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United States

Securities and Exchange Commission

Washington, DC 20549

FORM 10-K

OR

Commission File Number 1-11484

HUNGARIAN TELEPHONE AND CABLE CORP.

(Exact Name of Registrant as specified in its charter)

Registrant’s telephone number, including area code: (206) 654-0204

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

Securities registered pursuant to Section 12(g) of the Act: None

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).     Yes  ¨    No  x

As of March 26, 2004, 12,320,170 shares of the registrant’s Common Stock were outstanding, of which 4,320,388 were held by non-affiliates of the registrant. The aggregate market value of the registrant’s Common Stock held by non-affiliates, computed by reference to the closing price of the Common Stock on the American Stock Exchange as of the last business day of the registrant’s most recently completed second fiscal quarter was $39.5 million. The exclusion of shares owned by any person from such amount shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.

Documents Incorporated by Reference

Part III—Portions of the Registrant’s proxy statement for the Annual Meeting of Stockholders for the fiscal year ended December 31, 2003.

Cautionary Statement Regarding Forward-Looking Statements

Certain statements contained herein which express “belief,” “anticipation,” “expectation,” or “intention” or any other projection, insofar as they may apply prospectively and are not historical facts, are “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Because such statements include risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements. Factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements include, but are not limited to, the factors set forth in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 7A “Quantitative and Qualitative Disclosures about Market Risk.”

PART I

In this Form 10-K, all references to “$” or “U.S. dollars” are to United States dollars, all references to “EUR” or “euros” are to the euro which is the currency of the European Monetary Union, and all references to “HUF” or “forints” are to Hungarian forints. Certain amounts stated in euros and forints herein also have been stated in U.S. dollars solely for the informational purposes of the reader, and should not be construed as a representation that such euro or forint amounts actually represent such U.S. dollar amounts or could be, or could have been, converted into U.S. dollars at the rate indicated or at any other rate. Unless otherwise stated or the context otherwise requires, such amounts have been stated at December 31, 2003 exchange rates. The forint/U.S. dollar middle exchange rate as of December 31, 2003 was approximately 207.92 forints per U.S. dollar.

Item 1. Business

Company Overview

Hungarian Telephone and Cable Corp. (“HTCC” or the “Registrant” and, together with its consolidated subsidiary, the “Company”) provides basic telephone services in three defined regions within the Republic of Hungary (“Bekes”, “Nograd” and “Papa/Sarvar”, each an “Operating Area” and together, the “Operating Areas”) pursuant to five separate 25-year telecommunications concessions granted by the Hungarian government. HTCC provides its services through its Hungarian operating subsidiary, Hungarotel Távközlesi Rt. (“Hungarotel” or the “Operating Company”) in which HTCC has a 99.9% equity ownership stake. Hungarotel owns and operates virtually all existing public telephone exchanges and local loop telecommunications network facilities in its Operating Areas and was, until the expiration of its exclusivity rights on November 1, 2002, the sole provider of non-cellular local voice telephone services in such areas.

The Company acquired its concession rights from the Hungarian Ministry of Transportation, Telecommunications and Water Management (the “TTW Ministry”) for $11.5 million (at historical exchange rates) and purchased the existing telecommunications infrastructure in the Operating Areas in 1995 and 1996, including approximately 61,400 access lines, from Magyar Távközlési Rt. (“Matav”), the formerly State-controlled monopoly telephone company, for $23.2 million (at historical exchange rates). Since the acquisition of such existing networks, the Company has incurred capital expenditures through December 31, 2003 of $205 million (at historical exchange rates) to expand and upgrade the network facilities which has resulted in the completion of a modern telecommunications network in each of the Operating Areas. As of December 31, 2003, the Company’s telecommunications networks had

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approximately 194,800 access lines in service. The Company’s networks have the capacity, with only normal additional capital expenditures required, to provide basic telephone services to virtually all of the estimated 279,600 residences and 38,500 business and other institutional subscribers (including government institutions) within its Operating Areas.

The Company completed its network modernization and construction program in each of its Operating Areas primarily through turnkey construction contracts with Siemens, Ericsson and Fázis (a Hungarian contractor). The build-out was primarily financed through a bank credit facility and a contractor financing facility. See Item 3 “Legal Proceedings,” Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources,” and Notes 4 and 7(g) of Notes to Consolidated Financial Statements.

The following table sets forth certain information as of December 31, 2003 with respect to each of the Operating Areas.

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The following table sets forth the number of access lines served in each of the Operating Areas at takeover from Matav and at the end of each year from 1995 to 2003.

HTCC was organized under the laws of the State of Delaware on March 23, 1992. Its common stock is traded on the American Stock Exchange under the symbol “HTC.” The Company’s principal office in Hungary is located at Teréz krt. 46, H-1066, Budapest; telephone (361) 474-7700. The Company’s United States office is located at 1201 Third Avenue, Suite 3400, Seattle, Washington 98101-3034; telephone (206) 654-0204.

The Republic of Hungary

Hungary is located in Central Europe bordering on Austria, Slovenia, Croatia, Serbia and Montenegro, Romania, Ukraine and Slovakia. Six West European capitals are within a one-hour flight. Its total area is approximately 93,000 square kilometers. It has approximately 9.9 million inhabitants, approximately 1.8 million of whom reside in Hungary’s capital, Budapest.

For nearly 40 years, Hungary was under central state control with a one-party government and a centrally planned economy. Democracy was restored and the foundations of a market economy were built between 1988 and 1990. Free elections were held in 1990. Today, Hungary has a parliamentary democracy with a single-chamber National Assembly. As a result of a large scale privatization effort, private enterprise has become the basis of the Hungarian economy.

Today, Hungary is considered one of the most developed countries in Central and Eastern Europe. Since 1990, foreign direct investment has been approximately $27 billion. Foreign direct investment was over $1.8 billion in 2003. Together Hungary, Poland and the Czech Republic are the recipients of more than 50% of the total foreign direct investment into the former Communist countries in the region.

Since 1995, the Hungarian government has embarked on an economic stabilization effort aimed at putting the economy on a sustainable path of low-inflationary growth. The following table provides Hungary’s annual GDP growth and inflation rates since 1995.

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The unemployment rate has gradually decreased from 11.1% in 1995 to 5.8% in 2003

On May 1, 2004 Hungary and 9 other countries will join the European Union (“EU”). Hungary expects to adopt the euro as its currency between 2008 and 2010. Hungary joined the North Atlantic Treaty Organization (“NATO”) in 1999. Hungary is also a member of the World Trade Organization.

Overview of Hungarian Telecommunications Industry

The Hungarian Telecommunications Industry Prior to Privatization

In 1989, the Hungarian state-owned Post, Telegraph and Telephone (“PTT”) was divided into three separate companies: the Hungarian Broadcasting Company (“Antenna Hungaria”), the Hungarian Post Office (“Magyar Posta”) and Matav. The Hungarian PTT was historically the exclusive provider of telecommunications services in Hungary. The Hungarian telecommunications market was significantly underdeveloped without the investment in the telecommunications infrastructure necessary to achieve a comparable level of teledensity to that of Western Europe. As of December 31, 1995, Hungary had a basic telephone penetration rate of approximately 21 telephone access lines per 100 inhabitants compared to a European Union average of approximately 48 access lines per 100 inhabitants and a United States average of approximately 60 access lines per 100 inhabitants. Of such access lines in Hungary, approximately 40% were located in Budapest (in which approximately 18% of Hungary’s population resides). In the Company’s Operating Areas, access line penetration was approximately 9 access lines per 100 inhabitants as of December 31, 1995.

Privatization of Matav and Local Telephone Service

In 1992, the Hungarian government began the process of privatizing Hungary’s telecommunications industry by selling an initial 30% stake in Matav (raised to 67% in 1995) to MagyarCom, a company then wholly owned by Deutsche Telekom AG, the German public telephone operator (“Deutsche Telekom”), and Ameritech, a United States telecommunications company. In 1997 Matav completed its initial public offering pursuant to which MagyarCom’s stake in Matav was reduced to approximately 60% and the Hungarian State’s stake was reduced to approximately 6%. The Hungarian State also retained certain shareholder rights by retaining one “Golden Share.” In 1999 the Hungarian State sold its remaining 6% ownership interest in Matav but retained its “Golden Share.” In 2000 Deutsche Telekom purchased the entire ownership interest of SBC Communications Inc. (Ameritech’s successor) in MagyarCom. As of December 31, 2003, MagyarCom owned 59.2% of Matav while 40.8% was publicly traded.

In 1992, the TTW Ministry divided the country into 54 primary telecommunications service areas in order to take some of such primary telecommunications service areas out of Matav’s national network with respect to the provision of local basic telephone service. The TTW ministry allowed Matav to continue its monopoly in the provision of domestic and international long distance services through 2001. In 1993, the TTW Ministry solicited bids for concessions to build, own and operate telecommunications networks in the 25 service areas which had been chosen to exit the Matav system. The TTW Ministry awarded 23 concessions out of the 25 that the TTW Ministry solicited bids for. Holders of those 23 concessions today (each a Local Telephone Operator, “LTO”, and together the “LTOs”) include: the Company (5 concession areas); Invitel Telecommunications Services Rt., owned by AIG Global Investment CEE and GMT Communications Partners L.P. (9 concession areas); Monor Communications Group (“Monortel”), part of UnitedGlobalCom, Inc., the global television operator based out of Denver, Colorado (NASDAQ:UCOMA) (1 concession area); and Matav (8 concession areas). Matav also retained the rights to service the 2 concession areas for which there were no successful bidders. Each of the LTOs (including Matav) received 25-year licenses to provide local basic telephone service with exclusivity

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rights in their respective concession areas, which exclusivity rights all expired by the end of 2002. In addition to the fees paid to the government which aggregated approximately $80.0 million (at historical exchange rates), each of the non-Matav LTOs negotiated a separate asset purchase agreement with Matav for each concession area’s existing basic telephone plant and equipment, which led to the transfer of approximately 260,000 access lines from a total of 1.2 million access lines in the Matav system. Today Matav’s local basic telephone service covers approximately 72% of Hungary’s population and approximately 70% of its geographic area.

Domestic and International Long Distance Services

The TTW Ministry allowed Matav to continue its monopoly in the provision of domestic and international long distance services through 2001. In 1998 the TTW Ministry awarded PanTel Rt., a Hungarian company (“PanTel”), licenses to provide such services as data transmission, voice mail and other services which were not subject to exclusive concessions. PanTel built its own country-wide telecommunications network. The current shareholders of PanTel are MÁV Rt. (the Hungarian railway company) (10.1%); KFKI Computer Systems Kft. (a Hungarian information technology firm) (14.7%); and Royal KPN NV, the Dutch telecommunications company (75.2%).

At the end of 2001 the domestic and international long distance market was officially opened up to competition when Matav’s right to provide exclusive domestic and international long distance voice transmission expired. See “—Services and Pricing—Measured Service.”

Cellular Service

In 1993, the TTW Ministry awarded Westel and Pannon licenses to provide nationwide digital cellular telephone services. Westel already had a license to provide analog cellular telephone services. Today Matav owns 100% of Westel and Telenor ASA (the Norwegian telecommunications company) owns 100% of Pannon.

In 1999, the TTW Ministry awarded an additional digital mobile phone license to Vodafone Rt. (“Vodafone”), a subsidiary of Vodafone Group Plc., following a bidding process. Antenna Hungaria is a minority shareholder in Vodafone. Vodafone began operations in late 1999.

The Regulatory Framework

Telecommunications services in Hungary are currently regulated by the Information and Communications Ministry of the Hungarian government (the “IC Ministry”), the successor to the TTW Ministry, which is led by the Information and Communications Minister (the “IC Minister”). The National Communications Authority, a central administrative organization, reports to the IC Minister and the Hungarian government. The National Communications Authority is divided into two units: the Council of the National Communications Authority and the Office of the National Communications Authority.

Market Liberalization Legislation

In 2001, the Hungarian government enacted Act XL of 2001 which took effect on December 23, 2001. The goal of this act was to provide for a more liberalized telecommunications market by making market entry easier, promoting competition and harmonizing Hungary’s telecommunications laws with those of the European Union. In 2003 the Hungarian government enacted Act C of 2003 on Electronic Communications (the “Communications Act”). The goal of the Communications Act is to further promote competition and to harmonize Hungary’s telecommunications laws with the European Union

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framework that was put into effect in 2003. The Communications Act is a framework piece of legislation with the detailed governing regulations to be contained in a series of implementing decrees, not all of which have been issued to date. See “—Summary of the Communications Act” and “—Regulation.”

The Hungarian Telecommunications Industry Today

Since 1994, the LTOs and Matav have spent approximately $1 billion (at historical exchange rates) to build modern state-of-the-art telecommunications networks throughout Hungary. At the end of 2003 Matav had approximately 2.91 million access lines connected to its telecommunications network and the other LTOs (including the Company) had over 690,000 access lines connected to their telecommunications networks. The Company had 29 access lines per 100 inhabitants in its Operating Areas as compared to 36 access lines per 100 inhabitants in all of Hungary at the end of 2003.

At the end of 2003, Westel had a mobile cellular phone subscriber base of 3.77 million, while Pannon’s subscriber base was 2.6 million and Vodafone’s subscriber base was 1.3 million. The overall penetration rate for cellular service in Hungary was over 78% at the end of 2003.

Company Stockholders

The Company has three large stockholders who own 65% of the Company’s outstanding common stock (“Common Stock”) in the aggregate. Most of the remaining 35% of the Common Stock is held by the public and traded on the American Stock Exchange. Set forth below is a brief description of the three largest stockholders of the Company.

Ashmore Investment Management

Ashmore Investment Management (“Ashmore”) is a specialist emerging markets fund manager based out of London. It manages over $4.9 billion of assets.

As of March 26, 2004, Ashmore owned 14.8% of the outstanding Common Stock and 27.2% of the outstanding Common Stock on a fully diluted basis. See Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

Citizens Communications Company

Citizens Communications Company (together with its subsidiaries, “Citizens”), a New York Stock Exchange listed company (NYSE:CZN), is a telecommunications-focused company providing wireline communications services in rural areas and small and medium-sized towns and cities across the United States. Citizens has 2.4 million access lines in 23 states and is one of the nation’s largest rural local exchange carriers. For the year ended December 31, 2003, Citizens had $2.4 billion of revenue, operating income of $558 million and net income of $188 million.

In 1995, Citizens purchased 300,000 shares of HTCC’s Common Stock from a former executive of the Company and has since acquired an additional 1,902,908 shares of Common Stock and 30,000 shares of the Company’s Series A Preferred Stock convertible into 300,000 shares of Common Stock, pursuant to certain agreements entered into with HTCC (as amended and restated in certain cases, the “Citizens Agreements”). Citizens also purchased 103,000 shares of Common Stock on the open market. As of March 26, 2004, Citizens owned 18.7% of the outstanding Common Stock. The Citizens Agreements provide Citizens with certain preemptive rights to purchase, upon the issuance of Common Stock in certain circumstances to third parties, shares of Common Stock in order to maintain its

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percentage ownership interest on a fully diluted basis. Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

TDC

TDC A/S, formerly known as Tele Danmark A/S (together with its affiliates, “TDC”), is a Danish full-service provider of communications solutions throughout Europe. TDC is the leading provider of communications services in Denmark, the second-largest communications provider in Switzerland and holds significant interests in a range of communications companies elsewhere across Northern and Continental Europe. TDC’s stock trades on the Copenhagen Stock Exchange and the New York Stock Exchange (NYSE:TLD). SBC Communications, Inc. of San Antonio, Texas owns 42% of the shares of TDC, with the remaining shares held by individual and institutional shareholders all over the world. SBC’s shares trade on the New York Stock Exchange (NYSE:SBC).

At December 31, 2003, TDC had total assets of Danish Kroner 94.7 billion (approximately $15.9 billion) and shareholders’ equity of Danish Kroner 33.7 billion (approximately $5.7 billion). During 2003, TDC had net income of Danish Kroner 1.8 billion (approximately $302 million) on net revenues of Danish Kroner 50.263 billion (approximately $8.4 billion).

As a result of certain agreements between the Company and TDC (the “TDC Agreements”), the Company has issued 2,579,588 shares of Common Stock to TDC. In 2002 TDC purchased an additional 1,285,714 shares of Common Stock from a former shareholder of the Company. As of March 26, 2004, TDC owned 31.4% of the outstanding Common Stock. The TDC Agreements provide TDC with certain preemptive rights to purchase, upon the issuance of Common Stock in certain circumstances to third parties, shares of Common Stock in order to maintain its percentage ownership interest of the outstanding Common Stock. See Notes 4, 8 and 11 of Notes to Consolidated Financial Statements, and see also Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

Directors and Executive Officer

The current directors and executive officer of the Company are Ole Bertram, a Company director and the Company’s President and Chief Executive Officer; Daryl A. Ferguson, a Company director and the retired President and Chief Operating Officer of Citizens; Thomas Gelting, a Company director and a Vice-President in the Corporate Business Development department at TDC; Torben V. Holm, a Company director and the head of the Corporate Business Development department at TDC; John B. Ryan, a Company director and a financial consultant; William E. Starkey, a Company director and a retired Senior Executive with GTE Corporation; and Leonard Tow, a Company director and currently the Chairman, President and Chief Executive Officer of Citizens.

The Operating Areas

The following is a brief description of each of the Operating Areas:

Bekes

The Bekes Operating Area encompasses the southern portion of Bekes County, which borders Romania. The Bekes Operating Area is comprised of 75 municipalities and has a population of approximately 391,700 with an estimated 166,900 residences and 23,100 business and other potential subscribers (including government institutions). Bekes is the most intensively cultivated agrarian region in Hungary and produces a substantial portion of Hungary’s total wheat production. Industry, generally related to food processing, glass and textile production, is also a strong employer in the region. Foreign

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investors in the Operating Area include Owens-Illinois of the United States and a number of European manufacturers. The region is also a center for natural gas exploration and production. As of December 31, 2003, the Company had 108,600 access lines connected to its network in the Bekes Operating Area. The Company’s network in the Bekes Operating Area utilizes a combination of a conventional build, fiber optic and wireless local loop technology.

Nograd

The Nograd Operating Area is comprised of 76 municipalities in the eastern portion of Nograd County, which borders Slovakia. The Nograd Operating Area has a population of approximately 147,900, with an estimated 62,400 residences and 8,900 business and other potential subscribers (including government institutions). The principal economic activities in the Nograd Operating Area include light manufacturing, tourism, some coal mining and agriculture. Foreign investors in the region include the Italian-owned dairy producer, Sole, and the German company, Paramount Glass. The Nograd Operating Area’s proximity to Budapest, 1.5 hours by car, and its many cultural attractions makes it a desirable weekend and tourist destination. As of December 31, 2003, the Company had 45,400 access lines connected to its network in the Nograd Operating Area. The Company’s network in the Nograd Operating Area utilizes a combination of a conventional build, fiber optic and wireless local loop technology.

Papa/Sarvar

The Papa/Sarvar Operating Area is composed of 114 municipalities located in the counties of Veszprem and Vas. The population of the Papa/Sarvar Operating Area is approximately 128,400 with an estimated 50,300 residences and 6,500 business and other potential subscribers (including government institutions). The portion of the Papa/Sarvar Operating Area in Veszprem County is relatively underdeveloped economically with the principal economic activities centering around light industry, appliance manufacturing, agriculture and forest products. Significant foreign investors in Veszprem County include ATAG, the Dutch appliance maker, and Electricité de France. The principal economic activities in the portion of the Papa/Sarvar Operating Area located in Vas County include heavy manufacturing and assembling, agriculture and tourism. Significant employers in Vas County include: Linde (a German natural gas distributor); Flextronics (an electronics components assembler); and Saga (a British-owned poultry processor). As of December 31, 2003, the Papa/Sarvar Operating Area had 40,800 access lines connected to its network. The Company’s network in the Papa/Sarvar Operating Area utilizes a combination of a conventional build, fiber optic and wireless local loop technology.

Network Design and Performance

The Company has constructed a versatile modern communications network which substantially replaced the antiquated system purchased from Matav. This system provides many of the technologically advanced services currently available in the United States and Western Europe. The Company’s networks maintain the North American standard, or “P01”, grade of service. The P01 standard means that one call out of 100 will be blocked in the busiest hour of the busiest season. The Company believes that its ability to meet the telecommunications requirements of its customers through a combination of conventional fiber optic and wireless local loop technology affords it significant flexibility with respect to network development and network capital expenditures. The Company has replaced all manually operated local battery and common battery cord type switchboards purchased from Matav while retaining certain analog switching systems. The Company upgraded such analog switching systems allowing such systems to mimic many of the features available in modern digital switching systems with a minimal investment.

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Conventional Network Design

In developing its networks, the Company has implemented service quality and redundancy objectives on par with Western European and North American digital network standards. Certain of the networks constructed are based on digital hosts and remotes with fiber optic rings and copper feeder and distribution. Such a distribution system is the conventional system used in the United States and Western Europe. Telecommunications services are transmitted to the home through twisted pair copper wire telephone cable.

The Company’s conventional networks have been designed to employ an open architecture, generally using Synchronous Digital Hierarchy (“SDH”) technology for system resilience. The Company’s networks are designed to provide voice and high speed data services. The Company believes that the flexible design of the conventional networks it has constructed allows it to readily implement new technologies and provide enhanced or new services. The Company’s switches in its conventional networks allow it to connect to networks operated by other LTOs, Matav or PanTel in order to route voice and data transmissions.

Wireless Network Design

In certain portions of the Operating Areas, the Company is using wireless network technology based upon the Digital Enhanced Cordless Telecommunications (“DECT”) system which interfaces radio technology to fiber-optic, digital microwave or fixed copper networks. The use of DECT technology generally reduces the time and expense of installation and securing rights of way. In a conventional network build, significant investment must be made in order to offer service to a large proportion of potential customers whether or not they become actual customers. By contrast, the use of the DECT system in a network build-out provides for capital investment proportional to the number of customers actually connected because the radio links and other required equipment are installed only for those households choosing to take the service and are installed only at the time service is requested.

In many areas in which the Company is utilizing a wireless network design, the Company is deploying a fiber optic cable to the node in the same fashion as in a conventional network build-out. At each newly constructed node, the Company has constructed a radio base station (“RBS”), rather than switching to twisted pair copper wire distribution to the home. Each RBS has the capacity to provide service to between 200 and 600 customers. As additional customers are brought onto the network, the Company will install a transceiver unit at the subscriber’s premises. Such transceiver’s operating software is digitally encrypted so that it will operate only with its supporting RBS. A conventional telephone jack is then installed in the subscriber’s household near an electrical outlet which is used to power the transceiver unit. The subscriber then uses a conventional phone to make outgoing and receive incoming calls.

The DECT-based wireless local loop system provides the same grade of service as a conventional telephone network. In addition, a DECT-based network is able to provide the same services as a conventional copper network such as voice mail, call forwarding and call blocking.

Network Administration

The Company actively monitors the switching centers and all critical network operational parameters in each Operating Area. As digital features are introduced into their respective networks, the network technicians have the ability to monitor the networks and evaluate and respond accordingly. The Company will also be able to analyze the performance data generated by these systems in order to make the operating adjustments or capital expenditures necessary to enhance individual network operations.

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Services and Pricing

Services

The Company currently provides non-cellular local voice telephone services in its Operating Areas which allow subscribers to have facsimile and modem transmission capabilities. Up until Matav’s exclusivity rights to provide domestic and international long distance services expired at the end of 2001, the Company made domestic and international long distance services available to its subscribers through interconnection with Matav. Following the termination of Matav’s exclusivity rights to provide domestic and international long distance services at the end of 2001, the Company became its subscribers’ sole local and domestic and international long distance services provider. However, with the introduction of the Communications Act and carrier selection, competition in the domestic and international long distance market in the Company’s Operating Areas is now beginning. As a domestic and international long distance carrier, the Company is now responsible not only for the initiation of domestic and international long distance calls by its subscribers but for the transmission and termination of such calls. When the Company does not have the network capacity to carry a long distance call entirely on its own network, it transfers the calls to other telecommunications carriers, including PanTel and Matav, for completion pursuant to interconnection agreements. See “—Summary of the Communications Act.”

In addition to local, domestic long distance, and international voice services, the Company currently offers its subscribers data transmission and other value-added services, including ADSL Internet services, dial-up Internet access, voice mail, Internet Protocol-based voice services for international calls, leased line services, caller ID, call waiting, call forwarding, three-way calling, toll free calling services and audio text services. The Company is also an Internet Service Provider under the brand name “Globonet”.

The Company’s revenues are primarily derived from the provision of local, domestic long distance and international long distance telephone services which consist of (i) charges for measured telephone service, which vary depending on the day, the time of day, distance and duration of the call, and (ii) connection and subscription fees. The Company also receives other operating revenues consisting principally of charges and fees from leased lines, fees for the provision of ADSL Internet services and dial-up Internet services, detailed billing, other value added services such as voicemail and caller ID and other customer services, including revenues from the sale and lease of telephone equipment. The Company’s customers are on a one-month billing cycle.

Measured Service

The Company has two basic rates for outgoing calls, peak and off-peak, for each of local and domestic long distance calls and calls to Hungarian cellular phones within Hungary. The rates for outgoing international long distance calls are based solely on the country called and do not depend on the time of day called. The Company has established special rate plans for low usage subscribers which include a lower per month subscription fee and a higher variable fee for measured service. The measured service fee scheme is summarized below.

Local Calls—For all local calls between its customers within an Operating Area, the Company retains all of the revenues associated with the call. For local calls, the Company may choose to increase its rates up to the permitted amount or charge a lower rate. Given the Company’s exclusive rights to provide non-cellular local voice telephone service in its Operating Areas through 2002 and, until recently, a regulatory environment that did not support effective competition, the Company has not had competition in the non-cellular local voice telephone services market within its Operating Areas up until very recently. With the recent introduction of the Communications Act, competition among providers of local calls in the Company’s markets is just beginning such that the Company’s subscribers are now able to choose their local carrier either on a continuing or a call-by-call basis. However, the Company is the

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only telecommunications service provider to have built out a network capable of reaching all of the subscribers and potential subscribers in its Operating Areas. Therefore, in order to compete, a third party local service provider would have to establish a direct connection to the customer or use the Company’s network to provide local telephone service. See “—Summary of the Communications Act,” “—Strategy,” and “—Competition.”

Outgoing Domestic and International Long Distance Calls—Following the expiration of Matav’s exclusivity rights to provide domestic and international long distance services at the end of 2001, the Company became the only domestic and international long distance service provider for its subscriber base. As a long distance provider, the Company is responsible for the entire transmission of its subscribers’ outgoing domestic and international long distance calls. For calls between subscribers in its Operating Areas, the Company has the capability to carry the call from the calling party to the receiving party entirely over its telecommunications network of owned and leased facilities. For such calls the Company keeps the entire revenue collected from its subscribers. For subscriber calls initiated in one of the Company’s Operating Areas and terminating outside of one of the Company’s Operating Areas, whether within or outside Hungary, the Company has the authority to determine how to transmit the call outside of its local network. For calls to certain areas within Hungary, the Company has the network capability to deliver the call to the local telecommunications network containing the party receiving the call. In such cases, the Company collects the fee for the domestic long distance call from its subscriber and pays a regulated per minute interconnection termination fee to the telecommunications provider completing the call. Since the Company presently does not have its own nation-wide long distance network or an international network, international calls and certain domestic long distance calls initiated in its Operating Areas by its subscribers have to be transferred to another telecommunications carrier for transmission to the local telecommunications network of the party receiving the call. Therefore, the Company currently has interconnection arrangements in place with certain telecommunications providers with Hungarian nation-wide long distance and international networks (including Matav and PanTel) capable of transmitting international calls and certain domestic long distance calls from the Company’s network to the telecommunications network containing the party receiving the call. In such cases, the Company collects the fee for the domestic or international long distance call from its subscriber. The Company must then pay, directly or indirectly, both a per minute termination fee to the telecommunications provider completing the call and a per minute transmission fee (regulated if to Matav) to the telecommunications provider who transports the call from the Company’s network to the local telecommunications network of the telecommunications provider who completes the call.

With competition among providers of domestic and international long distance services beginning in the Company’s Operating Areas, the Company’s subscribers are now able to choose their domestic and international long distance services carrier either on a continuing or call-by-call basis. See “—Summary of the Communications Act,” “—Strategy,” and “—Competition.” If one of the Company’s subscribers chooses Matav or another long distance carrier, such carrier will be responsible for billing the Company’s local subscriber for domestic and international long distance charges and paying the Company an interconnection fee for initiating that call. That provider could outsource its billing responsibility to the Company. The Company’s interconnection fees for initiating and terminating domestic and international long distance calls for its local subscribers are regulated by a government-approved interconnection rate scheme. If the Company’s local subscriber chooses the Company as its long distance provider, the Company will bill its local subscriber for long distance calls and the Company must pay, directly or indirectly, a per minute interconnection fee to the telecommunications provider completing the call if the call goes outside of the Company’s network and, if necessary, a per minute interconnection fee to the telecommunications provider who transports the call from the Company’s network to the local telecommunications network of the telecommunications provider who completes the call.

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Incoming Domestic and International Long Distance Calls—For domestic and international long distance calls to the Company’s subscribers, the Company receives a regulated per minute interconnection fee from Matav or any other long distance provider for completing the call.

Cellular Calls—The rates for outgoing calls from a Company subscriber to a Hungarian cellular phone are set by the Company but subject to regulation. The Company must pay a per minute fee to the cellular carrier for completing the call. For calls to Pannon and Westel subscribers, this fee is currently regulated. The fees for calls to Vodafone subscribers are not regulated but are cost oriented. Until the Company’s networks are fully integrated with all of the cellular carriers’ networks, the Company must pay a fee for transmitting the calls from the Company’s Operating Areas to the cellular carriers’ networks. The price of calls from a Hungarian cellular phone to the Company’s customers are unregulated and set by the cellular carriers. The cellular carriers pay the Company a regulated per minute interconnection fee for completing mobile calls to the Company’s subscribers. See “—Summary of the Communications Act.”

Measured Service Price Regulation

The regulatory framework for regulating annual increases in the fees for (a) local calls, (b) domestic long distance and international calls and (c) subscription fees, includes a rebalancing formula, which provides for greater increases in charges for subscription fees and local calls than in domestic long distance and international calls. In addition to using the Hungarian Consumer Price Index (“CPI”) in setting rates, the IC Ministry uses an efficiency factor in calculating the maximum allowable price increase. For 2004, the IC Ministry approved an overall price increase of 6% for local calls and 10% for subscription fees, with such increases subject to an overall price cap determined, in part, by the CPI. The overall price cap covers a basket of telecommunications service fees such as the fees for individual and business subscription packages, local calls, domestic long distance calls, international long distance calls, mobile calls and the universal service packages. Given the computation of the annual increase in the overall price cap which is set at 2.8% for 2004 and the permitted increase in local calls and subscription fees, other fees may decrease in 2004.

Since 1998, the TTW Ministry and the IC Ministry (the successor to the TTW Ministry) have taken gradual steps to regulate the interconnection fees in accordance with internationally accepted benchmarks with the goal of creating a cost-based interconnection fee regime within the parameters of EU standards. To that end, starting in 1999, the interconnection fees were revised to compensate the LTOs more favorably for costs than in prior years. The Communications Act provides for the LTOs (including the Company) to be compensated for interconnection initiation and termination fees based on a Reference Interconnection Offer (“RIO”). The LTOs are responsible for submitting their RIOs to the National Communications Authority for approval. In 2002, the predecessor to the National Communications Authority approved the currently effective RIOs for all the LTOs. The LTOs recently submitted their new RIOs to the National Communications Authority for approval. Hungary is using the EU Long Run Incremental Cost model as its standard in determining interconnection fees. The Long Run Incremental Cost model is supposed to decrease interconnection fees. See “—Summary of the Communications Act.”

Subscription Fees. The Company collects a monthly subscription fee from its subscribers. The basic monthly subscription fee is HUF 4,500 ($21.64). In an effort to retain low usage customers, the Company has introduced different subscription fee options for its residential subscriber base. For a reduced monthly subscription fee, a residential subscriber agrees to pay his regular monthly measured service fee plus an additional percentage of such measured service fee which should lower the overall bill for low volume users. The IC Ministry regulates the subscription fees.

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Connection Fees. The Company charges its subscribers connection fees when they are added to the Company’s network. The Company may collect the full connection fee provided that the subscriber is connected within 30 days; otherwise, the Company may only collect a portion of the connection fee and must connect the subscriber within one year. Upon connection, the Company may collect the remaining portion of the fee. Connection fees are recognized as income over the expected subscriber life (presently seven years) from the date that the connection is made. Connection fees are regulated by the IC Ministry and the maximum fees are currently HUF 37,500 ($180.36) for residential subscribers and HUF 100,000 ($480.95) for business and other institutional subscribers (including government institutions). Customers requesting additional access lines are charged an additional connection fee per line. The Company can offer special promotions on the connection fees if it so chooses. In the past the Company has allowed its subscribers to pay connection fees on various installment plans.

Other Operating Revenue. The Company supplies private line service (point-to-point and point-to-multi-point) primarily to businesses. As of December 31, 2003, approximately 1,699 leased lines were in service. In addition, as of December 31, 2003, the Company had 1,837 public pay phones in the Operating Areas. The Company generates additional revenues from Internet Service (dial-up and broadband) and the provision of value-added services, including ISDN, voice mail, call waiting, call forwarding, and three-way calling, as well as through the sale and rental of telephone equipment.

Strategy

With the enactment of the Communications Act and the key implementing decrees, Hungary took significant steps towards facilitating a more competitive telecommunications market as it prepares to join the European Union. A more competitive environment will provide the Company with many opportunities and challenges.

In November 2002, the Company’s right to be the exclusive provider of non-cellular local voice telephone services in its Operating Areas expired. Matav’s and the other LTOs’ markets also became open to competition as their exclusive rights to provide non-cellular local voice telephone services in their markets also expired. Therefore, while the Company, Matav and the other LTOs still retain their rights to provide non-cellular local voice telephone services, they are subject to competition in this market. Competitors can enter these markets either by building out their own networks (an overbuild) or by using the existing network of the incumbent LTO. Subject to regulatory oversight, the Communications Act requires each LTO to “unbundle” its network to allow other telecommunications services providers to use that LTO’s network to compete in the provision of non-cellular local voice telephone service. The fees for such service are to be based on each LTO’s cost plus an allowable profit margin. According to the Communications Act, the fees are to be based on a certain Fully Distributed Cost model. The LTOs have recently submitted their Reference Unbundling Offers to the National Communications Authority for approval. See “—Competition,” and “—Summary of the Communications Act—Significant Market Power.”

Matav’s exclusivity rights to provide domestic and international long distance non-cellular voice services expired at the end of 2001. While the intent of the subsequent legislation was to create full competition in the domestic and international long distance markets commencing in 2002, certain technical, legal, economic and regulatory factors caused a delay in the introduction of effective competition in this market. Until very recently, the Company has been able to direct the long distance calls made by its subscriber base. See “—Services and Pricing—Measured Service.”

While the Company is now subject to competition in its non-cellular local voice telephone services markets, the Company is permitted to enter other local markets and expand its long distance services beyond its existing customer base. The Company’s goal is to provide the broadest array of telecommunications services with exceptional quality and service at reasonable prices by becoming the

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most efficient full service telecommunications provider in Central Europe. In order to both reach its goal and effectively compete in a more open Hungarian telecommunications market, the Company’s primary focus is to maintain its market dominance in the provision of non-cellular local voice telephone services in its Operating Areas while also becoming the premier provider of long distance services in its Operating Areas as competition for the long distance market takes hold in its Operating Areas, particularly in the business segment. To accomplish this goal, the Company is continuing and expanding its efforts to increase its product and service offerings and their usage, increase its marketing to its entire customer base, improve its customer service, and increase its operational efficiencies. Such efforts are intended to enable the Company to reduce operating costs and increase call revenues from its customer base to offset any market share lost to competitors. In addition to continuing to service its existing markets, the Company also intends to selectively compete outside its Operating Areas by offering newly liberalized services either by itself or in conjunction with other telecommunications service providers. The Company has implemented the following operational strategies in order to further its business objectives.

Products and Service Offerings

While the Company’s business and other institutional subscribers account for only 16% of the Company’s access lines, these customers accounted for a greater share of the Company’s revenue in 2003 than the Company’s residential subscribers. The Company believes that its business customers have the greatest need for the variety of new products and services that a modern telecommunications company can offer. The Company also believes that its business customers will be the primary target for competition in its Operating Areas once competition increases. Therefore, the Company intends to continue to solidify its relationship with its business customers to help them identify and solve their communications needs.

Since the availability of modern telecommunications services is still a relatively new phenomena in Hungary, educating the smaller and medium-sized business customers on the availability and benefits of the Company’s products and services is a continuing goal of the Company. The Company focuses on the marketing and sales of various products and services to its business customers such as managed lease lines, ADSL Internet service, dial-up Internet service, PBX sales and services, ISDN, and Digifon Services (e.g. call forwarding, call waiting, call blocking restrictions). The Company has an account manager assigned to each business customer who is responsible for continually meeting with each business customer to find out such customer’s telecommunications needs. The account manager can then demonstrate each of the Company’s products and services and, working together with that customer, develop a telecommunications strategy using the Company’s products and services which can best enhance that customer’s business.

For residential customers, the Company is focusing its efforts on educating the customer on the availability of such products and services as voice mail, caller ID and call waiting, which are all new to the Company’s residential customer base. The Company is also highlighting the benefits of the Internet and encouraging its use by offering special rate packages for Internet usage. One of the tools that the Company is deploying to increase customer awareness of these services is personal demonstrations with telephones and personal computers within the Company’s customer service centers, which are located in each of the Operating Areas.

The Company continues to offer the latest telecommunications products and services as they become available in the telecommunications marketplace. The Company began offering Internet Protocol-based voice services for international calls to its customers in 2000. This enabled the Company to offer long distance and international calling services at discounted rates. During 2001 the Company became an Internet Service Provider in all of its Operating Areas under the brand name “Globonet”. The Company introduced Caller ID in all of its Operating Areas in 2002 and in 2003 began offering ADSL

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Internet services (“broadband”) in certain cities throughout its Operating Areas. The Company is also reviewing its options with respect to such offerings as pre-paid calling plans, loyalty programs and teleconferencing to increase usage.

Marketing

For its residential customers and potential customers, the Company’s marketing efforts include advertising on radio and television, door-to-door marketing surveys, newspaper advertising, participation in local trade shows, direct mail, community meetings and billboard advertising. Since many Hungarians still prefer face-to-face personal marketing, the Company has leveraged the benefits of having a customer service center in each Operating Area to give personal demonstrations. To get new customers the Company has implemented short marketing campaigns targeting those residences without telephone service. To induce potential new customers the Company has offered special limited time only rates on the connection fee and special rate plans for infrequent telephone users. The Company has also used its special rate plans in an attempt to limit the disconnection rate of its customers. For business customers, the Company’s primary marketing tool has been direct contact with the business customers through the Company’s account managers.

Customer Service

The Company believes that providing a high level of customer service is important in attracting additional customers, increasing the usage of its existing products and services by its current customer base and retaining customers in a competitive environment. Prior to completion of the Company’s telecommunications networks, some customers waited for over 20 years for telephone service. Today, most residences and businesses can be connected to one of the Company’s networks within 7 days. The Company operates full time operator service centers in each of the Operating Areas which are staffed by operators capable of providing, among other things, call completion assistance, directory assistance and trouble reporting on a 24 hour basis. The Company also operates customer service centers in each of the Operating Areas which offer facsimile, Internet, photocopying and telephone bill payment services. These service centers also sell communications equipment, process telephone service applications and handle billing inquiries. The Company reorganized its customer service centers to make such centers more “customer friendly.” The Company is providing more choices for its customers and more product information instruction. For its business customers, the Company has account representatives for each customer to work with businesses to help them achieve their objectives with innovative telecommunications solutions.

Operational Efficiency

The Company has increased its productivity and operational efficiency by achieving certain economies of scale with respect to network management, administration, customer service, billing, accounts receivable, payroll processing, purchasing and network maintenance. For example, the Company has implemented a centralized operating and accounting system to serve all of its Operating Areas, which has given the Company a more efficient customer billing system and greater financial accountability. To capitalize on the Company’s contiguous concession areas, the Company reorganized its operations into three Operating Areas and one subsidiary from four Operating Areas and four subsidiaries, which achieved certain economies of scale. The merger of four Hungarian operating subsidiaries into one Hungarian operating subsidiary at the end of 2001 reduced overhead and maximized efficiencies. The Company now has 324 access lines per employee. During 2004 the Company will continue its ongoing efforts to streamline its operations.

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Recently Liberalized Services

With the Hungarian telecommunications market becoming open to competition, the Company intends to take advantage of select market opportunities. For example, the Hungarian domestic and international long distance market is now open for competition. Therefore, the Company is now providing under its own brand name domestic and international long distance services to its existing customer base in its Operating Areas and is licensed to provide long distance services throughout Hungary.

For calls originating in one of the Company’s Operating Areas and terminating in one of the Company’s other Operating Areas, the Company now has both the right and capability (through a combination of its owned networks and leased lines) to carry the call from the initiating caller to the recipient without passing through Matav’s network, thus saving the Company from any revenue sharing with Matav. For calls originating in one of the Company’s Operating Areas and terminating in certain parts of Hungary outside of the Company’s Operating Areas, the Company is capable of delivering the call to the local network of the recipient for completion. In this case, the Company keeps more revenue by not having to pay for transmission services between local networks. The Company has to pay the recipient’s local carrier a fee for completing the call. For other calls originating in one of the Company’s Operating Areas and terminating in other parts of Hungary, the Company may have to use another telecommunications provider, such as Matav or PanTel, to carry the call to the local network of the recipient for completion. In this case, the Company has to pay, directly or indirectly, a transmission fee and a completion fee to the carrier completing the call. For international calls from the Company’s Operating Areas, the Company has the right and capability (through a combination of its owned networks and leased lines) to carry the call up to the handoff to an international carrier for completion.

While the Company is licensed to provide long distance voice and data services and Internet services in markets outside of its Operating Areas, the Company does not presently have the network capability to provide such services entirely over its own network but it could enter selected markets as a reseller of another carrier’s network as needed. The Company is currently evaluating its opportunities to offer these and other liberalized services and may enter markets that it deems appropriate for its business strategy and goals. See “—Summary of the Communications Act.”

Mergers and Strategic Alliances

As the Hungarian telecommunications market continues to develop and become more liberalized and telecommunications providers enter and/or expand their presence in Hungary, the Company will continue to review its options with respect to any merger or strategic alliance possibilities that may enable the Company to increase its presence in the Hungarian telecommunications marketplace.

Competition

The Company’s concession rights provided for an eight-year period of exclusivity in the provision of non-cellular local voice telephone services, which ended in 2002, while the initial 25-year terms of the concession contracts are scheduled to expire in 2019. See also “—Regulation—Concession Contracts.” Therefore, other telecommunications service providers can enter the Company’s Operating Areas to compete with the Company in the non-cellular local voice services market. However, such competitors would have to develop their own telecommunications network (wire (though an overbuild) or wireless) or may use, subject to regulatory oversight, the Company’s network. At this point, the Company anticipates that the competition in the local wireline telephone services market will be centered around the Company’s business customers. Telecommunications provides with long distance networks in place may seek to establish direct connections to the business customers in order to bypass the Company’s networks in its Operating Areas. See “—Strategy,” and “—Summary of the Communications Act—Significant Market Power.”

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Historically, Matav with its country-wide network has been the exclusive provider of domestic and international long distance voice services. Prior legislation permitted other telecommunications service providers to enter the long distance voice market anywhere in Hungary in 2002. However, certain technical, legal, economic and regulatory factors have caused a delay in effective competition in this market. The Communications Act was enacted, in part, to address these shortcomings. As noted above, until recently the Company has been the only long distance carrier in its Operating Areas since the expiration of Matav’s monopoly. See “— Strategy,” “—Services and Pricing—Measured Service.” With carrier selection just beginning in the long distance market in the Company’s Operating Areas, the Company expects this to become a prime market for competition. Three telecommunications service providers have built long distance networks capable of servicing substantially all of Hungary: Matav; PanTel; and Invitel. These companies are capable of entering the Company’s Operating Areas to compete for the Company’s customers, particularly the business customers, in both the long distance market and the market for the provision of non-cellular local voice telephone services. PanTel has substantially built a nationwide fiber optic backbone network along the rights-of-way of MAV, the Hungarian railway. PanTel, which has recently started to provide full voice services in some parts of Hungary (outside of the Operating Areas), has been providing business communications services such as digital data, fax and video transmission using Internet Protocol (“IP”) data transmission technology and IP-based voice services primarily to large customers since 1999. Invitel provides local non-cellular voice telephone service in nine concession areas (covering approximately 15% of the country) and has built a fiber optic network throughout parts of Hungary. Most existing telecommunications service providers in Hungary have already entered the marketplace for voice-over IP services, which did not violate Matav’s now-expired exclusivity rights to provide long distance voice services.

Other Hungarian telecommunications providers, and potential providers, include the following entities which have either entered, or plan to enter, the telecommunications marketplace, particularly the business marketplace: e-Tel, an Irish telecommunications services provider; GTS Hungary Kft. (“GTS”) which provides data and voice transmission services through a nationwide microwave network and a satellite based network (GTS also owns one of the leading Hungarian ISPs); Antenna Hungaria, the national broadcaster which is still controlled by the state; Equant Hungary Kft., which provides IP-based data and voice transmission services; BT Hungaria, an affiliate of British Telecom; and Sweden’s Telia AB. Germany’s Infigate GmbH and U.S.—based UUNet, an affiliate of MCI, which are licensed to provide Internet services, are also entering the telecommunications market.

The Company faces intense competition from the three Hungarian cellular providers: Westel; Pannon; and Vodafone. The cellular market growth has been very fast in Hungary with a penetration rate of over 78% at the end of 2003. Unlike the United States and Western Europe, many Hungarians have gone from having no telephone (wireline or wireless) straight to a cellular wireless telephone without getting a traditional wireline telephone first. Historically, the airtime and monthly fees charged by the cellular operators are generally more than the fees for comparable services charged by the Company. The cellular telephone providers are, however, currently deploying various discounted pre-paid plans, which make pricing comparisons difficult.

The Hungarian cable television market is highly fragmented with over 400 cable television providers. The Hungarian cable television industry is undergoing consolidation. UPC, an affiliate of Monortel, is the largest cable television operator in Hungary.

Hungary, along with 9 other countries, will join the EU on May 1, 2004. Based on the harmonization of laws obligations that Hungary has undertaken in its agreement to join the EU, Hungary has been conforming its laws to those of the EU in order to be in harmony with the EU laws by May 1, 2004. The Communications Act was enacted as part of this harmonization process.

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Summary of the Communications Act

In November 2003 the Hungarian Parliament enacted the Communications Act, which took effect on January 1, 2004. The goal of the Communications Act is to further promote competition in the telecommunications market and to harmonize Hungary’s telecommunications laws with the current European Union regulatory framework. The Communications Act is a framework piece of legislation with the