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: June 30, 2004

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.

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:

w		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.
w		Results of operations. This section provides an analysis of AOLA’s results of operations for the three and six months ended June 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.
w		Financial condition and liquidity. This section provides an analysis of AOLA’s financial condition as of June 30, 2004 and cash flows for the three and six months ended June 30, 2004 and 2003.
w		Critical accounting policies. This section provides a review of our accounting policies and estimates considered most important to our reported financial condition and results.
w		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 and revenue sharing agreements with certain local telecommunications providers.

     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 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 July 31, 2004.

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

     We launched our new 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 more competitively priced. In Brazil, the web-based service allows consumers to pay for those features they need. 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” is the name of the web-based service we offer in Puerto Rico, which provides basic Internet connectivity, one email address, and minimal content. We continue to test a web-based service in Mexico, and our decision on whether or not to launch this service in Mexico will depend on these test results. We are primarily responsible for the hosting, 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 actively promote the AOLA country and the web-based services 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 service and our AOL-branded service in Puerto Rico to our new web-based services. As of June 30, 2004, approximately 22% of subscribers to our web-based services have migrated from our AOLA country services in Brazil and Argentina and the AOL-branded service in Puerto Rico.

     Our future membership levels and our economic performance will be highly influenced by the extent of success of our web-based product offerings. To date, growth of our web-based services has been slow. Approximately 18% of the membership totals as of June 30, 2004, were subscribers to our 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 this slight improvement is not sufficient to enable us to achieve cash self-sufficiency.

     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. The pricing of our broadband service in Brazil varies depending upon our telecommunications partner. We are also testing 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 the test results.

     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 interactive services in Brazil as the principal means of accessing Banco Itaú’s interactive financial services. Banco Itaú customers who become subscribers to the co-branded services are currently entitled to a 20% discount off the standard price for the unlimited, bundled service plan.

     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 fee of up to $1.0 million over the term of the agreement. 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 is required to establish functioning kiosks in 550 of its restaurants by August 31, 2004. Based on the current rate of implementation of kiosks in its restaurants, we do not expect McDonald’s to meet this target and expect they will be contractually obligated to refund to us a portion of our initial investment of $2.1 million.

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     Implementation under the terms of the modified agreement is currently behind schedule, and we do not expect that McDonald’s will be able to fully implement the agreement by the first quarter of 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. Under the terms of our modified marketing agreement, McDonald’s has until March 2005 to comply with its obligations. If we were to determine that the McDonald’s marketing agreement is not viable, it would result in a net impairment charge of approximately $0.8 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. 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 portion of the marketing effort. Our principal marketing arrangements were 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 delays over which we have limited control, as has been the case with McDonald’s in Brazil. Failure to achieve our internal subscriber objectives pursuant to the Banco Itaú agreement or the McDonald’s agreement will negatively impact our future membership levels.

     At June 30, 2004, our ending membership base was approximately 418,000 members, down from approximately 433,000 members at March 31, 2004. Membership in our Banco Itaú co-branded service was approximately 108,000 members at June 30, 2004, as compared with approximately 104,000 members at March 31, 2004, and accounted for approximately 26% of our total membership base. The decline in total membership during the second quarter of 2004 continued to be driven by low levels of new member registrations, which were insufficient to offset membership losses from attrition. Strong price competition from providers of free and paid Internet services in Brazil, as well as increased competition from broadband in Mexico, continues to negatively impact member acquisition and retention. Registration rates also continued 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. Our membership turnover rates continue to improve modestly in the Banco Itaú segment of our Brazil business, although not sufficiently to stem losses from reduced levels of marketing activities and continued competitive pressures. Excluding the Banco Itaú portion of our business, membership turnover has not improved in Brazil. Membership turnover appears to have stabilized in Mexico but has not improved in Puerto Rico.

     We expect that our membership base will decrease by as much as 15,000 members in the third quarter of 2004, driven by attrition from strong price competition in Brazil and by continued low levels of registrations resulting from the inability to effectively implement the McDonald’s channel in Brazil. Furthermore, we expect additional membership declines in the fourth quarter of 2004. Future membership will be significantly influenced by the success or failure of our web-based interactive services, our ability or inability to retain current members and improve productivity in existing channels and our success or failure in identifying alternative member acquisition channels.

     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 service. Our membership totals also include members participating in free trial periods and retention programs. As of June 30, 2004, 87% 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 June 30, 2004, were in free trial periods or member retention programs, compared with 14% at December 31, 2003.

     During the quarter ended June 30, 2004, we experienced a decrease in our subscription revenues as compared with the second 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 reductions in paid membership. Future subscription revenue performance will be highly influenced by the extent of success of our web-based product offerings in reducing membership turnover and in attracting new members, our ability to improve productivity in existing member acquisition channels and on our ability to identify alternative member acquisition channels. To date, our web-based services have not met our expectations for attracting and retaining new members. We expect our subscription revenues to decrease throughout 2004, driven by the continued reduction in paid membership 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 second quarter of 2004, as compared to the second quarter of 2003. We expect our advertising and other revenue to continue decreasing 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 by an interim agreement with different terms.

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     Although we expect our revenues to continue to decrease in 2004 from 2003 levels, we also expect certain of our costs to decrease as well. 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 expected to continue decreasing as a result of lower average number of kiosks in operation and additional reductions in the distributions of CDs. As a result, we continue to expect to further reduce our losses in 2004, as compared with 2003. However, on a sequential quarter basis, excluding one-time items, we expect our losses to increase modestly during the second half of 2004, as compared with the first half of 2004, driven primarily by continued declines in revenues. Available cash on hand at June 30, 2004 was $27.9 million, as compared with available cash on hand of $29.3 million at March 31, 2004 and of $32.9 million at December 31, 2003. We now expect available cash on hand will be sufficient to fund operations into the second quarter of 2005, based upon our current operating budget.

     During the quarter ended June 30, 2004, our net loss applicable to common stockholders was $26.9 million, an improvement of $3.0 million as compared with the second quarter of 2003. The loss for the quarter ended June 30, 2004 included a non-cash charge of $4.0 million related to the impairment of our value-added tax receivable in Argentina. The allowance was necessary since based on our current budget projections we no longer expect to generate sufficient taxable revenues in Argentina in the future to permit recovery of this asset.

     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. 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 might be.

     Results Of Operations

Consolidated Results of Operations

     Table 1 shows the consolidated results from operations for the three and six months ended June 30, 2004 and 2003.

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TABLE 2 - REVENUES BY SEGMENT
(DolIars in thousands, except percentages)

     Subscription revenues. Table 2 presents our subscription revenues on a consolidated and segment basis for the three and six months ended June 30, 2004 and 2003.

     We derive our subscription revenues from members paying fees to subscribe to our AOLA country services and to our web-based interactive 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 chose or was required to make. Such receipts from Banco Itaú were netted against and recorded as a reduction of marketing expenses and thus were not accounted for as subscription revenues. Amounts paid directly to us by subscribers that exceeded any time subsidized by Banco Itaú were 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, subsidies from Banco Itaú for its customers have not been material since the second half of 2003, nor were they material in the first six months of 2004. We do not expect subsidies from Banco Itaú for its customers to be material in future periods. 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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     Subscription revenue for the quarter ended June 30, 2004 was $12.0 million, a decrease of 24.5%, or $3.9 million, from $15.9 million in the second quarter of 2003. The decline in subscription revenues versus the prior-year period was driven by the loss of paid members in all operating segments except Puerto Rico. The loss of paying subscribers was primarily a result of increased competition, which resulted in members lost through attrition. New member registration rates were lower than necessary to replace membership attrition, and have been negatively impacted as well by the problems related to the implementation of the McDonald’s initiative in Brazil and the lack of alternative member acquisition channels. For the second quarter of 2004, subscription revenue in Brazil decreased to $4.0 million, down approximately $2.3 million, or 37.2%, from $6.3 million in the quarter ended June 30, 2003. Subscription revenue in Mexico decreased to $4.1 million in the second quarter of 2004, down $1.5 million, or 26.9%, from $5.6 million in the second quarter of 2003. Subscription revenue in Puerto Rico, however, was flat at approximately $3.5 million in the second quarter of 2004 as compared with the second quarter of 2003.

     Exchange rate fluctuations decreased reported revenue by approximately 3.5%, or by $0.6 million, for the quarter ended June 30, 2004, as compared with the second quarter of 2003. In constant currency terms, subscription revenue decreased by 20.9%, an amount less than the reported decrease of 24.5% during the three months ended June 30, 2004. Information on a constant currency basis excludes the effect of foreign currency translation on reported results and is provided to help explain variations in reported results and provide insight into the underlying operational performance of our business. On a segment basis, in constant currency terms, subscription revenue in the second quarter of 2004 decreased by 36.0% in Brazil and 20.4% in Mexico, as compared with the quarter ended June 30, 2003.

     Sequentially, reported subscription revenue declined by 11.5%, or approximately $1.5 million, from the $13.5 million recorded in the quarter ended March 31, 2004. All segments contributed to the sequential decrease, with Brazil declining by $0.9 million, Mexico declining by $0.5 million and Puerto Rico declining by $0.1 million, as compared with the first quarter of 2004. The loss of paying members was the main factor resulting in the reduction of subscription revenue as compared with the first quarter of 2004.

     For the six months ended June 30, 2004, revenues from subscription fees were $25.5 million, a decrease of $5.4 million, or 17.4% from $30.8 million recorded in the first six months of 2003. The decline in subscription revenues during the first half of 2004 as compared with the prior-year period was driven by decreases in all segments except for Puerto Rico. For the first half of 2004, subscription revenues in Brazil and Mexico decreased by $3.0 million and $2.6 million, respectively. The decrease in subscription revenue during the first half of 2004 resulted primarily from the loss of paid members, driven by the competitive trends previously described. Currency fluctuation did not have a material impact on reported revenue during the first six months of 2004.

     Future subscription revenue performance will be highly influenced by the success or failure of our web-based interactive services, our ability or inability to retain current members and improve productivity in existing channels and our success or failure in identifying alternative member acquisition channels. We expect our subscription revenues to continue decreasing through the end of 2004, driven by the continued reduction in paid membership and by the expected increase in subscribers to our lower-priced web-based services, rather than our higher-priced AOLA country services.

     For the three- and six-month periods ending June 30, 2004, we did not have any material subscription revenues from related parties, other than revenues received from America Online for subscribers related to members of the AOL-branded service in Puerto Rico. For the three and six months ended June 30, 2004, we had subscription revenue from America Online related to members of the A OL-branded service in Puerto Rico of $3.6 million and $7.2 million, respectively. For the three and six months ended June 30, 2003, our subscription revenue from America Online related to members of the AOL-branded service in Puerto Rico was $3.5 million and $6.9 million, respectively.

     At June 30, 2004 and December 31, 2003, we had deferred subscription revenues of approximately $3.7 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.

     Advertising and other revenues. Table 2 also presents our advertising and other revenues.

     Our advertising and other revenue is derived principally from:

•		advertising arrangements under which we receive fees for advertisements displayed on our interactive services;
•		advertising sponsorship or co-sponsorship arrangements that allow advertisers to sponsor an area on our interactive services in exchange for a fee;
•		fees we receive from America Online for programming services we provide to America Online for use on their Latino content area;
•		representation fees we receive from America Online for selling advertising on their interactive services;
•		revenues we receive from providers of Internet search services; 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 and of our web-based interactive services by our members results in incremental revenues to local telecommunications companies. To encourage incremental traffic on their local networks by our

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members, some local providers of network access have entered into agreements compensating us for routing our traffic on their networks.

     For the quarter ended June 30, 2004, revenue derived from advertising and other declined to $0.7 million, a decrease of $1.1 million, or 60.0%, from $1.8 million in the second quarter of 2003. The overall decrease was driven primarily by decreases in advertising sales. All our segments, except for Argentina, reported declines in advertising and other revenue. The increase in our Argentina segment was primarily due to revenue received by us from AOL Germany for German-language call center support services that we provided to them during the second quarter of 2004. Currency exchange rate fluctuations in Latin America did not have a material impact on reported advertising and other revenue during the quarter ended June 30, 2004, as compared with the prior-year second quarter.

     Sequentially, advertising and other revenue in the quarter ended June 30, 2004, experienced a small increase of $0.2 million, or 32.8%, from the first quarter of 2004, driven by increased advertising by Banco Itaú and revenues received from AOL Germany for call center services. We expect advertising and other revenue to increase modestly from current levels during the balance of 2004, as a result of incremental advertising from Banco Itaú and other revenues for call center support services and implementation of a search services contract with Google. However, we still expect advertising and other revenues to decrease throughout 2004, as compared with 2003, despite an improved online advertising environment in Latin America. The decline will be driven by 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 expiration of our agreement to provide programming services to America Online for their Latino content area, although we are currently negotiating a new agreement with America Online. There can be no assurance that we will be able to reach agreement with America Online regarding our potential provision of these services.

     For the six months ended June 30, 2004, revenue derived from advertising and other was $1.3 million, down $1.9 million, or 59.6%, from $3.2 million in the first half of 2003. The decrease occurred across all segments except for Argentina, which experienced a small increase as a result of the provision of call center services to AOL Germany. Currency fluctuations in Latin America did not have a material impact on advertising and other revenues during the first six months of 2004, as compared with the six-month period ended June 30, 2003.

     During the three and six months ended June 30, 2004, we had advertising and other revenues from related parties of approximately $0.2 million and $0.3 million, respectively. This compares with $0.8 million and $1.0 million, respectively, for the three and six months ended June 30, 2003. Advertising and other revenue from related parties consists primarily of revenues received from America Online for programming services we provided to them for their Latino content area, representation fees we receive from America Online for selling advertising on their interactive services, call center support services from AOL Germany and advertising by Banco Itaú on our AOLA country service in Brazil.

     As of June 30, 2004 and December 31, 2003, we had deferred advertising and other revenues of approximately $0.4 million and $0.3 million, respectively. Deferred advertising and other revenues consist of payments received in advance of our delivery of the related services and are recognized as income as the services are delivered.

Costs and expenses

     Total cost and expenses. Table 3 below shows our total costs and expenses on a consolidated and segment basis for the three and six months ended June 30, 2004 and 2003. Our total costs and expenses consist of cost of revenues, sales and marketing, and general and administrative expenses.

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TABLE 3 - COSTS AND EXPENSES
(DolIars in thousands, except percentages)

     Cost of revenues. Our cost of revenues includes:

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

     Certain payments received from providers of local network access, who 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 June 30, 2004, our cost of revenues was $8.7 million and comprised 27.7% of our total costs and expenses. Compared to the prior-year quarter ended June 30, 2003, cost of revenues decreased by $6.3 million, or 42.0%, from $15.0 million and represented 38.1% of total costs and expenses. During the quarter ended June 30, 2004, the decrease in cost of revenues was driven primarily by reductions in network and hosting expense ($2.9 million), member services ($2.6 million) and content ($0.6 million). The improvements in network costs reflect the significant reduction in the number of modems that was undertaken to size our network to reduced membership levels and other cost reductions negotiated with local telecommunications providers in 2003. 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 and the consolidation of Spanish–language call service centers in Argentina. Currency fluctuations decreased reported cost of revenues during the quarter ended June 30, 2004 by approximately $1.0 million.

     Sequentially, costs of revenues declined by $0.6 million, or by 6.9%, from $9.3 million in the quarter ended March 31, 2004, primarily as a result of lower member services expense.

     For the six months ended June 30, 2004, our cost of revenues was $18.0 million and comprised 30.7% of our total costs and expenses. Compared to the six-month period ended June 30, 2003, cost of revenues decreased by approximately $13.5 million, or 42.9%, from $31.5 million and 39.8% of total costs and expenses. During the first half of 2004, the decrease in cost of revenues reflected the underlying trends affecting the quarter ended June 30, 2004, namely reductions in network and telecommunications expense and member services

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expense. Currency devaluation reduced reported cost of revenues by $2.7 million during the six-month period ended June 30, 2004 as compared to the prior-year period.

     We expect cost of revenues to decrease modestly in 2004, as compared with 2003, as we continue to benefit from negotiated reductions in network costs, consolidation of Spanish-language member services in Argentina and outsourcing of call center operations in Brazil. However, we expect smaller improvements in year-over-year comparisons as historical currency devaluations and cost reductions become incorporated into base periods. As of July 31, 2004, our network provided coverage to 414 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 or near 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, maintenance, product development and other technical support services for our country operations pursuant to our online services agreement with America Online. For the three and six months ended June 30, 2004, cost of revenues incurred with related parties amounted to $2.1 million and $4.3 million, respectively. For the three and six months ended June 30, 2003, cost of revenues incurred with related parties amounted to $2.4 million and $6.4 million, respectively.

     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 partners who bring qualified registrations to our AOLA country services and our web-based 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 value 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 for the period ended December 31, 2003, as well as note 5 to our unaudited consolidated financial statements included herein). Until July 2005, we expect to incur approximately $9.3 million of expense each quarter related to the value of shares received by Banco Itaú under our strategic marketing agreement. For the five years following July 2005, we expect to incur approximately $2.2 million of quarterly expense related to this marketing agreement.

     For the quarter ended June 30, 2004, sales and marketing expenses were $12.4 million, a decrease of $5.0 million, or 28.8%, from $17.4 million in the second quarter of 2003. Sales and marketing expenses in the second quarter of 2004 accounted for 39.5% of total costs and expenses, compared with 44.4% in the prior year period. The decrease in sales and marketing expenses in the second quarter of 2004, as compared with the second quarter of 2003, was driven primarily by lower spending in both direct acquisition marketing ($2.7 million) and brand marketing ($3.4 million). The decrease in direct acquisition marketing costs was due mainly to efforts to reduce unproductive marketing activities which resulted in a reduction in the number of kiosks promoting our interactive services. We expect our sales and marketing expenses to decrease modestly for the remainder 2004, as compared with 2003. During the second quarter of 2004, currency fluctuations reduced reported sales and marketing expenses by $0.4 million as compared with the prior-year second quarter.

     We monitor the projected productivity of our kiosks located at Banco Itaú branches and have elected not to operate those with expected levels of registrations which are not economically beneficial. This has resulted in the closure of a substantial majority of the kiosks which Banco Itaú is obligated to operate under the revised Strategic Marketing agreement. In addition, we have also cancelled certain CD distributions Banco Itaú is obligated to make. As per the terms of the revised marketing agreement, we received from Banco Itaú a payment of approximately $1.0 million during the second quarter of 2004 in exchange for advertising on our service and in lieu of these marketing activities they were obligated to undertake. 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 expect to receive such a payment in the amount of $0.5 million from Banco Itaú in the third quarter of 2004, and another payment of approximately $0.8 million in the fourth quarter of 2004. Such payments from Banco Itaú are reflected as funds received from financing activities in our statement of cash flows and reduce future marketing expense associated with the amortization of shares given to Banco Itaú under our strategic marketing agreement. We have the right to choose to redeploy or reinstate some of the branches in the future, in which case we would forego such payments from Banco Itaú.

Sequentially, sales and marketing expenses increased by approximately $0.3 million (2.1%) from $12.1 million in the quarter ended March 31, 2004. This increase was primarily due to an increase in brand marketing related to the launch in June 2004 of version 9.0 of our AOLA country service software in Mexico. We expect to incur additional expense of approximately $0.8 million in the third quarter of 2004 in connection with this launch.

     For the six months ended June 30, 2004, sales and marketing expenses were $24.5 million, a decrease of $9.4 million, or 27.8%, from $34.0 million for the six months ended June 30, 2003. The decrease in sales and marketing expenses in the first half of 2004 was driven by lower spending in both direct acquisition marketing ($5.6 million) and brand marketing ($3.9 million). As discussed above, the decrease in direct acquisition marketing costs was due mainly to efforts to reduce unproductive marketing activities which resulted in a reduction in the number of kiosks promoting our interactive services. During the six months ended June 30, 2004, currency devaluation reduced sales and marketing expenses by $0.4 million as compared with the first half of 2003.

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     For the three and six month periods ended June 30, 2004, sales and marketing expenses paid to related parties were not material. For each of the three and six month periods ended June 30, 2003, sales and marketing expenses paid to related parties was $0.3 million. For the three and six months ended June 30, 2004, amounts received from Banco Itaú for subsidies it pays on behalf of its members were approximately $24,000 and $0.1 million, respectively. For the three and six months ended June 30, 2003, amounts received from Banco Itaú for these subsidies were approximately $0.4 million and $0.9 million, respectively. Subsidies paid by Banco Itaú on behalf of its members largely ceased during the third quarter of 2003 as a result of the revised marketing agreement with Banco Itaú, under which Banco Itaú is no longer required to make subsidy payments to us on behalf of its members to the co-branded service. Amortization expense related to the Banco Itaú marketing agreement was approximately $9.3 million and $10.4 million during the quarters ended June 30, 2004 and 2003, respectively. Amortization expense related to the Banco Itaú marketing agreement for the six-month periods ended June 30, 2004 and 2003 was approximately $19.0 million and $20.8 million, respectively.

     We expect to continue focusing our member acquisition efforts on existing marketing arrangements with third parties, emphasizing kiosks located in high traffic areas, including bank branches and retail outlets. However, reliance on third-party arrangements has also increased the potential for unforeseen delays over which we have limited control, as has been the case with McDonald’s in Brazil.

     General and administrative. General and administrative expenses consist primarily of personnel-related expenses, office lease payments, legal, tax and travel-related expenses, among others.

     For the three months ended June 30, 2004, our general and administrative costs decreased by approximately $0.6 million, or 8.3%, to $6.3 million, down from $6.8 million in the second quarter of 2003. The decrease in general and administrative expense was primarily due to fewer employees in the second quarter, as compared to the prior-year period. Currency fluctuations across our service countries did not have a material impact on our reported general and administrative expense, as compared with the prior-year period. On a sequential basis, our general and administrative costs were essentially flat as compared with the first quarter of 2004.

     We expect our general and administrative expenses to continue at or near current levels during the balance of 2004. For the quarter and six months ended June 30, 2004 and 2003, expenses incurred in general and administrative support services provided by related parties were not material.

     Argentina Value-Added Tax Allowance. We have not been successful in achieving growth in our interactive services in Argentina and do not expect future growth for this business. During the second quarter of 2004, based on projections of our taxable revenue in Argentina, we determined that it was not likely that we would be able to recover our value-added tax (“VAT”) receivable from the Argentine government with a value of approximately $4.0 million at June 30, 2004. This receivable, which arose in the normal conduct of our business, can only be recovered as we make sales in Argentina and make collections from our customers. As a result, in the quarter ended June 30, 2004, we recorded a non-cash charge to establish an allowance in order to reduce the value of this VAT asset to zero. We do not expect our interactive services in Argentina to form a material part of our operations in the foreseeable future. We expect that our call center operations in Argentina will continue to be the primary focus of our activities in Argentina.

     Interest Expense. Interest expense consists almost entirely of interest on our senior convertible notes outstanding. During the quarter ended June 30, 2004, interest expense was $4.4 million, down $0.1 million as compared with $4.5 million in the prior-year first quarter. We expect quarterly interest expense to remain at current levels since we expect our average balance of senior convertible notes outstanding will remain at current levels. For the six months ended June 30, 2004, interest expense was $8.5 million, compared with $8.9 million in 2003. Interest expense in the first quarter of 2004 benefited from a one time correction of historical interest paid.

     Interest on our senior convertible notes for the second quarter of 2004 was paid through the issuance of 5,945,725 shares of our series B preferred stock to Time Warner. Under the terms of the our senior convertible notes, we may choose to make payment of interest through the issuance of shares of our series B preferred stock, with the exception of the last payment, which must be paid in cash (approximately $3.2 million). To the extent we make payment through the issuance of shares, interest expense does not represent a cash outlay. Given our focus on cash preservation, we expect to continue to pay the interest on the senior convertible notes through the issuance of additional stock; consequently, interest expense should not have a cash impact on our financial condition, except for the final interest payment which must be paid in cash. However, depending on market conditions at the time, a decision by us to pay the interest on the senior convertible notes through the issuance of additional shares of stock could result in significant additional dilution to our existing shareholders.

     Other income, net. Other income, net consists primarily of foreign currency gains and losses and realized gains and losses on investments. For the quarter ended June 30 2004, other income, net was approximately $0.3 million, as compared with $15,000 in the quarter ended June 30, 2003. For the six-month periods ended June 30, 2004 and 2003, other income, net was approximately $0.4 million and $27,000, respectively.

     Income taxes. For each of the three months ended June 30, 2004 and 2003, we had an income tax expense of $29,000. For the six months ended June 30, 2004, we had income tax expense of $60,000, as compared with income tax expense of 2,000 in the comparable prior-year period.

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     Loss from operations. For the quarter ended June 30, 2004, our loss from operations was approximately $18.7 million, an improvement of $2.9 million, or 13.3%, from a loss of $21.5 million recorded in the second quarter of 2003. The improvement was driven primarily by reductions in costs and expenses of $11.9 million, and partially offset by the establishment of the $4.0 million valuation allowance against our Argentina VAT receivable. On a sequential quarter basis, our loss from operations increased by $5.3 million, up 39.8% from $13.3 million in the first quarter of 2004. This increase was driven primarily by the valuation allowance established against the Argentina VAT receivable and by the decrease in revenues of $1.3 million. Excluding the impact of the VAT allowance, the Company expects its losses to increase modestly during the second half of 2004, as compared with the first six months of 2004 due to lower revenue caused by the loss of paid members.

     For the six months ended June 30, 2004, our loss from operations was $32.0 million, an improvement of $13.3 million, or 29.4%, from $45.3 million in the comparable prior-year period. The improvement was driven by decreases in our costs and expenses of $24.6 million, partially offset by the reduction in revenues of $7.3 million and the establishment of the $4.0 million valuation allowance against our Argentina VAT receivable.

     Net loss applicable to common stockholders and loss per common share. Our net loss applicable to common stockholders, after interest expense, other expenses and dividends to preferred stockholders, was $26.9 million in the second quarter of 2004, an improvement of approximately $3.0 million, or 10.2%, as compared with a loss of $29.9 million recorded in the second quarter of 2003. Our loss per share, both basic and diluted, was $0.20 per share for the quarter ended June 30, 2004, as compared with losses per share, basic and diluted, of $0.22 in the prior-year quarter. 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.

     Net loss applicable to common stockholders includes interest expense and dividends on our preferred shares outstanding. For the quarter ended June 30, 2004, interest expense was approximately $4.4 million, as compared to $4.5 million in the prior-year quarter ended June 30, 2003. We expect interest expense to remain at $17.6 million per year at least through March 2007, when our senior convertible notes mature. Dividends on preferred stock were approximately $4.1 million, as compared to $3.9 million for the same quarter of the previous year, driven by the issuance of additional shares as payment of interest owed under our senior convertible notes.

     On a sequential quarter basis, our net loss applicable to common stockholders increased by $5.8 million, or 27.6% from $21.1 million in the first quarter of 2004. Our loss per share of $0.20 per share in the quarter ended June 30, 2004, both basic and diluted, increased from $0.16 per share, basic and diluted, as a result of the factors discussed above.

     For the six months ended June 2004, our net loss applicable to common stockholders was $47.9 million, an improvement of $13.2 million, or 21.6%, as compared with a loss of $61.1 million in the first half of 2003. Our loss per share during the first six months of 2004, both basic and diluted, was $0.35 per share, as compared with a loss per share, both basic and diluted, of $0.47 for the prior-year first half.

Financial Condition and Liquidity

     Current Financial Condition. Table 4 below highlights our consolidated financial condition at June 30, 2004 and at the end of the preceding fiscal year, December 31, 2003.

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TABLE 4 - FINANCIAL CONDITION (As of Balances)
(Dollars in thousands, except percentages)

     At June 30, 2004, we had $27.9 million of cash and cash equivalents, long-term debt of $160.0 million and a capital deficiency of $142.5 million. This represented a reduction in our cash and cash equivalents position of $5.0 million as compared to December 31, 2003, and a reduction of $1.5 million as compared with our cash balances on March 31, 2004. For the six-month period ended June 30, 2004, the decline in our cash and cash equivalents position resulted primarily from the financing of our loss from operations. Improved working capital performance aided our cash position through one-time items, such as the collection of old accounts receivable, and an increase in our payables to affiliates. We expect our rate of cash utilization to increase in the second half of 2004, driven by a modest increase in our losses and a reversal of certain working capital items. Our long-term debt position did not change, and is comprised entirely of our senior convertible notes.

     Our capital deficiency increased by $9.5 million as compared with our positions at December 31, 2003. The increase in our capital deficiency reflects our net loss for the six months ended June 30, 2004 of $40.2 million and the impact on the foreign currency translation adjustment from the appreciation of local currencies since December 31, 2003. These impacts were partially offset by the continued amortization of the Banco Itaú unearned services account during the first half of 2004, payments received from Banco Itaú in lieu of marketing activities it was obligated to undertake amounting to $2.4 million and the payment of interest on our senior convertible notes through the issuance of additional stock.

     Our current assets at June 30, 2004 amounted to $36.2 million, a decrease of $8.0 million, or 18.1%, as compared to $44.2 million at December 31, 2003. The decrease in current assets was driven primarily by the decrease in cash and cash equivalents, and by the establishment of the valuation allowance against our Argentine VAT receivable asset, which reduced this asset to zero. Current liabilities decreased $4.2 million, or 15.3%, to $23.0 million at June 30, 2004, from $27.2 million at December 31, 2003 driven by reductions in other accrued expenses and liabilities, accrued personnel costs and trade accounts payable. The reduction in accrued personnel costs reflected the payment of annual bonuses to employees, while the reduction in other accrued expenses and liabilities resulted mainly from our reduced spending on marketing activities and operating costs, and the payment of certain historical penalties related to the downsizing of our network.

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     We now expect that our cash on hand of $27.9 million as of June 30, 2004 will be sufficient to fund operations into the second quarter of 2005, based upon our current operating projections. Our expectations underlying our current operating budget and the duration of funding sufficiency are based upon certain estimates that we believe are commercially reasonable in relation to our historical experience. These estimates include paid membership levels and turnover, consumer acceptance of our web-based services, pricing of our services and continued cost reductions. These estimates are subject to a number of risks and uncertainties more particularly described in “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2003, and there can be no assurance that they will turn out to be accurate. As of June 30, 2004, approximately $1.0 million of our cash on hand served to collateralize our obligations under executive-retention agreements and is not, and will not be, available for general corporate use.

     We continue to explore various opportunities that could provide us with additional cash resources in the future to operate our business. We do not expect to reach cash flow breakeven with available cash on hand. During the second quarter of 2004, we hired an investment banking firm to help us explore potential strategic alternatives.

     In addition, we have not identified additional sources of financing necessary to repay the $160.0 million senior convertible notes that will be due in March 2007. There can be no assurance that we will be able to identify additional sources of capital to repay our debt obligations or operate our business. An additional restriction on our ability to obtain additional funding is that the holders of our senior convertible notes can require that the proceeds of any such financing or the sale of assets be used to repay the senior convertible notes. Additionally, there is no commitment or obligation from America Online, the Cisneros Group or Banco Itaú to fund any of our future requirements. Furthermore, Time Warner has stated that it does not intend to provide us with additional funding.

     Cash Flows and Liquidity. Table 5 illustrates our consolidated cash flows and capital spending by segment for the three- and six-month periods ended June 30, 2004 and 2003:

TABLE 5 - CASH FLOWS & CAPITAL SPENDING
(DolIars in thousands, except percentages)