Back to GetFilings.com

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended: September 30, 2003

Commission File Number: 000-31181

AMERICA ONLINE LATIN AMERICA, INC.

6600 N. Andrews Avenue
Suite 400
Fort Lauderdale, FL 33309
(Address of principal executive offices and zip code)

Registrant’s telephone number, including area code: (954) 689-3000

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Table of Contents

AMERICA ONLINE LATIN AMERICA, INC.

FORM 10-Q

INDEX

-2-

Table of Contents

    PART I. FINANCIAL INFORMATION

    ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

     Management’s discussion and analysis of financial condition and results of operations (“MD&A”) is provided as a supplement to the accompanying consolidated financial statements and related footnotes to help provide an understanding of the financial condition, changes in financial condition and results of operations of America Online Latin America, Inc. (“AOLA” or the “Company”). The MD&A is organized as follows:

	¨		Overview and recent developments. This section provides a general description of AOLA’s businesses, as well as recent developments that we believe are important in understanding our results of operations and future trends in our operations.
	¨		Results of operations. This section provides an analysis of AOLA’s results of operations for the three and nine months ended September 30, 2003 relative to the comparable periods in 2002. This analysis is presented on a consolidated basis, but also discusses relevant segment basis figures and results.
	¨		Financial condition and liquidity. This section provides an analysis of AOLA’s financial condition as of September 30, 2003 and cash flows for the three and nine months ended September 30, 2003 and 2002.
	¨		Critical accounting policies. This section provides a review of our accounting policies and estimates considered most important to our reported financial condition and results.
	¨		Forward-looking statements. This section discusses how certain forward-looking statements made by AOLA throughout MD&A and in the consolidated financial statements are based on management’s current expectations about future events and are inherently susceptible to uncertainty and changes in circumstances.

     This MD&A may not be indicative of the results for the full year and should be read in conjunction with the sections of our audited financial statements and notes thereto as well as our MD&A that are included in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2002.

     Overview and Recent Developments

     AOLA is one of the leading interactive service providers in Latin America. Our goal is to become Latin America’s leader in the development of the Internet, the global interactive medium that is changing the way people communicate, stay informed, are entertained, learn, shop and conduct business. We derive our revenues primarily from member subscriptions to our AOLA country services, the AOL-branded service in Puerto Rico and web-based interactive content and connectivity services. We also generate additional revenues from advertising and other revenue sources.

     The AOLA country services, the AOL-branded service in Puerto Rico and our web-based interactive content and connectivity services provide our members with easy and reliable access to local, regional and global online communities, content and localized versions of certain of America Online, Inc.’s (“America Online”) and AOLA interactive products. Our services enable members to access and explore the Internet and encourage members to participate in interactive communities through tools such as Spanish and Portuguese versions of AOL Instant Messenger, Buddy Lists, e-mail, public bulletin boards, online meeting rooms, conversations, chat and auditorium events. Our AOLA country services require members to use a software client program on their computers, whereas our web-based services do not require this software.

     Our markets in Latin America are Brazil, Mexico, Argentina and Puerto Rico. In November 1999, we launched our first AOLA country service, America Online Brazil. As of October 15, 2003, we offered our America Online Brazil service in 286 cities in Brazil. In July 2000, we launched our country service in Mexico, America Online Mexico. As of October 15, 2003, we offered our America Online Mexico service in 58 cities in Mexico. In August 2000, we launched our country service in Argentina, America Online Argentina. As of October 15, 2003, we offered our America Online Argentina service in 22 cities in Argentina. As part of the ongoing development of our service territory, in December 2000 we expanded into Puerto Rico under an agreement with America Online under which America Online transferred its economic interest in its existing subscriber base to us. We receive the net economic benefit associated with subscribers to the AOL-branded service in Puerto Rico and include these subscribers in our member totals. Subscribers in Puerto Rico are provided with both English and Spanish-language content through the AOL-branded service. As of October 15, 2003, service in Puerto Rico was offered island-wide.

     We consider countries in which we have launched our AOLA country services as operational segments and internally report our operations on a country-by-country basis. Although amounts for Argentina are not currently material and are not expected to be material in future reporting periods, we have decided not to consolidate Argentina with our corporate and other segment in order to facilitate historical segment comparisons. Each of our operating segments, except for Puerto Rico, derives its revenues through the

-3-

Table of Contents

provision of interactive services from subscription revenues to our AOLA country services and/or web-based interactive services and from advertising and other revenues. In Puerto Rico, we derive our subscription revenue from an arrangement with America Online whereby America Online transfers it net economic interests from members to the AOL-branded service in Puerto Rico to us. Our Puerto Rico segment also derives revenue from advertising and other revenue.

     In July 2003, we began testing a new web-based content and connectivity service in Argentina and launched this service, which is known as “AOL Web,” in October 2003. During September 2003, we launched a web-based service in Brazil and also began testing this concept in Mexico. Our new services offer subscribers a connection to the Internet and differing levels of email, content and support services. Our web-based service provides subscribers with local telephone numbers to access the Internet using standard dialers commonly available on computer operating systems. Members access the Internet by using any standard web browser, which is the user interface most frequently used by Internet users in Latin America. As a result, we will not need to distribute CDs to new members of the web-based services, nor will we incur costs similar to those associated with the maintenance of the existing client software for our AOLA country services. Our new web-based services are also priced at lower rates than our current country services and will also have lower costs. We expect this new service to better allow us to compete on the basis of price and to allow consumers to choose the features they need.

     We will be primarily responsible for the hosting, technical support, development and billing for our new services. Total out-of-pocket cost associated with the development and launch of this initiative in the nine months ended September 30, 2003, was approximately $0.9 million. We expect to incur an additional $2.4 million in the launch and development of these services through the first quarter of 2004.

     In Brazil, our web-based Internet connectivity service has been segmented to address four broad categories:

	1)		AOL Total, which provides content and email services (seven addresses) similar to our current AOLA country services;
	2)		AOL Executive, which focuses on news and sports relevant to adults and provides three email addresses;
	3)		AOL Youth, which provides content and services of interest to the youth segment and provides three email addresses; and
	4)		AOL Lite, which provides basic Internet connectivity, one email address, and minimal content.

     The unbundled AOL Total service, which does not include the cost of call center support, has been priced at R$29.90 per month (approximately $10.31), the same price as our unbundled, unlimited monthly AOL Brazil country service offering, while the unbundled AOL Executive and AOL Youth offerings have been priced at approximately 67% of our unbundled, unlimited monthly AOL Brazil country service offering. AOL Lite has been priced at 43% of our unlimited monthly AOL Brazil country service offering. Most new members of our AOLA country services are selecting unbundled plans, which do not provide free call center support. We expect this new web-based service to become our primary product offering in Brazil. Consequently, we will no longer be actively promoting the AOL country service in Brazil going forward, although it will still be available. We expect to experience migration of membership from our AOL Brazil country service to our new web-based offerings but are unable to estimate the extent of the migration or the resulting effect on our business.

     In Argentina, we offer only a full-featured version similar to the existing AOL Argentina country service in terms of features and content. AOL Web, unbundled, has been priced at ARS $18.90 per month (approximately $6.63), which is approximately 96% of the existing, unbundled AOL Argentina country service. Although we plan to actively promote AOL Web in Argentina, we also plan to continue to make available our existing AOL country service product.

     We currently plan to expand our new web-based connectivity services to our other country operations, although we do not expect it to become our primary product offering in either Mexico or Puerto Rico. Subscription revenue from our new web-based connectivity services is included under our existing country operating segments.

     In May 2003, we began testing a broadband service in Brazil and we launched our broadband service, AOL MAXX, nationally in August 2003. Our new broadband service is a full-featured product offering subscribers faster Internet access through DSL and unique content designed for delivery through high-speed channels. The gross margin contribution on our broadband product offering currently is similar to that of our AOLA Brazil country service. During the third quarter, we also began to test broadband products in Mexico and Argentina, although at present we do not have plans to launch nationally in these countries.

     In June 2000, we entered into a ten-year strategic alliance with Banco Itaú, one of the largest banks in Latin America. Banco Itaú is obligated to market and promote a co-branded version of our AOLA country service in Brazil as the principal means of accessing Banco Itaú’s interactive financial services. We also have begun marketing a version of our web-based content and connectivity interactive services in Banco Itaú branches containing the same co-branded features as the country service.

     On December 14, 2002, we amended our strategic marketing alliance with Banco Itaú. Under the terms of the revised agreement, we now oversee, in large part, the marketing activities for the co-branded service. Banco Itaú is obligated to establish kiosks and point-of-sale displays in hundreds of its bank branches for the promotion of the co-branded services, which are staffed by promoters trained by

-4-

Table of Contents

AOL Brazil. Potential subscribers are able to sample the co-branded services and register in the bank branches. The number of promoters varies depending on the success of the marketing efforts, which are reviewed every three months. If the marketing efforts do not meet specified goals, the number of promoters will be decreased, subject to a floor on the number of promoters. Conversely, if the marketing efforts exceed specified levels, the number of promoters will be increased, subject to a maximum number of promoters. Banco Itaú is also required to distribute, at our direction, CDs containing the software for the co-branded AOLA country service via in-branch promotions and direct mail. Banco Itaú must also produce and broadcast a certain number of television commercials promoting the co-branded services and provide exclusive online banking benefits to subscribers to the co-branded services. Banco Itaú is responsible for the cost of these marketing efforts. The modified marketing arrangements will remain in effect through March 2006, although the ten-year term of the agreement did not change. Banco Itaú is obligated to make cash payments to us if minimum annual revenue targets and marketing commitments are not met through March 2006. The maximum aggregate amount that Banco Itaú will be required to pay us if these targets are not met, which we refer to as reference payments, is $26.0 million, $21.0 million and $13.0 million in 2004, 2005 and 2006, respectively. We do not expect to receive any incremental amounts from Banco Itaú for the March 24, 2004 measurement date.

     During the quarter ended September 30, 2003, as a result of lower than expected productivity, we reduced the number of promoters. Because of this reduction and our cancellation of certain CD distributions, Banco Itaú made payments of $2.7 million to us during the third quarter of 2003, which is the only payment in lieu of marketing activities we have received from Banco Itaú under our revised marketing agreement during fiscal 2003. We expect these payments to continue in the future but the amounts to gradually decrease over time as per the terms of the revised marketing agreement. We have the right to redeploy or reinstate some of the promoters in the branches in the future, in which case we would forego such payments from Banco Itaú. Such payments from Banco Itaú are accounted for as funds from financing activities and will reduce future marketing expense by lowering the amortization expense associated with the shares issued to Banco Itaú. Payments we receive from Banco Itaú in lieu of marketing activities it is obligated to make serve to offset amounts that may be owed as reference payments.

     Banco Itaú’s customers who register for the co-branded services currently are entitled to a one-month free trial period, the length of which may be changed in the future and, if they subscribe to the monthly unlimited-use plan, are entitled to a 20% discount off the standard price. Banco Itaú, at its option, may subsidize hours for certain customers who were subscribers to the co-branded service prior to December 14, 2002. For the quarter ended September 30, 2003, the amount of subsidies paid by Banco Itaú for its members was not material. For the nine months ended September 30, 2003, we received $0.9 million in subsidies for its members from Banco Itaú. For further discussion of the revised marketing agreement with Banco Itaú, please see “Item 1 – Business – Strategic Alliance with Banco Itaú” in our Annual Report on Form 10-K/A for the year ended December 31, 2002.

     In January 2003, we entered into an agreement with McDonald’s in Brazil to market our service via kiosks in hundreds of McDonald’s restaurants in Brazil. As part of the agreement, we paid McDonald’s an initial fee of approximately $2.1 million and will pay an annual fee over the five-year term of the agreement, which together with the initial fee will in the aggregate total as much as $7.0 million. In addition, we will also pay McDonald’s a fee for each new member who becomes a paying member of our AOLA country service in Brazil through this agreement. The implementation of this agreement was delayed due to the addition of a new partner and to partner programming considerations; we launched the project in October 2003 and hope to implement it fully by the second quarter of 2004.

     We make our interactive services accessible to a broader audience of potential subscribers by offering multiple mechanisms through which our members can pay us, including credit cards, debit cards, cash payment methods (including “boletos”) and direct debits from bank accounts. Cash payment methods historically have accounted for a substantial majority of all new member registrations in Brazil, Mexico and Argentina. Cash payment methods are not available in Puerto Rico. However, the percentage of new registrations selecting cash payment alternatives has been declining in line with our efforts to improve the quality of our membership base. As of September 30, 2003, cash payment mechanisms were selected by approximately 34% of our subscribers in Brazil, 14% of our members in Mexico and 47% of our members in Argentina. As of September 30, 2003, cash payment alternatives had been selected by 23% of our total subscriber base. This compares with 45% of members in Brazil, 42% of members in Mexico and 51% of members in Argentina who had selected a cash payment option at December 31, 2002. Although we have not experienced any significant difficulties collecting subscription fees from members using credit cards and direct debit mechanisms, collection rates from members opting for the cash payment mechanisms historically have been lower and less timely. As a result, we continue to encourage conversion of these subscribers to non-cash payment options and terminate members who do not pay on a timely basis. In Mexico we have encouraged the sale of long-term prepaid plans, which now account for 37% of current AOL Mexico members, and eliminated free trial periods for members choosing the cash payment options. In Brazil and Argentina, we either offer discounts or apply surcharges to subscribers to our AOLA country and web-based content and connectivity services who choose cash payment options.

     In 2002, we implemented measures designed to better target higher-value members by focusing on targeted groups that have a greater likelihood of becoming members who pay on a timely basis and remain subscribers to our services for an extended period of time. This allowed us to increase the cost efficiency of our member acquisition marketing efforts, primarily through the elimination of the mass mailing of CDs containing our software. Instead, we have focused on more targeted activities such as the use of kiosks in high traffic retail and bank locations and distribution of our software through original equipment manufacturers and direct customer interaction channels. We are also relying to a greater extent on joint marketing arrangements where our partners are responsible for

-5-

Table of Contents

significant portions of the overall cost of the marketing effort. We also took steps to block access to our network and terminate members who were delinquent in the payment of their fees to us. This allowed us to reduce our costs of revenues and achieve improvements in our operating cost structure as the scope of our network and call center support operations was made proportional to the resulting reduced membership base and lower peak demand. We have continued focusing on these initiatives in 2003.

     At September 30, 2003, our ending membership base was 492,000 members, down from 625,000 members at June 30, 2003. In addition to subscribers to our AOLA country services, our membership numbers include members of our new web-based connectivity services and our new broadband offerings, which together accounted for less than 2% of total membership at September 30, 2003. The decline in membership during the third quarter was due to the termination of approximately 79,000 members of the Banco Itaú co-branded service who did not choose a paid plan, as well as lower than expected levels of new member registrations which were insufficient to offset membership attrition. As of September 30, 2003, we completed the termination of members of the Banco Itaú co-branded service who failed to choose a paid price plan. The termination of Banco Itaú members who did not select a paid plan did not have a material impact on our subscriber revenues for the quarter ended September 30, 2003. The reduction in the number of promoters at Banco Itaú branches, and strong price competition from providers of free and paid Internet services in Brazil, continue to negatively impact member acquisition and retention. Registration rates also continue to be negatively impacted by the delay in the implementation of the McDonald’s marketing agreement.

     We expect our membership base to decrease in the fourth quarter of 2003. The actual size and change of future membership will be significantly influenced by the timing and success of our new web-based interactive services. We expect the marketing agreements with Banco Itaú and McDonald’s to be our primary member acquisition channels over the medium-term future, although we do not expect to fully implement the McDonald’s agreement until the second quarter of 2004. As of September 30, 2003, approximately 21% of our total ending membership base was comprised of members to the Banco Itaú co-branded service and approximately 17% of our total subscribers were in free trial periods or member retention programs. We also expect that over the near term a significant percentage of our total subscribers will continue to be in free trial periods or member retention programs.

     RESULTS OF OPERATIONS

Consolidated Results of Operations

     Table 1 shows the consolidated results from operations for the three- and nine-month periods ended September 30, 2003 and 2002.

TABLE 1 - SELECTED OPERATING DATA
(In thousands, except share, per share amounts and percentages)

[Additional columns below]

[Continued from above table, first column(s) repeated]

				NINE MONTHS ENDED
				September 30,				September 30,								%
				2003				2002				Change				Change
				(unaudited)				(unaudited)
Condensed Consolidated Operations
Revenues:
		Subscriptions		$	45,600			$	47,693			$	(2,093	)			(4.4	)%
		Advertising and other			4,660				6,568				(1,908	)			(29.0	)
					50,260				54,261				(4,001	)			(7.4	)
Costs and expenses					114,898				179,497				(64,599	)			(36.0	)
Loss from operations				$	(64,638	)		$	(125,236	)		$	60,598				(48.4	)%
Net loss applicable to common stockholders				$	(89,709	)		$	(142,009	)			52,300				(36.8	)%
Loss per common share, basic and diluted				$	(0.68	)		$	(2.12	)		$	1.44				(67.9	)%
Weighted average number of common shares outstanding					132,143,528				67,066,773				65,076,755				97.0	%
Income / (loss) from operations by operating segment:
	- Brazil			$	(45,289	)		$	(76,311	)		$	31,022				(40.7	)%
	- Mexico				(8,165	)			(31,130	)			22,965				(73.8	)
	- Argentina				(1,298	)			(2,594	)			1,296				(50.0	)
	- Puerto Rico				1,531				374				1,157				309.4
	- Corporate and other				(11,417	)			(15,575	)			4,158				(26.7	)
				$	(64,638	)		$	(125,236	)		$	60,598				(48.4	)%
As a percentage of total loss from operations:
	- Brazil				70.1	%			60.9	%
	- Mexico				12.6	%			24.9	%
	- Argentina				2.0	%			2.1	%
	- Puerto Rico				(2.4	)%			(0.3	)%
	- Corporate and other				17.7	%			12.4	%
					100.0	%			100.0	%

Revenues

     Total revenues. As shown on Table 2, our total revenues consist principally of subscription revenues as well as revenues generated from advertising and other revenue sources.

-6-

Table of Contents

TABLE 2 - REVENUES
(Dollars in thousands, except percentages)