held at anytime. A general meeting is convened as frequently as set forth in the deed offoundation, but at least once a year.

 

The Boardof Directors must call an annual general meeting to approve the auditedfinancial statements for the prior year. Shareholders holding at leastone-tenth of the outstanding shares may require the Board of Directors to holdan extraordinary general meeting. The Board of Directors and the SupervisoryBoard also have the right to call an extraordinary general meeting. The Courtof Registration may call a general meeting if, following the request ofshareholders holding at least one-tenth of the outstanding shares, the Board ofDirectors

 

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fails to take anyaction within 30 days, or if the Board of Directors fails to call a generalmeeting within the periods prescribed by law or the Articles of Association.

 

The Boardof Directors must call a general meeting within eight days in order to takenecessary measures when:

 

•             due to losses, the equity ofthe company has decreased to two thirds of the share capital;

 

•             the equity of the Companyhas decreased below HUF 20 million;

 

•             the Company has stoppedpayments and its assets do not cover its debts;

 

•             the number of the members ofthe Board of Directors falls below six;

 

•             the number of the members ofthe Supervisory Board falls below six; or

 

•             upon the request of theholder of the Series “B” Share.

 

Typically, theBoard of Directors calls general meetings. To call a general meeting, the Boardof Directors must publish notice of the meeting and an agenda at least 30 daysbefore the scheduled date of the meeting in the official journal of theBudapest Stock Exchange. The Company must notify each director, the SupervisoryBoard and the auditor that a general meeting has been called within eight daysfollowing publication of notice.

 

A general meetinghas a quorum if shareholders representing more than half of the voting sharesare present in person or by proxy. If an agenda item requires the affirmativevote of the holder of the Series “B” Share, for a quorum the holder of theSeries “B” Share must also be present at the meeting in person or by proxy. Ifthe general meeting does not have a quorum, it will be reconvened within 15 days.A reconvened general meeting will have a quorum for those matters on theoriginal agenda, regardless of the number of shareholders present, except formatters requiring the holder of the Series “B” Share to be present.

 

The generalmeeting of the shareholders has the sole right to:

 

1.                                      approve and amend the Articles of Association;

 

2.                                      increase (except for the cases falling into the scope of authority ofthe Board of Directors) or decrease the Company’s registered capital;

 

3.                                      amend the rights attached to a series of shares or change their class;

 

4.                                      merge, consolidate, separate, terminate, dissolve, liquidate ortransform the Company into another form of association;

 

5.                                      convert shares from bearer form to registered form or vice-versa;

 

6.                                      decide on issuing convertible or subscription right bonds;

 

7.                                      elect members of the Supervisory Board, the Board of Directors and theCompany’s auditor;

 

8.                                      remove and fix the remuneration of the members of the SupervisoryBoard, the Board of Directors and the Company’s auditor;

 

9.                                      approve the financial statements and the amount of dividends to bedistributed if the Company is distributing dividends;

 

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10.                                approve changes in the Company’s registered scope of activities;

 

11.                                designate the persons entitled to subscribe for new shares in a closedsubscription;

 

12.                                alter the number or nominal value of the Series “B” Share and therights attached to the Series “B” Share;

 

13.                                approve the listing of the Company’s shares on a stock exchange;

 

14.                                approve the delisting of the Company’s shares from a stock exchangesubject to any group of shareholders agreeing to make a public tender topurchase the shares of those shareholders who do not vote in favor of thedelisting;

 

15.                                approve the dematerialization of securities the Company has previouslyissued in printed form;

 

16.                                approve an issue that is within its competence pursuant to law or theCompany’s Articles of Association;

 

17.                                transfer or encumber a valuable right held by the Company that enablesit to continue a specific activity of the Company;

 

18.                                transfer all or a substantial part of the Company’s assets;

 

19.                                generally approve the acquisition of shares which would result in aperson or persons acting in concert holding ten percent or more of theoutstanding voting shares of the Company;

 

20.                                approve the payment of a dividend advance determined on the basis ofinterim accounting;

 

21.                                change the corporate form from a public to a private company; and

 

22.                                approve the repurchase of shares and accept a public tender offer inrespect of treasury shares.

 

**The Supervisory Board**

 

The SupervisoryBoard supervises the management of the Company. It may request information fromthe executive officers or the managerial employees of the Company and mayinspect the books and documents of the Company. Supervisory Board members shallbear unlimited, joint and several liability for damages caused to the Companythrough the violation of their supervisory obligations.

 

The SupervisoryBoard comprises a minimum of three and a maximum of 15 members at Matáv. Atpresent the Supervisory Board consists of nine members. Its members shall beelected by the General Meeting for a period of one year. The Supervisory Boardacts as a body. It may assign certain supervisory tasks to any of its membersor may divide supervisory tasks between its members on a permanent basis. Themembers must act in person, not through a representative. The members of theSupervisory Board may not be instructed in their capacity as such by theshareholders of the Company or their employers. The Supervisory Board carriesout its activities in accordance with the rules of procedure established by theSupervisory Board, which are approved by the company’s general meeting.

 

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**The Board of Directors**

 

The Board ofDirectors is the executive body of the Company and represents the Company infront of third parties, courts of law and other authorities. The Board ofDirectors exercises its rights and performs its duties as an independent body.

 

The Board ofDirectors comprises a minimum of six and a maximum of eleven members. The members ofthe Board of Directors are elected for a term of one year commencing at anannual general meeting and expiring at the next year’s annual general meeting.Members of the Board of Directors may be removed or re-elected by the generalmeeting at any time. The Board of Directors carries out its activity in accordance with the rules of procedureestablished by the Board of Directors and subject to the provisions ofapplicable law and the Company’s articles.

 

The members of the Board of Directors must actwith the degree of care that can generally be expected from persons in such aposition and shall be held liable, in accordance with the provisions of thegeneral rules of civil law, for damages to the Company caused by their failureto carry out their tasks in the appropriate manner. The members of the Board ofDirectors shall bear unlimited, joint and several liability for all and anydamage resulting from the untruthfulness of any data, right or fact enteredinto the share register or any damage resulting from a late or non-existingentry.

 

**Capital Increases, Preemptive Rights**

 

Any increase inthe registered capital of the Company is implemented in accordance with theresolution of the General Meeting or the resolution of the Board of Directorsby means of a new issue of shares, either through a public offering or aprivate placement of shares, by converting the Company’s reserves in excess ofthe registered share capital into authorized share capital or by convertingconvertible bonds into shares. If the General Meeting decides on issuing newshares, the shareholders of the Company by a three-quarters’ majority may passa resolution at a general meeting granting existing shareholders preemptiverights in proportion to their shareholdings. In April 2002, the General Meetingof the Company by way of modification of the Articles of Association authorizedthe Board of Directors to increase the registered capital of the Company by amaximum amount of HUF 1,700,000 thousand, that is One Billion Seven HundredMillion HUF, offered exclusively to such investors who wish to participate inthe manager incentive program to be implemented at the Company. The issue priceshall be at least the par value of the share. This authorization of the Boardof Directors shall be effective for five years until the date of the GeneralMeeting, closing the business year of 2006. This authorization includes theauthorization of the Board of Directors to amend in this respect the Articlesof Association of the Company.

 

Unless thegeneral meeting or the Board of Directors otherwise determines by athree-quarters’ majority vote, if the Company converts all or a portion of itsreserves in excess of its registered capital into registered capital, it mustoffer the newly issued shares free of charge to existing shareholders inproportion to their shareholding. If the general meeting decides otherwise by athree-quarters’ majority vote, the decision will be valid only if it alsoincludes the price or price-setting principles for the issue of shares.

 

**Voting Rights and Voting**

 

Each ordinaryshare entitles the holder to one vote. Only shareholders or their proxiesregistered in the shareholders’ register six business days prior to a generalmeeting may cast a vote. The Series “B” Share has special voting rightsdescribed below. The matters listed in clauses 1. to 6. and 11. to 14. above,any decision overriding a resolution of the Board of Directors and preemptiveshareholder rights in the event of a capital increase, all require a minimumthree-quarters’ majority of votes cast by the shareholders present orrepresented at the general meeting. All other matters submitted to a generalmeeting require only a simple majority vote.

 

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*Series “B” Share*

 

The HungarianState owns the Series “B” Share. Only the Minister or his legal successor mayexercise rights attached to the Series “B” Share. Except as described below,the Series “B” Share has the same rights as the ordinary shares. The holder ofthe Series “B” Share is entitled:

 

1.            tonominate one member of the Board of Directors and one member of the SupervisoryBoard and effectively to elect, remove or replace these members;

 

2.            if theCompany’s registered capital is increased, a new class of shares is issued orthe rights attached to a particular class of shares change, to require theArticles of Association to be amended so that the voting rights of the Series“B” Share will be sufficient to nominate, elect or remove the Series “B”director or Supervisory Board member;

 

3.            toinspect the shareholders’ register and the books maintained by a depository ofthe Company’s shares approved by the Company and to request copies of theregister or books;

 

4.            if theCompany dissolves without a successor company, to purchase all or part of theCompany’s assets, including shares of subsidiaries or affiliates, for a priceequal to the appraised fair market value of such assets;

 

5.            torequest from the Board of Directors detailed information about a material factsignificantly affecting the Company’s financial position; and

 

6.            torequest that the Company audit or investigate any issue or prepare reports orprovide information on issues within the scope of activities of the Company’sauditor or the Supervisory Board pursuant to law or the Articles ofAssociation.

 

The holder of theSeries “B” Share must be present, in person or by proxy, for a quorum, and itsapproval is required to pass shareholders’ resolutions related to any:

 

1.            increaseand decrease of the Company’s registered capital;

 

2.            changeof rights attached to any class of shares, including any amendment to therights of the Series “B” Share or the creation of a new class of shares withrights superior or equal to the rights or adversely affecting the rights of theSeries “B” Share, or any amendment to the rights attached to any existing classof shares that would grant them rights superior or equal to the rights attachedto the Series “B” Share;

 

3.            mergerinto or consolidation with another business entity, de-merger, transformationinto another form of business association and termination of the Company withouta legal successor;

 

4.            transfer,creation or encumbrance of a valuable right that enables the Company to operateaccording to the Universal Telecommunications Service Contract;

 

5.            electionor removal of the Series “B” director or Supervisory Board member;

 

6.            conversionof a type of shares by means of replacing or stamping them;

 

7.            transferof all or a substantial part of the assets of the Company that would render theCompany incapable of performing its obligations under the UniversalTelecommunications Service Contract;

 

8.            amendmentto the Articles of Association which would impair the rights of the holder ofthe Series “B” Share, including authorizing the Board of Directors to increasethe Company’s registered capital;

 

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9.            issuanceof convertible bonds or bonds conferring preemptive rights; and

 

10.      decisions onsignificant transfers of shares.

 

*Transfer of Shares*

 

The holder of theSeries “B” Share and other shareholders holding at least a simple majority ofthe shares must generally approve a transfer of shares that would result in aperson or group of persons holding ten percent or more of the outstandingvoting stock of the Company. The consent of the holder of the Series “B” Shareis also required to transfer shares if the transferee would acquire more than49.9 percent of the outstanding voting stock of the Company.

 

In registering atransfer of shares, the registrar may request evidence that the shares weretransferred in accordance with the Articles of Association. If the Companyestablishes that the transfer occurred in violation of the Articles ofAssociation or if the transferee refuses to produce the necessary evidence, theCompany may refuse to register the transfer. The Board of Directors mayinvalidate registrations based on untrue, false or misleading statements. Onlyshareholders registered in the Company’s register may exercise shareholderrights vis-a-vis the Company or transfer shares. A registered shareholder mustnotify the Company within eight days of any transfers of its shares or it willbe liable for liquidated damages.

 

**Materialcontracts**

 

*Purchase of the Remaining 49 Percent Interest inWestel and Westel 0660*

 

On October 21,1999, Matáv announced that it had entered into an agreement with DT providingMatáv the option to acquire DT’s 49 percent interest in Westel and Westel 0660for a price of U.S. dollar 885 million.

 

On December 21,2001 Matáv paid DT EUR 920 million (HUF 227 billion) and had agreed to pay in2002 an additional amount equal to 49 percent of the dividend to be declared byWestel for 2001. Based on the amount of dividend with respect to 2001 declaredby Westel, Matáv had to pay an additional HUF 11.5 billion. No dividends weredeclared by Westel 0660. The purchase price was financed by way of a mediumterm EUR loan provided by DT at an interest rate of EURIBOR plus 50 basispoints.

 

*Acquisition of MakTel*

 

In December 2000,the Company, on behalf of a consortium, reached agreement with the governmentof Macedonia to purchase 51 percent of MakTel on its privatization. The closingof the transaction took place on January 15, 2001, whereby the Company paid EUR343.3 million on behalf of the consortium in accordance with the relevantagreement. The 51 percent ownership acquired by Matáv was contributed onJanuary 16, 2001 to a newly established Macedonian acquisition vehicle,Stonebridge.

 

In accordancewith the Deed between Matáv, SEEF and CosmoTelco, the latter two acquired a 6.1percent and a 7.4 percent ownership respectively in Stonebridge reducingMatáv’s investment in Stonebridge to EUR 301.5 million. Matáv, consequently,has an 86.5 percent stake in Stonebridge, which owns 51 percent of MakTel,thereby Matáv has an effective ownership percent in MakTel of approximately 44percent.

 

The Deed providesfor a put option which entitles SEEF to sell its shares to Matáv on May 15 ofeach of 2003, 2004 or 2005 or upon the occurrence of certain events at a priceformula also set out in the Deed. The formula takes into account the purchaseprice paid by the consortium for the shares, EBITDA and the net debt of MakTel.

 

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CosmoTelco andMatáv entered into a call option agreement whereby CosmoTelco has the right toacquire additional shares in Stonebridge from Matáv such that CosmoTelco’sholding can be increased to 29 percent of the issued share capital ofStonebridge. The price for each share is based on Matáv’s acquisition cost plusholding costs. Before the expiration of CosmoTelco’s call option on February 8,2002, Matáv and CosmoTelco amended the option agreement as a result of whichCosmoTelco had one more year (until February 2003) to exercise its option for a10 percent share in Stonebridge. Matáv paid a fee of EUR 7 million in returnfor CosmoTelco to let the option for the remaining 11.55 percent share toexpire unused on February 8, 2002.

 

On February 7,2003 Matáv and CosmoTelco amended the option agreement. The parties agreed toextend the exercise date of the option for the 10 percent share in Stonebridgeuntil September 30, 2003, leaving all other conditions of the agreementunchanged.

 

Pursuant to theterms of the Deed, SEEF sent an official notice to Matáv on March 7, 2003stating that it was electing to exercise its put option with respect to 50percent of its shareholding in Stonebridge. Matáv expects to pay EUR 20.9million as the SEEF put option price. Following the financial closing of thetransaction, which is expected to occur on May 15, 2003, the shareholders ofStonebridge will be Matáv with an 89.55 percent stake, SEEF with a 3.05 percentstake and CosmoTelco with a 7.4 percent stake.

 

**ExchangeControl**

 

The investment byforeigners in Hungarian securities is regulated by Act XXIV of 1988 on Foreign Investments,as amended (the “Foreign Investment Act”), Act XCIII of 2001 on Elimination ofExchange Restrictions, as amended (the “Exchange Act”) and Act CXX of 2001 onthe Capital Market, as amended (the “Capital Market Act”) and implementingdecrees. The Foreign Investment Act and the Capital Market Act regulate foreigninvestment in Hungarian equities. In addition, the Capital Market Act and theExchange Act regulates foreign investment in Hungarian debt instruments andflows of cash. The regulations in these acts do not restrict foreigners frominvesting in registered shares issued by Hungarian companies, nor do theyrestrict the total number of shares foreigners may own. In addition, foreignersmay establish wholly owned subsidiaries in Hungary to acquire all the shares ofa Hungarian company.

 

Shares held byforeign investors may generally, under Hungarian law, be sold withoutrestrictions to other foreigners or Hungarian persons. Foreign investors maydeposit proceeds from sales to Hungarian persons in a convertible HungarianForint account, the balance of which may be converted into foreign currency andrepatriated without restriction, subject to withholding tax rules, or may bepaid into a foreign currency account of the foreigner in Hungary or abroad.Similarly, foreign investors may convert dividends paid by Hungarian companiesinto foreign currency and repatriate the proceeds, subject to withholding taxrules. If a foreign shareholder does not wish to repatriate sale proceeds ordividend payments, it may elect to receive and deposit such payments inHungarian Forints into a convertible HUF denominated account established withany commercial bank in Hungary. Such accounts will accrue interest in HungarianForints. The balance remains freely convertible into foreign currency and maysubsequently be repatriated or reinvested in Hungary.

 

On June 16, 2001,the Government Decree 88/2001 (VI. 15) came into force and essentiallyeliminated all of the previous restrictions regarding the conversion of HungarianForint into foreign currencies and transactions between foreigners andHungarian persons. Consequently foreign investors may:

 

•                  freely convert HUFfunds;

 

•                  freely sell securitiesand instruments not qualifying as securities to domestic persons in HUF and inforeign currency; and

 

•                  freely invest in shortterm instruments and securities in Hungary (except for receivables derivingfrom compensation coupons regulated by the Compensation Act).

 

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**Taxation**

 

Thefollowing is a summary, under current law, of the principal Hungarian and USfederal income tax considerations relevant to an investment by a US taxpayer inour ordinary shares or ADSs (which we refer to collectively in this summary asthe “shares”).  This summary applies toyou only if you are eligible for benefits as a US resident under the currentincome tax convention between the United States and Hungary (the “Treaty”) inrespect of your investment in the shares. In general, you will be eligible for such benefits if:

 

•*                 *you are:

 

•*                      *an individualUS citizen or resident;

 

•*                      *a UScorporation; or

 

•*                      *a partnership,estate, or trust to the extent your income is subject to taxation in the UnitedStates as the income of a resident, either in your hands or in the hands ofyour partners or beneficiaries;

 

•*                 *you are not also aresident of Hungary for Hungarian tax purposes;

 

•*                 *you are thebeneficial owner of the shares (and the dividends paid with respect thereto);

 

•*                 *you hold the sharesas a capital asset for tax purposes; and

 

•*                 *you do not hold theshares in connection with the conduct of business through a permanentestablishment, or the performance of personal services through a fixed base, inHungary.

 

Thissummary does not purport to be a comprehensive description of all of the taxconsiderations that may be relevant to any particular investor, and does notaddress the tax treatment of investors who are subject to special rules.  We have assumed that you are familiar withthe tax rules applicable to investments in securities generally and with anyspecial rules to which you may be subject. You should consult your own tax advisers regarding the tax consequencesof the ownership of our shares in the light of your own particularcircumstances.

 

You shouldalso note that the United States and Hungary are currently in the process ofrenegotiating their income tax convention. Any resulting new treaty may have provisions that differ from thosedescribed herein.

 

Ingeneral, the Hungarian and US federal income tax considerations relevant to aninvestment in the shares will be similar to the considerations relevant toinvestments in equity securities issued by other Hungarian corporations.

 

Withregard to Hungarian taxation:

 

•*                 *dividends that youreceive on the shares will generally be subject to Hungarian withholding tax ata rate of 20 percent (35 percent in the case of any portion paid to anindividual that exceeds an amount equal to 30 percent of the proportion of thecompany’s equity represented by such individual’s ownership interest in thecompany), but you will be entitled to claim a refund from the Hungarian taxauthorities to the extent the amount withheld exceeds the 15 percent rateprovided under the Treaty;

 

•*                 *under the Treaty,capital gains that you realize on a sale or other disposition of the shareswill not be subject to any Hungarian tax provided that you can show entitlementto Treaty benefits by presenting a certificate of tax residence from the USInternal Revenue Service; and

 

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•*                 *no Hungariantransfer taxes or stamp duties will apply to a purchase, sale, or otherdisposition of the shares that you make.

 

In thecase of holders other than individuals, the Company is entitled to withhold taxfrom dividends at the Treaty rate of 15 percent provided that the holderentitled to such dividend submits its residence certificate and beneficialownership declaration to the Company before the dividend payment.

 

In thecase of individuals, in order to obtain the refund of Hungarian withholding taxdescribed above, you must file a claim with the Hungarian tax authorities whichmust include official certification from the US Internal Revenue Service thatyou are entitled to Treaty benefits, a statement from the payer showing thatthe tax has been withheld, and a declaration that you are the beneficial ownerof the income and that the amount received will be treated as income for US taxpurposes. A claim form may be obtained from APEH Észak-budapesti Igazgatósága,1139 Budapest, Petneházy u. 6-8, PO Box 45, Hungary. You should consult yourown tax advisers for additional details with respect to the procedure forclaiming such refunds.

 

Withregard to US federal income taxation:

 

•*                 *if you hold sharesin ADS form, you will be treated as holding the underlying ordinary shares forUS federal income tax purposes, and deposits and withdrawals of ordinary sharesin exchange for ADSs will not be taxable events;

 

•*                 *you must includethe gross amount of cash dividends paid on the shares, without reduction forHungarian withholding tax, in ordinary income on the date that you or the ADSdepositary receive them, translating dividends paid in Hungarian forints intoUS dollars using the exchange rate in effect on the date of receipt;

 

•*                 *dispositions ofshares that you make will generally give rise to capital gain or loss, whichwill be long-term capital gain or loss, subject to taxation at reduced ratesfor non-corporate taxpayers, if the shares were held for more than one year;

 

•*                 *Hungarian taxwithheld from dividends will be treated, up to the 15 percent rate providedunder the Treaty, as a foreign income tax that, subject to generally applicablelimitations under US tax law, is eligible for credit against your US federalincome tax liability or, if you have elected to deduct such taxes, may bededucted in computing taxable income; and

 

•*                 *fluctuations in thedollar-forint exchange rate between the date that you receive a dividend andthe date that you receive a related refund of Hungarian withholding tax maygive rise to foreign currency gain or loss, which is generally treated asordinary income or loss for US tax purposes.

 

**Documentson Display**

 

Matáv is subjectto the informational requirements of the U.S. Securities Exchange Act of 1934,as amended. In addition, we are required to file annual reports and otherinformation we make public in Hungary or with the Budapest Stock Exchange withthe U.S. Securities and Exchange Commission under the Exchange Act. We file ourannual reports on or before June 30 each year. We file other information at thetime we make it public in Hungary or file it with the Budapest Stock Exchange.

 

You may read andcopy the registration statement, including the attached exhibits, the reports,statements or other information that we file at the Commission’s publicreference room in Washington D.C., which is located at Room 1024, 450 FifthStreet, N.W., Washington, D.C., 20549. These documents are also available atthe Commission’s regional office located at Citicorp Center, 500 West MadisonStreet, Suite 1400, Chicago, Illinois, 60661. You can request copies of thesedocuments, upon payment of a duplicating fee, by writing the Commission at 450Fifth Street, N.W., Washington D.C., 20549. Please call the Commission at 1-800-SEC-0330

 

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for furtherinformation on the operation of the public reference rooms. In addition, youmay also obtain the reports and other information we file at the offices of theNew York Stock Exchange, Inc., 20 Broad Street, New York, New York, 10005.

 

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**ITEM 11****— QUANTITATIVE AND QUALITATIVEDISCLOSURES****ABOUT MARKET RISK**

 

**Market Risk Sensitive Instruments**

 

Financialinstruments carried on the balance sheet include cash and bank balances,investments, receivables, trade payables, leases and borrowings. Matáv is alsoa party to financial instruments that reduce exposure to fluctuations inforeign currency exchange.

 

Matáv isexposed to interest and foreign exchange rate risk associated with its debt andanticipated transactions. Matáv has no significant concentrations of creditrisk. As the vast majority of the revenues and expenses of the Hungarianentities arise in Hungarian Forints, the measurement currency of Matáv is HUF,therefore Matáv’s objective is to minimize the level of its financial risk inHUF terms.

 

Matáv isexposed to financial market risk through interest rate fluctuations. This isdue to the fact that changing EUR and HUF interest rates affect the fair valueof fixed rate debts and also affect the cash outflow through the variable ratedebts. To control interest rate risk, a combination of fixed and floating ratedebt is used within the foreign currency and HUF portfolios. Since in 2002 themajority of the debt portfolio was transformed or swapped to HUF, the interesttargets are mainly related to the HUF debt portfolio. Before 2002 the floatingrate elements dominated in the HUF portfolio due to decreasing HUF interest rates.

 

Matáv is exposedto foreign exchange risk related to foreign currency debt and foreign exchangepayments (i.e. international third party telecommunications carriers andcapital expenditure). To reduce foreign exchange risk, Matáv targeted toincrease the proportion of its borrowings in Hungarian Forint. Matáv’s foreignexchange debt portfolio is denominated in, or swapped to, Euro after MakTelprepaid its USD denominated debt in 2002. The National Bank of Hungary liftedthe devaluation of the Hungarian Forint against the Euro in October 2001 afterwidening the intervention band from +/-2.25 percent to +/-15 percent as of May4, 2001. The introduction of this new foreign exchange regulation increased theforeign exchange risk of Matáv significantly.

 

In 2000, 2001 and2002 Matáv occasionally entered into derivative contracts for risk reductionpurposes. These foreign currency forward contracts and swap arrangements weretaken to reduce the exchange rate risk related to the debt portfolio and/or theforeign exchange denominated payment obligations.

 

Derivativeinstruments are limited to foreign currency forward contracts and swapagreements that are recognized at cost in the financial statements oninception. As of December 31, 2002, Matáv had no open foreign currency forwardpositions.

 

Included in bankloans is a USD denominated loan amounting to HUF 3,984 million that is subjectto interest based on a fixed rate of 7.05 percent. This loan is subject to across currency interest rate swap arrangement which entitles Matáv to receiveUSD interest and principal payments at fixed rates, and obliges it to pay EURinterest and principal repayments at floating rates of the EURIBOR rate plus amargin of 0.66 percent. The EUR principal payments are fixed at a rate of1.0777 USD/EUR. The timing and amount of the USD payments to be receivedexactly match the underlying payment obligations on the USD loan. This is anamortizing loan with semi-annual repayments with a final maturity in 2011. In2000 Matáv accounted for interest and foreign exchange movements on these loansat the EUR rate.

 

Included in bankloans is a USD denominated loan amounting to HUF 4,122 million that is subjectto interest based on a fixed rate of 6.56 percent. This loan is subject to across currency swap agreement. This swap agreement entitles Matáv to receiveUSD interest and principal payments at fixed rates, and obliges it to pay EURinterest and principal payments at fixed rates of 5.17 percent. EUR principalpayments are determined according to the EUR equivalent of the USD principalpayments at a rate of 1.0277 USD/EUR. The timing and amount of the USD paymentsreceived exactly match the underlying payment obligations of the USD loans.This is an amortizing loan with semi-annual repayments with a final maturity in2011.

 

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In 2000 Matávaccounted for interest and foreign exchange movements on these loans at the EURrate.

 

From 2001 the twoloans described above are accounted for as USD loans, while the fair value ofthe swap agreements is accounted for separately as derivative assets and isdisclosed in other non current assets.

 

For theacquisition of a 44 percent stake in MakTel, Matáv received a loan of EUR 301.5million (HUF 79,985 million) from Deutsche Telekom Finance B.V. on January 15,2001. The loan was based on a variable rate of EURIBOR plus a margin of 30basis points and repayable in one amount on January 31, 2006. Interest paymentsare due semi-annually.

 

Matáv has enteredinto a swap agreement on February 4, 2002 in order to exchange the cash flowsof the EUR 301.5 million loan to HUF cash flows. The counter-party in thetransaction was DT. The cross currency swap agreement entitled Matáv to receiveEUR interest and principal payments and pay HUF interest and principalpayments. The EUR loan was subject to floating rate interest based on 6 monthEURIBOR plus a margin of 30 basis points, while under the swap Matáv wasobliged to pay an interest based on 6 month BUBOR plus a margin of 34 basispoints. The HUF principal payment was fixed at a rate of one EUR to 244.36 HUF(HUF 73,675 million). The timing and the amount of the EUR payments to bereceived under the swap were matched with the underlying payment obligations onthe EUR loan.

 

As of November 4,2002, the loan and the swap agreement were replaced with a new fixed 9.36percent interest HUF loan of HUF 73,675 million, leaving the repayment termsunchanged.

 

For theacquisition of the remaining 49 percent stake in Westel, Matáv received a loanof EUR 920 million (HUF 226,750 million) from Deutsche Telekom Finance B.V. onDecember 20, 2001. The loan is based on a variable rate of EURIBOR plus amargin of 50 basis points and repayable in one amount on August 14, 2003.Interest payments are due quarterly.

 

In 2002, Matávconcluded four swap agreements in order to exchange some of the cash flowsrelated to the above mentioned EUR loan to HUF cash flows. The counter-party inthe transaction is DT. The cross currency swap agreement entitles Matáv toreceive EUR interest subject to 3 month EURIBOR plus a margin of 50 basispoints and EUR 525 million principal amount, while Matáv has the obligation topay HUF interest subject to 3 month BUBOR plus a margin of 50-57 basis pointsand HUF 126,644 million principal amount. The timing of the EUR payments to bereceived under the swaps are matched with the timing of the EUR paymentobligations relating to the original EUR loan.

 

In 2002, EUR 230million of the portion of the loan for which no swap agreements were in placewas repaid. As a result of the early repayments, the balance of the loan as ofDecember 31, 2002 is EUR 690 million (HUF 162,771 million), of which EUR 165million is not covered with swap agreements.

 

The loandescribed above is accounted for as a EUR loan, while the fair value of theswap agreements is accounted for separately as a derivative liability and isdisclosed in other non current liabilities.

 

The financialasset portfolio is relatively small compared to the debt portfolio of Matáv andmainly includes bank deposits.

 

As of December31, 2002, Matáv’s cash and cash equivalent’s balance included HUF denominatedcash equivalent instruments in an amount of HUF 1,761 million at an averageinterest rate of 1.97 percent, MKD denominated cash balance in an amount of HUF6,689 million at an average interest rate of 5.82 percent and other foreignexchange denominated instruments at an amount of HUF 401 million with anaverage interest rate of 1.43 percent.

 

The net carryingamounts of financial assets including cash, investments, receivables andpayables and finance lease obligations reflect reasonable estimates of fairvalue due to the relatively short period to maturity of the instruments.

 

129

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Thefollowing table is a summary of Matáv’s market sensitive debt instruments,including fair value calculated using the discounted cash flow method. Averagerates disclosed represent the weighted average rates of fixed rate and variablerate portfolios at period end. The book values of variable rate loans andborrowings approximate their fair values as shown below at December 31, 2002.

 
|                                          |   | **Maturities**                             |   |     |   |     |   |
|-----------------------------------------------|--------|--------------------------------------------|--------|----------|--------|----------|--------|
|                                          |   | **2003**                                   |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **after  2007** |   | **Total** |   | **Fair  value** |   |
|                                          |   | **(in  HUF millions, except percentages)** |   |
| **Bank loans (HUF denominated)**              |   |                                       |   |     |   |     |   |   |   |   |   |   |   |   |   |   |   |
| Fixed rate                                    |   | 6,300                                      |   | 12,500   |   | —   |   | — |   | — |   | — |   | 18,800 |   | 19,437 |   |
| Average interest rate                         |   | 9.31                                       | %      | 11.75    | %      |     |   |   |   |   |   |   |   | 10.93 | % |   |   |
| Variable rate                                 |   | 33,408                                     |   | 25,634   |   | 13,375   |   | 625 |   | 3,124 |   | — |   | 76,166 |   | 76,166 |   |
| Average interest rate                         |   | 9.18                                       | %      | 9.25     | %      | 9.46     | %      | 10.25 | % | 9.88 | % |   |   | 9.29 | % |   |   |
| Total                                         |   | 39,708                                     |   | 38,134   |   | 13,375   |   | 625 |   | 3,124 |   | 0 |   | 94,966 |   | 95,603 |   |
|                                          |   |                                       |   |     |   |     |   |   |   |   |   |   |   |   |   |   |   |
| **Bank loans (foreign currency denominated)** |   |                                       |   |     |   |     |   |   |   |   |   |   |   |   |   |   |   |
| Fixed rate                                    |   | 2,098                                      |   | 2,098    |   | 2,098    |   | 2,098 |   | 2,098 |   | 7,342 |   | 17,832 |   | 19,963 |   |
| Average interest rate                         |   | 6.92                                       | %      | 6.92     | %      | 6.92     | %      | 6.92 | % | 6.92 | % | 6.92 | % | 6.92 | % |   |   |
| Total                                         |   | 2,098                                      |   | 2,098    |   | 2,098    |   | 2,098 |   | 2,098 |   | 7,342 |   | 17,832 |   | 19,963 |   |
|                                          |   |                                       |   |     |   |     |   |   |   |   |   |   |   |   |   |   |   |
| Total bank loans                              |   | 41,806                                     |   | 40,232   |   | 15,473   |   | 2,723 |   | 5,222 |   | 7,342 |   | 112,798 |   | 115,566 |   |
|                                          |   |                                       |   |     |   |     |   |   |   |   |   |   |   |   |   |   |   |
| **Bonds (HUF denominated)**                   |   |                                       |   |     |   |     |   |   |   |   |   |   |   |   |   |   |   |
| Fixed rate                                    |   | 13,076                                     |   | —   |   | —   |   | — |   | — |   | 131 |   | 13,207 |   | 13,246 |   |
| Average interest rate                         |   | 9.20                                       | %      |     |   |     |   |   |   |   |   | 0.00 | % | 9.11 | % |   |   |
| Variable rate                                 |   | 10,000                                     |   | —   |   | —   |   | — |   | — |   | — |   | 10,000 |   | 10,000 |   |
| Average interest rate                         |   | 10.28                                      | %      |     |   |     |   |   |   |   |   |   |   | 10.28 | % |   |   |
| Total                                         |   | 23,076                                     |   | 0        |   | 0        |   | 0 |   | 0 |   | 131 |   | 23,207 |   | 23,246 |   |

 

130

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**ITEM 12****— DESCRIPTION OF SECURITIES OTHER THAN EQUITYSECURITIES**

 

Not applicable.

 

 

**PART II**

 

**ITEM 13****— DEFAULTS, DIVIDEND ARREARAGES ANDDELINQUENCIES**

 

None.

 

**ITEM 14****— MATERIAL MODIFICATIONS TO THE RIGHTS OFSECURITY HOLDERS AND USE OF PROCEEDS**

 

None.

 

**ITEM 15****— CONTROLS AND PROCEDURES**

 

Within the 90days prior to the date of this report, the Company carried out an evaluationunder the supervision and with the participation of the Company’s management,including the Company’s Chief Executive Officer and Chief Financial Officer, ofthe effectiveness of the design and operation of the Company’s disclosurecontrols and procedures.  Based upon andas of the date of that evaluation, the Chief Executive Officer and ChiefFinancial Officer concluded that the disclosure controls and procedures areeffective in all material respects to ensure that information required to bedisclosed in the reports the Company files and submits under the Exchange Actis recorded, processed, summarized and reported as and when required.

 

**ITEM 16****— (RESERVED)**

 

 

**PART III**

 

**ITEM 17****— FINANCIAL STATEMENTS**

 

See pages F-1through F-45 incorporated herein by reference.

 

**ITEM 18****— FINANCIAL STATEMENTS**

 

Not applicable.

 

131

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**ITEM 19****— EXHIBITS**

 

1.1.  Articles of Association of Matáv(incorporated herein by reference to Exhibit 1.1. of Matáv’s 2001 Form 20-Fdated May 9, 2002).

 

3.1.        Form ofDeposit Agreement, dated as of October 8, 1997, among Matáv, Morgan GuarantyTrust Company of New York, as Depository, and holders from time to time ofAmerican Depositary Receipts issued thereunder, including the form of AmericanDepositary Receipt (incorporated herein by reference to Exhibit 4.1. of Matáv’sForm F-1 dated November 13, 1997).

 

3.1.      Agreement tofurnish to the Securities and Exchange Commission copy of the HUF 45 billionMedium Term Note Program upon request (incorporated herein by reference toExhibit 2.2. of Matáv’s 2001 Form 20-F dated May 9, 2002).

 

4.1.   Concession Agreement, dated December 19,1993, between the Minister and MagyarCom (incorporated herein by reference toExhibit 10.1. of Matáv’s Form F-1 dated November 13, 1997).

 

4.2.   Assignment and Assumption, dated December 22,1993, by and among MagyarCom, Matáv and the Minister (incorporated herein byreference to Exhibit 10.2. of Matáv’s Form F-1 dated November 13, 1997).

 

4.3.1.Concession Contract, as amended, dated December 22, 1993, between the Ministerand Matáv (incorporated herein by reference to Exhibit 4.3.1. of Matáv’s 2001Form 20-F dated May 9, 2002).

 

4.3.2.Contract for the revision and termination of the Nationwide Concession Contractconcluded on December 22, 1993 and the Concession Contract concluded on May 25,1994 and for the provision of universal telecommunications services, datedJanuary 28, 2002, by and among the Minister and Matáv (incorporated herein byreference to Exhibit 4.3.2. of Matáv’s 2001 Form 20-F dated May 9, 2002).

 

4.4.   Shareholders’ Agreement, dated September 26,1997, by and among Matáv, MagyarCom and the Minister (incorporated herein byreference to Exhibit 10.5. of Matáv’s Form F-1 dated November 13, 1997).

 

4.5.   Amended and Restated Framework ServicesAgreement, dated January 1, 2000, by and among Matáv, Deutsche Telekom AG,Ameritech International Inc. and MagyarCom Services Kft. (incorporated hereinby reference to Exhibit 4.5. of Matáv’s 2001 Form 20-F dated May 9, 2002).

 

4.6.1.Share Purchase Agreement between the Republic of Macedonia and Matáv relatingto the sale of 50 percent of the issued share capital of MakedonskiTelekomunikacii dated December 22, 2000 (incorporated herein by reference toExhibit 4.6.1 of Matáv’s 2001 Form 20-F dated May 9, 2002).

 

4.6.2.Subscription and Shareholders’ Deed between Matáv, Cosmotelco Added Value ServicesS.A., SEEF Holdings Limited and Telemacedonija Ad Skopje, dated December 14,2000 (incorporated herein by reference to Exhibit 4.6.2. of Matáv’s 2001 Form20-F dated May 9, 2002).

 

4.6.3.First Supplemental Deed to the Subscription and Shareholders’ Deed betweenMatáv, CosmoTelco Added Value Services S.A., SEEF Holdings Limited andTelemacedonija Ad Skopje, dated December 14, 2000 (incorporated herein byreference to Exhibit 4.6.3. of Matáv’s 2001 Form 20-F dated May 9, 2002).

 

4.6.4.Second Supplemental Deed to the Subscription and Shareholders’ Deed betweenMatáv, CosmoTelco Added Value Services S.A., SEEF Holdings Limited andTelemacedonija Ad Skopje, dated December 14, 2000 (incorporated herein byreference to Exhibit 4.6.4. of Matáv’s 2001 Form 20-F dated May 9, 2002).

 

132

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4.6.5.Shareholders Agreement between the Republic of Macedonia and Matáv in relationto Makedonski Telekomunikacii, dated January 15, 2001 (incorporated herein byreference to Exhibit 4.6.5. of Matáv’s 2001 Form 20-F dated May 9, 2002).

 

4.6.6.Modification of the Subscription and Shareholders’ Deed between Matáv andCosmoTelco Added Value Services S.A. with respect to the option, dated February7, 2002 (incorporated herein by reference to Exhibit 4.6.6. of Matáv’s 2001Form 20-F dated May 9, 2002).

 

4.6.7.Agreement for Call Option Extension between Matáv and CosmoTelco Added ValueServices S.A. with respect to the option, dated February 7, 2003.

 

4.6.8.Election of Exercise the Put Option of SEEF Holdings Limited dated March 7,2003.

 

4.7.1.Call Option Agreement between Deutsche Telekom AG and Matáv, dated October 20,1999 (incorporated herein by reference to Exhibit 4.7.1. of Matáv’s 2001 Form20-F dated May 9, 2002).

 

4.7.2.Westel Proxy between Deutsche Telekom AG and Matáv, dated October 20, 1999(incorporated herein by reference to Exhibit 4.7.2. of Matáv’s 2001 Form 20-Fdated May 9, 2002).

 

4.7.3.Business Share Sale and Purchase Agreement, dated December 21, 2001 betweenDeutsche Telekom AG and Matáv (incorporated herein by reference to Exhibit4.7.3. of Matáv’s 2001 Form 20-F dated May 9, 2002).

 

4.7.4.Share Sale and Purchase Agreement, dated December 21, 2001 between DeutscheTelekom AG and Matáv (incorporated herein by reference to Exhibit 4.7.4. ofMatáv’s 2001 Form 20-F dated May 9, 2002).

 

4.7.5.Determination of the foreign exchange rate for the exercise of the Westel CallOption and e-denomination of purchase price to Euro, letter dated October 31,2001 from Deutsche Telekom AG to Matáv (incorporated herein by reference toExhibit 4.7.5. of Matáv’s 2001 Form 20-F dated May 9, 2002).

 

4.7.6.Loan Agreement between Deutsche Telekom International Finance B.V. and Matáv tofinance the acquisition of a 49 percent stake both in Westel and Westel 0660,dated December 20, 2001 (incorporated herein by reference to Exhibit 4.7.6. ofMatáv’s 2001 Form 20-F dated May 9, 2002).

 

4.8.   Loan Agreement for the purpose of Financingthe Acquisition of MakTel, dated January 11, 2001 between Matáv and DeutscheTelekom AG (incorporated herein by reference to Exhibit 4.8. of Matáv’s 2001Form 20-F dated May 9, 2002).

 

8.1.   See “Significant Subsidiaries” in “Item 4.Information on the Company” for significant subsidiaries as of December 31,2000. All subsidiaries were incorporated in Hungary, except for MakTel andStonebridge A.D., which were incorporated in Macedonia.

 

10.1.Independent Auditors’ Consent of PricewaterhouseCoopers.

 

10.2.Certification of the CEO and the CFO pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

133

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**SIGNATURES**

 

The registranthereby certifies that it meets all of the requirements for filing on Form 20-Fand that it has duly caused and authorized the undersigned to sign this annualreport on its behalf.

 

Date: May9, 2003

 

 
|   |   | **Magyar Távközlési Rt.** |
|--------|--------|------------------------------------------|
|   |   |                                     |
|   |   |                                     |
|   | By:    | /s/ Elek Straub                          |   |
|   | Name:  | Elek Straub                              |
|   | Title: | Chairman and  Chief Executive Officer    |
|   |   |                                     |
|   |   |                                     |
|   | By:    | /s/ Dr. Klaus  Hartmann                  |   |
|   | Name:  | Dr. Klaus  Hartmann                      |
|   | Title: | Chief Financial  Officer                 |

 

134

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**CertificationPursuant to Section 302 of the Sarbanes-Oxley Act of 2002**

 

I, Elek Straub,certify that:

 

1.               Ihave reviewed this annual report on Form 20-F of Matáv;

 

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

 

3.               Basedon my knowledge, the financial statements, and other financial informationincluded in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this annual report;

 

4.               Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and have:

 

a.)designed such disclosure controls and procedures to ensure that materialinformation relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this annual report is being prepared;

 

b.)evaluated the effectiveness of the registrant’s disclosure controls andprocedures as of a date within 90 days prior to the filing date of this annualreport (the “Evaluation Date”); and

 

c.)presented in this annual report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.               Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

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

 

b.)any fraud, whether or not material, that involves management or other employeeswho have a significant role in the registrant’s internal controls.

 

6.               Theregistrant’s other certifying officers and I have indicated in this annualreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

Date: May9, 2003

 
|   | By:    | /s/ Elek Straub                       |   |
|--------|--------|---------------------------------------|--------|
|   | Name:  | Elek Straub                           |
|   | Title: | Chairman and  Chief Executive Officer |

 

135

----

 

**CertificationPursuant to Section 302 of the Sarbanes-Oxley Act of 2002**

 

I, Dr. KlausHartmann, certify that:

 

1.               Ihave reviewed this annual report on Form 20-F of Matáv;

 

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

 

3.               Basedon my knowledge, the financial statements, and other financial informationincluded in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this annual report;

 

4.               Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and have:

 

a.)designed such disclosure controls and procedures to ensure that materialinformation relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this annual report is being prepared;

 

b.)evaluated the effectiveness of the registrant’s disclosure controls and proceduresas of a date within 90 days prior to the filing date of this annual report (the“Evaluation Date”); and

 

c.)presented in this annual report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

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

 

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

 

b.)any fraud, whether or not material, that involves management or other employeeswho have a significant role in the registrant’s internal controls

 

6.               Theregistrant’s other certifying officers and I have indicated in this annualreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

Date: May9, 2003

 
|   | By:    | /s/ Dr. Klaus  Hartmann  |   |
|--------|--------|--------------------------|--------|
|   | Name:  | Dr. Klaus  Hartmann      |
|   | Title: | Chief Financial  Officer |

 

136

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**MAGYAR TÁVKÖZLÉSI RT.**

 

**INDEX TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

 

 
| **Consolidated Financial Statement:**                                                                                  |
|------------------------------------------------------------------------------------------------------------------------|
| Independent  Accountant’s Report                                                                                  |
| Consolidated Balance Sheets  at December 31, 2001 and 2002                                                             |
| Consolidated Income  Statements for the years ended December 31, 2000, 2001 and 2002                                   |
| Consolidated Cash  Flow Statements for the years ended December 31, 2000, 2001 and 2002                                |
| Consolidated  Statements of Changes in Shareholders’ Equity for the years ended December  31, 2000, 2001 and 2002 |
| Notes to the  Consolidated Financial Statements                                                                        |

 

F-1

----

 

# ***INDEPENDENT ACCOUNTANT’S REPORT***TO THE BOARD OF DIRECTORS OF MAGYAR TÁVKÖZLÉSI RT.

 

We have audited the accompanying consolidated balancesheets of Magyar Távközlési Rt. (“Matáv”) and its subsidiaries as of December31, 2002 and 2001, and the related consolidated statements of income, cashflows and changes in shareholders’ equity for each of the three years in theperiod ended December 31, 2002. These financial statements are theresponsibility of Matáv’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

 

We conducted our audits in accordance with auditingstandards generally accepted in the United States of America. Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Matáv and itssubsidiaries at December 31, 2002 and 2001, and the consolidated results oftheir operations and their cash flows for each of the three years in the periodended December 31, 2002 in accordance with International Financial ReportingStandards.

 

International Financial Reporting Standards vary incertain important respects from accounting principles generally accepted in theUnited States of America. The application of the latter would have affected thedetermination of consolidated net income for each of the three years in theperiod ended December 31, 2002 and the determination of consolidatedshareholders’ equity at December 31, 2002 and 2001 to the extent summarized inNote 32 to the consolidated financial statements.

 

 

PricewaterhouseCoopers

 

 

Budapest

February 10, 2003

 

F-2

----

 

**MAGYARTÁVKÖZLÉSI RT.CONSOLIDATED BALANCE SHEETS**

 
|                                                 |   |      |       | **At December 31,**   |       |
|------------------------------------------------------|--------|-----------|------------|-----------------------|------------|
|                                                 |   |      |       | **HUF**               |       | **U.S.$** |   |
|                                                 |   | **Notes** |       | **2001**              |       | **2002** |   | **2002** |   |
|                                                 |   |      |       | **(in HUF millions)** |       | **(million  USD)** |   |
|                                                 |   |      |       |                  |       |   |   | **(unaudited)(note 2)** |   |
| **ASSETS**                                           |   |      |       |                  |       |   |   |   |   |
| **Current assets**                                   |   |      | ** ** |                  | ** ** |   | ** ** |   | ** ** |
| Cash and cash equivalents                            |   | 4         |       | 10,117                |       | 8,851 |   | 39 |   |
| Trading investments                                  |   | 5         |       | 327                   |       | 447 |   | 2 |   |
| Trade and other receivables                          |   | 6         |       | 88,079                |       | 88,921 |   | 395 |   |
| Inventories                                          |   | 7         |       | 13,297                |       | 13,063 |   | 58 |   |
| Assets held for disposal                             |   |      |       | 3,725                 |       | 2,285 |   | 10 |   |
| **Total  current assets**                            |   |      |       | 115,545               |       | 113,567 |   | 504 |   |
|                                                 |   |      |       |                  |       |   |   |   |   |
| **Non current assets**                               |   |      | ** ** |                  | ** ** |   | ** ** |   | ** ** |
| Property, plant and equipment                        |   | 8         |       | 654,298               |       | 645,087 |   | 2,865 |   |
| Intangible assets                                    |   | 9         |       | 306,029               |       | 295,199 |   | 1,311 |   |
| Associates                                           |   | 11        |       | 6,209                 |       | 4,607 |   | 21 |   |
| Other non current investments                        |   | 12        |       | 6,990                 |       | 2,251 |   | 10 |   |
| Deferred tax assets                                  |   | 24        |       | 3,816                 |       | 6,619 |   | 29 |   |
| Other non current assets                             |   | 13        |       | 11,309                |       | 10,121 |   | 45 |   |
| **Total  non current assets**                        |   |      |       | 988,651               |       | 963,884 |   | 4,281 |   |
|                                                 |   |      |       |                  |       |   |   |   |   |
| **Total  assets**                                    |   |      |       | 1,104,196             |       | 1,077,451 |   | 4,785 |   |
|                                                 |   |      | ** ** |                  | ** ** |   | ** ** |   | ** ** |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**        |   |      | ** ** |                  | ** ** |   | ** ** |   | ** ** |
| **Current liabilities**                              |   |      | ** ** |                  | ** ** |   | ** ** |   | ** ** |
| Loans and other borrowings – third party        |   | 14        |       | 33,607                |       | 65,569 |   | 291 |   |
| Loans from related parties                           |   | 14        |       | —                |       | 162,771 |   | 723 |   |
| Trade and other payables                             |   | 16        |       | 122,126               |       | 101,857 |   | 452 |   |
| Deferred revenue                                     |   | 17        |       | 3,430                 |       | 2,722 |   | 12 |   |
| Provision for liabilities and charges                |   | 18        |       | 3,320                 |       | 11,150 |   | 50 |   |
| **Total  current liabilities**                       |   |      |       | 162,483               |       | 344,069 |   | 1,528 |   |
|                                                 |   |      |       |                  |       |   |   |   |   |
| **Non current liabilities**                          |   |      | ** ** |                  | ** ** |   | ** ** |   | ** ** |
| Loans and other borrowings – third party        |   | 14        |       | 118,855               |       | 71,992 |   | 320 |   |
| Loans from related parties                           |   | 14        |       | 300,908               |       | 73,675 |   | 327 |   |
| Deferred revenue                                     |   | 17        |       | 7,101                 |       | 4,456 |   | 20 |   |
| Deferred tax liability                               |   | 24        |       | 1,763                 |       | 2,646 |   | 12 |   |
| Provision for liabilities and charges                |   | 18        |       | —                |       | 1,040 |   | 4 |   |
| Other non current liabilities                        |   | 19        |       | 4,617                 |       | 3,993 |   | 18 |   |
| **Total  non current liabilities**                   |   |      |       | 433,244               |       | 157,802 |   | 701 |   |
|                                                 |   |      |       |                  |       |   |   |   |   |
| **Minority  interests**                              |   | 20        |       | 48,169                |       | 59,436 |   | 264 |   |
|                                                 |   |      |       |                  |       |   |   |   |   |
| **Shareholders’  equity**                       |   |      |       |                  |       |   |   |   |   |
| Common stock                                         |   |      |       | 103,736               |       | 104,281 |   | 463 |   |
| Additional paid in capital                           |   |      |       | 22,955                |       | 27,382 |   | 121 |   |
| Treasury stock                                       |   |      |       | (163                  | )          | (4,488 | ) | (20 | ) |
| Cumulative translation adjustment                    |   |      |       | (2,420                | )          | (4,348 | ) | (19 | ) |
| Retained earnings                                    |   |      |       | 336,192               |       | 393,317 |   | 1,747 |   |
| **Total  shareholders’ equity**                 |   |      |       | 460,300               |       | 516,144 |   | 2,292 |   |
|                                                 |   |      |       |                  |       |   |   |   |   |
| **Total  liabilities and shareholders’ equity** |   |      |       | 1,104,196             |       | 1,077,451 |   | 4,785 |   |

 

Theseconsolidated financial statements were accepted for the Board of Directors onFebruary 10, 2003 and signed on their behalf by:

 
| Elek  Straub                          |   | Dr.  Klaus Hartmann      |
|---------------------------------------|--------|--------------------------|
| Chairman  and Chief Executive Officer |   | Chief  Financial Officer |

 

Theaccompanying notes form an integral part of these consolidated financialstatements.

 

F-3

----

 

**MAGYARTÁVKÖZLÉSI RT.CONSOLIDATED INCOME STATEMENTS**

 
|                                                                                           |   |      |   | **For the year ended December 31,**             |   |
|------------------------------------------------------------------------------------------------|--------|-----------|--------|-------------------------------------------------|--------|
|                                                                                           |   |      |   | **HUF**                                         |   | **U.S.$** |   |
|                                                                                           |   | **Notes** |   | **2000**                                        |   | **2001** |   | **2002** |   | **2002** |   |
|                                                                                           |   |      |   | **(in HUF millions, except per share amounts)** |   | **(million** |   |
|                                                                                           |   |      |   |                                            |   | **USD)  (unaudited)  (note 2)** |   |
|                                                                                           |   |      |   |                                            |   |   |   |   |   |   |   |
| **Revenues**                                                                                   |   | 21        |   | 445,945                                         |   | 547,735 |   | 590,585 |   | 2,623 |   |
|                                                                                           |   |      |   |                                            |   |   |   |   |   |   |   |
| Employee-related expenses                                                                      |   |      |   | (66,024                                         | )      | (75,962 | ) | (89,264 | ) | (396 | ) |
| Depreciation and amortization                                                                  |   |      |   | (94,720                                         | )      | (116,622 | ) | (122,741 | ) | (545 | ) |
| Payments to other network operators                                                            |   |      |   | (55,617                                         | )      | (72,606 | ) | (81,078 | ) | (360 | ) |
| Cost of telecommunications equipment sales                                                     |   |      |   | (34,111                                         | )      | (39,101 | ) | (39,744 | ) | (177 | ) |
| Other operating expenses                                                                       |   | 22        |   | (99,382                                         | )      | (124,044 | ) | (135,518 | ) | (602 | ) |
| **Total  operating expenses**                                                                  |   |      |   | (349,854                                        | )      | (428,335 | ) | (468,345 | ) | (2,080 | ) |
|                                                                                           |   |      |   |                                            |   |   |   |   |   |   |   |
| **Operating  profit**                                                                          |   |      |   | 96,091                                          |   | 119,400 |   | 122,240 |   | 543 |   |
|                                                                                           |   |      |   |                                            |   |   |   |   |   |   |   |
| Net interest and other charges                                                                 |   | 23        |   | (20,992                                         | )      | (13,104 | ) | (27,919 | ) | (124 | ) |
| Share of associates’ results before income tax                                            |   |      |   | 2,174                                           |   | 1,703 |   | 691 |   | 3 |   |
|                                                                                           |   |      |   |                                            |   |   |   |   |   |   |   |
| **Profit  before income tax**                                                                  |   |      |   | 77,273                                          |   | 107,999 |   | 95,012 |   | 422 |   |
|                                                                                           |   |      |   |                                            |   |   |   |   |   |   |   |
| Income tax expense                                                                             |   | 24        |   | (7,752                                          | )      | (11,733 | ) | (13,245 | ) | (59 | ) |
|                                                                                           |   |      |   |                                            |   |   |   |   |   |   |   |
| **Profit  after income tax**                                                                   |   |      |   | 69,521                                          |   | 96,266 |   | 81,767 |   | 363 |   |
|                                                                                           |   |      |   |                                            |   |   |   |   |   |   |   |
| Minority interest                                                                              |   | 20        |   | (2,869                                          | )      | (13,706 | ) | (13,639 | ) | (60 | ) |
|                                                                                           |   |      |   |                                            |   |   |   |   |   |   |   |
| **Net  income**                                                                                |   |      |   | 66,652                                          |   | 82,560 |   | 68,128 |   | 303 |   |
|                                                                                           |   |      |   |                                            |   |   |   |   |   |   |   |
| **Basic  earnings per share**                                                                  |   |      |   |                                            |   |   |   |   |   |   |   |
|                                                                                           |   |      |   |                                            |   |   |   |   |   |   |   |
| Weighted average number of common stock outstanding  (millions)                                |   |      |   | 1,037                                           |   | 1,037 |   | 1,038 |   | 1,038 |   |
|                                                                                           |   |      |   |                                            |   |   |   |   |   |   |   |
| Net income (HUF millions)                                                                      |   |      |   | 66,652                                          |   | 82,560 |   | 68,128 |   | 303 |   |
| Basic earnings per share (HUF)                                                                 |   |      |   | 64.27                                           |   | 79.61 |   | 65.66 |   | 0.29 |   |
|                                                                                           |   |      |   |                                            |   |   |   |   |   |   |   |
| **Diluted  earnings per share**                                                                |   |      |   |                                            |   |   |   |   |   |   |   |
|                                                                                           |   |      |   |                                            |   |   |   |   |   |   |   |
| Weighted average number of common stock outstanding  (millions)                                |   |      |   | 1,037                                           |   | 1,037 |   | 1,038 |   | 1,038 |   |
| Number of dilutive convertible bonds/ share options  (millions)                                |   |      |   | 5                                               |   | — |   | — |   | — |   |
| Weighted average number of common stock outstanding  for diluted earnings per share (millions) |   |      |   | 1,042                                           |   | 1,037 |   | 1,038 |   | 1,038 |   |
| Net income (HUF millions)                                                                      |   |      |   | 66,652                                          |   | 82,560 |   | 68,128 |   | 303 |   |
| Diluted earnings per share (HUF)                                                               |   |      |   | 63.97                                           |   | 79.61 |   | 65.66 |   | 0.29 |   |

 

Theaccompanying notes form an integral part of these consolidated financialstatements.

 

F-4

----

 

**MAGYAR TÁVKÖZLÉSI RT.**

 

**CONSOLIDATED CASH FLOWSTATEMENTS**

 
|                                                                  |   |      |   | **For the year ended December 31,** |       |
|-----------------------------------------------------------------------|--------|-----------|--------|-------------------------------------|------------|
|                                                                  |   |      |   | **HUF**                             |       | **U.S.$** |   |
|                                                                  |   | **Notes** |   | **2000**                            |       | **2001** |   | **2002** |   | **2002** |   |
|                                                                  |   |      |   | **(in HUF millions)**               |       | **(million USD)** |   |
|                                                                  |   |      |   |                                |       |   |   |   |   | **(unaudited)  (note 2)** |   |
|                                                                  |   |      |   |                                |       |   |   |   |   |   |   |
| **Cash  flows from operating activities**                             |   |      |   |                                |       |   |   |   |   |   |   |
| Operating profit                                                      |   |      |   | 96,091                              |       | 119,400 |   | 122,240 |   | 543 |   |
| Depreciation and amortization                                         |   |      |   | 94,720                              |       | 116,622 |   | 122,741 |   | 545 |   |
| Change in payables                                                    |   |      |   | 7,728                               |       | 13,978 |   | (4,454 | ) | (20 | ) |
| Change in inventory                                                   |   |      |   | (1,634                              | )          | (3,450 | ) | 552 |   | 2 |   |
| Change in receivables                                                 |   |      |   | (12,133                             | )          | (5,587 | ) | (1,092 | ) | (5 | ) |
| Amortization of deferred revenue                                      |   |      |   | (4,652                              | )          | (3,499 | ) | (3,353 | ) | (15 | ) |
| Interest paid                                                         |   |      |   | (15,123                             | )          | (19,416 | ) | (27,259 | ) | (121 | ) |
| Commissions and bank charges                                          |   |      |   | (2,042                              | )          | (2,420 | ) | (3,296 | ) | (14 | ) |
| Income tax paid                                                       |   |      |   | (8,150                              | )          | (13,383 | ) | (13,234 | ) | (59 | ) |
| Other cash flows from operations                                      |   |      |   | 1,644                               |       | (5,700 | ) | 6,198 |   | 28 |   |
| **Net  cash flows from operating activities**                         |   |      |   | 156,449                             |       | 196,545 |   | 199,043 |   | 884 |   |
|                                                                  |   |      |   |                                |       |   |   |   |   |   |   |
| **Cash  flows from investing activities**                             |   |      |   |                                |       |   |   |   |   |   |   |
| Purchase of tangible and intangible assets                            |   | 10        |   | (152,784                            | )          | (127,747 | ) | (109,988 | ) | (488 | ) |
| Purchase of investments                                               |   |      |   | (3,568                              | )          | (1,740 | ) | (229 | ) | (1 | ) |
| Purchase of subsidiaries                                              |   | 2         |   | —                              |       | (324,813 | ) | (13,230 | ) | (59 | ) |
| Cash acquired through business combinations                           |   | 2         |   | —                              |       | 6,314 |   | — |   | — |   |
| Interest received                                                     |   |      |   | 2,067                               |       | 2,141 |   | 660 |   | 3 |   |
| Dividends received                                                    |   |      |   | 1,009                               |       | 779 |   | 1,437 |   | 6 |   |
| Purchase of trading investments – net                            |   |      |   | (2,313                              | )          | 6,417 |   | (120 | ) | (1 | ) |
| Proceeds from disposal of fixed assets                                |   |      |   | 9,784                               |       | 9,099 |   | 1,529 |   | 7 |   |
| **Net  cash flows from investing activities**                         |   |      |   | (145,805                            | )          | (429,550 | ) | (119,941 | ) | (533 | ) |
|                                                                  |   |      |   |                                |       |   |   |   |   |   |   |
| **Cash  flows from financing activities**                             |   |      |   |                                |       |   |   |   |   |   |   |
| Dividends paid to shareholders and minority interest                  |   |      |   | (9,411                              | )          | (18,806 | ) | (11,437 | ) | (51 | ) |
| Proceeds from loans and other borrowings                              |   |      |   | 261,870                             |       | 522,464 |   | 217,429 |   | 966 |   |
| Repayment of loans and other borrowings                               |   |      |   | (256,955                            | )          | (273,300 | ) | (286,787 | ) | (1,274 | ) |
| Proceeds from issue of common stock                                   |   |      |   | 129                                 |       | — |   | 4,973 |   | 22 |   |
| Purchase of treasury stock                                            |   |      |   | (256                                | )          | (36 | ) | (4,488 | ) | (20 | ) |
| Proceeds from sale of treasury stock                                  |   |      |   | 104                                 |       | — |   | 85 |   | 0 |   |
| Other                                                                 |   |      |   | 587                                 |       | (125 | ) | 171 |   | 1 |   |
| **Net  cash flows from financing activities**                         |   |      |   | (3,932                              | )          | 230,197 |   | (80,054 | ) | (356 | ) |
|                                                                  |   |      |   |                                |       |   |   |   |   |   |   |
| Effect of foreign exchange rate changes on cash  and cash equivalents |   |      |   | —                              |       | (371 | ) | (314 | ) | (1 | ) |
|                                                                  |   |      |   |                                |       |   |   |   |   |   |   |
| **Change  in cash and cash equivalents**                              |   |      |   | **6,712**                           | ** ** | **(3,179** | **)** | **(1,266** | **)** | **(6** | **)** |
|                                                                  |   |      |   |                                |       |   |   |   |   |   |   |
| Cash and cash equivalents, beginning of year                          |   |      |   | 6,584                               |       | 13,296 |   | 10,117 |   | 45 |   |
| Cash and cash equivalents, end of year.                               |   |      |   | 13,296                              |       | 10,117 |   | 8,851 |   | 39 |   |

 

Theaccompanying notes form an integral part of these consolidated financialstatements.

 

F-5

----

 

**MAGYAR TÁVKÖZLÉSI RT.**

 

**CONSOLIDATED STATEMENTS OFCHANGES IN SHAREHOLDERS’ EQUITY**

** **
|                                                          |   | **Shares  of  Common  stock** |   | **Common  stock** |   | **Additional  Paid-in  capital** |   | **Treasury  stock** |   | **Cumulative  translation  adjustment** |   | **Retained  earnings  (k)** |   | **Total  Shareholders’  equity** |   |
|---------------------------------------------------------------|--------|-------------------------------|--------|-------------------|--------|----------------------------------|--------|---------------------|--------|-----------------------------------------|--------|-----------------------------|--------|---------------------------------------|--------|
|                                                          |   | **(in  HUF millions)**        |   |
| **Balance  at December 31, 1999**                             |   | 1,037,281,600                 |   | 103,728           |   | 22,834                           |   | —              |   | —                                  |   | 201,017                     |   | 327,579                               |   |
| Dividend                                                      |   |                          |   |              |   |                             |   |                |   |                                    |   | (9,335                      | )      | (9,335                                | )      |
| Stock issuance(b)                                             |   | 77,270                        |   | 8                 |   | 121                              |   |                |   |                                    |   |                        |   | 129                                   |   |
| Purchase of treasury stock(c)                                 |   |                          |   |              |   |                             |   | (256                | )      |                                    |   |                        |   | (256                                  | )      |
| Sale of treasury stock(c)                                     |   |                          |   |              |   |                             |   | 129                 |   |                                    |   | (25                         | )      | 104                                   |   |
| Net income as previously reported(h)                          |   |                          |   |              |   |                             |   |                |   |                                    |   | 68,763                      |   | 68,763                                |   |
| **Balance  at December 31, 2000**                             |   | 1,037,358,870                 |   | 103,736           |   | 22,955                           |   | (127                | )      | —                                  |   | 260,420                     |   | 386,984                               |   |
|                                                          |   |                          |   |              |   |                             |   |                |   |                                    |   |                        |   |                                  |   |
| **Acquisition  of additional 49% interest in Westels**        |   |                          |   |              |   |                             |   |                |   |                                    |   |                        |   |                                  |   |
| Equity effect(e)                                              |   |                          |   |              |   |                             |   |                |   |                                    |   | 252,408                     |   | 252,408                               |   |
| Net income effect(h)                                          |   |                          |   |              |   |                             |   |                |   |                                    |   | (2,111                      | )      | (2,111                                | )      |
| **Balance  at December 31, 2000 after restatement**           |   | 1,037,358,870                 |   | 103,736           |   | 22,955                           |   | (127                | )      | —                                  |   | 510,717                     |   | 637,281                               |   |
|                                                          |   |                          |   |              |   |                             |   |                |   |                                    |   |                        |   |                                  |   |
| Effect of adopting IAS 39(d)                                  |   |                          |   |              |   |                             |   |                |   |                                    |   | 501                         |   | 501                                   |   |
| Dividend                                                      |   |                          |   |              |   |                             |   |                |   |                                    |   | (10,373                     | )      | (10,373                               | )      |
| Purchase of treasury stock(c)                                 |   |                          |   |              |   |                             |   | (36                 | )      |                                    |   |                        |   | (36                                   | )      |
| Cumulative Translation Adjustment                             |   |                          |   |              |   |                             |   |                |   | (2,420                                  | )      |                        |   | (2,420                                | )      |
|                                                          |   |                          |   |              |   |                             |   |                |   |                                    |   |                        |   |                                  |   |
| **Acquisition  of additional 49% interest in Westels**        |   |                          |   |              |   |                             |   |                |   |                                    |   |                        |   |                                  |   |
| Equity effect(g)                                              |   |                          |   |              |   |                             |   |                |   |                                    |   | (247,213                    | )      | (247,213                              | )      |
| Net income effect(f)                                          |   |                          |   |              |   |                             |   |                |   |                                    |   | 7,354                       |   | 7,354                                 |   |
| Net income before the impacts of  the Westel transaction |   |                          |   |              |   |                             |   |                |   |                                    |   | 75,206                      |   | 75,206                                |   |
| **Net  income reported in the income statement**              |   |                          |   |              |   |                             |   |                |   |                                    |   | 82,560                      |   |                                  |   |
| **Balance  at December 31, 2001**                             |   | 1,037,358,870                 |   | 103,736           |   | 22,955                           |   | (163                | )      | (2,420                                  | )      | 336,192                     |   | 460,300                               |   |
|                                                          |   |                          |   |              |   |                             |   |                |   |                                    |   |                        |   |                                  |   |
| Price correction of Westel transaction(i)                     |   |                          |   |              |   |                             |   |                |   |                                    |   | 485                         |   | 485                                   |   |
| Dividend                                                      |   |                          |   |              |   |                             |   |                |   |                                    |   | (11,410                     | )      | (11,410                               | )      |
| Net income                                                    |   |                          |   |              |   |                             |   |                |   |                                    |   | 68,128                      |   | 68,128                                |   |
| Cumulative Translation Adjustment                             |   |                          |   |              |   |                             |   |                |   | (1,928                                  | )      |                        |   | (1,928                                | )      |
| Sale of treasury stock(c)                                     |   |                          |   |              |   |                             |   | 163                 |   |                                    |   | (78                         | )      | 85                                    |   |
| Stock issuance(b)                                             |   | 552,730                       |   | 55                |   | 429                              |   |                |   |                                    |   |                        |   | 484                                   |   |
| Stock issuance (j)                                            |   | 4,900,000                     |   | 490               |   | 3,998                            |   |                |   |                                    |   |                        |   | 4,488                                 |   |
| Purchase of treasury stock(j)                                 |   |                          |   |              |   |                             |   | (4,488              | )      |                                    |   |                        |   | (4,488                                | )      |
|                                                          |   |                          |   |              |   |                             |   |                |   |                                    |   |                        |   |                                  |   |
| **Balance  at December 31, 2002(a)**                          |   | 1,042,811,600                 |   | 104,281           |   | 27,382                           |   | (4,488              | )      | (4,348                                  | )      | 393,317                     |   | 516,144                               |   |
|                                                          |   |                          |   |              |   |                             |   |                |   |                                    |   |                        |   |                                  |   |
| Of which treasury stock                                       |   | 4,900,000                     |   |              |   |                             |   |                |   |                                    |   |                        |   |                                  |   |
| **Shares  of common stock outstanding at December 31, 2002**  |   | 1,037,911,600                 |   |              |   |                             |   |                |   |                                    |   |                        |   |                                  |   |

 

Theaccompanying notes form an integral part of these consolidated financialstatements.

 

F-6

----

 

**MAGYAR TÁVKÖZLÉSI RT.**

 

**CONSOLIDATEDSTATEMENTS OF CHANGES IN SHAREHOLDERS’EQUITY (notes)**

 

----

(a)          Inaddition to the 1,042,811,600 issued shares of common stock (nominal value ofHUF 100), total shareholders’ equity includes one Series “B” preference shareat the nominal value of HUF 10,000 at December 31, 2002. This Series “B” shareis held by the Prime Minister’s Office and bestows certain rights on its owner,including access to information, and the appointment of a Director. This sharemay only be held by the Government or its nominee.

 

(b)         In June2000, 630,000 shares of common stock of the Company were registered which weresubscribed by Investel (a consolidated subsidiary of the Group). In 2000 77,270of these shares were issued outside the Group for HUF 129 million. In 2002 theremaining 552,730 shares were issued outside the Group for HUF 484 million.

 

(c)          During2000 the Company purchased 129,591 shares of its common stock and sold 54,827shares of this common stock. These transactions resulted in a loss of HUF 25million. During 2001 the Company purchased 21,333 shares of its common stock.In 2002 the Company sold 96,097 shares of common stock. The transactionresulted in a loss of HUF 78 million.

 

(d)         In 2001 theCompany adopted IAS 39 “Financial instruments – Recognition and Measurement”and has recognized the cumulative effect of the change in accounting directlyin equity for the derivative asset of HUF 589 million with a related deferredtax liability of HUF 88 million (see note 24).

 

(e)          InDecember 2001 the Company acquired 49 percent of the common stock of Westel andWestel 0660 (“the Westels”) from Deutsche Telekom (“DT”). The Company wascontrolled by DT, hence this was a transaction between parties under commoncontrol. The financial statements were restated as if the Westels had beenwholly owned subsidiaries of Matáv from March 23, 2000, the date when DTacquired 49% of the Westels. The consideration for the Company’s acquisition ofthe Westels was financed by a loan from DT. Terms of the loan agreement aredescribed in Note 14. The loan agreement was completed on December 20, 2001.The book value of the Company’s additional share of net assets (includinggoodwill and other intangibles) of the Westels on March 23, 2000 has beenpresented as an increase in equity at December 31, 2000 (HUF 252,408 million).See Note 2 for more details.

 

(f)            Thisreflects the amortization of goodwill and intangible assets of HUF –16,411million (2000: HUF -16,780 million) relating to the additional 49% shareholdingin the Westels, the related deferred tax of HUF 26 million (2000: HUF 456million) and the reduction in the minority interest in the net profit of theWestels of HUF 23,739 million (2000: HUF 14,213 million).

 

(g)         The loanagreement with DT was completed on December 20, 2001 and the totalconsideration payable by the Company for the additional 49% share in theWestels was transferred from equity to liabilities. In addition, the reductionof equity included dividends paid by Westel to DT prior to the transaction.

 

(h)         The netincome in 2000 of HUF 66,652 million as reported in the income statementcomprises HUF 68,763 million as previously reported and a net income effect ofHUF (2,111) million due to the acquisition of the Westels.

 

(i)             InMarch 2002, the final price for the 49% shares of Westel was reduced by HUF 485million from the estimated amount due to the lower amount of dividend declaredby Westel for the year 2001.

 

(j)             As aresult of the new employee stock ownership program launched in 2002, theCompany issued 4,900,000 shares of common stock, which were repurchasedimmediately. See note 25 for more details.

 

(k)          Thedistributable reserves of the Company under Hungarian law at December 31, 2001and 2002 amounted to approximately HUF 248,000 million and HUF 260,000 million,respectively.

 

Theaccompanying notes form an integral part of these consolidated financialstatements.

 

F-7

----

 

 

**MAGYAR TÁVKÖZLÉSI RT.**

** **

**NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS**

** **

**1 Principal activities**

 

MagyarTávközlési Rt. (the “Company” or “Matáv Rt.”) with its subsidiaries form theMatáv Group (“Matáv” or “the Group”). Matáv is the principal supplier oftelecommunications services in Hungary. Matáv is a full-servicetelecommunications provider.

 

The Company had exclusive rights through December 2001 to provide domestic longdistance and international public telephony services throughout Hungary. Of the54 local concession areas, the Company had exclusive rights to provide localpublic fixed line telephony service in 31 areas until December 23, 2001. Sincethat date, Matáv Rt. is subject to competition in these areas. Matáv Rt. hadexclusive rights in additional five concession areas through May 2002, whileits subsidiary, Emitel had exclusive rights in an additional three concessionareas through November 2002. In the remaining 15 local concession areas, theconcession holders had exclusive rights until December 2002, from which timeMatáv can compete in these areas.

 

Matáv isHungary’s largest mobile telecommunications provider through its subsidiaries,Westel Mobil Távközlési Rt. (“Westel”) and Westel Rádiótelefon Kft. (“Westel0660”). In addition, Matáv provides leased lines, data transmission, corporatenetwork, cable television, internet and sells and leasestelecommunications equipment.

 

Matáv had 16,114full time equivalent employees at December 31, 2002, while at the end of 2001the number of employees was 16,633.

 

**2 Basis of presentation**

 

The Company wasincorporated in Hungary on December 31, 1991 and commenced business on January1, 1992. The Company’s registered address is Krisztina körút 55, 1013 Budapest,Hungary.

 

The consolidatedfinancial statements have been prepared under the historical cost convention,except as disclosed in the accounting policies below, and in compliance withInternational Financial Reporting Standards (“IFRS”).

 

Theconsolidated financial statements are shown in millions of Hungarian Forints(“HUF”). For the convenience of the reader, the consolidated balance sheet,income statement and cash-flow statement for the year 2002 are also presentedin millions of U.S. dollars (“USD”) translated at a rate of HUF 225.16 to USD1.00 (the official rate of the National Bank of Hungary at December 31, 2002).These translations are unaudited.

 

Thepreparation of financial statements in conformity with IFRS requires managementto make estimates and assumptions that affect the amounts reported in the financial statements and notes thereto. Actual resultscould differ from those estimates.

 

***Acquisition of the remaining 49% ownership in Westel MobilRt. (Westel) and Westel Rádiótelefon Kft. (Westel 0660)***

 

In March 2000, Deutsche Telekom finalised the purchase of MediaOne’sinterests in mobile operations in Central and Eastern Europe including MediaOneInternational B.V. which owned 49% of Westel and 49% of Westel 0660. At thesame time the Company was granted an option to purchase the 49% holdings inWestel and Westel 0660 from Deutsche Telekom during the fifteen-month periodending September 2001. On December 21, 2001 the Company became a 100% owner ofboth Westel and Westel 0660. The final purchase price included HUF 226,750million (EUR 920 million), paid in December 2001, financed by a loan from DT asdescribed in 

 

F-8

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note 14, plus HUF 11,515 million paid in 2002, equal to 49%of the amount of dividends declared by Westel for the year 2001.

 

TheCompany was controlled by DT, hence this was a transaction between partiesunder common control. The financial statements were restated as if the Westelswere wholly owned subsidiaries of the Company from March 23, 2000, the datewhen DT acquired 49% of the Westels. The consideration for the Company’sacquisition of the Westels was financed by a loan from DT. The terms of theloan agreement are described in note 14. The loan agreement was completed onDecember 20, 2001. The book value of the Company’s additional share of net assets(including goodwill and other intangibles) of the Westels on March 23, 2000were presented as an increase in equity at December 31, 2000 (HUF 252,408million).

 

Below is a summary of the impact of the restatement on shareholders’equity and net income in HUF millions.

 
|                                             |   | **At  December 31,**   |       |
|--------------------------------------------------|--------|------------------------|------------|
|                                             |   | **2000**               |       | **2001** |   |
|                                             |   | **(in  HUF millions)** |       |
|                                             |   |                   | ** ** |   | ** ** |
| Equity (excluding the effect of the restatement) |   | 386,984                |       | 449,862 |   |
| Adjustment in relation to the Westel acquisition |   | 250,297                |       | 257,651 |   |
| Transfer of consideration payable to liability   |   | —                 |       | (247,213 | ) |
| As restated                                      |   | 637,281                |       | 460,300 |   |

 

The increase inequity as of December 31, 2000 reflects the Company’s additional share of theassets and liabilities (including goodwill and other intangibles) of Westel andWestel 0660 at March 23, 2000, which was presented as equity because the loanfrom DT was not completed until December 20, 2001. The decrease in equity inDecember 2001 reflects the loan agreement with DT, which was completed onDecember 20, 2001, dividends paid by Westel to DT prior to the transaction andadditional consideration payable. The consideration payable by the Company wasthen transferred from equity to liabilities.

 
|                                             |   | **At  December 31,**   |       |
|--------------------------------------------------|--------|------------------------|------------|
|                                             |   | **2000**               |       | **2001** |   |
|                                             |   | **(in  HUF millions)** |       |
|                                             |   |                   | ** ** |   | ** ** |
| Net income (before the restatement)              |   | 68,763                 |       | 75,206 |   |
| Adjustment in relation to the Westel acquisition |   | (2,111                 | )          | 7,354 |   |
| As restated                                      |   | 66,652                 |       | 82,560 |   |

 

The adjustmentsabove reflect the additional amortization of goodwill and intangible assets ofHUF -16,411 million (2000: HUF -16,780 million), the related deferred tax ofHUF 26 million (2000: HUF 456 million) and the reduction in the minorityinterest of HUF 23,738 million (2000 HUF: 14,213 million). The minorityinterest in Westel and Westel 0660 was eliminated and considered as part of theGroup’s net income both for 2000 and 2001.

 

F-9

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The minorityinterest in the net income of the two companies between March 31, 2000 andDecember 21, 2001 was as follows:

 
|        |   | **At  December 31,**   |       |
|-------------|--------|------------------------|------------|
|        |   | **2000**               |       | **2001** |   |
|        |   | **(in  HUF millions)** |       |
|        |   |                   | ** ** |   | ** ** |
| Westel      |   | 13,987                 |       | 23,542 |   |
| Westel 0660 |   | 226                    |       | 196 |   |

 

***Acquisition of Makedonski Telekommunikacii A.D. (MakTel)***

 

In December 2000,the Company, on behalf of a consortium, reached agreement with the governmentof Macedonia to purchase 51 percent of MakTel on its privatization. The closingof the transaction took place on January 15, 2001 whereby the Company paid EUR343.3 million on behalf of the consortium in accordance with the relevantagreement. The 51 percent ownership acquired by the Company was contributed onJanuary 16, 2001 to a newly established Macedonian holding company, StonebridgeCommunications AD (“Stonebridge”).

 

In accordancewith a subscription and shareholders’ deed (“Deed”) between the Company, SEEFHoldings Ltd. (“SEEF”) and CosmoTelco Added Value Services S.A. (“CosmoTelco”),the latter two acquired a 6.1 percent and a 7.4 percent ownership respectivelyin Stonebridge reducing Matáv’s investment in Stonebridge to EUR 301.5 million.  Matáv, consequently, has an 86.5 percentstake in Stonebridge, which owns 51 percent of MakTel, thereby Matáv has aneffective ownership percent in MakTel of approximately 44 percent. The totalacquisition cost of the 44% effective ownership amounted to HUF 83,380 million.

 

The Deed providesfor a put option which entitles SEEF to sell its shares to Matáv on May 15 ofeach of 2003, 2004 or 2005 or upon the occurrence of certain events at a priceformula also set out in the Deed. The formula takes into account the purchaseprice paid by the consortium for the shares, the current earnings beforeinterest, tax, depreciation and amortization (EBITDA) and the net debt ofMaktel.

 

CosmoTelco andthe Company entered into a call option agreement whereby CosmoTelco had theright to acquire additional shares in Stonebridge from Matáv such thatCosmoTelco’s holding could have been increased to 29 percent of the issuedshare capital of Stonebridge. The price for each share is based on Matáv’sacquisition cost plus holding costs. Before the expiration of CosmoTelco’s calloption on February 8, 2002 Matáv and CosmoTelco amended the option agreement asa result of which CosmoTelco has until February 2003 to exercise its option fora 10% share in Stonebridge. Matáv paid a fee of EUR 7 million (HUF 1,715million) in return for CosmoTelco letting the option for the remaining 11.55%share expire unexercised on February 8, 2002.

 

Matáv’s ownershipinterest of 86.5% in Stonebridge equals its share of voting rights.Stonebridge’s ownership interest of 51% in Maktel equals its share of votingrights.

 

MakTel has been aconsolidated subsidiary of the Group from January 15, 2001 on the basis thatMatáv controls Stonebridge through its 86.5% share of ownership and Stonebridgecontrols Maktel through its 51% share of ownership.

 

***Acquisition of the remaining 50% ownership in Emitel Rt.***

 

Matáv Rt. hadbeen a 50% owner of Emitel since its establishment and accounted for Emitel asan associated company in its consolidated financial statements. On December 31,2000, the Company agreed with Aphrodite BV, the owner of the other 50% stakethat it would purchase the remaining shares. The change of ownership wasconditional on the approval of the Minister responsible for telecommunicationsin Hungary as well as on the 

 

F-10

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approval of the Hungarian Competition Office, whichMatáv received in June 2001. The price of HUF 13,930 million was determined onthe closing of the transaction on July 2, 2001, from which date Emitel has beena consolidated subsidiary of the Group.

 

***The assets and liabilities of subsidiaries acquired in 2001are summarized in the table below:***

 
|                               |   | **Westel and  Westel 0660** |       | **Maktel** |       | **Emitel** |       |
|------------------------------------|--------|-----------------------------|------------|------------|------------|------------|------------|
|                               |   | **(in  HUF millions)**      |       |
|                               |   |                        | ** ** |       | ** ** |       | ** ** |
| Total purchase consideration       |   | 239,018                     |       | 83,380     |       | 13,930     |       |
|                               |   |                        |       |       |       |       |       |
| Fair value of net assets acquired  |   | 51,223                      |       | 32,027     |       | 5,847      |       |
|                               |   |                        |       |       |       |       |       |
| Goodwill                           |   | 187,795                     |       | 51,353     |       | 8,083      |       |
|                               |   |                        |       |       |       |       |       |
| Fair value of net assets acquired: |   |                        |       |       |       |       |       |
| Cash and cash equivalents          |   | —                      |       | 5,488      |       | 826        |       |
| Trading investments                |   | —                      |       | 699        |       | —     |       |
| Receivables                        |   | —                      |       | 10,096     |       | 742        |       |
| Inventory                          |   | —                      |       | 785        |       | 96         |       |
| Property, plant and equipment      |   | —                      |       | 74,023     |       | 10,270     |       |
| Intangible assets                  |   | 6,246                       |       | 171        |       | 311        |       |
| Associates                         |   | —                      |       | —     |       | (3,234     | )          |
| Trade and other payables           |   | 2,192                       |       | (5,768     | )          | (1,018     | )          |
| Deferred revenue                   |   | —                      |       | —     |       | (391       | )          |
| Loans and other borrowings         |   | —                      |       | (19,661    | )          | (1,265     | )          |
| Net deferred tax assets            |   | (1,124                      | )          | 2,157      |       | (490       | )          |
| Minority interests                 |   | 54,832                      |       | (35,963    | )          | —     |       |
| Equity adjustment                  |   | (10,923                     | )          | —     |       | —     |       |
|                               |   | 51,223                      |       | 32,027     |       | 5,847      |       |

 

The purchase of subsidiaries in the cash flowstatement for the year ended December 31, 2002 includes the additional purchaseprice paid for the Westels in the amount of HUF 11,515 million, and HUF 1,715million paid to CosmoTelco to let its option for 11.55% share in Stonebridgeexpire unexercised.

 

**3 Statement of accounting policies**

 

***(a) Principles of consolidation***

 

The consolidatedfinancial statements include the financial statements of the Company and itssubsidiaries over which the Company has control. Inter-company balances andtransactions have been eliminated in the consolidation.

 

Associatedcompanies (companies for which Matáv has significant influence but not control)and joint ventures (companies where the activity is subject to joint controlbased on a contractual arrangement) are accounted for in the consolidatedfinancial statements using the equity method of accounting.

 

Businesscombinations are accounted for according to the purchase method of accountingprescribed by IAS 22 – Business combinations.

 

F-11

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***(b) Cash and cash equivalents***

 

Cash and cashequivalents include cash in banks and all highly liquid deposits withmaturities of three months or less and exclude all overdrafts.

 

***(c) Financial investments***

 

Financial investments include securitiesissued by the government, the maturities of which are between three months andone year. The purchases of these investments are accounted for at the tradedate.

 

At January 1, 2001 the Group adopted IAS 39and classified its investments into the following categories: trading,held-to-maturity and available-for-sale. Investments that are acquiredprincipally for the purpose of generating a profit from short-term fluctuationsin price are classified as trading investments and included in current assets.Investments with fixed maturity that the management has the intent and abilityto hold to maturity are classified as held-to-maturity and are included in noncurrent assets.

 

Investments intended to be held for anindefinite period of time, which may be sold in response to needs for liquidityor changes in interest rates, are classified as available-for-sale. These areincluded in non current assets unless management has the express intention ofholding the investment for less than 12 months from the balance sheet date orunless they will need to be sold to raise operating capital, in which case theyare included in current assets. Management determines the appropriateclassification of its investments at the time of the purchase and re-evaluatessuch designation on a regular basis.

 

Trading and available-for-sale investmentsare subsequently carried at fair value, while held-to-maturity investments arecarried at amortized cost. Any changes in the carrying values are accounted forin the income statement.

 

During the period Matáv did not hold anyavailable-for-sale or held-to-maturity types of investments.

 

***(d) Receivables***

 

Receivables arestated at their recoverable amount, after accounting for any impairment lossesincluded in other operating expenses. Recoverable amounts are estimated takinginto account potential delays and defaults on payments.

 

Amounts due andreceivable from other network operators are shown net where a right of set-offexists and the amounts are settled on a net basis.

 

***(e) Inventories***

 

Inventories arestated at the lower of cost or net realizable value using the historical costmethod of accounting, and are valued on a weighted average basis. Phone setsare often sold for less than cost in connection with promotions to obtain newsubscribers with minimum commitment periods. Such loss on the sale of equipmentis only recorded when the sale occurs as the normal resale value of the phonesets approximates cost.

 

F-12

----

 

***(f) Property, plant and equipment***

 

Property, plantand equipment are stated at historical cost less accumulated depreciation,except for certain assets, which were revalued at incorporation. Cost in the caseof the outside plant, comprises all expenditures including the cabling withincustomers’ premises and interest on related loans. When assets are retired ordisposed of, the cost and accumulated depreciation are removed from theaccounts and any related gain or loss is recognized in the consolidated incomestatement. Maintenance and repairs are charged to expense when incurred.

 

Depreciation iscalculated on a straight-line basis from the time the assets are deployed overtheir remaining useful lives. Matáv regularly reviews these lives forconsistency with current development plans and advances in technology.

 

The useful livesassigned are as follows: 

 
| Buildings                           |   | 10 - 50  years |   |
|-------------------------------------|--------|----------------|--------|
| Duct, cable and other outside plant |   | 25 - 38  years |   |
| Telephone exchanges                 |   | 7 - 15  years  |   |
| Other fixed assets                  |   | 3 - 12  years  |   |

 

***(g) Intangible assets***

 

Costs associatedwith developing internal computer software that has a probable benefitexceeding the cost beyond one year are recognized as intangible assets.Expenditures which enhance and extend the benefits of computer softwareprograms beyond their original specifications and lives are recognized as acapital improvement and added to the original cost of the software.

 

Costs associatedwith the maintenance of existing computer software programs are expensed asincurred.

 

Costs associatedwith the acquisition of long term licenses are capitalized including anyrelated borrowing costs. Matáv starts amortizing the acquired cellular licensesas bandwidths are made available for usage.

 

Goodwillrepresents the excess of the cost of an acquisition over the fair value of theGroup’s share of the net assets of the acquired subsidiary/associatedundertaking at the date of acquisition. Goodwill on acquisitions is reported inthe balance sheet as an intangible asset and is amortized using thestraight-line method over its estimated useful life.

 

Intangible assetsare amortized over their respective economic lives. The useful lives ofconcessions and licenses were determined based on the terms of the underlyingagreements. Such assets are stated at cost less amortization on a straight-linebasis over the following periods:

 
|                                 |   | **Years**   |   |
|--------------------------------------|--------|-------------|--------|
|                                 |   |        |   |
| Concessions and licenses             |   | 8 - 25      |   |
| Software                             |   | 3 -  5 |   |
| Leasehold interests                  |   | 6           |   |
| Customer base and brand-name         |   | 2 - 10      |   |
| Goodwill on purchase of subsidiaries |   | 10 - 20     |   |

 

F-13

----

 

***(h) Impairment of non current assets***

 

                             Matáv regularly reviews its non current assets, including property,plant and equipment, intangible assets and associates and other long-terminvestments for impairment. Impairment losses are recognized as an expense forassets whose carrying value exceeds their recoverable amount. Impairment lossesof tangible and intangible assets are included in the depreciation andamortization line of the income statement, while impairment losses of other noncurrent assets are included in net interest and other charges.

 

***(i) Leased assets***

 

*Lessor*

 

Assets leased outunder operating leases are included in property, plant and equipment in thebalance sheet. They are depreciated over their expected useful lives on a basisconsistent with similar fixed assets. Rental income is recognized on astraight-line basis over the lease term.

 

*Lessee*

 

Leases ofproperty, plant and equipment where Matáv assumes substantially all thebenefits and risks of ownership are classified as finance leases. Financeleases are capitalized at the fair value of the asset or if lower, at theestimated present value of the future minimum lease payments. Each leasepayment is allocated between the liability and finance charges so as to achievea constant rate on the finance balance outstanding. The corresponding rentalobligations, net of finance charges, are included in loans and other borrowings.The interest element of the finance charge is charged to the income statementover the lease period. The property, plant and equipment acquired under financelease contracts are depreciated over the lease term or the useful life of theasset.

 

Costs in respectof operating leases are charged to the consolidated income statement on astraight-line basis over the lease term, included in other operating expenses.

 

***(j) Financial Instruments***

 

Financialinstruments carried on the balance sheet include cash and bank balances,investments, receivables, trade creditors, leases and borrowings and other noncurrent liabilities. The particular recognition methods adopted are disclosedin the individual policy statements associated with each item.

 

Matávadopted International Accounting Standards No. 39 (IAS 39), “FinancialInstruments: Recognition and Measurement” on January 1, 2001. IAS 39 requiresthat every derivative instrument (including certain derivative instrumentsembedded in other contracts) be recorded in the balance sheet as either anasset or a liability measured at its fair value. The statement requires thatchanges in the derivative’s fair value be recognized in earnings unlessspecific hedge accounting criteria are met.

 

Thecumulative effect of adopting IAS 39 was recognized against the retainedearnings on January 1, 2001.

 

Matáv doesnot apply hedge accounting for its financial instruments, all gains and lossesare recognized in the income statement. The fair value of derivativeinstruments is included in other non current assets and other non currentliabilities in the consolidated balance sheet.

 

The fairvalue of publicly traded derivatives and trading and available-for-salesecurities is based on quoted market prices at the balance sheet date. The fairvalue of interest rate swaps is calculated as the present value of 

 

F-14

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the estimated future cash flows. The fair value offorward foreign exchange contracts is determined based on forward exchange marketrates at the balance sheet date.

 

Inassessing the fair value of non-traded derivatives and other financialinstruments, the Group makes assumptions that are based on market conditionsexisting at each balance sheet date and estimated discounted value of futurecash flows are used to determine fair value for the remaining financialinstruments.

 

***(k) Deferred revenue***

 

A portion of feescharged to customers in Hungary upon connection to the fixed line network priorto October 15, 1997 represented contributions to the cost of networkconstruction. The capital contribution element of such fees was deferred and isamortized to revenue over the life of the related assets. Legislation wasenacted effective October 15, 1997 eliminating refunds of such fees andsignaling the removal of any capital contribution element of future customerfees. Since October 1997, these connection fees and related costs arerecognized in the income statement upon connection, reflecting the change inrelated legislation and the advanced development of the network.

 

***(l) Revenues***

 

Revenues for allservices (note 21), shown net of VAT**and discounts and after eliminated saleswithin the Group, are recognized when products and services are provided.

 

A proportion ofthe revenue received is paid to other operators for the use of their networks,where appropriate. These revenues and costs are stated gross in theseconsolidated financial statements.

 

Revenues earnedfrom connecting subscribers to the mobile network are recognized upon serviceactivation. Revenue and costs from sale of telephone sets is recognized upondelivery.

 

Revenues fromsale of public phone cards, prepaid mobile cards and prepaid Internet cards arerecognized when used by the customers or when expire with unused units.

 

***(m) Operating expenses***

 

Researchand development as well as marketing costs are expensed as incurred.

 

Provisionsare recognized when Matáv has a present legal or constructive obligation as aresult of past events and it is probable that an outflow of resources embodyingeconomic benefits will be required to settle the obligation, and a reliableestimate of the amount of the obligation can be made.

 

***(n) Foreign currencies***

 

Monetary assetsand liabilities denominated in foreign currencies are translated into the localcurrency (HUF or MKD) at the exchange rates at the balance sheet date and anyunrealized exchange gains and losses are recognized immediately. Gains andlosses that arise on foreign currency transactions and financing activities areincluded under net interest and other charges.

 

F-15

----

 

For the initialconsolidation of foreign subsidiaries acquired, their assets and liabilities atthe acquisition date were incorporated into the consolidated financialstatements after translating the balances into HUF using the exchange rateprevailing at that date. The fair value adjustments resulting from the purchaseprice allocation and goodwill is accounted for in HUF.

 

As the majorityof the revenues and expenses of the Macedonian subsidiaries arise in MKD, themeasurement currency of these entities is MKD. At year-end the assets andliabilities of the foreign subsidiaries are translated into HUF using theexchange rates prevailing on the balance sheet date. The income statements ofthe foreign subsidiaries are translated into HUF using the average rate ofexchange during the year. The translation difference arising on consolidationis booked against the cumulative translation adjustment in shareholders’ equity.

 

***(o) Loans and other borrowings***

 

Borrowings arerecognized initially at the proceeds received, net of transaction costs. Insubsequent periods they are stated at amortized costs. Any difference betweenthe proceeds and the redemption value is recognized in the income statementover the period of the borrowings.

 

Borrowing costsare recognized as an expense as incurred net of amounts capitalized. Intereston general borrowings is capitalized as part of the cost of the relevant fixedasset, up to the date of commissioning and is then amortized over the periodthe asset is depreciated. The rate used to determine the amount of borrowingcosts eligible for capitalization is defined as the ratio of equity to debtfinancing, where debt excludes short term borrowings and loans related tofinancing of acquisitions.

 

***(p) Income tax***

 

Deferred tax isrecognized, using the liability method, for all temporary differences arisingbetween the tax bases of assets and liabilities and their carrying values forfinancial reporting purposes. Currently enacted tax rates are used to determinedeferred income tax.

 

The principaltemporary differences arise from depreciation on property, plant and equipment,intangible assets, deferred revenue, impairment of receivables and inventory,provisions for liabilities and charges, government loans and tax losses carriedforward.

 

***(q) Pensions and other post-retirement benefits***

 

Matáv hadprovided post-retirement meal and other benefits to their retirees. Under IAS19 the expected costs of these benefits were accrued over the period ofemployment using a single actuarial method not tied to the funding of the plan.The valuation of these obligations had been carried out using the projectedunit cost method. During 2000 Matáv terminated the provision of such benefitsto its former employees, which resulted in the reversal of the accumulatedprovision to employee related expenses.

 

Payments todefined contribution pension plans are recognized as expense in the period inwhich they become due. Payments amounted to HUF 1,850 million, HUF 2,082million and HUF 2,218 million for the years ended December 31, 2000, 2001 and2002, respectively.

 

F-16

----

 

***(r) Equity compensation plans***

 

Thesefinancial statements do not include any compensation expenses related to equitycompensation plans.

 

***(s) Earnings per share***

 

Basic earningsper share is calculated by dividing income for the period by the weightedaverage number of common stocks outstanding, while diluted earnings per shareis calculated considering the weighted average number of dilutive convertiblebonds and share options in addition to the number of common stocks outstanding.

 

***(t) Comparative information***

 

In order tomaintain consistency with the current year presentation, certain items havebeen reclassified for comparative purposes.

 

**4 Cash and cash equivalents**

 

Cash and cashequivalents held by the Hungarian members of the Group are primarilydenominated in Hungarian Forint and concentrations of credit risk are limitedas Matáv places its cash with substantial credit institutions. Cash and cashequivalents held by the Macedonian subsidiaries are denominated in MacedonianDenars, Euros and in U.S. dollars.

 

**5 Trading investments**

 

Financialinvestments consist of treasury instruments with maturities of three to twelvemonths, held for trading purposes.

 

**6 Receivables**

 
|                                  |   | **At  December 31,**   |       |
|---------------------------------------|--------|------------------------|------------|
|                                  |   | **2001**               |       | **2002** |   |
|                                  |   | **(in  HUF millions)** |       |
|                                  |   |                   | ** ** |   | ** ** |
| Domestic  trade receivables           |   | 74,936                 |       | 68,181 |   |
| Foreign  trade receivables            |   | 22,330                 |       | 21,254 |   |
| Receivables  from related parties     |   | 644                    |       | 1,731 |   |
| Advances  paid for current assets     |   | 480                    |       | 444 |   |
| Receivables  from associates          |   | 668                    |       | 420 |   |
| Taxes  receivable                     |   | 6,277                  |       | 3,945 |   |
| Other  receivables                    |   | 3,429                  |       | 4,759 |   |
| Other  prepayments and accrued income |   | 1,960                  |       | 8,686 |   |
|                                  |   | 110,724                |       | 109,420 |   |
| Less  impairment loss                 |   | (22,645                | )          | (20,499 | ) |
|                                  |   | 88,079                 |       | 88,921 |   |

 

F-17

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Concentrations ofcredit risk relating to trade receivables are limited due to the large numberof customers comprising Matáv’s customer base and their dispersion across manydifferent industries and geographic areas. The allowance for impairment lossand changes therein for 2001 and 2002 are as follows:

 
|                                    |   | **At  December 31,**   |       |
|-----------------------------------------|--------|------------------------|------------|
|                                    |   | **2001**               |       | **2002** |   |
|                                    |   | **(in  HUF millions)** |       |
|                                    |   |                   | ** ** |   | ** ** |
| Impairment  loss, beginning of period   |   | (18,469                | )          | (22,645 | ) |
| Change  in the composition of the Group |   | (3,338                 | )          | — |   |
| Charged  to expense                     |   | (6,462                 | )          | (4,972 | ) |
| Utilized                                |   | 5,624                  |       | 7,118 |   |
| Impairment  loss, end of period         |   | (22,645                | )          | (20,499 | ) |
|                                    |   |                   |       |   |   |
| **7 Inventories**                       |   |                   |       |   |   |
|                                    |   |                   |       |   |   |
|                                    |   | **At  December 31,**   |       |
|                                    |   | **2001**               |       | **2002** |   |
|                                    |   | **(in  HUF millions)** |       |
|                                    |   |                   | ** ** |   | ** ** |
| Cables,  wires and other inventory      |   | 5,573                  |       | 5,917 |   |
| Inventory  for resale                   |   | 10,483                 |       | 9,682 |   |
| Subtotal                                |   | 16,056                 |       | 15,599 |   |
| Less  allowances for obsolete inventory |   | (2,759                 | )          | (2,536 | ) |
|                                    |   | 13,297                 |       | 13,063 |   |

 

F-18

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**8 Property, plant and equipment**

** **
|                                                   |   | **Land**               |       | **Buildings** | ** ** | **Duct,  cable  and other  outside  plant** | ** ** | **Telephone  exchanges** | ** ** | **Other** | ** ** | **Capital  work in  progress** | ** ** | **Total** | ** ** |
|--------------------------------------------------------|--------|------------------------|------------|---------------|------------|---------------------------------------------|------------|--------------------------|------------|-----------|------------|--------------------------------|------------|-----------|------------|
|                                                   |   | **(in  HUF millions)** | ** ** |
| **Cost**                                               |   |                   |       |          |       |                                        |       |                     |       |      |       |                           |       |      |       |
| January  1, 2002                                       |   | 4,112                  |       | 105,506       |       | 255,077                                     |       | 494,231                  |       | 111,801   |       | 28,380                         |       | 999,107   |       |
| Change  in the composition  of the Group          |   | 3                      |       | 18            |       | 1,972                                       |       | 3                        |       | 582       |       | 140                            |       | 2,718     |       |
| Additions                                              |   | 381                    |       | 5,663         |       | 11,590                                      |       | 59,404                   |       | 15,430    |       | (7,562                         | )          | 84,906    |       |
| Disposals                                              |   |                   |       |          |       | (3,125                                      | )          | (15,767                  | )          | (5,788    | )          | (275                           | )          | (24,955   | )          |
| Translation  adjustment                                |   | (1                     | )          | (637          | )          | (1,456                                      | )          | (2,362                   | )          | (577      | )          | (152                           | )          | (5,185    | )          |
| Reclassifications  from assets  held for disposal |   |                   |       | 812           |       |                                        |       |                     |       |      |       |                           |       | 812       |       |
| Other  reclassifications                               |   |                   |       |          |       |                                        |       | 7,016                    |       | (7,016    | )          |                           |       | 0         |       |
| December  31, 2002                                     |   | 4,495                  |       | 111,362       |       | 264,058                                     |       | 542,525                  |       | 114,432   |       | 20,531                         |       | 1,057,403 |       |
|                                                   |   |                   |       |          |       |                                        |       |                     |       |      |       |                           |       |      |       |
| **Depreciation**                                       |   |                   |       |          |       |                                        |       |                     |       |      |       |                           |       |      |       |
| January  1, 2002                                       |   |                   |       | 16,969        |       | 62,873                                      |       | 200,867                  |       | 64,100    |       |                           |       | 344,809   |       |
| Change  in the  composition of the Group          |   |                   |       | 1             |       | 326                                         |       |                     |       | 129       |       |                           |       | 456       |       |
| Charge  for the year                                   |   |                   |       | 3,138         |       | 10,804                                      |       | 59,255                   |       | 17,323    |       |                           |       | 90,520    |       |
| Impairment  losses                                     |   |                   |       | 503           |       |                                        |       | 2,347                    |       |      |       |                           |       | 2,850     |       |
| Disposals                                              |   |                   |       |          |       | (3,104                                      | )          | (15,737                  | )          | (5,773    | )          |                           |       | (24,614   | )          |
| Translation  adjustment                                |   |                   |       | (146          | )          | (514                                        | )          | (760                     | )          | (285      | )          |                           |       | (1,705    | )          |
| Reclassifications                                      |   |                   |       |          |       |                                        |       | 3,687                    |       | (3,687    | )          |                           |       | 0         |       |
| December  31, 2002                                     |   |                   |       | 20,465        |       | 70,385                                      |       | 249,659                  |       | 71,807    |       |                           |       | 412,316   |       |
|                                                   |   |                   |       |          |       |                                        |       |                     |       |      |       |                           |       |      |       |
| **Net book value**                                     |   |                   |       |          |       |                                        |       |                     |       |      |       |                           |       |      |       |
| December  31, 2002                                     |   | 4,495                  |       | 90,897        |       | 193,673                                     |       | 292,866                  |       | 42,625    |       | 20,531                         |       | 645,087   |       |
|                                                   |   |                   |       |          |       |                                        |       |                     |       |      |       |                           |       |      |       |
| **Net book value**                                     |   |                   |       |          |       |                                        |       |                     |       |      |       |                           |       |      |       |
| December  31, 2001                                     |   | 4,112                  |       | 88,537        |       | 192,204                                     |       | 293,364                  |       | 47,701    |       | 28,380                         |       | 654,298   |       |

 

Change in thecomposition of the Group includes the assets of the companies that becameconsolidated subsidiaries at January 1, 2002. See note 11 for more details.

 

Additions tocapital work in progress are shown net of transfers to assets in service.

 

Impairment lossescharged in 2002 relate to the public payphone assets and certain assets using3.5 GHz technology (fixed line segment), accounted for due to changes in marketconditions. The recoverable amount, determined at the cash generating unitlevel, represents the value in use determined using discounted cash flowanalysis.

 

Impairment lossescharged in 2001 in an amount of HUF 1,843 million mostly related to analogcellular (mobile segment) and security monitoring equipment (fixed linesegment).

 

Included in telephoneexchanges at 31 December 2002 are assets subject to finance leases with a grossbook value of HUF 1,476 million and net book value of HUF 365 million.

 

F-19

----

 

As of January 1,2002, the Company revised and changed the useful lives of certain tangiblefixed assets considering their technical obsolescence (eg. network, servers,rooters). This change resulted in additional planned depreciation in an amountof HUF 4,202 million.

 

Included intelephone exchanges at 31 December 2002 are assets leased under operating leasecontracts to customers with a gross book value of HUF 11,183 million and netbook value of HUF 6,561 million. Depreciation for the year of these assetsamounted to HUF 1,237 million.

 

**9 Intangible assets**

** **
|                                    |   | **Concession  costs and  licenses** |   | **Software** |   | **Leasehold  interest** |   | **Brand  name** |   | **Goodwill** |   | **Total** |   |
|-----------------------------------------|--------|-------------------------------------|--------|--------------|--------|-------------------------|--------|-----------------|--------|--------------|--------|-----------|--------|
|                                    |   | **(in  HUF million)**               |   | ** **   |
| **Cost**                                |   |                                |   |         |   |                    |   |            |   |         |   |      |   |
| January  1, 2002                        |   | 21,450                              |   | 51,989       |   | 6,669                   |   | 7,546           |   | 280,804      |   | 368,458   |   |
| Change  in the composition of the Group |   |                                |   | 17           |   | 422                     |   |            |   | 4,941        |   | 5,380     |   |
| Additions                               |   | (1,212                              | )      | 13,631       |   | 614                     |   |            |   |         |   | 13,033    |   |
| Disposals                               |   |                                |   | (2,833       | )      | (652                    | )      |            |   |         |   | (3,485    | )      |
| Translation  adjustment                 |   | (28                                 | )      | (284         | )      |                    |   |            |   |         |   | (312      | )      |
| December  31, 2002                      |   | 20,210                              |   | 62,520       |   | 7,053                   |   | 7,546           |   | 285,745      |   | 383,074   |   |
|                                    |   |                                |   |         |   |                    |   |            |   |         |   |      |   |
| **Amortization**                        |   |                                |   |         |   |                    |   |            |   |         |   |      |   |
| January  1, 2002                        |   | 3,983                               |   | 24,779       |   | 3,423                   |   | 1,321           |   | 28,923       |   | 62,429    |   |
| Change  in the composition of the Group |   |                                |   | 9            |   | 36                      |   |            |   |         |   | 45        |   |
| Charge  for the year                    |   | 1,060                               |   | 11,510       |   | 762                     |   | 755             |   | 13,428       |   | 27,515    |   |
| Impairment  losses                      |   | 520                                 |   |         |   |                    |   |            |   | 916          |   | 1,436     |   |
| Disposals                               |   |                                |   | (2,831       | )      | (653                    | )      |            |   |         |   | (3,484    | )      |
| Translation  adjustment                 |   | (10                                 | )      | (56          | )      |                    |   |            |   |         |   | (66       | )      |
| December  31, 2002                      |   | 5,553                               |   | 33,411       |   | 3,568                   |   | 2,076           |   | 43,267       |   | 87,875    |   |
|                                    |   |                                |   |         |   |                    |   |            |   |         |   |      |   |
| **Net book value**                      |   |                                |   |         |   |                    |   |            |   |         |   |      |   |
| December  31, 2002                      |   | 14,657                              |   | 29,109       |   | 3,485                   |   | 5,470           |   | 242,478      |   | 295,199   |   |
|                                    |   |                                |   |         |   |                    |   |            |   |         |   |      |   |
| **Net book value**                      |   |                                |   |         |   |                    |   |            |   |         |   |      |   |
| December  31, 2001                      |   | 17,467                              |   | 27,210       |   | 3,246                   |   | 6,225           |   | 251,881      |   | 306,029   |   |

 

Change in thecomposition of the Group includes the assets of the companies that becameconsolidated subsidiaries at January 1, 2002. See note 11 for more details.

 

The negativeaddition in the Concession costs and licenses represent the reversal of theunrealized portion of borrowing costs capitalized in prior years related tolicense fees payable in foreign currency.

 

The amortizationexpense of intangible assets including goodwill is accounted for in theDepreciation and amortization line of the Income statement.

 

Impairment lossescharged in 2002 relate to the 3.5 GHz license (fixed line segment), accountedfor due to changes in market conditions. The recoverable amount represents thevalue in use determined using discounted cash-flow analysis. The impairmentlosses on goodwill relate to investments in various subsidiaries of the fixedline segment (HUF 491 million in 2001).

 

F-20

----

 

Impairment lossescharged in 2001 for software in an amount of HUF 468 million related to the analogcellular activity.

 

**10 Purchase of tangible and intangible assets**

 
|                                                |   | **For  the year ended December 31,** | ** ** |
|-----------------------------------------------------|--------|--------------------------------------|------------|
|                                                |   | **2000**                             |       | **2001** | ** ** | **2002** | ** ** |
|                                                |   | **(in HUF millions)**                | ** ** |
|                                                |   |                                 |       |   |   |   |   |
| Additions to property, plant and equipment          |   | 132,385                              |       | 101,725 |   | 84,906 |   |
| Additions to intangible assets                      |   | 26,598                               |       | 15,817 |   | 13,033 |   |
| Total capital expenditure                           |   | 158,983                              |       | 117,542 |   | 97,939 |   |
|                                                |   |                                 |       |   |   |   |   |
| Change in payables relating to capital expenditures |   | (6,199                               | )          | 10,205 |   | 12,049 |   |
|                                                |   | 152,784                              |       | 127,747 |   | 109,988 |   |

 

**11 Associates**

 
|                                         |   | **For  the year ended  December 31,** | ** ** |
|----------------------------------------------|--------|---------------------------------------|------------|
|                                         |   | **2001**                              |       | **2002** | ** ** |
|                                         |   | **(in  HUF millions)**                | ** ** |
|                                         |   |                                  | ** ** |   | ** ** |
| Opening  balance of associates               |   | 8,438                                 |       | 6,209 |   |
| Additions  to associates                     |   | 300                                   |       | 80 |   |
| Share of  associates’ profit before tax |   | 1,703                                 |       | 691 |   |
| Share of  associates’ corporate tax     |   | (51                                   | )          | (136 | ) |
| Dividend  payments                           |   | (779                                  | )          | (1,437 | ) |
| Disposals                                    |   | (168                                  | )          | — |   |
| Associates  becoming subsidiaries            |   | (3,234                                | )          | (800 | ) |
| Closing  balance of associates               |   | 6,209                                 |       | 4,607 |   |

 

Certain companiesincluded in the opening balance of associates are consolidated subsidiaries in2002 as they fall under the scope of SIC 33 - Consolidation and Equity Method -Potential Voting Rights and Allocation of Ownership Interests (effectiveJanuary 1, 2002).

 

**12 Other non current investments**

 
|                           |   | **At  December 31,**   | ** ** |
|--------------------------------|--------|------------------------|------------|
|                           |   | **2001**               |       | **2002** | ** ** |
|                           |   | **(in  HUF millions)** | ** ** |
|                           |   |                   | ** ** |   | ** ** |
| Other  non current investments |   | 6,990                  |       | 2,251 |   |

 

Other non currentinvestments at December 31, 2002 include loans given to third partiesclassified as originated loans under IAS 39, while the balance at December 31,2001 included loans receivable from both third parties and associates.

 

Other non currentinvestments decreased as a result of change in the consolidation methoddescribed in note 11 as loans receivable from the affected associated companiesare eliminated on consolidation in 2002.

 

F-21

----

 

**13 Other non current assets**

 
|                                  |   | **At  December 31,**   | ** ** |
|---------------------------------------|--------|------------------------|------------|
|                                  |   | **2001**               |       | **2002** | ** ** |
|                                  |   | **(in  HUF millions)** | ** ** |
|                                  |   |                   | ** ** |   | ** ** |
| Derivatives                           |   | 2,671                  |       | 1,001 |   |
| Prepayments  falling due after 1 year |   | 4,978                  |       | 6,103 |   |
| Other non  current assets             |   | 3,660                  |       | 3,017 |   |
|                                  |   | 11,309                 |       | 10,121 |   |

 

Derivativesinclude the fair value of the cross-currency interest rate swaps related to theUSD loans disclosed in note 15.

 

**14 Loans and other borrowings**

 
|                                           |   |      |       | **At  December 31,**   |       |
|------------------------------------------------|--------|-----------|------------|------------------------|------------|
|                                           |   | **Notes** |       | **2001**               | ** ** | **2002** | ** ** |
|                                           |   |      |       | **(in  HUF millions)** |       |
|                                           |   |      | ** ** |                   | ** ** |   | ** ** |
| Bank  loans                                    |   | (a)       |       | 127,063                |       | 112,798 |   |
| Bonds                                          |   | (b)       |       | 23,217                 |       | 23,207 |   |
| Finance  leases                                |   |      |       | 888                    |       | 552 |   |
| Other                                          |   |      |       | 1,294                  |       | 1,004 |   |
| Loans  and other borrowings – third party |   |      |       | 152,462                |       | 137,561 |   |
|                                           |   |      |       |                   |       |   |   |
| Loans  from related parties                    |   | (c)       |       | 300,908                |       | 236,446 |   |
| Total  loans and other borrowings              |   |      |       | 453,370                |       | 374,007 |   |

 

At December 31,2002, principal repayments fall due in:

 
|                              |   | **Maturity  At December 31,** | ** ** |
|-----------------------------------|--------|-------------------------------|------------|
|                              |   | **2001**                      |       | **2002** | ** ** |
|                              |   | **(in HUF millions)**         | ** ** |
| Year                              |   |                          |       |   |   |
| 2002                              |   | 33,607                        |       | — |   |
| 2003                              |   | 279,612                       |       | 228,340 |   |
| 2004                              |   | 40,451                        |       | 40,660 |   |
| 2005                              |   | 10,264                        |       | 15,733 |   |
| 2006                              |   | 77,858                        |       | 76,576 |   |
| 2007                              |   | 3,003                         |       | 5,225 |   |
| Thereafter                        |   | 8,575                         |       | 7,473 |   |
| Total  loans and other borrowings |   | 453,370                       |       | 374,007 |   |

 

The effectiveborrowing costs (total interest payable and other charges) for Matáv’s loansand borrowings were 12.7%, 7.5% and 6.96% for the years ended 2000, 2001 and2002, respectively. The weighted average interest rate on borrowings(denominated in Hungarian Forints and foreign currencies) was 6.88% in 2000,9.61% in 2001 and 5.39% in 2002.

 

F-22

----

 

**(a) Bank loans**

 

Bank loansanalyzed by currency are as follows:

 
|   |   | **At  December 31,**   | ** ** |
|--------|--------|------------------------|------------|
|   |   | **2001**               |       | **2002** | ** ** |
|   |   | **(in  HUF millions)** | ** ** |
|   |   |                   | ** ** |   | ** ** |
| HUF    |   | 88,155                 |       | 94,966 |   |
| EUR    |   | 17,888                 |       | 9,726 |   |
| USD    |   | 21,020                 |       | 8,106 |   |
|   |   | 127,063                |       | 112,798 |   |

 

Bank loansdenominated in HUF in an amount of HUF 76,166 million at December 31, 2002 weresubject to variable interest rates. Variable rate loans raised in HungarianForint are subject to interest rates between 8.36% and 10.25% and are based onvarious rates, including BUBOR (Budapest Inter-bank Offered Rate), yield oftreasury bills. Bank loans of HUF 18,800 million are subject to fixed interestrates ranging from 9.15% to 11.75%.

 

All foreigncurrency bank loans are subject to fixed interest rates, ranging between 5.99%and 7.65%.

 

The bank loanshave maturities ranging from 2003 to 2011.

 

Included in bankloans are loans from the European Investment Bank totaling HUF 38,489 millionand HUF 30,332 million at December 31, 2001 and 2002, respectively. Themajority of these loans are taken in foreign currency, which are subject tointerest rates of between 5.99% and 7.65%. These loans are amortizing loanswith repayments falling due every year through 2011.

 

Included in bankloans is a USD denominated loan amounting to HUF 3,984 million that is subjectto interest based on a fixed rate of 7.05%. This loan is subject to across-currency interest rate swap arrangement, which is described in note 15.

 

Included in bankloans is a USD denominated loan amounting to HUF 4,122 million that is subjectto interest based on a fixed rate of 6.56%. This loan is subject to a crosscurrency swap agreement, which is described in note 15.

 

Loans totalingHUF 27,550 million and HUF 31,791 million at December 31, 2001 and 2002 areroll-over loans which can be prepaid at any time and may be drawn down in oneto six month rolling periods. However, the facility under which the loans areprovided has final repayment dates falling due after one year and are,therefore, classified as long-term.

 

Certain loanagreements contain covenant restrictions that require the maintenance ofpre-defined financial ratios. Breach of those covenants would make HUF 54,882million due and payable in 30 days if not remedied.  At December 31, 2002 the Company was in compliance with thesecovenants. One of the covenants allows a debt to EBITD (earnings beforeinterest, tax and depreciation) ratio of maximum 2.5 and 3.0 (in the differentagreements), while the actual ratio was 1.53. The other covenant requires themaintenance of an EBITD to interest expense ratio of minimum 2.0, while theactual ratio was 8.8.

 

F-23

----

 

**(b) Bonds**

 

On March 24,1998, the Company issued five-year bonds with a total amount of HUF 10 billionwith interest payable semi-annually at an interest rate of 50 basis points overthe average yield of the last three auctions of 6-month Hungarian TreasuryBills.

 

On June 22, 2000Matáv launched a HUF 45 billion bond program. This program allows Matáv toissue fixed, floating or zero coupon bonds with maturities of between 1 and 10years. On July 12, 2000, Matáv issued three-year, fixed rate tranche in thenominal amount of HUF 10 billion. The bonds were sold at an average price 51basis points over the 3-year Hungarian Treasury Bills. On March 21, 2001 Matávissued 2.5-year fixed rate 9.25% bonds in the nominal amount of HUF 3 billion.The bonds were sold at an average price 74 basis points over the 3-yearHungarian Treasury Bills.

 

**(c)Loans from related parties**

 

Included in loansfrom related parties is a HUF denominated loan in an amount of HUF 73,675million received from Deutsche Telekom Finance B.V. The loan is subject tofixed 9.36% interest rate, repayable in one amount on January 31, 2006.Interest payments are due semi-annually.

 

Included in loansfrom related parties is a EUR denominated loan in an amount of HUF 162,771million (EUR 690 million) received from Deutsche Telekom Finance B.V. The loanis based on a variable rate of EURIBOR plus a margin of 50 basis points andrepayable in one amount on August 14, 2003. Interest payments are duequarterly. EUR 525 million of the loan is subject to various cross-currency interestrate swap agreements (note 15).

 

**(d)Credit facilities and pledges**

 

At December 31,2002, Matáv had undrawn committed credit facilities of HUF 14,227 million.These credit facilities, should they be drawn down, are subject to an interestrate of LIBOR, BUBOR and commercial floating bank prime rates plus a margindepending on the currency and institution providing the facilities. There arepledges on receivables for loans totaling HUF 1,004 million.

 

**15Quantitative and Qualitative Information about Financial Instruments**

 

Financialinstruments carried on the balance sheet include cash and bank balances,investments, receivables, trade payables, leases and borrowings. Matáv is alsoa party to financial instruments that reduce exposure to fluctuations inforeign currency exchange.

 

Matáv is exposedto interest and foreign exchange rate risk associated with its debt andanticipated transactions. Matáv has no significant concentrations of creditrisk. As the vast majority of the revenues and expenses of the Hungarianentities arise in Hungarian Forints, the measurement currency of Matáv is HUF,therefore Matáv’s objective is to minimize the level of its financial risk inHUF terms.

 

Matáv is exposedto financial market risk through interest rate fluctuations. This is due to thefact that changing EUR and HUF interest rates affect the fair value of fixedrate debts and also affect the cash outflow through the variable rate debts. Tocontrol interest rate risk, a combination of fixed and floating rate debt isused within the foreign currency and HUF portfolios. Since in 2002 the majorityof the debt portfolio was transformed or swapped to HUF, the interest targetsare mainly related to the HUF debt portfolio. Before 2002 the floating rateelements dominated in the HUF portfolio due to decreasing HUF interest rates.

 

F-24

----

 

Matáv is exposedto foreign exchange risk related to foreign currency debt and foreign exchangepayments (i.e. international third party telecommunications carriers andcapital expenditure). To reduce foreign exchange risk, Matáv targeted toincrease the proportion of its borrowings in Hungarian Forint. Matáv’s foreignexchange debt portfolio is denominated in, or swapped to, Euro after Maktel prepaidits USD denominated debt in 2002. The National Bank of Hungary lifted thedevaluation of the Hungarian Forint against the Euro in October 2001 afterwidening the intervention band from +/-2.25% to +/-15% as of May 4, 2001. Theintroduction of this new foreign exchange regulation increased the foreignexchange risk of the Group significantly.

 

In 2000, 2001 and2002 Matáv occasionally entered into derivative contracts for risk reductionpurposes. These foreign currency forward contracts and swap arrangements weretaken to reduce the exchange rate risk related to the debt portfolio and/or theforeign exchange denominated payment obligations.

 

Derivativeinstruments are limited to foreign currency forward contracts and swapagreements that are recognized at cost in the financial statements oninception. As of December 31, 2002, Matáv had no open foreign currency forwardpositions.

 

Included in bankloans is a USD denominated loan amounting to HUF 3,984 million that is subjectto interest based on a fixed rate of 7.05%. This loan is subject to a crosscurrency interest rate swap arrangement which entitles Matáv to receive USDinterest and principal payments at fixed rates, and obliges it to pay EURinterest and principal repayments at floating rates of the EURIBOR rate plus amargin of 0.66%. The EUR principal payments are fixed at a rate of 1 EUR =1.0777 USD. The timing and amount of the USD payments to be received exactlymatch the underlying payment obligations on the USD loan. This is an amortizingloan with semi-annual repayments with a final maturity in 2011. In 2000 Matávaccounted for interest and foreign exchange movements on these loans at the EURrate.

 

Included in bankloans is a USD denominated loan amounting to HUF 4,122 million that is subject tointerest based on a fixed rate of 6.56%. This loan is subject to a crosscurrency swap agreement. This swap agreement entitles Matáv to receive USDinterest and principal payments at fixed rates, and obliges it to pay EURinterest and principal payments at fixed rates of 5.17%. EUR principal paymentsare determined according to the EUR equivalent of the USD principal payments ata rate of 1.0277 USD/EUR. The timing and amount of the USD payments receivedexactly match the underlying payment obligations of the USD loans. This is anamortizing loan with semi-annual repayments with a final maturity in 2011. In2000 Matáv accounted for interest and foreign exchange movements on these loansat the EUR rate.

 

From 2001 the twoloans described above are accounted for as USD loans, while the fair value ofthe swap agreements is accounted for separately as derivative assets and isdisclosed in other non current assets.

 

For theacquisition of a 44% stake in Maktel, Matáv received a loan of EUR 301.5million (HUF 79,985 million) from Deutsche Telekom Finance B.V. on January 15,2001. The loan was based on a variable rate of EURIBOR plus a margin of 30basis points and repayable in one amount on January 31, 2006. Interest paymentsare due semi-annually.

 

Matáv has enteredinto a swap agreement on February 4, 2002 in order to exchange the cash flowsof the EUR 301.5 million loan to HUF cash flows. The counter-party in thetransaction was Deutsche Telekom AG. The cross currency swap agreement entitledMatáv to receive EUR interest and principal payments and pay HUF interest andprincipal payments. The EUR loan was subject to floating rate interest based on6 month EURIBOR plus a margin of 30 basis points, while under the swap Matávwas obliged to pay an interest based on 6 month BUBOR plus a margin of 34 basispoints. The HUF principal payment was fixed at a rate of 1 EUR to 244.36 HUF(HUF 73,675 million). The timing and the amount of the EUR payments to bereceived under the swap were matched with the underlying payment obligations onthe EUR loan.

 

F-25

----

 

As of November 4,2002, the loan and the swap agreement were replaced with a new fixed 9.36%interest HUF loan of HUF 73,675 million, leaving the repayment terms unchanged.

 

For theacquisition of the remaining 49% stake in Westel, Matáv received a loan of EUR920 million (HUF 226,750 million) from Deutsche Telekom Finance B.V. onDecember 20, 2001. The loan is based on a variable rate of EURIBOR plus amargin of 50 basis points and repayable in one amount on August 14, 2003.Interest payments are due quarterly.

 

In 2002, Matávconcluded four swap agreements in order to exchange some of the cash flowsrelated to the above mentioned EUR loan to HUF cash flows. The counter-party inthe transaction is Deutsche Telekom AG. The cross currency swap agreemententitles Matáv to receive EUR interest subject to 3 month EURIBOR plus a marginof 50 basis points and EUR 525 million principal amount, while Matáv has theobligation to pay HUF interest subject to 3 month BUBOR plus a margin of 50-57basis points and HUF 126,644 million principal amount. The timing of the EURpayments to be received under the swaps are matched with the timing of the EURpayment obligations relating to the original EUR loan.

 

In 2002 EUR 230million was repaid of the portion of the loan for which no swap agreements werein place. As a result of the early repayments, the balance of the loan as ofDecember 31, 2002 is EUR 690 million (HUF 162,771 million), of which EUR 165million is not covered with swap agreements.

 

The loandescribed above is accounted for as a EUR loan, while the fair value of theswap agreements is accounted for separately as a derivative liability and isdisclosed in other non current liabilities.

 

The financialasset portfolio is relatively small compared to the debt portfolio of Matáv andmainly includes bank deposits.

 

As of December31, 2002, Matáv’s cash and cash equivalent’s balance included HUF denominatedcash equivalent instruments in an amount of HUF 1,761 million at an averageinterest rate of 1.97%, MKD denominated cash balance in an amount of HUF 6,689million at an average interest rate of 5.82% and other foreign exchangedenominated instruments at an amount of HUF 401 million with an averageinterest rate of 1.43%.

 

The net carryingamounts of financial assets including cash, investments, receivables andpayables and finance lease obligations reflect reasonable estimates of fairvalue due to the relatively short period to maturity of the instruments.

 

F-26

----

 

Thefollowing table is a summary of Matáv’s market sensitive debt instruments,including fair value calculated using the discounted cash flow method. Averagerates disclosed represent the weighted average rates of fixed rate and variablerate portfolios at period end. The book values of variable rate loans andborrowings approximate their fair values as shown below at December 31, 2002.

 
|                                             |   | **Maturities**                             | ** ** |     | ** ** |     | ** ** |
|--------------------------------------------------|--------|--------------------------------------------|------------|----------|------------|----------|------------|
|                                             |   | **2003**                                   |       | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **after  2007** | ** ** | **Total** | ** ** | **Fair  value** | ** ** |
|                                             |   | **(in  HUF millions, except percentages)** | ** ** |
| **Bank loans (HUF****Denominated)**              |   |                                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |
| Fixed  rate                                      |   | 6,300                                      |       | 12,500   |       | —   |       | — |   | — |   | — |   | 18,800 |   | 19,437 |   |
| Average  interest rate                           |   | 9.31                                       | %          | 11.75    | %          |     |       |   |   |   |   |   |   | 10.93 | % |   |   |
| Variable  rate                                   |   | 33,408                                     |       | 25,634   |       | 13,375   |       | 625 |   | 3,124 |   | — |   | 76,166 |   | 76,166 |   |
| Average  interest rate                           |   | 9.18                                       | %          | 9.25     | %          | 9.46     | %          | 10.25 | % | 9.88 | % |   |   | 9.29 | % |   |   |
| Total                                            |   | 39,708                                     |       | 38,134   |       | 13,375   |       | 625 |   | 3,124 |   | 0 |   | 94,966 |   | 95,603 |   |
|                                             |   |                                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |
| **Bank loans (foreign currency****denominated)** |   |                                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |
| Fixed  rate                                      |   | 2,098                                      |       | 2,098    |       | 2,098    |       | 2,098 |   | 2,098 |   | 7,342 |   | 17,832 |   | 19,963 |   |
| Average  interest rate                           |   | 6.92                                       | %          | 6.92     | %          | 6.92     | %          | 6.92 | % | 6.92 | % | 6.92 | % | 6.92 | % |   |   |
| Total                                            |   | 2,098                                      |       | 2,098    |       | 2,098    |       | 2,098 |   | 2,098 |   | 7,342 |   | 17,832 |   | 19,963 |   |
|                                             |   |                                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |
| Total  bank loans                                |   | 41,806                                     |       | 40,232   |       | 15,473   |       | 2,723 |   | 5,222 |   | 7,342 |   | 112,798 |   | 115,566 |   |
|                                             |   |                                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |
| **Bonds (HUF denominated)**                      |   |                                       |       |     |       |     |       |   |   |   |   |   |   |   |   |   |   |
| Fixed  rate                                      |   | 13,076                                     |       | —   |       | —   |       | — |   | — |   | 131 |   | 13,207 |   | 13,246 |   |
| Average  interest rate                           |   | 9.20                                       | %          |     |       |     |       |   |   |   |   | 0.00 | % | 9.11 | % |   |   |
| Variable  rate                                   |   | 10,000                                     |       | —   |       | —   |       | — |   | — |   | — |   | 10,000 |   | 10,000 |   |
| Average  interest rate                           |   | 10.28                                      | %          |     |       |     |       |   |   |   |   |   |   | 10.28 | % |   |   |
| Total                                            |   | 23,076                                     |       | 0        |       | 0        |       | 0 |   | 0 |   | 131 |   | 23,207 |   | 23,246 |   |

 

**16 Trade and other payables**

 
|                                            |   | **At  December 31,**   | ** ** |
|-------------------------------------------------|--------|------------------------|------------|
|                                            |   | **2001**               |       | **2002** | ** ** |
|                                            |   | **(in  HUF millions)** | ** ** |
|                                            |   |                   | ** ** |   | ** ** |
| Domestic  trade payables                        |   | 47,832                 |       | 38,285 |   |
| Foreign  trade payables                         |   | 11,409                 |       | 8,854 |   |
| Amounts  owed to related parties                |   | 12,859                 |       | 1,406 |   |
| Taxation  and social security                   |   | 12,661                 |       | 8,384 |   |
| Accrued  expenses and prepayments               |   | 19,830                 |       | 21,947 |   |
| Amounts  received in advance                    |   | 1,460                  |       | 7,000 |   |
| Salaries  and wages                             |   | 9,462                  |       | 7,378 |   |
| Payables  to associates                         |   | 87                     |       | 230 |   |
| Dividends  payable to minority interest holders |   | 63                     |       | 8 |   |
| Other  payables                                 |   | 6,463                  |       | 8,365 |   |
|                                            |   | 122,126                |       | 101,857 |   |

 

F-27

----

 

Amounts owed torelated parties at December 31, 2001 included an expected amount of HUF 12,000million as additional purchase price payable to MediaOne for the acquisition ofthe Westels (note 2). The final amount paid in 2002 was HUF 11,515 million,while the remaining HUF 485 million was released to equity.

 

**17 Deferred revenue**

 
|                                     |   | **At  December 31,**   | ** ** |
|------------------------------------------|--------|------------------------|------------|
|                                     |   | **2001**               |       | **2002** | ** ** |
|                                     |   | **(in  HUF millions)** | ** ** |
|                                     |   |                   | ** ** |   | ** ** |
| Beginning  of period                     |   | 13,639                 |       | 10,531 |   |
| Change  in the composition of the Group  |   | 391                    |       | — |   |
| Amortization                             |   | (3,499                 | )          | (3,353 | ) |
| End of  period                           |   | 10,531                 |       | 7,178 |   |
| Amount  to be recognized within one year |   | 3,430                  |       | 2,722 |   |

 

**18 Provision for liabilities and charges**

** **
|               |   | **Severance**          |       | **Customer  loyalty  programs** | ** ** | **Other** | ** ** | **Total** | ** ** |
|--------------------|--------|------------------------|------------|---------------------------------|------------|-----------|------------|-----------|------------|
|               |   | **(in  HUF millions)** | ** ** |
|               |   |                   |       |                            |       |      |       |      |       |
| January  1, 2002   |   | 540                    |       | 2,293                           |       | 487       |       | 3,320     |       |
| Amounts  used      |   | (540                   | )          | (2,090                          | )          | (487      | )          | (3,117    | )          |
| Additions          |   | 8,623                  |       | 2,333                           |       | 1,031     |       | 11,987    |       |
| December  31, 2002 |   | 8,623                  |       | 2,536                           |       | 1,031     |       | 12,190    |       |

 

The provision forseverance relates to the employee termination benefit payable in 2003 and 2004in accordance with the agreement made with employee representatives. The amountof HUF 1,040 million payable in 2004 is included in provisions for liabilitiesand charges under non current liabilities.

 

Provision forcustomer loyalty programs includes the fair value of discount credits earned bycustomers that have not been utilized.

 

Other provisionsinclude liabilities deriving mainly from legal cases and guarantee obligations.

 

**19 Other non current liabilities**

 
|                          |   | **At  December 31,**   | ** ** |
|-------------------------------|--------|------------------------|------------|
|                          |   | **2001**               |       | **2002** | ** ** |
|                          |   | **(in  HUF millions)** | ** ** |
|                          |   |                   |       |   |   |
| Long  term concession payable |   | 4,428                  |       | — |   |
| Derivatives                   |   | —                 |       | 3,993 |   |
| Other                         |   | 189                    |       | — |   |
|                          |   | 4,617                  |       | 3,993 |   |

 

Derivativesinclude the fair value of the swap agreements concluded with Deutsche TelekomAG related to the loans received from Deutsche Telekom Finance B.V. See note 15for more details.

 

F-28

----

 

**20 Minority interests**

 

In cases wheresubsidiaries are not wholly owned by the Group, the consolidated balance sheetsand income statements reflect the share of investment and results held by thirdparties.

 
|                                                        |   | **For  the year ended December 31,** | ** ** |
|-------------------------------------------------------------|--------|--------------------------------------|------------|
|                                                        |   | **2000**                             |       | **2001** | ** ** | **2002** | ** ** |
|                                                        |   | **(in  HUF millions)**               | ** ** |
|                                                        |   |                                 |       |   |   |   |   |
| Beginning  of period                                        |   | 23,012                               |       | 1,228 |   | 48,169 |   |
| Acquisition  of minority interest in Westel and Westel 0660 |   | (25,290                              | )          | — |   | — |   |
| Acquisition  of Maktel                                      |   | —                               |       | 35,963 |   | — |   |
| Share of  results for the year                              |   | 2,869                                |       | 13,706 |   | 13,639 |   |
| Dividends  paid / payable to minority shareholders          |   | (143                                 | )          | (58 | ) | (56 | ) |
| Other  movement in capital contributed by minority interest |   | 780                                  |       | 396 |   | 128 |   |
| Cumulative  translation adjustment                          |   | —                               |       | (3,066 | ) | (2,444 | ) |
| End of  period                                              |   | 1,228                                |       | 48,169 |   | 59,436 |   |

 

The balance ofminority interest at December 31, 2002 includes an amount of HUF 1,275 million(2001: HUF 2,100 million) in relation to the call option of CosmoTelcorepresenting the loss to Matáv had CosmoTelco exercised its option for the 10%interest in Stonebridge at December 31, 2002 (see note 2).

 

**21 Revenues**

 
|                                              |   | **For  the year ended December 31,** | ** ** |
|---------------------------------------------------|--------|--------------------------------------|------------|
|                                              |   | **2000**                             |       | **2001** | ** ** | **2002** | ** ** |
|                                              |   | **(in  HUF millions)**               | ** ** |
| Domestic  fixed line telecommunications services: |   |                                 |       |   |   |   |   |
| Subscriptions,  connections and other charges     |   | 83,691                               |       | 97,487 |   | 98,050 |   |
| Domestic  traffic revenue                         |   | 129,517                              |       | 123,366 |   | 118,812 |   |
| Other  usage                                      |   | 19,136                               |       | 17,254 |   | 15,024 |   |
| International  traffic revenues                   |   | 39,008                               |       | 32,212 |   | 27,076 |   |
| Mobile  telecommunications services               |   | 108,885                              |       | 140,234 |   | 178,492 |   |
| Revenue  from international activities            |   | —                               |       | 59,977 |   | 67,330 |   |
| Leased  lines and data transmission               |   | 26,111                               |       | 30,977 |   | 34,142 |   |
| Other  services                                   |   | 39,597                               |       | 46,228 |   | 51,659 |   |
|                                              |   | 445,945                              |       | 547,735 |   | 590,585 |   |

 

Revenue frominternational activities includes the total consolidated revenues of Maktel.

 

Included in otherservices is HUF 6,061 million of subsidies from the Universal TelecommunicationSupport Fund that is meant to compensate for the maintenance of low usagediscount packages provided by the fixed line telecom service providers of theGroup. Contributions payable to the Fund are shown as part of fees and leviesin other operating expenses (see below), in an amount of HUF 5,064 million.

 

F-29

----

 

**22 Other operating expenses**

 
|                                     |   | **For  the year ended December 31,** | ** ** |
|------------------------------------------|--------|--------------------------------------|------------|
|                                     |   | **2000**                             |       | **2001** | ** ** | **2002** | ** ** |
|                                     |   | **(in  HUF millions)**               | ** ** |
|                                     |   |                                 |       |   |   |   |   |
| Materials,  maintenance and service fees |   | 38,946                               |       | 53,946 |   | 57,538 |   |
| Subcontractors  and agent commissions    |   | 12,277                               |       | 11,514 |   | 18,098 |   |
| Fees and  levies                         |   | 11,901                               |       | 15,921 |   | 24,014 |   |
| Marketing                                |   | 10,348                               |       | 13,360 |   | 13,514 |   |
| Consulting                               |   | 6,775                                |       | 6,736 |   | 7,483 |   |
| Rental  fees                             |   | 4,192                                |       | 5,667 |   | 6,348 |   |
| Other  expenses                          |   | 14,943                               |       | 16,900 |   | 8,523 |   |
|                                     |   | 99,382                               |       | 124,044 |   | 135,518 |   |

 

The remunerationof the Company’s Directors amounted to 7 million in 2002 (HUF 7 million in2001, HUF 13 million in 2000). The remuneration of the members of the Company’sSupervisory Board amounted to HUF 7 million in 2002 (HUF 7 million in 2001, HUF7 million in 2000).

 

**23 Net interest and other charges**

 
|                                       |   | **For  the year ended December 31,** | ** ** |
|--------------------------------------------|--------|--------------------------------------|------------|
|                                       |   | **2000**                             |       | **2001** | ** ** | **2002** | ** ** |
|                                       |   | **(in  HUF millions)**               | ** ** |
| Interest  expense:                         |   |                                 |       |   |   |   |   |
| Hungarian  Forint                          |   | 11,490                               |       | 11,592 |   | 14,173 |   |
| Foreign  currency                          |   | 5,318                                |       | 9,149 |   | 12,459 |   |
| (Gains)  / losses on swap agreements       |   | —                               |       | (582 | ) | 9,435 |   |
| Net  foreign exchange losses / (gains)     |   | 4,835                                |       | (6,930 | ) | (10,948 | ) |
| Bank  charges and other financial expenses |   | 2,042                                |       | 2,420 |   | 3,686 |   |
| Total  interest expense and other charges  |   | 23,685                               |       | 15,649 |   | 28,805 |   |
| Interest  capitalized                      |   | (626                                 | )          | (404 | ) | (226 | ) |
| Interest  and other financial income       |   | (2,067                               | )          | (2,141 | ) | (660 | ) |
|                                       |   | 20,992                               |       | 13,104 |   | 27,919 |   |

 

**24 Income tax**

 
|                                                               |   | **For  the year ended December 31,** | ** ** |
|--------------------------------------------------------------------|--------|--------------------------------------|------------|
|                                                               |   | **2000**                             |       | **2001** | ** ** | **2002** | ** ** |
|                                                               |   | **(in  HUF millions)**               | ** ** |
|                                                               |   |                                 |       |   |   |   |   |
| Income  tax charge on the profit for the year                      |   | (8,625                               | )          | (9,464 | ) | (15,113 | ) |
| Deferred  income taxes                                             |   | 1,102                                |       | (2,218 | ) | 2,004 |   |
| Income  tax on the Group’s share of the results of associates |   | (229                                 | )          | (51 | ) | (136 | ) |
| Income  tax expense                                                |   | (7,752                               | )          | (11,733 | ) | (13,245 | ) |

 

The Company andthe Westels qualified for a reduction in income tax payable on meeting certainconditions. The reduction in the tax payable amounted to a 100% allowance forfive years from the date of qualification, and a 60% allowance for a furtherfive years. Through 1998, Matáv Rt. and Westel qualified for the 100%allowance. Through 1995, Westel 0660 utilized the 100% allowance. From January1, 1999, Matáv Rt. has been utilizing the

 

F-30

----

 

reduced allowance of 60%, for a maximum possible fiveyears (effective tax rate of 7.2%). Westel 0660 utilized the reduced allowanceof 60% until December 31, 1999.

 

Managementbelieves that the conditions underlying the reduction in income tax willcontinue to be met by Matáv Rt. As result of Matáv’s acquisition of theremaining 49% of Westel, foreign ownership fell below 30%, hence Westel lostits 60% reduction in income tax as of December 21, 2001. This resulted in adeferred tax credit of approximately HUF 1,600 million in 2001. All otherHungarian subsidiaries were subject to income tax of 18%, while the Macedoniancompanies are subject to income tax of 15%.

 

Deferredtax assets are recognized for tax loss carry forwards only to the extent thatrealization of the related tax benefit is probable. Recognized tax losses ofHUF 1,615 million will expire in 2003, HUF 100 million will expire in 2005, HUF5,842 million will expire in 2006 and HUF 5,112 million will expire in 2007. Ofthe recognized tax losses, HUF 4,949 million is not subject to statutorylimitations.

 

Matáv’s deferredtax balances are as follows.

 
|                                                            |   | **Balance at   December  31, 2001** |       | **Cumulative  translation  adjustment** |       | **Income  statement  effect** |       | **Balance at  December  31, 2002** |       |
|-----------------------------------------------------------------|--------|-------------------------------------|------------|-----------------------------------------|------------|-------------------------------|------------|------------------------------------|------------|
|                                                            |   |                                |       |                                    |       |                          |       |                               |       |
| Deferred tax assets and (liabilities)                           |   |                                | ** ** |                                    | ** ** |                          | ** ** |                               | ** ** |
| Net  operating loss carry-forward                               |   | 52                                  |       |                                    |       | 3,117                         |       | 3,169                              |       |
| Investments  in subsidiaries                                    |   | (1,055                              | )          |                                    |       | (1,016                        | )          | (2,071                             | )          |
| Impairment  of receivables, inventory and financial investments |   | 3,884                               |       | (39                                     | )          | (440                          | )          | 3,405                              |       |
| Property,  plant and equipment and intangible assets            |   | (1,909                              | )          | (23                                     | )          | (209                          | )          | (2,141                             | )          |
| Derivative  assets                                              |   | (184                                | )          |                                    |       | (225                          | )          | (409                               | )          |
| Trade  and other payables                                       |   | 45                                  |       | (22                                     | )          | (248                          | )          | (225                               | )          |
| Loans  and other borrowings                                     |   | (54                                 | )          |                                    |       | 204                           |       | 150                                |       |
| Deferred  revenue                                               |   | 929                                 |       |                                    |       | (121                          | )          | 808                                |       |
| Provisions  for liabilities and charges                         |   | 345                                 |       |                                    |       | 942                           |       | 1,287                              |       |
| Total  net deferred tax assets                                  |   | 2,053                               |       | (84                                     | )          | 2,004                         |       | 3,973                              |       |
|                                                            |   |                                |       |                                    |       |                          |       |                               |       |
| Add  back: deferred tax liability                               |   | 1,763                               |       |                                    |       |                          |       | 2,646                              |       |
|                                                            |   |                                |       |                                    |       |                          |       |                               |       |
| Deferred  tax assets                                            |   | 3,816                               |       |                                    |       |                          |       | 6,619                              |       |

 

Deferred tax assetsand liabilities are determined by the legal entities of the Group.

 

F-31

----

 

Thereconciliation between the reported income tax expense and the theoreticalamount arising by applying the statutory income tax rates is as follows:

 
|                                                         |   | **For  the year ended December 31,** | ** ** |
|--------------------------------------------------------------|--------|--------------------------------------|------------|
|                                                         |   | **2000**                             |       | **2001** | ** ** | **2002** | ** ** |
|                                                         |   | **(in  HUF millions)**               | ** ** |
|                                                         |   |                                 |       |   |   |   |   |
| IFRS  profit before income tax                               |   | 77,273                               |       | 107,999 |   | 95,012 |   |
| Tax at  18%                                                  |   | (13,910                              | )          | (19,440 | ) | (17,102 | ) |
| Effect  of reduced tax rates                                 |   | 8,510                                |       | 11,259 |   | 2,686 |   |
| Tax on  items not subject to tax                             |   | 981                                  |       | 1,368 |   | 2,027 |   |
| Tax  effect of recognition / (non-recognition) of tax losses |   | (352                                 | )          | (1,151 | ) | 1,925 |   |
| Tax on  non deductible expenses                              |   | (2,511                               | )          | (4,459 | ) | (2,837 | ) |
| Temporary  differences reversing at different rates          |   | (241                                 | )          | 741 |   | 192 |   |
| Income  tax expense (before associates’ tax)            |   | (7,523                               | )          | (11,682 | ) | (13,109 | ) |
| Share of  associates tax expense                             |   | (229                                 | )          | (51 | ) | (136 | ) |
| Income  tax expense                                          |   | (7,752                               | )          | (11,733 | ) | (13,245 | ) |

 

Items not subjectto income tax consist primarily of amortization of investment contribution feesand connection fees to revenue as well as the share of associates’ profitbefore income tax as the results of the associates are not included in thereconciliation.

 

**25 Management Incentive Plans**

 

**(a) Convertible bonds**

 

From June 29,1998 to July 1, 1998, Matáv Rt. issued 7 million convertible bearer bonds,known as the “Management Incentive Program Bond” each with a face value of HUF1. The holder of a bond could convert it into one newly issued Matáv A seriesregistered common stock with a face value of HUF 100, in accordance with theallocation and conversion rules. On July 1, 1998, 4,231 thousand bonds wereallocated to management. In 1999, 402 thousand bonds were forfeited. In 2000additional 876 thousand bonds were allocated to management and 283 thousandbonds were forfeited. In 2001, 242 thousand bonds were forfeited.

 

The Bondscould be converted into newly issued Matáv A series registered common stockover a three year period with one third vesting each year beginning July 1,1999. Bonds could not be converted after the end of the bond’s term, June 2002.None of the bonds were converted into shares and so all outstanding bonds wereforfeited in 2002.

 

Theconversion price of the bonds was the Hungarian Forint equivalent of USD 5.75per bond, calculated based on the USD/HUF exchange rate quoted by the HungarianNational Bank on the day of conversion, less the face value of the bond, butnot less than the initial public offering price of HUF 730 per share.

 

Compensation costwas not recognized in these financial statements for the fair value or theintrinsic value of the bonds granted.

 

F-32

----

 

**(b) Share options**

 

On April 26,2002, the annual Shareholders’ Meeting approved the introduction of a newmanagement share option plan and authorized the Company’s Board of Directors topurchase 17 million “A” series registered ordinary shares, each having anominal value of HUF 100 as treasury shares.

 

On July 1, 2002, the Company granted 3,964,600 options to participants ofthe stock option plan at an exercise price of HUF 933 for the first tranche(exercisable in 2003) and HUF 950 for the second and third tranches(exercisable in 2004 and 2005). The Company’s share price as quoted on the BET(Budapest Stock Exchange) on the grant date was HUF 833 per share. The optionshave a life of five years from the grant date, meaning that the options areforfeited without replacement or compensation on June 30, 2007.

 

The option withrespect to the maximum of one-third of the shares that can be purchased underthe relevant option (first tranche) may be exercised from July 1, 2003 untilthe end of the term.

 

The option withrespect to the maximum of a further one-third of the shares that can bepurchased under the option (second tranche) may be exercised from July 1, 2004until the end of the term.

 

The option withrespect to the rest of the shares that can be purchased under the option (thethird tranche) may be exercised from July 1, 2005 until the end of the term.

 

Compensation costwas not recognized in these financial statements for the fair value of theoptions granted.

 

## ***26Commitments***

 

***(a) Lease commitments***

 

Operating leasecommitments were mainly in respect of the lease of buildings, network and othertelecommunications facilities. Finance leases relate to the sale and lease backof PBX and other telecommunications equipment. Future minimum lease paymentsunder finance and operating leases at December 31, 2001 and 2002 are asfollows:

 
|                                                         |   | **Finance  Leases  At December 31,** | ** ** |
|--------------------------------------------------------------|--------|--------------------------------------|------------|
|                                                         |   | **2001**                             |       | **2002** | ** ** |
|                                                         |   | **(in HUF millions)**                | ** ** |
| Year                                                         |   |                                 |       |   |   |
| 2002                                                         |   | 410                                  |       | — |   |
| 2003                                                         |   | 462                                  |       | 455 |   |
| 2004                                                         |   | 139                                  |       | 155 |   |
| 2005 and  thereafter                                         |   | —                               |       | — |   |
| Total  minimum lease payments                                |   | 1,011                                |       | 610 |   |
| Less:  amounts representing interest                         |   | (123                                 | )          | (58 | ) |
| Present  value of net minimum lease payments                 |   | 888                                  |       | 552 |   |
|                                                         |   |                                 |       |   |   |
| Less:  finance lease obligations included in short-term debt |   | 331                                  |       | 406 |   |
|                                                         |   |                                 |       |   |   |
| Long-term  finance lease obligations                         |   | 557                                  |       | 146 |   |

 

F-33

----

 
|                          |   | **Operating  Leases  At December 31,** | ** ** |
|-------------------------------|--------|----------------------------------------|------------|
|                          |   | **2001**                               |       | **2002** | ** ** |
|                          |   | **(in HUF millions)**                  | ** ** |
| Year                          |   |                                   |       |   |   |
| 2002                          |   | 3,245                                  |       | — |   |
| 2003                          |   | 2,502                                  |       | 2,065 |   |
| 2004                          |   | 2,082                                  |       | 1,579 |   |
| 2005                          |   | 1,388                                  |       | 1,324 |   |
| 2006                          |   | 966                                    |       | 1,348 |   |
| 2007                          |   | 778                                    |       | 1,415 |   |
| Thereafter                    |   | —                                 |       | 1,533 |   |
| Total  minimum lease payments |   | 10,961                                 |       | 9,264 |   |

 

***(b) Purchase commitments***

 

As of December31, 2000, 2001 and 2002 capital expenditures amounting to HUF 18.2 billion, HUF11.2 billion and HUF 7.5 billion, respectively, principally relating to thetelecommunications network, had been committed to under contractualarrangements, with the majority of payments due within one year.

 

***(c) M-RTL***

 

Matáv Rt.acquired a 25% share in M-RTL, a television broadcasting company in 1997. MatávRt. committed to provide M-RTL with equity and debt financing if M-RTL needsthat. At December 31, 2002 Matáv Rt. has outstanding commitments ofapproximately DEM 4 million (in proportion to its ownership) to provide furtherfunds to M-RTL. In 2002 M-RTL repaid all its loans to its founders and alsopaid dividends of HUF 1.6 billion, which makes Matáv believe that thiscommitment will not have to be delivered upon.

 

***(d) Contingencies***

 

In November 2002Westel and the other significant Hungarian mobile company were designated bythe National Telecom Regulatory Authority (“HIF”) as having Significant MarketPower (“SMP”) in the interconnection market. Westel filed its cost calculationmethodology and relevant cost/tariff data based on the mandatory Long RangeIncremental Cost (“LRIC”), meeting the provisions of law. The other companyappealed against the decision. This was accepted by the court but is beingappealed by HIF and is now subject to review by the Supreme Court. In order toavoid a competitive disadvantage and to ensure non-discriminatory treatment,Westel filed an official request with HIF, asking for the delay of execution ofany decision regarding implementation of its SMP obligations until finalsettlement of the judicial review.

 

There is anon-going investigation by the Competition Office into accusations ofmonopolistic behavior in the Hungarian mobile market, the current status ofwhich is a recommendation to the Competition Council to levy a penalty of HUF1.9 billion on Westel. Matáv believes that the basis for the CompetitionOffice’s findings is not well founded and that the amount of a potentialliability is not material to the financial statements as of December 31, 2002.

 

F-34

----

 

**27 Lease revenues**

 

Operating leaserevenues relate primarily to the leasing of PBX equipment where Matáv is thelessor.

 
| **Year**                                 |   |                  |   |
|------------------------------------------|--------|-----------------------|--------|
|                                     |   | **(in HUF millions)** |   |
|                                     |   |                  |   |
| 2003                                     |   | 5,346                 |   |
| 2004 –  2006                        |   | 8,977                 |   |
| 2007 and  thereafter                     |   | 1,207                 |   |
| Total  minimum lease payments receivable |   | 15,530                |   |

 

**28 Related party transactions**

 

**MagyarComGmbH**

 

The Company ismajority owned by MagyarCom GmbH (59.49%), which is owned by Deutsche TelekomAG. In 2002 Matáv paid dividends of HUF 6,792 million to MagyarCom GmbH, whilethe amount in 2001 amounted to HUF 6,174 million.

 

Matáv had norevenues or expenses incurred in the three-year period ended December 31, 2002or receivables and payables at the end of 2001 or 2002.

 

**MagyarCom Services Kft.**

 

MagyarComServices Kft., a Hungarian company owned by Deutsche Telekom, provides Matávwith management and consultancy services. The total service fees charged in2000, 2001 and 2002 amounted to HUF 2,478 million and HUF 1,563 million and HUF2,028 million, respectively. Matáv had outstanding payable to MagyarComServices Kft. of HUF 573 million at December 31, 2002 (HUF 515 million atDecember 31, 2001). Matáv had no amounts receivable from MagyarCom ServicesKft. as of the same dates.

 

**Deutsche Telekom Group**

 

Matáv hadtelecommunications revenues amounting to HUF 7,589 million (HUF 5,992 millionin 2001, HUF 5,168 million in 2000) from other Deutsche Telekom Group members.Operating expenses to Deutsche Telekom Group members amounted to HUF 4,852million in 2002. (HUF 5,900 million in 2001, HUF 4,658 million in 2000)

 

Matáv hadoutstanding payable to other Deutsche Telekom Group members of HUF 833 millionat December 31, 2002 (HUF 344 million at December 31, 2001). Matáv had amountsreceivable from other DT Group members amounting to HUF 1,731 million in 2002.(HUF 644 million in 2001)

 

Related to theswap agreements concluded with Deutsche Telekom AG (note 15), Matáv hadinterest expense of HUF 5,040 million in 2002 included in the gains and losseson swap agreements. Accrued interest at December 31, 2002 amounted to HUF 1,041million included in the fair value of the swap agreements in other non currentliabilities.

 

Related to theloan agreement concluded with Deutsche Telekom Finance B.V. Matáv had interestexpense of HUF 13,654 million in 2002, and HUF 3,846 million in 2001. For theloan balances refer to note 14 and 15.

 

F-35

----

 

Accrued interest at December 31, 2002 amounted to HUF4,298 million (HUF 1,918 million in 2001), included in accrued expenses.

 

Deutsche Telekomhas pledged its support for Matáv’s financing needs through to June 30, 2004.

 

**Governments**

 

Matáv providesservices to Government departments and businesses in Hungary and Macedonia onarm’s length basis, however, individually none of these customers represent asignificant source of revenue.

 

***Associates***

 

Hunsat is a jointventure founded by the Company (50%) and Antenna Hungária Rt. The revenues ofHunsat include membership fees paid by the establishing owners and subsidiesreceived from an international space communications organization. Costsincurred by Matáv including payment of these membership fees amounted to HUF160 million in 2002, HUF 269 million in 2001 and HUF 324 million in 2000. Anyprofits made by Hunsat are repaid to the joint venture partners.

 

As M-RTL, theHungarian television broadcast company, in which Matáv has a 25% share ofownership, operates mostly through production agencies, the transactionsbetween M-RTL and Matáv Group are insignificant.

 

**29 Principal investees**

 

At December 31,2002 the principal operating associates and subsidiaries of the Group, whichare incorporated in Hungary and Macedonia, were as follows:

 
| **Associates**                                                                             |   | **Group  interest  in capital** | ** ** | **Activity**                            | ** ** |
|--------------------------------------------------------------------------------------------|--------|---------------------------------|------------|-----------------------------------------|------------|
|                                                                                       |   |                            |       |                                    |       |
| Hunsat  Magyar Űrtávközlési Koordinációs Egyesülés |   | 50.00                           | %          | Satellite communications                |       |
| Magyar  RTL Televízió Rt.                                                        |   | 25.00                           | %          | Television broadcast company            |       |
|                                                                                       |   |                            |       |                                    |       |
| **Subsidiaries**                                                                           |   | **Group  interest  in capital** | ** ** | **Activity**                            | ** ** |
|                                                                                       |   |                            | ** ** |                                    | ** ** |
| Axelero  Rt.                                                                               |   | 100.00                          | %          | Internet service and content provider   |       |
| Emitel  Rt.                                                                                |   | 100.00                          | %          | Local telecommunications operator       |       |
| InvesTel  Rt.                                                                              |   | 100.00                          | %          | Cable TV holding                        |       |
| Makedonski  Telekommunikacii AD (Maktel)                                                   |   | 44.11                           | %          | Macedonian telecommunications company   |       |
| Matávcom  Kft.                                                                        |   | 100.00                          | %          | Solutions for business customers        |       |
| MatávkábelTV  Kft.                                                               |   | 100.00                          | %          | Cable television operator               |       |
| Stonebridge  A.D.                                                                          |   | 86.46                           | %          | Macedonian holding company              |       |
| Westel  Rádiótelefon Kft.                                                        |   | 100.00                          | %          | Cellular telephone services             |       |
| Westel  Mobil Távközlési Rt                                                 |   | 100.00                          | %          | GSM digital cellular telephone services |       |

 

F-36

----

 

The Group’s interest in the capital ofsubsidiaries and associates equals the voting rights therein, with theexception of Maktel, where the Company holds 51% of the voting rights due toits voting power exercised through its ownership in Stonebridge.

 

Maktel and Stonebridge are incorporated in theRepublic of Macedonia, while the rest of the subsidiaries and associates areincorporated in the Republic of Hungary.

 

**30 Segment information**

 

Matáv has threeoperating segments, fixed line telecommunications, mobile telecommunicationsand international activities.

 

The fixed linetelecommunications segment provides local telephony in Matáv’s 39 local primaryareas, domestic and international long distance services on a nationwide basisas well as related services such as leased lines, data transmission, PBX,corporate networks cable TV services and internet.

 

The mobilesegment consists of services provided by Westel and Westel 0660. Westelprovides digital services in the 900 and 1,800 MHz frequency bandwidth, whileWestel 0660 provides analog services in the 450 MHz frequency bandwidth.Services provided between the Company, Westel and Westel 0660 are made on anarms-length basis. Westel and Westel 0660 each provide distribution for theother’s products. Both Westel and Westel 0660 lease space at base stations toeach other and from the Company on a contract basis.

 

The Internationalsegment includes the four Macedonian companies, Stonebridge, the holdingcompany through which Matáv controls Maktel. Maktel, Macedonia’s exclusivefixed line telecommunications company, Mobimak, Maktel’s subsidiary, a cellulartelecommunications service provider in Macedonia and Telemacedonia A.D. throughwhich Matáv provides management and consultancy services to Maktel, MobimakA.D. and Stonebridge.

 

Of the 2002 totalrevenue of the International segment HUF 23,616 million is generated by themobile activities. Of the total assets of the International segment HUF 29,297is related to the mobile activities, before the allocation of any goodwillthereto.

 

Of the total netbook value of goodwill as at December 31, 2002, HUF 15,706 million is allocatedto the Fixed line segment, HUF 180,454 million to the Mobile segment and HUF46,318 million to the International segment.

 

F-37

----

 

The followingtable presents a summary of operating results of the Group by segment for theyears ended December 31, 2000, 2001 and 2002. The segments presented below aresubstantially consistent with the format used by the Company’s ManagementCommittee.

 
|                                                     |   | **For  the year ended December 31,** | ** ** |
|----------------------------------------------------------|--------|--------------------------------------|------------|
|                                                     |   | **2000**                             |       | **2001** | ** ** | **2002** | ** ** |
|                                                     |   | **(in  HUF millions)**               | ** ** |
| **Revenues**                                             |   |                                 |       |   |   |   |   |
| Total  revenue of Fixed line segment                     |   | 326,280                              |       | 333,685 |   | 336,306 |   |
| Fixed  line revenue from other segments                  |   | (9,491                               | )          | (11,221 | ) | (11,620 | ) |
| Fixed  line revenue from external customers              |   | 316,789                              |       | 322,464 |   | 324,686 |   |
|                                                     |   |                                 |       |   |   |   |   |
| Total  revenue of Mobile segment                         |   | 159,345                              |       | 198,947 |   | 232,612 |   |
| Mobile  revenue from other segments                      |   | (30,189                              | )          | (33,653 | ) | (34,043 | ) |
| Mobile  revenue from external customers                  |   | 129,156                              |       | 165,294 |   | 198,569 |   |
|                                                     |   |                                 |       |   |   |   |   |
| Total  revenue of International segment                  |   | —                               |       | 60,034 |   | 67,562 |   |
| International  revenue from other segments               |   | —                               |       | (57 | ) | (232 | ) |
| International  revenue from external customers           |   | —                               |       | 59,977 |   | 67,330 |   |
|                                                     |   |                                 |       |   |   |   |   |
| Total  revenue of the Group                              |   | 445,945                              |       | 547,735 |   | 590,585 |   |
|                                                     |   |                                 |       |   |   |   |   |
| **Depreciation and  amortization**                       |   |                                 |       |   |   |   |   |
| Fixed  line                                              |   | 60,932                               |       | 65,948 |   | 76,664 |   |
| Mobile                                                   |   | 33,788                               |       | 40,282 |   | 35,423 |   |
| International                                            |   | —                               |       | 10,392 |   | 10,654 |   |
| Total                                                    |   | 94,720                               |       | 116,622 |   | 122,741 |   |
|                                                     |   |                                 |       |   |   |   |   |
| **Operating profit**                                     |   |                                 |       |   |   |   |   |
| Fixed  line                                              |   | 70,837                               |       | 60,143 |   | 43,664 |   |
| Mobile                                                   |   | 25,254                               |       | 35,793 |   | 52,390 |   |
| International                                            |   | —                               |       | 23,464 |   | 26,186 |   |
| Total                                                    |   | 96,091                               |       | 119,400 |   | 122,240 |   |
|                                                     |   |                                 |       |   |   |   |   |
| **Share of associates’  results before income tax** |   |                                 |       |   |   |   |   |
| Fixed  line                                              |   | 2,174                                |       | 1,703 |   | 691 |   |
| Total                                                    |   | 2,174                                |       | 1,703 |   | 691 |   |

 

F-38

----

 
|                                                        |   | **For  the year ended December 31,** | ** ** |
|-------------------------------------------------------------|--------|--------------------------------------|------------|
|                                                        |   | **2000**                             |       | **2001** | ** ** | **2002** | ** ** |
|                                                        |   | **(in  HUF millions)**               | ** ** |
| **Assets**                                                  |   |                                 |       |   |   |   |   |
| Fixed  line                                                 |   | 584,937                              |       | 601,290 |   | 563,917 |   |
| Mobile                                                      |   | 374,953                              |       | 359,614 |   | 361,535 |   |
| International                                               |   | —                               |       | 148,438 |   | 157,894 |   |
| Inter-segment  elimination                                  |   | (8,813                               | )          | (12,989 | ) | (14,979 | ) |
| Total  segment assets                                       |   | 951,077                              |       | 1,096,353 |   | 1,068,367 |   |
| Unallocated  assets                                         |   | 3,347                                |       | 7,843 |   | 9,084 |   |
| Total  assets                                               |   | 954,424                              |       | 1,104,196 |   | 1,077,451 |   |
|                                                        |   |                                 |       |   |   |   |   |
| **Capital expenditures on  tangible and intangible assets** |   |                                 |       |   |   |   |   |
| Fixed  line                                                 |   | 111,134                              |       | 75,050 |   | 49,245 |   |
| Mobile                                                      |   | 41,650                               |       | 36,494 |   | 41,532 |   |
| International                                               |   | —                               |       | 16,203 |   | 19,211 |   |
| Total                                                       |   | 152,784                              |       | 127,747 |   | 109,988 |   |
|                                                        |   |                                 |       |   |   |   |   |
| **Liabilities**                                             |   |                                 |       |   |   |   |   |
| Fixed  line                                                 |   | 94,191                               |       | 102,048 |   | 88,073 |   |
| Mobile                                                      |   | 40,549                               |       | 43,766 |   | 40,503 |   |
| International                                               |   | —                               |       | 7,511 |   | 11,046 |   |
| Inter-segment  elimination                                  |   | (8,813                               | )          | (12,989 | ) | (14,979 | ) |
| Total  segment liabilities                                  |   | 125,927                              |       | 140,336 |   | 124,643 |   |
| Unallocated  liabilities                                    |   | 189,988                              |       | 455,391 |   | 377,228 |   |
| Total  liabilities                                          |   | 315,915                              |       | 595,727 |   | 501,871 |   |

 

Unallocatedassets include tax assets, while unallocated liabilities include loans andother borrowings and tax liabilities.

 

Inter-segmentpricing is on arms’ length basis.

 

*Geographic Information:*Matáv’s fixed line and mobile segments operate exclusively in Hungary,while the international segment operates in Macedonia. Matáv does not analyzeresults on a more detailed level based on geographic areas within Hungary orMacedonia.

 

**31 Subsequent event**

 

On February 7,2003 Matáv and CosmoTelco amended the option agreement described in note 2. Theparties agreed to extend the exercise date of the option for the 10% share inStonebridge until September 30, 2003, leaving all other conditions of theagreement unchanged.

 

F-39

----

 

**32 Reconciliation to U.S. GAAP**

 

Matáv’sconsolidated financial statements are prepared in accordance with InternationalFinancial Reporting Standards (IFRS), which differ in certain respects fromU.S. GAAP. The principal differences between IFRS and U.S. GAAP are presentedbelow, together with explanations of the adjustments that affect consolidatednet income for each of the three years for the period ended December 31, 2002and total shareholders’ equity as of December 31, 2001 and 2002.

 
|                                                                         |   |      |   | **For  the year ended December 31,**              | ** ** |
|------------------------------------------------------------------------------|--------|-----------|--------|---------------------------------------------------|------------|
|                                                                         |   | **Notes** |   | **2000**                                          | ** ** | **2001** | ** ** | **2002** | ** ** |
|                                                                         |   |      |   | **(in  HUF millions, except  per share amounts)** | ** ** |
|                                                                         |   |      |   |                                              |       |   |   |   |   |
| Net  income under IFRS                                                       |   |      |   | 66,652                                            |       | 82,560 |   | 68,128 |   |
| Adjustments  for U.S. GAAP:                                                  |   |      |   |                                              |       |   |   |   |   |
| Cumulative  effect of adopting SAB 101                                       |   | (a)       |   | (22,167                                           | )          | — |   | — |   |
| Deferred  revenue                                                            |   | (a)       |   | 14,453                                            |       | 2,433 |   | 2,456 |   |
| Post-retirement  benefits                                                    |   | (b)       |   | (621                                              | )          | — |   | — |   |
| Management  Incentive Plan Bonds                                             |   | (c)       |   | (134                                              | )          | (37 | ) | — |   |
| Amortization  of intangible assets                                           |   | (d)       |   | 1,253                                             |       | (2,665 | ) | (6,455 | ) |
| Amortization  of goodwill                                                    |   | (d)       |   | 1,281                                             |       | 119 |   | 14,344 |   |
| Cumulative  effect of adopting SFAS 133                                      |   | (e)       |   | —                                            |       | 589 |   | — |   |
| Cumulative  income tax effect of adopting SAB 101 (2000) and SFAS 133 (2001) |   |      |   | 3,042                                             |       | (88 | ) | — |   |
| Deferred  income tax on U.S. GAAP adjustments                                |   |      |   | 5                                                 |       | (1,194 | ) | (627 | ) |
| Minority  interest impact of U.S. GAAP adjustments                           |   |      |   | 744                                               |       | 514 |   | 307 |   |
| Net  income under U.S. GAAP                                                  |   |      |   | 64,508                                            |       | 82,231 |   | 78,153 |   |
|                                                                         |   |      |   |                                              |       |   |   |   |   |
| Other  comprehensive income                                                  |   | (f)       |   | —                                            |       | (2,420 | ) | (1,928 | ) |
| Total  comprehensive income                                                  |   |      |   | —                                            |       | 79,811 |   | 76,225 |   |
|                                                                         |   |      |   |                                              |       |   |   |   |   |
| Basic  earnings per share under U.S. GAAP                                    |   |      |   | 62.20                                             |       | 79.30 |   | 75.32 |   |
| Diluted  earnings per share under U.S. GAAP                                  |   |      |   | 61.91                                             |       | 79.30 |   | 75.32 |   |

 

F-40

----

 
|                                               |   |      |   | **At  December 31,**   |   |
|----------------------------------------------------|--------|-----------|--------|------------------------|--------|
|                                               |   | **Notes** |   | **2001**               |   | **2002** |   |
|                                               |   |      |   | **(in  HUF millions)** |   |
|                                               |   |      |   |                   |   |   |   |
| Shareholders’  equity under IFRS              |   |      |   | 460,300                |   | 516,144 |   |
| Adjustments  for U.S. GAAP:                        |   |      |   |                   |   |   |   |
| Deferred  revenue                                  |   | (a)       |   | (17,602                | )      | (15,146 | ) |
| Intangible  assets                                 |   | (d)       |   | (1,412                 | )      | (7,867 | ) |
| Amortization  of goodwill                          |   | (d)       |   | 1,400                  |   | 15,744 |   |
| Deferred  income tax on U.S. GAAP adjustments      |   |      |   | 1,222                  |   | 595 |   |
| Minority  interest impact of U.S. GAAP adjustments |   |      |   | 1,259                  |   | 1,566 |   |
| Shareholders’  equity under U.S. GAAP         |   |      |   | 445,167                |   | 511,036 |   |

 

***(a) Deferred revenue***

 

In December 1999,the Securities and Exchange Commission issued Staff Accounting Bulletin No.101, “Revenue Recognition in Financial Statements,” (SAB 101) which providesadditional guidance in applying generally accepted accounting principles. Incertain cases, SAB 101 requires up-front fees to be deferred and recognizedover the expected period of customer relationship.

 

Under U.S. GAAPMatáv applied the guidance of SAB 101 as follows:

 

For fixed linecustomers a relationship period of 10 years was assessed and up-front fees aredeferred over that term. Incremental direct costs are also deferred to theextent of the revenues. For mobile subscribers activation fees are deferredover a 4-year customer relationship period together with incremental directcosts up to the amount of revenue deferred.

 

***(b) Post-retirement benefits***

 

During 2000 Matávterminated the provision of post-retirement benefits, therefore, the differencein equity was eliminated. The difference in net income in 2000 reflects therelease of the difference between the provisions under IFRS and U.S. GAAP,accumulated in prior years.

 

***(c) The Management Incentive Program – Convertible bonds andStock options***

 

Compensationexpense is calculated on convertible bonds granted under the “ManagementIncentive Plan” and disclosed in the U.S. GAAP income statement adjustments inaccordance with APB 25. Total compensation expense is based on the differencebetween the exercise price and the market price on the grant date. The exerciseprice in Hungarian Forint on the grant date was HUF 1,262 (USD 5.75 convertedinto Hungarian Forints at the middle exchange rate as of the grant date, 219.42HUF/USD). The closing market price on the grant date was HUF 1,296. Totalcompensation expense of HUF 143 million was going to be recognized over thethree-year vesting period starting July 1, 1998. The amount amortized in 1999was HUF 42 million taking into account the impact of the forfeits.

 

In 2000, 876thousand bonds were allocated to management. Compensation expense of HUF 117million was calculated in relation to the new grants.  As two thirds of the newly allocated bonds became convertible onJuly 1, 2000, the corresponding proportion of the compensation expense wasrecognized immediately. The remaining one third was amortized until July 1,2001. In total, HUF 134 million compensation expense was recognized in

 

F-41

----

 

2000, while the remaining HUF 37 million wasrecognized in 2001. In 2002 all outstanding convertible bonds were forfeited.

 

The accountingtreatment for the stock options issued for the new incentive program (note 25)required no U.S. GAAP adjustment in accordance with APB 25, as the share priceon the grant date was higher than the exercise price.

 

The table belowshows the movements in the number of convertible bonds and stock options.

 
| **in thousands**                                     |   | **1999** | ** ** | **2000** | ** ** | **2001** | ** ** | **2002** | ** ** |
|------------------------------------------------------|--------|----------|------------|----------|------------|----------|------------|----------|------------|
|                                                 |   |     |       |     |       |     |       |     |       |
| Opening number of convertible bonds                  |   | 4,231    |       | 3,829    |       | 4,422    |       | 4,180    |       |
| New  grants of convertible bonds                     |   | —   |       | 876      |       | —   |       | —   |       |
| New grants  of stock options                         |   | —   |       | —   |       | —   |       | 3,964    |       |
| Forfeits  of convertible bonds                       |   | (402     | )          | (283     | )          | (242     | )          | (4,180   | )          |
| Closing  number of convertible bonds / stock options |   | 3,829    |       | 4,422    |       | 4,180    |       | 3,964    |       |

 

In 1995, the FASBissued SFAS 123, “Accounting for Stock-Based Compensation”. This pronouncementrequires Matáv to calculate the value of the stock options at the date of grantusing an option pricing model. Matáv has elected to apply the “pro formadisclosure only” option permitted under SFAS 123, instead of recognizing thecompensation expense calculated using the Black Scholes method, as shown below.The amounts in 2000 and 2001 are related to the convertible bond programdescribed above, while amounts for 2002 are related to the stock option programlaunched in 2002 (note 25).

 
|                                         |   | **2000** |   | **2001** | ** ** | **2002** | ** ** |
|----------------------------------------------|--------|----------|--------|----------|------------|----------|------------|
|                                         |   |     |   |     |       |     |       |
| Net  income as reported (HUF million)        |   | 64,508   |   | 82,231   |       | 78,153   |       |
| Net  income pro forma (HUF million)          |   | 63,503   |   | 81,897   |       | 77,805   |       |
|                                         |   |     |   |     |       |     |       |
| Basic  earning per share as reported (HUF)   |   | 62.20    |   | 79.30    |       | 75.32    |       |
| Basic  earning per share pro forma (HUF)     |   | 61.24    |   | 78.97    |       | 74.99    |       |
|                                         |   |     |   |     |       |     |       |
| Diluted  earning per share as reported (HUF) |   | 61.91    |   | 79.30    |       | 75.32    |       |
| Diluted  earning per share pro forma (HUF)   |   | 60.94    |   | 78.97    |       | 74.99    |       |

 
| The assumptions used in the pricing model and  resulting fair values were as follows: |   |
|---------------------------------------------------------------------------------------|--------|
| Risk  free rate                                                                       |   |   |   |   |   | 8.31 | % |
| Expected  dividend yield                                                              |   |   |   |   |   | 1.51 | % |
| Expected  option term (years)                                                         |   |   |   |   |   | 5 |   |
| Expected  stock volatility                                                            |   |   |   |   |   | 40 | % |
| Grant  date value per option                                                          |   |   |   |   |   | HUF 284 |   |

 

F-42

----

 

***(d) Amortization of intangible assets***

 

Due to thedifferent revenue and intangible asset recognition rules of IFRS and US GAAP,the shareholders’ equity of Westel, Maktel and Emitel on acquisition wasdifferent under the different accounting conventions resulting in differencesin goodwill, and in the value of customer base recognized on acquisition.

 

According to USGAAP the gross book value of goodwill recognized on acquisition was lower byHUF 25,656 million at Westel, HUF 1,012 million at Maktel and HUF 91 million atEmitel. The gross book value of other intangibles recognized was higher by HUF37,856 million at Westel, HUF 4,150 million at Maktel and HUF 360 million atEmitel respectively.

 

The followingtable shows the differences in amortization charges of intangibles:

 
|                                                        |   | **For  the year ended December 31,** | ** ** |
|-------------------------------------------------------------|--------|--------------------------------------|------------|
|                                                        |   | **2000**                             |       | **2001** | ** ** | **2002** | ** ** |
|                                                        |   | **(in HUF millions)**                | ** ** |
|                                                        |   |                                 |       |   |   |   |   |
| IFRS amortization expense of  intangibles (excl. goodwill)  |   | (13,974                              | )          | (14,031 | ) | (14,607 | ) |
| *US-GAAP adjustment to amortization expense*                |   |                                 |       |   |   |   |   |
| Westel                                                      |   | 1,253                                |       | (2,357 | ) | (5,913 | ) |
| Maktel                                                      |   | —                               |       | (299 | ) | (506 | ) |
| Emitel                                                      |   | —                               |       | (9 | ) | (36 | ) |
| Total US-GAAP adjustment to  amortization expense           |   | 1,253                                |       | (2,665 | ) | (6,455 | ) |
|                                                        |   |                                 |       |   |   |   |   |
| US-GAAP  amortization expense of intangibles excl. Goodwill |   | (12,721                              | )          | (16,696 | ) | (21,062 | ) |
|                                                        |   |                                 |       |   |   |   |   |
| IFRS amortization expense of  goodwill                      |   | (10,989                              | )          | (18,172 | ) | (14,344 | ) |
| *US-GAAP adjustment to goodwill amortization expense*       |   |                                 |       |   |   |   |   |
| Westel                                                      |   | 1,281                                |       | 46 |   | 9,390 |   |
| Maktel                                                      |   | —                               |       | (143 | ) | 2,568 |   |
| Emitel and other subsidiaries                               |   | —                               |       | 216 |   | 2,386 |   |
| Total  US-GAAP adjustment to goodwill amortization          |   | 1,281                                |       | 119 |   | 14,344 |   |
|                                                        |   |                                 |       |   |   |   |   |
| US-GAAP amortization expense  of goodwill                   |   | (9,708                               | )          | (18,053 | ) | — |   |

 

After theadoption of SFAS 141 and 142 at January 1, 2002, goodwill is no longeramortized, therefore all goodwill related amortization expense recognizedaccording to IFRS is reversed in the US GAAP statements. was tested forimpairment by reporting segment as of January 1, 2002 and in the last quarterof 2002. As the fair value of the net assets of the reporting segments washigher than the book value, no impairment charge was necessary for recognizedgoodwill.

 

As of December31, 2002 for US GAAP the net book value of goodwill recognized was HUF 9,116million lower, while the net book value of other intangibles was HUF 24,823higher.

 

F-43

----

 

The followingtable shows the expected amortization expense of all intangible assets recordedunder US GAAP in the following years:

 
| **Year** |   | **Amortization**       |   |
|----------|--------|------------------------|--------|
|     |   | **(in  HUF millions)** |   |
| 2003     |   | 16,136                 |   |
| 2004     |   | 12,538                 |   |
| 2005     |   | 8,768                  |   |
| 2006     |   | 5,676                  |   |
| 2007     |   | 3,252                  |   |

 

***(e) Adoption of SFAS 133***

 

IAS 39 issubstantially similar to SFAS 133, however the cumulative effect of adoptingthe new standard in 2001 was recognized against the retained earnings underIFRS, while the same effect was recognized in the income statement under U.S.GAAP.

 

***(f) Other comprehensive income***

 

Othercomprehensive income includes the cumulative translation adjustment related tothe consolidation of the financial statements of the Macedonian subsidiaries(mainly Maktel). This item is not subject to tax.

 

## ***33 Additionaldisclosures required for U.S. GAAP***

 

***Accrued interest***

 

Included inaccrued expenses as disclosed in the IFRS financial statements, is accruedinterest in an amount of HUF 5,827 million at December 31, 2002 (HUF 3,939million in 2001).

 

***Valuation allowance of deferred tax assets***

 

At December 31,2002 Matáv recognized deferred tax assets for all tax losses carried forward,while at December 31, 2001 the deferred tax asset of HUF 2,062 million for taxlosses in an amount of HUF 11,455 million was offset by a 100% valuationallowance.

 

***Involuntary termination benefits***

 

The numberemployees to be terminated in 2003 is 1,450 and 450 in 2004, for which HUF8,623 million provision was recorded in 2002. The employees impacted by theheadcount reduction in 2003 and 2004 include mostly network and logisticspersonnel.

 

The total paymentmade related to employee termination in 2002 amounted to HUF 1,982 million, ofwhich HUF 540 million was charged against the provision for liabilities andcharges as at December 31, 2001, while the rest was recognized as an expense in2002.

 

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***Recent accounting pronouncements***

 

On January 1,2003 Matáv is required to adopt Statement of Financial Accounting Standards(SFAS) No. 143, “Accounting for Asset Retirement Obligations”. SFAS 143requires that the fair value of a liability for an asset retirement obligationbe recognized in the period in which it is incurred if a reasonable estimate offair value can be made. The associated asset retirement costs are capitalizedas part of the carrying amount of the long-lived asset.  The Company is currently evaluating theimpact of SFAS 143 on its financial statements.

 

SFAS 146“Accounting for Costs Associated with Exit or Disposal Activities” was issuedin June 2002, and is effective for exit or disposal activities that areinitiated after December 31, 2002. The provisions of the statement change thedate of recognition of a liability for a cost associated with an exit ordisposal activity from the date of an entity’s commitment to an exit plan tothe date when the liability is incurred. The statement also establishes thatthe fair value is the objective for initial measurement of the liability. Matávcurrently does not plan to exit or dispose of any of its significantactivities.

 

SFAS 148“Accounting for Stock-Based Compensation” is an amendment of SFAS 123 and is tobe applied for financial statements for fiscal years beginning after December15, 2003. The statement was issued to provide alternative methods of transitionfor a voluntary change to the fair value based method of accounting for stock-basedemployee compensation. In addition, this statement amends the disclosurerequirements of the preceding statement to require more prominent disclosuresin the financial statements about the method of accounting for stock-basedemployee compensation and the effect of the method used on the reportedresults. The Company is currently evaluating the impact of SFAS 148 on itsfinancial statements.

 

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