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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended: March 31, 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    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

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INTRODUCTION

     Management’s discussion and analysis of results of operations and financial condition (“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. This section provides a general description of AOLA’s businesses, as well as recent developments that we believe are important in understanding the results of operations and anticipates future trends in our operations.
	•		Results of operations. This section provides an analysis of AOLA’s results of operations for the three months ended March 31, 2003 relative to the comparable period 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 March 31, 2003 and cash flows for the three months ended March 31, 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/A for the fiscal year ended December 31, 2002.

Overview

     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 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 and the AOL-branded service in Puerto Rico. We also generate additional revenues from advertising and other revenue sources. Our comprehensive online services, which are available to subscribing members, are developed on a country-by-country and regional basis and are tailored to local interests.

     The AOLA country services and the AOL-branded service in Puerto Rico 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”) interactive products. Our AOLA country services seamlessly integrate the Internet, enabling members to access and explore the Internet. We believe the AOLA country services 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 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 April 30, 2003, we offered our America Online Brazil service in 273 cities in Brazil. In July 2000, we launched our country service in Mexico, America Online Mexico. As of April 30, 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 April 30, 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 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 April 30, 2003, service in Puerto Rico was offered island-wide.

     In June 2000, we entered into a ten-year strategic alliance with Banco Itaú, one of the largest banks in Latin America. We launched a co-branded, customized version of our America Online Brazil service that Banco Itaú began marketing to its customers in December 2000 and Banco Itaú is obligated to promote the co-branded service as the principal means of accessing Banco Itaú’s interactive financial services. As of December 31, 2002, Banco Itaú reported that it had approximately 9.2 million active customers, of which 2.6 million were registered to use online banking services, primarily through Banco Itaú’s proprietary service, as well as the

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AOL co-branded service. We believe that this relationship will enable us to expand our Internet presence in Brazil by allowing us to gain access to Banco Itaú’s online as well as offline customer base.

     The Banco Itaú co-branded service is substantially the same as our AOLA country service in terms of technology and content, except that we offer a co-branded welcome screen for Banco Itaú customers, a Banco Itaú toolbar icon, a special version of our finance channel and links that directly connect Banco Itaú’s customers to its online financial services. Subscribers to the co-branded service have access to our full line of features as provided to our general customers, including e-mail with multiple AOL screen names, instant messaging, Internet access, interaction with our worldwide online community and our 24-hour customer service.

     On December 14, 2002, we amended our strategic marketing alliance with Banco Itaú. Under the new 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 service, which are staffed by promoters trained by AOL Brazil. The number of promoters will vary depending on the success of the marketing efforts, which are reviewed quarterly. 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. Potential subscribers are able to sample the co-branded service and register in the bank branches. The roll out of kiosks began and was completed in the first quarter of 2003. Banco Itaú is also required to distribute, at our direction, CD-ROM’s containing the software for the co-branded 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 service and provide exclusive online banking benefits to subscribers to the co-branded service. 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. 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.

     Banco Itaú’s customers who register for the co-branded service after December 14, 2002 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. Prior to the new agreement, Banco Itaú was required to offer its subscribers at least one hour of subsidized usage per month following the expiration of their trial period, although Banco Itaú was responsible to us only for actual usage by the subscriber. Banco Itaú is no longer required to subsidize usage for new subscribers to the co-branded service who register after December 14, 2002; however, Banco Itaú, at its option, may subsidize hours for certain customers who were subscribers to the co-branded service prior to December 14, 2002. In addition, during a short transition period, Banco Itaú is required to pay us a nominal amount for subscribers who have not used the service during the previous month and who are no longer in their free trial period.

     Under the terms of our original agreement with Banco Itaú, Banco Itaú and we established subscriber targets for the co-branded service of 250,000 verified subscribers at December 10, 2001 and 500,000 at December 10, 2002 (subsequently moved to April 30, 2003) and a secondary target of a total of 1,000,000 verified subscribers at December 10, 2002 (subsequently moved to April 30, 2003). In addition, Banco Itaú and we had established the following additional targets: (i) for the 12-month period ending December 10, 2003, revenues generated from subscribers to the co-branded service would account for at least 39% of our aggregate revenues in Brazil, (ii) on December 10, 2004, there would be at least 2,000,000 verified subscribers, and for the twelve months ended on that date revenues generated from subscribers to the co-branded service would account for at least 46% of our aggregate revenues in Brazil, and (iii) for the 12-month period ending December 10, 2005, revenues generated from subscribers to the co-branded service would account for at least 56% of our aggregate revenues in Brazil. Verified subscribers are those subscribers who have used the co-branded service in any two of the three months preceding the applicable measurement date or who have first accessed the co-branded service in the month prior to the applicable measurement date. Under the agreement, if the verified subscriber level and revenue targets were not met, Banco Itaú was required to make a reference payment to us. Banco Itaú met the subscriber target for the co-branded service of 250,000 verified subscribers at the December 10, 2001 measurement date.

     Under the terms of the new agreement, Banco Itaú and we have eliminated the subscriber targets for the period ending April 30, 2003 (which is the second measurement period under the agreement) and have replaced the targets for the remaining three years with targets based on a combination of minimum revenue levels (in the same percentages as described above for each of the next three years) and the fulfillment of the marketing commitments described above. If these new targets are not met, Banco Itaú is required to make reference payments to us. The dates for measuring performance with these new targets were moved to March 24, 2004, 2005 and 2006. The aggregate amounts that Banco Itaú will be required to pay us if the marketing or revenue targets are not met, which are subject to annual ceilings, have been reduced from an aggregate of approximately $135.4 million to approximately $60.0 million for the balance of the initial five-year marketing period. In addition, the aggregate amount that Banco Itaú would be obligated to pay us in the event of a termination of the agreement prior to March 24, 2006 has been reduced from approximately $158.0 million to approximately $70.0 million.

     In addition to attracting subscribers by offering broad geographical coverage of our country services, we make our country services accessible to a broader audience of potential subscribers by offering multiple mechanisms through which our members can

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pay us. The AOLA country services were initially launched with credit cards as the primary subscriber payment method, although Brazil concurrently offered a cash payment method known as the “boleto.” The boleto is a customary form of payment in Brazil under which Brazilian banks that we designate act as conduits for collecting the related payments. In addition, customers of certain banks in Brazil, including customers of our Banco Itaú co-branded service, have the option of permitting direct debits from their accounts for purposes of paying subscriber fees. In May 2001, we began to offer cash payment options in Mexico and Argentina. Under cash payment alternatives, members can subscribe to our AOLA country services without using a credit card, thus allowing us to reach a greater number of potential members. Members in Puerto Rico may pay their subscription fees either through credit cards or direct debit to their bank accounts. The majority of Puerto Rican members select credit cards as their payment vehicle.

     Since its introduction, the “cash payment” alternative has accounted for a substantial majority of all new member registrations in Brazil, Mexico and Argentina and as of March 31, 2003 represented the payment mechanism selected by approximately 31% of our subscribers in Brazil (other than those to the Banco Itaú co-branded service), 25% of our members in Mexico and 45% of our members in Argentina. 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 have historically been lower and less timely. As a result, in Brazil, Mexico and Argentina, we are taking steps to improve the validation of registration data provided by cash payment subscribers by requiring these subscribers to call our customer service centers to finalize their registration. In Mexico, we are also emphasizing prepaid subscription plans whereby subscribers pay in advance for service periods ranging up to one year. Results to date indicate these efforts have resulted in a reduction of the overall percentage of members who have selected the cash method as their payment option. In Mexico, prepaid plans are growing in importance and currently account for about 25% of current AOL Mexico members; however, they are not currently actively marketed in Brazil, Argentina and Puerto Rico.

     As of March 31, 2003, approximately 27% of our total subscriber base (excluding subscribers to the Banco Itaú co-branded service) has selected payment options other than credit card, direct debit or prepaid plans. We are taking steps to encourage conversion of these subscribers to non-cash payment options; for instance, we offer discounts to subscribers to our AOLA country services who choose credit card payment options. Recently, we have also eliminated free trial periods for subscribers choosing the cash payment option in Mexico.

     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 derives its revenues through the provision of interactive services from subscription revenues and advertising and other revenues. We are currently planning to test services that supplement our AOLA country services, where we may assume partial responsibility for certain operational aspects which are currently performed by America Online or third parties.

RESULTS OF OPERATIONS

Consolidated Results

     Table 1 shows the consolidated results from operations for the three-month periods ended March 31, 2003 and 2002.

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TABLE 1 — SELECTED OPERATING DATA

     Revenues. Our total revenues for the quarter ended March 31, 2003 were approximately $16.3 million, down $1.9 million from $18.2 million in the first quarter of 2002. This decline was driven by a decline of approximately $0.7 million in subscription revenues and a decline of approximately $1.1 million in advertising and other revenue. The decrease in subscription revenues as compared with the first quarter of 2002 was driven primarily by the impact of devaluation of regional currencies. Excluding the effects of devaluation, subscription revenues increased 19.8% from the comparable quarter in the prior year. The decrease in advertising and other revenues continues to reflect depressed advertising markets in Latin America and the focusing of available advertising budgets on traditional media channels by major advertisers rather than online advertising.

     Cost and expenses. Total costs and expenses for the quarter ended March 31, 2003 were approximately $40.1 million, down $31.6 million, or 44.0%, from $71.6 million in the quarter ended March 31, 2002. The decrease in total costs and expenses was driven by reductions in costs of revenues and marketing expenditures, which were driven by our strategy to target higher value members in our acquisition marketing efforts and to adjust the size of our network and call center operations to support only members who pay their fees to us on a timely basis. Devaluation of local currencies also accounted for about 20% of the improvement versus the prior year period.

     Loss from operations. For the quarter ended March 31, 2003, our loss from operations was approximately $23.8 million, an improvement of $29.7 million, or 55.5%, from the $53.4 million recorded in the comparable prior year period. The improvement was driven primarily by reductions in costs and expenses, which more than offset the impact of lower revenues as compared with the prior-year period. Devaluation of local currencies accounted for approximately $3.0 million of the improvement.

     Net loss applicable to common stockholders and loss per common share. Our net loss applicable to common stockholders, after dividends to preferred stockholders, was $31.2 million during the first quarter of 2003, an improvement of $26.4 million, or 45.8% versus a loss of $57.6 million recorded in the first quarter of 2002. Net loss applicable to common stockholders includes interest expense and dividends on our preferred shares outstanding. During the quarter ended March 31, 2003, net interest expense increased to

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$4.4 million, up from net interest income of $0.5 million in the prior-year period as a result of our issuance of $160.0 million in senior convertible notes as part of our March 2002 financing round. Dividends on preferred stock decreased to $3.0 million from $4.6 million as a result of the conversion of preferred stock to class A common stock by America Online and the Cisneros Group in support of our efforts to remain listed on the Nasdaq SmallCap Market. Our loss per share, both basic and diluted, was $0.25 per share for the three-month period ended March 31, 2003, as compared with losses per share of $0.86 in the comparable prior-year period. An increase in the weighted average number of common shares outstanding during the period from 67,059,909 to 125,303,515 accounted for approximately half of the improvement in reported earnings per share. The increase in weighted average shares of common stock outstanding resulted from the conversion of preferred stock into class A common stock in January 2003 by America Online and the Cisneros Group.

     Recent Developments and Outlook. In 2002, we implemented measures designed to better target higher-value members and to increase the efficiency of our member acquisition efforts 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. We also took steps to terminate members who were delinquent in the payment of their fees to us. As a result of these efforts, we have significantly reduced our rate of spending on marketing expenditures, 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 significant portions of the overall cost of the marketing effort.

     In the first quarter of 2003, we largely completed the termination of members who were delinquent in their payments to us. By doing so, we have been able to achieve significant 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. Telecommunications and network expense were reduced by resizing our network to meet lower peak demand, which was achieved by restricting access for members who do not make timely subscription fee payments and through the termination of members who were delinquent in their payments.

     Given our increased focus on direct marketing channels for member acquisition, we expect the implementation of partner marketing agreements such as the revised marketing agreement with Banco Itaú, and the recently completed agreement with McDonald’s in Brazil, to be our primary member acquisition vehicles during 2003. The marketing agreement with McDonald’s in Brazil will establish interactive kiosks in hundreds of McDonald’s restaurants in Brazil. Although the effectiveness of these agreements is unproven at present, we expect the timing of the growth in our membership base will be significantly influenced by the extent of the success of the revised marketing agreement with Banco Itaú and the agreement with McDonald’s. We also expect to increase our efforts to promote long-term prepaid plans in Mexico, which have experienced significantly higher membership retention levels.

     During the quarter ended March 31, 2003, our rate of member acquisition was negatively affected by our more targeted marketing efforts, and by delays in the implementation of the revised Banco Itaú and the McDonald’s marketing agreements. This resulted in a lower rate of new member additions, which was not sufficient to offset the impact from termination of members who are delinquent in their payment of fees to us and the termination of members to the Banco Itaú co-branded who failed to choose a paid subscription plan. During the quarter ended March 31, 2003, we experienced a reduction in our ending membership base to 795,000 members, as compared with 1.18 million ending members at December 31, 2002. This reduction in overall ending members did not result in a material impact on our subscriber revenues for the quarter ended March 31, 2003. Furthermore, as a consequence of this reduction, the proportion of paying members in our total membership base improved during the first quarter of 2003.

     We expect our membership base to continue to decrease during the second quarter of 2003, as a result of the continued termination of members to the Banco Itaú co-branded service who do not choose a paid subscription plan and the current levels of membership turnover being experienced by our AOL country services. We expect our membership levels to stabilize after the second quarter of 2003 and membership growth to possibly resume in the second half of 2003 once the revised marketing agreement with Banco Itaú and the McDonald’s marketing agreement are fully implemented. As of March 31, 2003, approximately 34% of our total ending membership base was comprised of members of the Banco Itaú co-branded service. We also expect that over the near term a substantial percentage of our total subscribers will continue to be in free trial periods or member retention programs.

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.

     Our total reported revenues for the three months ended March 31, 2003 were approximately $16.3 million, a decrease of more than $1.8 million, or 10.3%, as compared with revenues of $18.2 million in the first quarter of 2002. The decrease was driven by a decline of approximately $1.1 million, or 45.9%, in advertising and other revenues, although revenues from subscriptions to our AOLA country services and the AOL-branded service in Puerto Rico also declined by approximately $0.7 million. Revenue from subscription fees were $15.0 million, down 4.7% from $15.7 million in the comparable prior-year quarter, and accounted for 91.8% of total revenues. In constant currency terms, total revenues rose 12.0% before the negative translation impact of the stronger U.S. dollar,

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driven by an increase of 19.8% in subscription revenues. Advertising and other revenue fell 37.4% in constant currency terms during the first quarter of 2003, as compared with the first quarter of 2002. Information on a constant currency basis excludes the effect of foreign currency translation on reported results. Constant currency results are calculated by translating the current period results at the monthly average exchange rates of the prior-year comparable period.

     During the first quarter of 2003, Brazil accounted for $6.2 million in revenue, and represented 38.0% of total revenue, down from $8.0 million and 44.0% of total revenue in the first quarter of 2002. Revenue from Mexico was $6.0 million and accounted for 36.8% of total revenue, a decrease of $0.9 million and down from 37.9% of total revenue in the first quarter of 2002. Puerto Rico accounted for $3.4 million of revenue, an increase of $1.1 million from the comparable prior-year period, and represented 20.9% of total revenue, up from 12.9% of total revenues in the prior-year quarter ended March 31, 2002. Revenue from Argentina totaled $0.5 million and accounted for 3.1% of total revenues, down from $0.9 million and 5.0% of total revenues in the prior-year comparable quarter. Revenue from corporate and other was $0.2 million and accounted for 1.2% of total revenues, up from $33,000 and 0.2% of total revenues in the first quarter of 2002.

     Subscription revenues. Table 2 presents our subscription revenues on a consolidated and segment basis for the three months ended March 31, 2003 and 2002. We derive our subscription revenues from members paying fees to subscribe to our AOLA country services and from revenues received from America Online related to subscribers to the AOL-branded service in Puerto Rico. Subscription revenues do not include amounts paid to us by Banco Itaú on behalf of its customers for subsidies that it chooses or was required to make. Such receipts are netted against and recorded as a reduction of marketing expenses and thus are not accounted for as subscription revenues. Amounts paid directly to us by subscribers that exceed any time subsidized by Banco Itaú are included in subscription revenues. Under the terms of the revised marketing agreement, Banco Itaú is no longer required to subsidize its customers who are subscribers to the co-branded service. As a result, we expect subsidies from Banco Itaú for its customers to decrease to immaterial levels in the second quarter of 2003. For subscribers that have elected to pay their subscription fees with credit cards, we begin to recognize subscription revenues when the fees become due and are confirmed as collectible. For subscribers that pay through means other than credit cards, we begin to recognize subscription revenues when we receive payment.

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TABLE 2 — REVENUES

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     Subscription revenues for the first quarter of 2003 were $15.0 million, a decrease of 4.7%, or approximately $0.7 million, as compared to the first quarter of 2002. All segments except Puerto Rico and corporate and other experienced declines. Brazil, Mexico and Argentina subscription revenues declined by $1.0 million, $0.5 million and $0.3 million, respectively. The decrease in subscription revenues was primarily due to the impact of of devaluation on translated local currency results. In constant currency terms, subscription revenues for the quarter ended March 31, 2003 increased 24.9% in Brazil, 8.4% in Mexico and 49.7% in Puerto Rico, respectively, versus the prior-year quarter ended March 31, 2002. Subscription revenues in Argentina, however, declined by 14.7% in the first quarter of 2003 as compared with the prior-year period on a constant currency basis. As a percentage of total subscription revenue, during the quarter ended March 31, 2003, Mexico became our largest segment, accounting for 38.1% of the total. Brazil accounted for 36.9% of subscription revenues, while Puerto Rico accounted for 22.2% and Argentina for 2.7%.

     Sequentially, subscription revenue declined 2.3%, or $0.3 million, versus the quarter ended December 31, 2002. Brazil and Mexico recorded sequential declines in subscription revenue of 2.0% and 6.6%, respectively, while Puerto Rico experienced an increase of 4.7% and Argentina experienced an increase of 6.3%. Sequential results in Brazil were aided by a 5.1% quarter-over-quarter appreciation of the Brazilian real, which partially offset a 6.7% decline in local currency subscription revenues. The decline in subscription revenues in Mexico was primarily the result of a decline in the value of the peso on translated results, as local currency revenues were flat. In contrast, Puerto Rico experienced a sequential increase of 6.3% versus the fourth quarter of 2002. In constant currency terms, our subscription revenues decreased by 1.9% versus the preceding quarter.

     Current trends in subscription revenues are being negatively impacted by a decrease in new member registrations, which have been negatively impacted by reduced spending on member acquisition activities, and by delays in the implementation of the revised Banco Itaú and the McDonald’s marketing initiatives. The reduced level of new registrations has not been sufficient to offset the current high level of terminations and member turnover. Although this is impacting overall membership in the short term, the impact on revenue and net loss has been small, since the members being lost have generally been lower quality members. Subscription revenues have also been negatively impacted by an increase in our member turnover resulting from lower priced competitors, including providers of free Internet access. We expect this impact to increase over the balance of 2003. Going forward, we expect that subscription revenues will depend largely on the success of expected marketing initiatives in achieving registration of the targeted higher value members, and on our success in converting those members who register for the free trial periods and in retaining higher value members who subscribe to paid plans of the Banco Itaú co-branded service. We expect that revenue in the second quarter of 2003 will also continue to be negatively impacted versus the prior year comparable period by the devaluation of the Latin American currencies over the past year.

     At March 31, 2003 and December 31, 2002, we had deferred subscription revenues of approximately $4.3 million and $4.5 million, respectively. Deferred subscription revenues consist of fees for subscription services received or confirmed as collectible from credit card accounts and prepaid subscription plans in advance of our having earned those subscription revenues. The lack of change in our deferred subscription revenue reflects the relatively flat quarter-over-quarter performance in subscription revenues.

     Advertising and other revenues. Table 2 presents our advertising and other revenues on a consolidated and segment basis for the three months ended March 31, 2003 and 2002. These revenues are principally derived from advertising arrangements under which we receive fees from advertisements displayed on our interactive services, sponsorship or co-sponsorship arrangements that allow advertisers to sponsor an area on our interactive services in exchange for a fee and revenue sharing arrangements with local telecommunications providers. Because local telephone service in Latin America is often metered, the utilization of our AOLA country services by our members results in incremental revenues to local telecommunications companies. To encourage incremental traffic on their local networks by our members, local providers of network access may enter into agreements compensating us for routing our traffic on their networks.

     For the first quarter of 2003, revenue derived from advertising and other was $1.3 million, a decrease of 45.9%, or approximately $1.1 million, from the $2.5 million recorded in the first quarter of 2002. The overall decrease was driven by declines in advertising and other revenues in all our segments except corporate and other, reflecting continued weakness in the Latin American advertising market. Currency devaluations in Latin America reduced reported revenues from advertising and other by approximately $0.2 million, as compared with the prior year period.

     Our advertising and other revenues experienced a sequential decline of $1.2 million during the first quarter of 2003, as compared to the quarter ended December 31, 2002. We expect advertising and other revenue to decrease for the full year during fiscal 2003, as compared to results in fiscal 2002, as advertisers continue to direct limited resources to traditional media channels, rather than to online advertising and as several long-term agreements mature. We expect future advertising and other revenue to recover only along with overall market conditions. We expect to continue deriving the substantial majority of our revenues from subscriptions to our AOLA country services, rather than advertising and other revenues.

     During the three months ended March 31, 2003, we had advertising and other revenues from affiliated companies of approximately $0.7 million, as compared with $0.4 million for the first quarter of 2002. Advertising and other revenues from related parties

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consisted of revenues received from Banco Itaú related to advertising on our AOLA country service in Brazil and revenues received from America Online for programming services we provide to them for their Latino content area.

     As of March 31, 2003 and December 31, 2002, we had deferred advertising and other revenues of approximately $0.4 million and $0.5 million, respectively. Deferred advertising and commerce revenues consist of payments received in advance of our delivery of the related services and are recognized as income as the services are delivered. Our deferred revenue balance related to advertising and other is related primarily to our long-term contract with Hollywood Media Corp. The reduction in deferred advertising and other revenue is primarily related to the amortization of a long-term contract with Hollywood Media Corp, which will be fully amortized by the third quarter of 2003.

Costs and expenses

     Total cost and expenses. As shown on Table 3 below, our total costs and expenses consist of cost of revenues, sales and marketing, and general and administrative expenses.

TABLE 3 — COSTS AND EXPENSES

     For the quarter ended March 31, 2003, total costs and expenses were $40.1 million, down 44.0%, or $31.5 million, from $71.6 million reported in the quarter ended March 31, 2002. All major cost categories experienced reductions, although cost of revenues and sales and marketing accounted for over 90% of the improvement in absolute terms. The decrease in total costs and expenses was driven by reductions in costs of revenues and marketing expenditures, which were driven by our strategy to target higher value

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members in our acquisition marketing efforts and to adjust the size our network and call center operations to support only members who pay their fees to us on a timely basis. Currency devaluations reduced total reported costs and expenses by $6.6 million during the first quarter of 2003 as compared with the first quarter of 2002.

     From an operational segment perspective, the reduction in total costs and expenses in the quarter ended March 31, 2003 occurred primarily in Brazil ($15.2 million) and Mexico ($14.2 million). Our corporate and other segment and Argentina both also reduced the costs and expenses for the quarter by $1.0 million and $1.7 million, respectively, as compared with the first quarter of 2002. Puerto Rico, however, increased its costs and expenses by $0.5 million.

     Sequentially, total costs and expenses in the quarter ended March 31, 2003 declined by $9.2 million, or 18.6%, from the quarter ended December 31, 2002. Brazil, Mexico and Argentina recorded sequential declines of $3.7 million, $3.7 million and $0.2 million, respectively, while Puerto Rico experienced an increase of $0.3 million from the preceding quarter. Going forward, we expect cost and expenses to decrease in absolute terms from levels experienced in fiscal 2002, driven by the impact of currency devaluation on reported costs, the consolidation of Spanish-language member services in Argentina and negotiated reductions in network costs with local telecommunications companies. We expect that the rate of improvement in year-over-year comparisons will begin to decrease after the first half of fiscal 2003, once the impact of currency devaluations and of recent cost reduction initiatives are incorporated into the base periods.

     Cost of revenues. Our cost of revenues includes:

	•		network-related costs consisting primarily of fees paid to third parties to carry our data over their telecommunications networks;
	•		personnel and related costs for customer support and in-house product and content development;
	•		fees we pay to America Online for use of their servers that run our interactive services (i.e. hosting services);
	•		fees we pay to America Online for technical support and training;
	•		fees we pay to America Online for current period product development maintenance expense and amortization of capitalized product development costs;
	•		fees paid to third-party content providers; and,
	•		collection costs and certain miscellaneous taxes.

     Payments received from providers of local network access, who may have entered into agreements compensating us for routing our traffic on their networks, are treated as credits and reduce our cost of revenues.

     For the quarter ended March 31, 2003, our cost of revenues was $16.6 million, and accounted for 41.3% of our total costs and expenses. Compared to the quarter ended March 31, 2002, cost of revenues decreased by $15.5 million, or 48.3%, from $32.1 million and 44.8% of total costs and expenses. Although reductions were experienced in all cost categories during the quarter ended March 31, 2003, the decrease in cost of revenues was driven primarily by reductions in network and hosting expense ($14.2 million) and member services ($2.5 million). Other costs of revenue also showed an improvement of $0.5 million, driven by lower billing and collections costs, which resulted from lower membership levels. The improvements in network costs reflect the significant reduction in the number of modems that was undertaken in 2002 to size our network to reduced membership levels and other cost reductions negotiated with local telecommunications providers during the course of 2002. Additionally, the reduction in member services expense is a result of lower membership levels and actions taken to reduce costs such as outsourcing of call center employees in Brazil. Initial benefits from the consolidation of Spanish–language call centers in Argentina, which was completed in February 2003, were also experienced. These benefits were partially offset by $0.8 million of costs to reduce personnel headcount in member services and other areas. The quarter ended March 31, 2002 included a charge of approximately $3.6 million related to our reduction of network commitments. Currency devaluation reduced reported cost of revenues by $4.0 million during the quarter ended March 31, 2003.

     Going forward, we expect cost of revenues to decrease in absolute terms from levels experienced in fiscal 2002, driven by the impact of currency devaluation on reported costs, the consolidation of Spanish-language member services in Argentina and negotiated reductions in network costs with local telecommunications providers. We expect that the rate of improvement in year-over-year comparisons will begin to decrease after the first half of fiscal 2003, once the impact of currency devaluations and of recent cost reduction initiatives are incorporated into the base periods. If implemented, the supplemental services that we plan to test would also result in initial additional expenditures, although the amount of such expenditures could not be predicted at this time As of April 2003, our network provided coverage to 353 cities in our three service countries. Service in Puerto Rico is available island-wide. In the near term, we expect to maintain the number of cities in our network at current levels.

     Cost of revenues paid to related parties primarily consists of payments made or due to America Online and its affiliates for the costs of hosting, member services, product development and other technical support and training services for our country operations. During the first quarter of 2003 and 2002, the cost of these services amounted to $3.9 million and $6.2 million, respectively. As of March 31, 2003, America Online billed us approximately $3.8 million over and above amounts we have recorded in our statements of operations. The difference relates to a portion of items under dispute, primarily for support services provided by America Online. We are currently negotiating with America Online regarding the total amount in dispute and at this point do not expect to pay this

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approximately $3.8 million difference. As a result, this amount is not reflected in our consolidated statement of operations. In the event we are unable to negotiate a favorable resolution of this dispute, we may be required to recognize an incremental charge to our future cost of revenues. We are also currently negotiating the method for calculating amounts due for 2003 under our online services agreement with America Online.

     Sales and marketing. Sales and marketing expenses consist of costs to acquire and retain our members, operating expenses for our sales and marketing efforts and other general marketing costs. The costs to acquire and retain our members include direct marketing costs such as the costs to staff and operate kiosks established at retail locations, the payment of bounties to OEM and other partners who bring qualified registrations to our AOLA country services through their distribution channels and the distribution of our software on CDs to potential customers as well as the costs of brand advertising on television and in newspapers, magazines and other media. Also included in sales and marketing expense is amortization of the shares of our class A common stock issued to Banco Itaú in consideration for its entering into the strategic marketing alliance with us (see “Item 1 – Business — Strategic Alliance with Banco Itaú” in our Annual Report on Form 10-K/A for the period ended December 31, 2002, as well as Note 5 to our unaudited consolidated financial statements for the three months ended March 31, 2003).

     For the first quarter of 2003, sales and marketing expenses were $16.5 million and represented 41.3% of our total costs and expenses, a reduction of $13.9 million, or 45.7%, from $30.4 million and 42.5% of total costs and expenses in the first quarter of 2002. During the quarter ended March 31, 2003, currency devaluation reduced sales and marketing expenses by $1.7 million as compared with the prior-year period.

     The decrease in sales and marketing expenses in the quarter ended March 31, 2003, as compared with the comparable prior-year period, was driven by lower spending in both direct acquisition marketing ($10.5 million) and brand marketing ($3.4 million). The reduction in direct acquisition marketing costs was due to the greatly reduced level of CD distribution that has resulted from our strategy to target higher value members (those that have a greater likelihood of not only becoming members, but also becoming subscribers who pay on a timely basis and remain subscribers to our services for an extended period of time). As a consequence, we are focusing our acquisition marketing efforts on channels that in the past have resulted in higher subscription rates relative to their acquisition cost, such as original equipment manufacturers (“OEMs”) and direct customer interaction channels (i.e. staffed kiosks in malls, bank branches and other strategic locations offering live demonstration of the country services and immediate registration), which do not require the mass distribution of CDs containing our software. We evaluated the productivity and marginal contribution of our kiosks and as a result reduced the number of points of sales during the first quarter of 2003, as compared with the fourth quarter of 2002. This reduction in the overall number of kiosks also contributed towards lower direct marketing expense during the first quarter of 2003. Our targeted marketing efforts have also been instrumental in allowing us to significantly reduce brand marketing expenditures, since mass mailings of CDs are typically supported by heavy media spending.

     For the quarters ended March 31, 2003 and 2002, amounts received from Banco Itaú for subsidies it pays on behalf of its members were approximately $0.5 million and $1.5 million, respectively. Subsidies paid by Banco Itaú on behalf of its members are expected to largely cease during the second quarter of 2003 as a result of the revised marketing agreement with Banco Itaú. Amortization expense related to the Banco Itaú Marketing Agreement was approximately $10.3 million during each of the quarters ended March 31, 2003 and 2002.

     We expect to continue focusing member acquisition efforts on OEMs and on kiosks located in high traffic areas. As a result, we expect our brand marketing efforts to continue at current levels in the near term. We also expect our direct marketing expenses related to the operation of kiosks to decrease sequentially in the second quarter of 2003, as a result of the lower number of kiosks funded by us. We expect sales and marketing expenses to begin increasing again in the third quarter of 2003 as a result of the agreement we recently entered into with McDonalds in Brazil. As part of the agreement, AOL Brazil will pay McDonald’s an initial fee and annual fees in the aggregate amount of up to $7,000,000 over the two-year term of the agreement, as well as a fee for each new member who becomes a paying member of the AOLA country service in Brazil through this promotion.

     General and administrative. For the three months ended March 31, 2003, our general and administrative costs decreased to $7.0 million, a decline of 23.4%, or $2.1 million, from $9.1 million in the first quarter of 2002. The decrease in general and administrative expense was primarily due to lower legal expenses, reduced bad debt expense associated with advertising and other revenues and other lower miscellaneous expense. General and administrative expense for the first quarter of 2003 was impacted by a charge of approximately $0.5 million for severance expense related to terminations that took place during the period. For the quarter ended March 31, 2003, currency devaluations across our service countries reduced reported general and administrative expense by $1.0 million, as compared with the first quarter of 2002.

     We expect that our general and administrative expenses will continue to decrease modestly in the second quarter of 2003 before leveling during the second half of 2003. Both America Online and the Cisneros Group provide us with general and administrative services. For the quarter ended March 31, 2003, we incurred expenses of approximately $0.1 million for support services provided by America Online. For the quarter ended March 31, 2002, we incurred fees of approximately $1.4 million and $0.1 million for support services provided by America Online and for services provided by the Cisneros Group, respectively.

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     Other (Expenses)/Income, net. Other (expense)/income, net consists almost entirely of interest on our senior convertible notes outstanding. For the quarter ended March 31, 2003, interest expense was approximately $4.4 million, as compared to $0.1 million in the quarter ended March 31, 2002. We completed the final placement of senior convertible notes to AOL Time Warner (“AOLTW”) under the terms of the March 2002 note purchase agreement, on December 30, 2002. As a result, average debt outstanding during the first quarter of 2003 was $160.0 million, as compared to $2.1 million in the prior-year first quarter. Interest on the AOLTW notes for the first quarter of 2003 was paid through the issuance of 10,513,739 shares of our series B preferred stock. Under the terms of the AOLTW Notes, we may choose to make payment of interest through the issuance of shares of our series B preferred stock. To the extent we do so, interest expense does not represent a cash outlay. Given our focus on cash preservation, we expect future payments of interest to be undertaken through the issuance of new shares.

     The balance of other (expense)/income, net consists primarily of interest income, foreign currency gains and losses and realized gains and losses on investments. For the quarter ended March 31, 2003, other (expense) income, net was $21,000, down from $0.5 million in the quarter ended March 31, 2002. This decrease was due primarily to significantly lower foreign currency gains in the current period, as compared with the prior year period.

     Income taxes. We had a credit against income tax expense of $27,000 in the three months ended March 31, 2003, as compared with no expense or credit in the comparable period in 2002.

FINANCIAL CONDITION AND LIQUIDITY

     Current Financial Condition. Table 4 below highlights our current consolidated financial condition at March 31, 2003 and at the end of the preceding fiscal year, December 31, 2002.

TABLE 4 — FINANCIAL CONDITION (As of Balances)