UNITED STATES

FORM 10-Q

For the quarterly period ended: September 30, 2004

Commission File Number: 000-31181

AMERICA ONLINE LATIN AMERICA, INC.

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 o

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

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

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AMERICA ONLINE LATIN AMERICA, INC.

FORM 10-Q

INDEX

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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, 2004 relative to the comparable periods in 2003. 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, 2004 and cash flows for the three and nine months ended September 30, 2004 and 2003.
	•		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 for the fiscal year ended December 31, 2003.

     Overview and Recent Developments

     America Online Latin America, Inc. (“we,” “us,” “AOLA” or the “Company”) is a provider of interactive services in Latin America. We derive our revenues principally from member subscriptions to our AOLA country services, the AOL-branded service in Puerto Rico and our web-based interactive services. We also generate additional revenues from advertising and other revenue sources. Other revenue sources include programming services provided to America Online, Inc. (“America Online”) for its Latino content area, revenue sharing agreements with certain local telecommunications providers, and call center support services that we provide to America Online’s German subsidiary.

     Our AOLA country services and web-based interactive services provide our members with easy and reliable access to online communities, content and localized versions of certain of America Online 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, web logs, public bulletin boards, online meeting rooms, conversations, chat and auditorium events. Our AOLA country services require members to use a client software program on their computers, whereas our web-based services do not require this software. Members of most of our services can personalize their online experience through a variety of features, including customized news and e-mail controls. Our interactive services typically also provide members with local and regional content organized into channels, making areas of interest easy to find, and our AOLA country services also provide access to the extensive global content of the AOL service.

     Our main markets in Latin America are Brazil, Mexico and Puerto Rico. We have no current plans to expand to other markets in Latin America. We consider countries in which we have launched our AOLA country services or web-based interactive services as operational segments and internally report our operations on a country-by-country basis. Each of our operating segments, except for Puerto Rico, derives its subscription revenues through the provision of interactive services and also from advertising and other revenue sources. In Puerto Rico, we derive our subscription revenue from our arrangement with America Online whereby America Online transfers it net economic interests from

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members to the AOL-branded service in Puerto Rico to us. Our Puerto Rico segment also derives revenue from advertising and other revenue. Although amounts for Argentina are not 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.

     In the table below, we provide the date on which we first launched our country service in each market and our market service coverage as of September 30, 2004.

     Subscribers in Puerto Rico are provided with both English and Spanish language content through the AOL-branded service.

     We launched our web-based content and connectivity services in Brazil, Argentina and Puerto Rico in September 2003, October 2003 and February 2004, respectively. Our web-based services are priced at lower rates than our AOLA country services and are designed to be more competitively priced. Our web-based Internet connectivity service in Brazil is segmented to address four broad categories: AOL Total, which is similar to our full-featured AOLA country service; AOL Executive; AOL Youth; and AOL Lite.

     Unlike Brazil, in Puerto Rico we offer only one web-based product, “Conexis,” which provides basic Internet connectivity, one email address, and minimal content. A web-based service is available in Mexico, although it is not actively promoted. We do not expect this web-based service to become a significant part of our business in Mexico. We are primarily responsible for the technical support, development and billing for our web-based services.

     We believe our web-based services in Brazil will become our primary product there, although at present the majority of our members in Brazil use the AOLA country service. We no longer actively promote the AOLA country service in Brazil, although it is still available and a limited number of new members continue to select it. We no longer promote either the AOLA country service or the web-based service in Argentina, although they are still available. We do not expect our web-based product offering in Puerto Rico to become our primary product offering. We expect to experience migration of membership from our AOL Brazil country services and our AOL-branded service in Puerto Rico to our web-based services. As of September 30, 2004, approximately 20% of active subscribers to our narrowband web-based services have migrated from our AOLA country services in Brazil, Mexico and Argentina and the AOL-branded service in Puerto Rico.

     To date, growth of our web-based services has been slow and we do not expect any significant change in the near future. Approximately 19% of the membership totals as of September 30, 2004 were subscribers to our narrowband web-based interactive services. Results to date in Brazil indicate that membership turnover is slightly lower for our web-based offerings than for our AOLA country services, although we believe this slight improvement is not sufficient to enable us to achieve cash self-sufficiency with available cash.

     We launched our broadband service in Brazil, AOL MAXX, nationally in August 2003. Our broadband service is a full-featured product offering subscribers faster Internet access through DSL and cable and unique content designed for delivery through high-speed channels. Subscribers to our broadband services in Brazil can select either our AOLA country service or our web-based service. The pricing of our broadband service in Brazil varies depending upon our telecommunications partner. We also continue to test broadband products in Mexico, although at present we do not have plans to launch nationally. A decision on whether or not to launch our broadband service in Mexico will depend on our ability to reach agreement with a broadband partner on favorable economic terms. Approximately 7.2% of the membership totals as of September 30, 2004, were subscribers to our broadband interactive services in Brazil.

     In June 2000, we entered into a ten-year strategic agreement 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 interactive services in Brazil as the principal means of accessing Banco Itaú’s interactive financial services. Banco Itaú customers who become subscribers to the full AOL country services and the AOL Total web-based services are entitled to a 20% discount off the standard price. Subscribers of all of the other prices plans are entitled to smaller discounts, except broadband subscribers who are not entitled to any discount.

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     In January 2003, we entered into a five-year agreement with McDonald’s in Brazil to market our service via kiosks in McDonald’s restaurants in Brazil. We paid McDonald’s an initial fee of approximately $2.1 million and are required to pay an annual maintenance fee of up to approximately $1.3 million over the term of the agreement. The maintenance fee amount is based upon the number of restaurants containing operating kiosks, is denominated in Brazilian reals and is subject to adjustment based on the rate of inflation in Brazil. In addition, we also are required to pay McDonald’s a fee for each new member who becomes a paying member of our service in Brazil. We launched the project in a limited number of restaurants in October 2003, but the implementation of this agreement has been subject to a number of delays and still has not been fully implemented.

     In March 2004, we modified our agreement with McDonald’s under which, among other things, McDonald’s was required to establish functioning kiosks in 550 of its restaurants by August 31, 2004. On that date, we and McDonald’s concluded that only 375 restaurants were functioning. Therefore, McDonald’s paid us a penalty of approximately $0.8 million. For accounting purposes the amount was netted against our initial investment of $2.1 million and will reduce our amortization of the balance of our investment. The next measurement date will be March 31, 2005, at which point the required target is to establish functioning kiosks in 600 of its restaurants.

     Implementation under the terms of the modified agreement remains behind schedule, and we do not expect that McDonald’s will be able to fully implement the agreement or satisfy its other obligations under the agreement by March 31, 2005, as required. To date, the productivity rates have been low in restaurants where kiosks have been established. We no longer expect McDonald’s to become a significant member acquisition channel. If we determine that the McDonald’s marketing agreement were to be non-viable, it would result in a net impairment charge of approximately $0.7 million related to the initial fee we paid McDonald’s in 2003 which is currently being amortized over the life of the agreement. Although failure to successfully implement the McDonald’s agreement will negatively impact our future membership levels, the financial impact is not expected to be material in 2004. Depending upon the results at the next measurement date, management will assess all commercial and legal options. The outcome of these decisions may materially affect our financial results in 2005. Going forward, we expect our primary member acquisition channel in Brazil to be our marketing relationship with Banco Itaú.

     Commencing in the second quarter of 2002, we began to reduce our spending on acquisition marketing activities and we began to increase our reliance on co-branded and joint marketing arrangements, where a third-party partner is responsible for implementing a significant percentage of the marketing effort. Our principal marketing arrangements are our strategic marketing agreement with Banco Itaú and our McDonald’s marketing agreement, both in Brazil. In Mexico and Puerto Rico, we have continued our reliance on existing distribution channels, focusing primarily on targeted increases in the number of kiosks located at retail locations such as shopping malls and general merchandise stores. Our reliance on the marketing efforts of strategic partners has reduced the rate at which we use cash and has lowered our sales and marketing expenses, since costs incurred by our partners are not accounted for in our results. However, reliance on third-party arrangements has also increased the potential for unforeseen events and delays over which we have limited control, as has been the case with McDonald’s in Brazil. Failure to achieve our expected subscriber objectives pursuant to the Banco Itaú agreement would negatively impact our future membership levels.

     At September 30, 2004, our ending membership base was approximately 400,000 members, down from approximately 418,000 members at June 30, 2004. Membership in our Banco Itaú co-branded service was approximately 103,000 members at September 30, 2004, as compared with approximately 108,000 members at June 30, 2004, and accounted for approximately 26% of our total membership base. The decline in total membership during the third quarter of 2004 continued to be driven by low levels of new member registrations, which were insufficient to offset membership losses from attrition. During the third quarter of 2004, the banking system in Brazil experienced a general strike that lasted approximately 30 days. We believe that this event generated a small negative impact in our volume of new member registrations for the Banco Itaú co-branded services. Strong price competition from providers of free and paid Internet services in Brazil, as well as increased competition from broadband providers in Mexico, continue to negatively impact member acquisition and retention. Registration rates also continue to be negatively impacted by the lack of progress in the implementation of the McDonald’s marketing agreement and low productivity in restaurants where kiosks have been established. Although membership turnover rates during the first three quarters of 2004 improved modestly from the comparative prior-year periods, they have remained relatively constant during the first nine months of 2004. Management does not expect improvement in membership turnover rates during the remainder of 2004 and into 2005.

     We expect that our membership base will decrease by as much as 9,000 members in the fourth quarter of 2004, driven by the loss of paying members and strong price competition from providers of free and paid Internet service in Brazil and Mexico. Future membership levels will be significantly influenced by our ability to retain current members and improve productivity in existing membership acquisition channels and our success in identifying alternative member acquisition channels.

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     Total membership counts include members of our AOLA country services, our web-based interactive services and broadband service, as well as members of the co-branded Banco Itaú services. Our membership totals also include members participating in free trial periods and retention programs. As of September 30, 2004, 90% of our members, including members still in their trial periods, had selected credit cards, direct debit and other non-cash payment options, which have a better rate of collection than cash-payment methods, as compared with approximately 81% at December 31, 2003. Approximately 11% of our total subscribers at September 30, 2004 were in free trial periods or member retention programs, compared with 14% at December 31, 2003.

     During the quarter ended September 30, 2004, we experienced a decrease in our subscription revenues as compared with the third quarter of 2003. This reduction was driven by declines in Brazil and Mexico, partially offset by a small increase in Puerto Rico. The losses in Brazil and Mexico were driven primarily by decreases in paying members. Future subscription revenue performance will be highly influenced by the extent of our success in reducing membership turnover and in attracting new members, our ability to improve productivity in existing member acquisition channels and our ability to identify alternative member acquisition channels. To date, our web-based services have not met our expectations for attracting and retaining members. We expect our subscription revenues to decrease in the future, driven by the continued decreases in paying members and by the expected change of the subscriber mix in favor of our lower-priced web-based services, rather than our higher-priced AOLA country services.

     Advertising and other revenue also decreased in the third quarter of 2004, as compared to the third quarter of 2003. We expect our advertising and other revenue to continue to decrease during the balance of 2004, as compared to 2003, as a result of our reduced membership base, our lack of success in attracting significant commitments from traditional media advertisers and the expiration of long-term contracts in 2003. Other revenues are also expected to decrease due to the replacement of our agreement to provide programming services to America Online for their Latino content area with an interim agreement containing different terms.

     We expect our revenues to decrease in the future. However, as a result of lower costs we also expect to further reduce our losses in 2004, as compared with 2003. Hosting expenses and telecommunication costs are expected to decrease, primarily as a result of negotiated reductions in network unit prices and capacity achieved in 2003, while sales and marketing expenses are decreasing as a result of lower average number of kiosks in operation and additional reductions in the distribution of CDs, which contain client software. However, on a sequential quarter basis, excluding one-time items, we expect our losses to increase modestly in the fourth quarter of 2004, as compared with each of the first three quarters of 2004, driven primarily by continued declines in revenues. In the upcoming quarters, management believes that further reductions in costs and expenses will not be sufficient to entirely offset reductions in revenue, and therefore net loss is expected to remain flat or increase modestly on a year-over-year basis. We do not expect to reach cash breakeven with current available funds. Available cash on hand at September 30, 2004 was $25.2 million, as compared with available cash on hand of $27.9 million at June 30, 2004 and of $32.9 million at December 31, 2003. Based upon our current operating budget, we expect that available cash on hand will be sufficient to fund operations into the third quarter of 2005.

     During the quarter ended September 30, 2004, our net loss applicable to common stockholders was $23.6 million, an improvement of $5.0 million as compared with the third quarter of 2003.

     Regulations relating to local telephone pricing in Brazil are currently scheduled to expire in January 2006. At such time, we believe rules governing interconnection fees between telecommunications providers may also be modified. If such rules were to be modified, we would expect our costs to increase because we would not receive payments we currently receive from telecommunications providers for routing our traffic over their lines. During the second quarter of 2004, Brazilian regulators issued for public commentary proposed rules that would accelerate the implementation of changes governing interconnection fees, but no actions have been taken as of this time. We cannot predict at this time whether or not these regulations will be enacted or, if enacted, what form of alternative rate pricing might be adopted, or what any potential effect on our business could be. These changes would also likely impact the competition for interactive services in Brazil, although we cannot predict what the impact may be.

     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, 2004 and 2003.

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

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     Revenues

     Total revenues. Our total revenues consist principally of subscription revenues, and also include revenues generated from advertising and other revenue sources.

TABLE 2 — REVENUES BY SEGMENT
(In thousands, except percentages)