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Interim management report - First quarter 2009 results Public guidance maintained despite recessionary impact

Budapest, May 7, 2009

Magyar Telekom (Reuters: NYSE: MTA.N, BSE: MTEL.BU and Bloomberg: NYSE: MTA US, BSE: MTELEKOM HB), the leading Hungarian telecommunications service provider, today reported its consolidated financial results for the first quarter of 2009, in accordance with International Financial Reporting Standards (IFRS).

Highlights:

  • Revenues were down by 2.0% to HUF 159.4 bn (EUR 541.2 m) in the first quarter of 2009 over the same period in 2008. Revenue decline was mainly due to lower fixed line and mobile voice revenues in Hungary, but fixed line internet revenues also declined. These declines were partly offset by growth in mobile internet, SI/IT, data and TV revenues, as well as by the revenue growth at the international subsidiaries driven by the translation impact of the weakening forint.
  • EBITDA declined by 6.3% to HUF 64.6 bn , with an EBITDA margin of 40.5%. Underlying EBITDA , which is EBITDA excluding investigation-related costs (HUF 1.7 bn in 1Q 2009 against HUF 1.5 bn in 1Q 2008), as well as severance payments and accruals (HUF 0.4 bn in 1Q 2009 against HUF 0.1 bn in 1Q 2008) decreased by 5.6% quarter-on-quarter. Underlying EBITDA margin was 41.8% in the first quarter of 2009 compared to 43.4% in the same period of 2008. While part of the EBITDA decline comes from the HUF 1.3 bn one-off gain on real estate sales in Q1 2008 (sale of MontMak), EBITDA is under pressure from the recessionary environment in Hungary which is accelerating the revenue mix change by increasing the ratio of low-margin revenues.
  • Profit attributable to equity holders of the company ( net income ) decreased by 2.9%, from HUF 22.2 bn (EUR 85.5 m) to HUF 21.5 bn (EUR 73.1 m). Besides lower EBITDA, the decline was also due to higher net financial expenses partly offset by lower depreciation and amortization expenses as well as lower income tax in the first quarter of 2009. Net financial expenses increased driven by the higher interest rates on our loan portfolio, as well as due to foreign exchange losses resulting from the forint weakening. Depreciation expenses decreased due to the extension of the useful life of a number of assets during 2008. Income taxes were down as according to the new Macedonian tax regime no current and deferred taxes should be accounted at the Macedonian subsidiary until the dividend has been paid out of net income.
  • Net cash generated from operating activities increased from HUF 49.1 bn to HUF 50.5 bn. The lower EBITDA and higher net finance expenses were offset by decreased working capital requirements and lower level of income tax paid.
  • Investments in tangible and intangible assets (CAPEX) increased by HUF 7.1 bn to HUF 19.9 bn in Q1 2009 mainly driven by the increase in satellite TV subscriptions and accelerated fibre network rollout. Of the total CAPEX, HUF 7.9 bn is related to the Consumer Services Business Unit, HUF 0.7 bn to Business Services Business Unit, HUF 0.3 bn to Group Headquarters, HUF 8.7 bn to the Technology Business Unit, while in Macedonia the CAPEX spending was HUF 1.4 bn, in Montenegro HUF 0.8 bn.
  • Net debt decreased from HUF 238.7 bn to HUF 217.8 bn by the end of March 2009 compared to the end of March 2008 level. The net debt ratio (net debt to net debt plus total equity) also decreased to 24.8% at end-March 2009.


Christopher Mattheisen, Chairman and CEO commented: “We have experienced a tough first quarter, driven by the fierce competition, especially in the wireline markets, but also by the deteriorating economic environment that could be felt throughout all business units of Magyar Telekom. The major impact of the recession was seen in the traditional voice services, both in the residential and corporate segments, where usage, tariff levels and customer churn numbers all came under pressure and resulted in declining revenues. However, there are also positive signs especially in our TV, mobile broadband and SI/IT products. Demand for our satellite TV service introduced last November remains strong, helping us to boost IPTV sales. The number of mobile broadband customers continued to grow and SI/IT revenues also increased in the first quarter.
Building on the foundations laid last year, when we aligned the company to face these challenges with the launch of a leaner organization and stronger brand structure, as well as more competitive packages, this year we again made a significant step forward. We launched the commercial sale of our fibre optic services, and the faster broadband packages on our upgraded cable network are also available. In parallel, we are further simplifying our service portfolio to make it even more transparent and attractive for customers. Thanks to these changes, the perception of Magyar Telekom as a genuine triple-play service provider is rapidly increasing.
Although the external environment has deteriorated quite significantly since we published our public targets for this year, we still believe that the announced targets can be met if the economic situation does not worsen further. In terms of revenues, the new initiatives and the seasonality of the telecoms business gives us confidence that we will achieve the targeted 1% decline for the full year, while on the EBITDA level, the cost cutting measures we have introduced should ensure that we meet our full-year target of a 1-2% decline. In terms of CAPEX, we are also maintaining our target for this year of nominally flat spending compared to the previous year.”


Consumer Services Business Unit (CBU)

Revenues before intersegment elimination fell by 5.4% to HUF 78.9 bn in Q1 2009 compared to the same period last year. EBITDA declined by 2.1% and EBITDA margin was 59.0% in the first quarter. CAPEX increased significantly to HUF 7.9 bn due to the higher number of satellite TV and IPTV connections.

  • Fixed line revenues declined by 6.6% in Q1 2009. The decline was driven by decreasing voice revenues with increasing mobile substitution causing a continuous reduction in customer base, traffic volume and average tariff levels. Although churn in the traditional copper line remained high in the first quarter, which is a clear sign of declining household income levels, the accelerated migration towards VoIP and VoCable solutions mitigated voice access churn to an annual 7.4%. Internet revenues also decreased reflecting the declining prices, although the number of broadband customers increased, and ADSL sales in particular showed a new impetus. Demand for our TV products remained strong. The number of total TV customers exceeded 505,000 by the end of March with growth mostly driven by the newly launched satellite TV service, while demand for IPTV also strengthened.
  • Mobile revenues showed a decline of 4.5% to HUF 45.1 bn in the first quarter, as both usage and tariff levels showed a negative trend, while customer growth slowed significantly. Penetration level in Hungary decreased in the first quarter compared to the end-2008 level, mainly due to the increased churn of inactive customers and the cancellation of double and triple SIM cards. However, T-Mobile was able to increase its market share to 44.2% share of total SIM cards by end-March 2009. Despite the continued rise in non-voice service revenues and usage, ARPU showed an 11.5% decrease year-on-year due to the declining tariff levels and regulatory impacts. Wholesale voice revenues declined further due to the annual cut in mobile termination rates effective from January 2009, while equipment sales revenues also declined due to customers deciding to delay handset upgrades in the economic recession.


Business Services Business Unit (BBU)

Revenues before intersegment elimination were up by 4.0% to HUF 42.9 bn while EBITDA decreased by 8.2% to HUF 20.3 bn and EBITDA margin was 47.2% in Q1 2009. The declining EBITDA margin is driven by the accelerated revenue mix change: an increasing proportion of revenues is coming from the lower margin SI/IT services while higher-margin traditional revenues are declining faster.

  • Fixed line revenues were down by 4.8% mainly due to mobile substitution, as the significantly lower average mobile tariff levels resulted in a decrease in both fixed line traffic and number of lines. In addition, the recession put pressure on voice revenues, headcount reduction, rationalization and cost cutting decisions at our key corporate clients had a direct impact on their telecommunications spending.
  • Mobile revenues decreased by 4.5%. The above mentioned recessionary impacts had a similar impact on the mobile spending of our corporate clients, thus churn and decline of average tariff levels accelerated in the first quarter this year. Although, thanks to the increasing usage of mobile broadband, non-voice revenues are rapidly increasing and already represent 23.0% of the ARPU of corporate clients, ARPU was still down by 17.2% in the first quarter compared to the same period last year.
  • SI/IT revenues were up by 28.8% in the first quarter of 2009 due to higher outsourcing revenues at IQSYS (predominantly due to a one-off sale of assets in a finance lease transaction) and infrastructure revenues at KFKI. The increasing revenues show that our strategy of an integrated approach and ability to offer the full range of ICT services is paying off. Although the recession had little impact on our first quarter results in this area, the impact will most probably be more visible in the rest of the year.  


Macedonia

In Macedonia, revenues were up by 12.7% and EBITDA was flat thanks to the weakening of the Hungarian forint against the Macedonian Denar. Excluding the FX impact (the forint weakened on average by 12.8% to the Denar in the first quarter), revenues were flat and EBITDA was down by 11.2%. EBITDA margin was 55.0% in the first quarter of 2009, down from 61.9% a year earlier. The strong EBITDA and margin decline was due to the one-off gain on real estate sales of HUF 1.3 bn in Q1 2008 (sale of MontMak).

  • Fixed line revenues declined by 6.7% in local currency, driven by increasing competition coming from alternative and mobile operators. The strong competitive situation coupled with the unfavorable economic environment resulted in an increased annual churn rate and further decline in outgoing traffic. Growth in internet and IPTV customers partly offset the voice revenue decline, while the introduction of double and triple play packages should help  minimise churn.
  • Mobile revenues were up by 7.7% in local currencies thanks to strong growth in the customer base and the improving customer mix. These were able to offset the strong decline in ARPU, which resulted from the continuous tariff decreases after the entrance of the third mobile operator in 2007.


Montenegro

Revenues of the Montenegrin subsidiary were up by 4.8% in the first quarter and EBITDA was up by 17.6%. However, excluding the strong FX impact (the forint weakened by 12.9% to the euro on average in the first quarter of 2009 against the same quarter in 2008), revenues declined by 7.1% while EBITDA was up by 4.2%. EBITDA margin increased from 30.5% in Q1 last year to 34.2% in Q1 this year as lower equipment costs offset the revenue decline. Both handset subsidies and number of handsets sold decreased in the mobile market this year compared to last year when due to the entrance of the third mobile operator competition was very fierce.

  • Fixed line revenues declined by 8.4% in local currency in Q1 2009 due to lower voice retail and wholesale revenues, partly offset by increasing internet and TV revenues. Voice retail revenues were down, driven by the high mobile substitution, which accelerated after the entrance of the third mobile operator into the Montenegrin mobile market. The decline in wholesale traffic revenues was mainly driven by significantly lower transit traffic from the mobile competitor Promonte since it rerouted its Serbian traffic in April 2008. Internet revenues, however, showed a steep increase thanks to the growing number of ADSL and IPTV customers.
  • Mobile revenues were down by 5.4% in local currencies in Q1 2009. The strong growth in the customer base could not offset the decline in tariff levels and usage driven by the market entry of the third mobile operator in 2007. Declining retail revenues were partly offset by higher wholesale revenues driven by the introduction of SMS interconnect fees during 2008.


Technology Business Unit (TBU)

Revenues increased slightly by 2.7% to HUF 2.7 bn and EBITDA increased by 7.3% to HUF -11.2 bn. As the Technology Business Unit is a cost centre responsible for the operations and development of the mobile and fixed network as well as IT management, its cost base mainly consists of employee-related expenses and network depreciation. Network-related investments are also generated by TBU. CAPEX increased by 15.6% to HUF 8.7 bn in Q1 2009, mainly driven by the accelerated roll-out of the fibre optic network and upgrade of the cable network.


Group Headquarters

Revenues before intersegment elimination were down by 11.9% to HUF 33.1 bn. EBITDA decreased to HUF -5.0 bn due to lower gain on real estate sales and also somewhat higher investigation-related expenses this year (HUF 1.7 bn in Q1 2009 compared to HUF 1.5 bn in Q1 2008). The revenue decline is mainly driven by lower wholesale revenues, especially within mobile revenues, reflecting the 15% cut in mobile termination rates since beginning of this year.


As previously disclosed, in the course of conducting their audit of Magyar Telekom’s 2005 financial statements, PwC identified two contracts the nature and business purposes of which were not readily apparent to them. In February 2006, the Company’s Audit Committee retained White & Case (the “independent investigators”), as its independent legal counsel, to conduct an internal investigation into whether the Company had made payments under those, or other contracts, potentially prohibited by U.S. laws or regulations, including FCPA or internal Company policy. The Company’s Audit Committee also informed the DOJ and the SEC and the HSFA of the internal investigation.
Based on the documentation and other evidence obtained by it, White & Case preliminarily concluded that there was reason to believe four consulting contracts entered into in 2005 were entered into to serve improper objectives, and further found that during 2006 certain employees had destroyed evidence that was relevant to the investigation. White & Case also identified several contracts at our Macedonian subsidiary that could warrant further review. In February 2007, our Board of Directors determined that those contracts should be reviewed and expanded the scope of the internal investigation to cover these additional contracts and any related or similarly questionable contracts or payments. In May 2008, the independent investigators provided us with a “Status Report on the Macedonian Phase of the Independent Investigation.” In the Status Report, White & Case stated, among other things, that “there is affirmative evidence of illegitimacy in the formation and/or performance” of six contracts for advisory, marketing, acquisition due-diligence and/or lobbying services in Macedonia, entered into between 2004 and 2006 between us and/or various of our affiliates on the one hand, and a Cyprus-based consulting company and/or its affiliates on the other hand, under which we and/or our affiliates paid a total of over EUR 6.7 million. The internal investigation is continuing into these and other contracts and certain related issues identified by the independent investigators.
In 2007, the Supreme State Prosecutor of the Republic of Montenegro informed the Board of Directors of Crnogorski Telekom, our Montenegrin subsidiary, of her conclusion that the contracts subject to the internal investigation in Montenegro included no elements of any type of criminal act for which prosecution would be initiated in Montenegro.
Hungarian authorities also commenced their own investigations into the Company’s activities in Montenegro. The Hungarian National Bureau of Investigation (NBI) has informed us that it closed its investigation of the Montenegrin contracts as of May 20, 2008 without identifying any criminal activity.
On March 28, 2009, the NBI informed the Company that, based on a report received by it, it had begun a criminal investigation into alleged misappropriation of funds relating to payments made in connection with the Company's ongoing internal investigation into certain contracts entered into by members of the Magyar Telekom group and related matters. The NBI has requested from the Company materials and information relating to such payments. The Company is cooperating with the ongoing NBI investigation.
United States authorities commenced their own investigations concerning the transactions which are the subject of our internal investigation, to determine whether there have been violations of U.S. law. 
The Ministry of Interior of the Republic of Macedonia has also issued requests to our Macedonian subsidiaries, requesting information and documents concerning certain of our subsidiaries’ procurement and dividend payment activities in that country (together with U.S. investigations, and the ongoing NBI investigation, the “Government investigations”). During 2007, the U.S. authorities expanded the scope of their investigations to include an inquiry into our actions taken in connection with the internal investigation and our public disclosures regarding the internal investigation.
By letter dated February 27, 2009 addressed to counsel to the Audit Committee, the DOJ requested that the Audit Committee pursue all reasonable avenues of investigation prior to completing and issuing a final report of the internal investigation, including investigation into matters recently identified to counsel for the Audit Committee by the DOJ. The DOJ recognized that a delay in the completion of the report may result from investigation into these matters. The DOJ also requested that the Audit Committee refrain from disseminating any such final report until further notice from the DOJ because of the DOJ's concern that such dissemination could interfere with the DOJ's investigation. The Company, its Board of Directors, and its Audit Committee continue to support the internal investigation and the continuing cooperation with and assistance to the Governmental investigations, as being in the best interests of the Company and its shareholders. In its February 27 letter, the DOJ stated that the internal investigation has been of assistance to the DOJ and that such assistance will be taken into account in determining the appropriate disposition of this matter by the DOJ, if any.
According to an extract of a press conference published on the official web site of the Macedonian Ministry of Interior on December 10, 2008, the Organized Crime Department of the Ministry submitted files to the Basic Public Prosecution Office of Organized Crime and Corruption in Macedonia, with a proposal to bring criminal charges against four individuals, including three former Magyar Telekom Group employees.  According to that public information, these individuals are alleged to have committed an act of “abuse of office and authorizations” in their position in Makedonski Telekom by concluding five consultancy contracts with Chaptex Holdings Ltd in the period 2005-2006 for which there was allegedly no intention nor need for any services in return.
We cannot predict when the internal investigation or the ongoing Government investigations will be concluded, what the final outcome of those investigations may be, or the impact, if any, they may have on our financial statements or results of operations. We cannot predict what impact, if any, these investigations will have on each other. Government authorities could seek criminal or civil sanctions, including monetary penalties, against us or our affiliates, as well as additional changes to our business practices and compliance programs. 
Magyar Telekom incurred HUF 1.7 bn expenses relating to the investigation in the first quarter of 2009, which are included in other operating expenses of Group Headquarters.

About Magyar Telekom

Magyar Telekom is the principal provider of telecom services in Hungary. Magyar Telekom provides a full range of telecommunications and ICT services including traditional fixed line and mobile telephony, data transmission, non-voice, SI/IT services. Magyar Telekom is the majority owner of Makedonski Telekom, the leading fixed line operator and its subsidiary T-Mobile Macedonia, the leading mobile operator in Macedonia. Magyar Telekom also has a majority stake in Crnogorski Telekom. This Group provides fixed, mobile and Internet services in Montenegro. Key shareholders of Magyar Telekom as of March 31, 2009 include MagyarCom Holding GmbH (59.21%), owned by Deutsche Telekom AG. Treasury shares amount to 0.14% of issued capital, while the remaining 40.65% is publicly traded.

This investor news contains forward-looking statements. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. These statements are based on current plans, estimates and projections, and therefore should not have undue reliance placed upon them. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update publicly any of them in light of new information or future events.

Forward-looking statements involve inherent risks and uncertainties. We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. Such factors are described in, among other things, our Annual Report on Form 20-F for the year ended December 31, 2007 filed with the U.S. Securities and Exchange Commission.