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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(MARK ONE)

000-21193
Commission File Number

SUNTERRA CORPORATION
(Exact name of registrant as specified in its charter)

1781 Park Center Drive
Orlando, Florida 32835
(407) 532-1000
(Address of principal executive offices including zip code)

(407) 532-1000
(Registrant’s telephone number including area code)

WWW.SUNTERRA.COM
(Registrant’s Website Address)

             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. o Yes x No

             Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12,13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a bankruptcy court. x Yes o No

             Number of shares outstanding of the issuer’s common stock, par value $0.01 per share, at November 8, 2002: 18,045,077.

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SUNTERRA CORPORATION

INDEX

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SAFE HARBOR STATEMENT - CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including in particular statements about our plans, objectives, expectations and prospects under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. You can identify these statements by forward-looking words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “seek” and similar expressions. Although we believe that the plans, objectives, expectations and prospects reflected in or suggested by our forward-looking statements are reasonable, those statements involve uncertainties and risks, and we can give no assurance that our plans, objectives, expectations and prospects will be achieved. Important factors that could cause our actual results to differ materially from the results anticipated by the forward-looking statements are contained in our Annual Report on Form 10-K for the year ended December 31, 2001 under the headings “Business-Risk Factors”, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in that report and herein and relate, without limitation, to matters arising from the emergence of the Company and certain of its subsidiaries as debtors from proceedings under Chapter 11 of the Bankruptcy Code. Any or all of these factors could cause our actual results and financial or legal status to differ materially from those expressed or referred to in any forward-looking statement. All written or oral forward-looking statements attributable to us are expressly qualified in their entirety by these cautionary statements. Forward-looking statements speak only as of the date on which they are made.

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SUNTERRA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands except per share data)
(Unaudited)

(a) Interest expense is comprised of contractual interest of $3,967, net of capitalized interest of $25 for the two months ended September 30, 2002. Interest expense is comprised of contractual interest of $4,401 and $15,864, net of unaccrued interest of $3,358 and $10,096 and capitalized interest of $16 and $94 for the month ended July 31, 2002 and the three months ended September 30, 2001, respectively.

The accompanying notes are an integral part of these condensed consolidated financial statements.

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SUNTERRA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands except per share data)
(Unaudited)

(a) Interest expense is comprised of contractual interest of $32,971 and $46,478, net of unaccrued interest of $23,558 and $30,296 and capitalized interest of $250 and $235 for the seven months ended July 31, 2002 and the nine months ended September 30, 2001, respectively.

The accompanying notes are an integral part of these condensed consolidated financial statements.

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SUNTERRA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except per share data)
(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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SUNTERRA CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)

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The accompanying notes are an integral part of these condensed consolidated financial statements.

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SUNTERRA CORPORATION
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share amounts)
(Unaudited)

Note 1 – Background and Basis of Presentation

The operations of Sunterra Corporation (Sunterra) and its wholly owned subsidiaries consist of (i) marketing and selling vacation ownership interests at its resort locations and off-site sales centers, which entitle the buyer to use a fully-furnished vacation residence, generally for a one-week period each year in perpetuity (Vacation Intervals), and vacation points which may be redeemed for occupancy rights, for varying lengths of stay, at participating resort locations (Vacation Points, and together with Vacation Intervals, Vacation Interests), both of which generally include a deeded, fee-simple interest in a particular unit, (ii) marketing and selling Vacation Points representing a beneficial interest in a trust which holds title to vacation property real estate for the benefit of purchasers of those points, (iii) leasing Vacation Intervals at certain Caribbean locations, (iv) acquiring, developing, and operating vacation ownership resorts, (v) providing consumer financing to individual purchasers for the purchase of Vacation Interests at its resort locations and off-site sales centers, and (vi) providing resort rental management and maintenance services for which the Company (defined below) receives fees paid by the resorts’ homeowners’ associations.

The accompanying condensed consolidated financial statements have been presented in accordance with SOP 90-7 and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. However, in the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the seven months ended July 31, 2002 and the two months ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002.

These statements should be read in conjunction with the audited financial statements and footnotes included in the Company’s 2001 Annual Report on Form 10-K. Accounting policies used in preparing these financial statements are the same as those described in such Form 10-K, unless otherwise noted herein. As a result of adopting fresh start reporting upon emerging from Chapter 11 status, the Company’s financial statements are not comparable with those prepared before the Plan was confirmed, including the historical condensed consolidated financial statements included herein. References to “Predecessor” refer to Sunterra and its subsidiaries through July 31, 2002. References to “Successor” refer to Sunterra and its subsidiaries on or after August 1, 2002.

As of December 31, 2001, the Company’s consolidated stockholders’ deficiency of $335.8 million, its status as a debtor-in-possession operating under Chapter 11 Bankruptcy Court protection, the lack of approval of the proposed plan of reorganization, and the Company’s lack of binding commitments for exit and post-emergence working capital financing, gave rise to substantial doubt about the Company’s ability to continue as a going concern. As further described in Notes 2 and 5 below, in June and July of 2002, the Company’s reorganization plan was confirmed by the Bankruptcy Court and the Company successfully obtained exit and working capital financing and emerged from Chapter 11. Accordingly, management believes that the restructuring of the Company’s business and its capital structure have provided the Company the ability to continue as a going concern. The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which assumes continuity of operations and realization of assets and settlement of liabilities and commitments in the normal course of business.

Certain reclassifications were made to the 2001 condensed consolidated financial statements to conform to the 2002 presentation.

Note 2 – Reorganization of the Business Under Chapter 11

On May 31, 2000 (the Petition Date), Sunterra Corporation and 36 of its wholly owned subsidiaries each filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code (Chapter 11) in the United States Bankruptcy Court for the District of Maryland (Baltimore Division) (the Bankruptcy Court). Two additional subsidiaries subsequently filed voluntary petitions under Chapter 11 of the Bankruptcy Code. The bankruptcy cases of Sunterra Corporation and its subsidiaries that filed for relief under the Bankruptcy Code were jointly administered. These entities were operated as debtors-in-possession (the Debtor Entities) in accordance with the provisions of the Bankruptcy Code. Sunterra Corporation’s subsidiaries that did not file voluntary petitions for relief under Chapter 11 (the Non-Debtor Entities, and collectively with the Debtor Entities, the Company) continued to operate their respective businesses outside the protection of the Bankruptcy Code.

Plan of Reorganization

On January 31, 2002, the Debtor Entities filed a joint plan of reorganization (as amended on February 20, 2002, April 19, 2002, April 26, 2002 and May 9, 2002, the Proposed Plan) and accompanying disclosure statements with the Bankruptcy Court. The Bankruptcy Court confirmed the Proposed Plan (the Plan) by an order entered on June 21, 2002. According to the terms of the Plan, it became effective when certain conditions, as set forth in the Plan, were either satisfied or waived by the Official Committee of Unsecured Creditors. The conditions to the effectiveness of the Plan were fulfilled on July 29, 2002 (the Effective Date) and the Debtor Entities emerged from their Chapter 11 proceedings on that date.

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The Plan provides for (i) payment in full of allowed administrative and fee claims (which include, among other things, assumed contracts, professional fees and indenture trustee fees and expenses), debtor-in-possession lender claims and priority taxes; and (ii) settlement and resolution of all other claims against the Debtor Entities as of the Petition Date. The Plan provides for distributions to creditors of: (i) cash, (ii) new debt securities, (iii) shares of common stock of the reorganized Company, and (iv) warrants for the purchase of New Sunterra Stock. Certain of the unsecured creditors have also received or will receive non-transferable beneficial interests in a trust to be established for purposes of pursuing certain claims against third parties. Pursuant to the terms of the Plan, the Debtor Entities are deemed substantively consolidated and treated as a single entity to eliminate: (i) cross-corporate guaranties by one Debtor Entity of another Debtor Entity, (ii) duplicate claims against more than one Debtor Entity, and (iii) intercompany claims among the substantively consolidated Debtor Entities. As a result of the substantive consolidation, each claim filed against one of the Debtor Entities is deemed to be filed against all of the debtors as a single entity. The consolidated assets create a single fund from which all claims against the consolidated Debtor Entities will be satisfied.

Under the Bankruptcy Code, pre-petition liabilities and creditors must be satisfied before stockholders may receive any distribution. The Plan provides for no distributions to the holders of the Predecessor company’s common stock, and all then outstanding shares of such common stock were canceled as of the Effective Date.

Pursuant to the Plan, the following transactions were completed on or about the Effective Date:

Fresh Start Adjustments

The accompanying condensed consolidated financial statements have been presented in conformity with the American Institute of Certified Public Accountants’ (AICPA) Statement of Position 90-7, Financial Reporting By Entities In Reorganization Under the Bankruptcy Code, as amended (SOP 90-7). In accordance with SOP 90-7, the Company was required to adopt fresh-start reporting because the holders of the existing voting shares immediately prior to filing and confirmation of the Plan received less than 50% of the voting shares of the emerging entity, and its reorganization value was less than the total of its post-petition liabilities and allowed claims. For accounting purposes, the Company assumed that the Plan was consummated on July 31, 2002. Under fresh-start accounting, all assets and liabilities are restated to reflect their reorganization value, which approximates fair value at the date of reorganization. The fresh start adjustments were based upon the work of outside appraisers and financial consultants, as well as internal valuation estimates using discounted cash flow analyses, to determine the relative fair values of the assets and liabilities of the Company. The estimate of reorganization value was based on a number of assumptions regarding the anticipated future performance of the Company, industry performance, general business and economic conditions and other matters.

The liabilities of reorganized Sunterra consist primarily of post-petition current liabilities, notes payable issued in settlement of certain pre-petition claims, certain outstanding pre-petition allowed claims, and amounts outstanding under the Exit Financing Facility. In accordance with fresh-start accounting, a gain on forgiveness of pre-petition liabilities of $232.7 million resulting from the implementation of the Plan is included in the Predecessor company’s condensed consolidated statement of operations for the seven months ended July 31, 2002. In addition, the accumulated deficit of the Predecessor company as of

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July 31, 2002 totaling $282.0 million (after the effect of the gain on cancellation of pre-petition liabilities) was eliminated, and, at August 1, 2002, the reorganized Successor company’s financial statements showed no beginning retained earnings or deficit. In addition, all accumulated depreciation and amortization were reduced to $0 at July 31, 2002.

The Company determined that the reorganization value of the assets at July 31, 2002 exceeded the fair value of identifiable assets and recognized $138.8 million as reorganization value in excess of amounts allocable to identifiable assets – goodwill. In accordance with Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, the excess reorganization value is assumed to have an indefinite useful life and will not be amortized. The excess reorganization value will be tested for impairment at least annually as specified in SFAS No. 142. As a result of adopting fresh start reporting upon emerging from Chapter 11 status, the Company’s financial statements are not comparable with those prepared before the Plan was confirmed, including the historical condensed consolidated financial statements included herein.

The Company is still in the process of evaluating the fair value of certain real estate and development costs, and the accompanying condensed consolidated financial statements do not reflect any adjustments for these assets. The amount of fresh start adjustments, if any, ultimately recorded by the Company with respect to these assets could result in material changes to the amounts presented below.

The effects of the Plan and implementation of fresh-start accounting on the condensed consolidated balance sheet as of July 31, 2002 is as follows:

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Note 3 – New Accounting Standards

In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all business combinations be accounted for under a single method, the purchase method. Use of the pooling-of-interests method is no longer permitted. SFAS No. 141 requires that the purchase method be used for business combinations initiated after September 30, 2001. SFAS No. 142 requires that goodwill and certain other intangible assets with indefinite useful lives no longer be amortized to earnings, but instead be reviewed at least on an annual basis for impairment. The amortization of goodwill and certain other intangible assets with indefinite useful lives ceased upon adoption of SFAS No. 142, which occurred on January 1, 2002. In accordance with disclosure requirements of SFAS No. 142, amortization expense for goodwill, net loss and net loss per share assuming the Company had adopted SFAS No. 142 during the three months ended September 30, 2001 are $0.4 million, $18.6 million and $0.52 per share, respectively. Amortization expense for goodwill, net loss and net loss per share during the nine months ended September 30, 2001 are $1.1 million, $38.8 million and $1.08 per share, respectively.

In August 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations, which is applicable for fiscal years beginning after September 15, 2002. SFAS No. 143 requires an enterprise to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of a tangible long-lived asset. SFAS No. 143 also requires the enterprise to record the contra to the initial obligation as an increase to the carrying amount of the related long-lived asset (i.e., the associated asset retirement costs) and to depreciate that cost over the remaining useful life of the asset. The liability is changed at the end of each period to reflect the passage of time (i.e., accretion expense) and changes in the estimated future cash flows underlying the initial fair value measurement. The Company adopted SFAS No. 143 to correspond with the implementation of fresh start accounting as of July 31, 2002. Adoption of SFAS No. 143 did not have a material impact on the accompanying condensed consolidated financial statements.

In September 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which is applicable for fiscal years beginning after December 15, 2001. SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed Of, and portions of APB Opinion 30, Reporting the Results of Operations. SFAS No. 144 provides a single accounting model for long-lived assets to be disposed of and significantly changes the criteria that would have to be met to classify an asset as held-for-sale. Classification as held-for-sale is an important distinction since such assets are not depreciated and are stated at the lower of fair value less costs to dispose and carrying amount. SFAS No. 144 also requires components of reporting units be treated as discontinued operations, and that expected future operating losses from discontinued operations to be displayed in the period(s) in which the losses are incurred, rather than as of the measurement date as previously required. The adoption of SFAS No. 144 on January 1, 2002 did not have a material impact on the accompanying condensed consolidated financial statements.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 eliminates the requirement to classify gains and losses from the extinguishment of indebtedness as extraordinary, requires certain lease modifications to be treated the same as a sale-leaseback transaction, and makes other non-substantive technical corrections to existing pronouncements. The Company has adopted SFAS No. 145 in 2002 and classified the net gain on settlement of debt (Note 9) as a component of reorganization expenses on the accompanying condensed consolidated financial statements.

In June 2002, the FASB issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities. The standard nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring) and requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The Company adopted SFAS No. 146 with the implementation of fresh start accounting as of July 31, 2002. The adoption of this statement did not have a material impact on the accompanying condensed consolidated financial statements.

Note 4 – Exit Financing Facility

On July 29, 2002, the Company entered into an agreement for a two-year $300 million senior secured exit and working capital credit facility (the Exit Financing Facility). The proceeds of the Exit Financing Facility were or are to be used to pay amounts payable in connection with consummation of the Plan, provide mortgage receivable and other working capital financing to the Company and to pay fees and expenses related to the Exit Financing Facility. A portion of proceeds from the initial funding drawn on the Exit Financing Facility was used to pay off amounts outstanding under the Debtor Entities’ debtor-in-possession (DIP) facility.

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At September 30, 2002, availability of borrowings under the Exit Financing Facility is $55.1 million. The availability of borrowings under the Exit Financing Facility is based on the amount of eligible mortgages receivable, the value of eligible vacation interests inventory and the value of certain real property and other assets. The Exit Financing Facility is secured by a first priority lien on mortgages and contracts receivable and vacation interests inventory, as well as certain real property and other assets of the Company, subject to certain exceptions. Borrowings under the Exit Financing Facility bear interest at an annual rate equal to one month LIBOR plus 3%, 5%, or 7%, depending on the type of asset collateralizing various advances. In addition to the facility fee (2.5% of $300 million) paid in connection with the commitment and the closing of the Exit Financing Facility, the Company issued warrants exercisable for 1,190,148 shares of new common stock at an exercise price of $15.25 per share (the deemed value of the shares solely for purposes of the Plan), subject to adjustment under certain anti-dilution provisions of the warrant agreement and will pay an unused commitment fee of 0.25% per annum on the excess availability under the credit facility. The value of the warrants issued to the Exit Financing Facility lender of $8.7 million was determined using a Black-Scholes model based on a risk free interest rate of 3.81%, expected volatility of 50% and an expected life of 5 years. The value of the warrants was recorded as a capitalized financing cost that will be amortized over the term of the Exit Financing Agreement.

Note 5 – Liabilities Subject to Compromise

Under Chapter 11, actions to enforce certain claims against the Debtor Entities were generally stayed if such claims arose, or were based on events that occurred, before the Petition Date. Such liabilities were reflected in the accompanying condensed consolidated balance sheets as liabilities subject to compromise at December 31, 2001. Liabilities subject to compromise were either cancelled or reinstated as of July 31, 2002 in accordance with the terms of the Plan. Liabilities subject to compromise on the accompanying condensed consolidated balance sheet as of December 31, 2001 are presented below:

Note 6 – Mortgages and Contracts Receivable, Net

The following summarizes the Company’s total mortgages and contracts receivable:

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Activity in the allowance for loan and contract losses associated with mortgages and contracts receivable is as follows:

Note 7 – Real Estate and Development Costs, Net

Real estate and development costs consist of the following:

Note 8 – Reorganization Costs, Net

Reorganization costs are comprised of expenses and losses offset by income and gains that were realized or incurred by the Company as a result of reorganization under Chapter 11 and are expensed as incurred. These items have been segregated from normal operating costs and consist of the following:

Note 9 – Gain on Settlement of Debt

In January 2002, pursuant to an order of the Bankruptcy Court, the Company entered into an agreement (the Finova Agreement) with Finova Capital Corporation (Finova) that provided for payment by the Company of various loans and financing facilities (Finova Loans) from Finova or its affiliates. Pursuant to the Finova Agreement, the Company paid, in cash and by application of other funds, $100 million (determined after giving effect to a prior release to Finova of $5 million held by Finova as cash collateral) and Finova returned collateral securing the Finova Loans. The payment to Finova represented a discount of $27.0 million from the principal amount of the Finova Loans. Pursuant to the Finova Agreement, the Company

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and Finova each released the other parties from liabilities and obligations relating to the Finova Loans and certain other matters, including those that were the subject of pending litigation between the parties. The Company obtained a portion of the funds to pay the Finova Loans from term loans under its debtor-in-possession (DIP) financing facility and paid a brokerage fee of $13.4 million to its DIP lender for negotiating the settlement with Finova. The Company recorded a net gain on settlement of debt of $13.6 million, which is included as an offset to reorganization costs.

In May 2002, the Company executed amendments to lease agreements relating to a 1999 sale-leaseback transaction, payments on which were suspended as a result of the bankruptcy proceedings. As a result of the amendments, the minimum lease terms have been extended from November 2002 to April 2004, and the Company’s payment obligations have been reduced by $1.1 million, which is recorded as an offset to reorganization expenses as a gain on settlement of debt.

Pursuant to the Plan and the confirmation order of the Bankruptcy Court (the Confirmation Order), Bank of America, Societe Generale, OCM Real Estate Opportunities Fund II, L.P (as successor to Union Bank of California, N.A. and Bank of Hawaii), (the “Bank Group”) and the Debtors agreed to adopt certain terms and conditions to govern the discharge and complete satisfaction of all obligations of the Debtors to the Bank Group.

Pursuant to the Confirmation Order, all obligations owing by the borrower to OCM Real Estate Opportunities Fund II, L.P. (approximately $18.2 million included accrued interest payable) were settled and satisfied in full effective July 26, 2002 for a cash payment of approximately $12.3 million. The Company recognized a gain on settlement of debt, net of fees and expenses, of approximately $5.6 million that is included as an offset to reorganization costs.

The Debtor Entities, Bank of America and Societe Generale (“Lenders”) entered into an agreement to amend and restate the existing credit agreement in its entirety and to set forth the terms of repayment for all outstanding obligations owing by the Debtor to the Lenders as of July 26, 2002 in the amount of approximately $18.4 million, including accrued interest payable. Pursuant to the terms of the agreement, the Debtors agreed to a cash payment of approximately $7.2 million and the issuance of a 5-year note payable for approximately $11.2 million. The note bears interest at a rate of prime plus 2% and is collateralized by certain mortgages receivable. No gain or loss was recognized on this transaction. All obligations owing to the Lenders were satisfied in full on November 5, 2002.

Pursuant to the Plan and the Confirmation Order, OCM Real Estate Opportunities Fund II, L.P. (as successor to Union Bank of California, N.A.) and the Debtors agreed to settle all outstanding obligations totaling approximately $11.1 million for a cash payment of $10.2 million. The Company recognized a gain on settlement of debt of approximately $0.9 million which is included as an offset to reorganization costs.

Note 10 – Comprehensive (Loss) Income

Comprehensive (loss) income includes all changes in equity (net assets) during a period from non-owner sources. The reconciliation of net (loss) income to comprehensive net (loss) income is as follows:

Note 11 – Segment and Geographic Information

The Company currently operates in two geographic segments, the North America and foreign segments. During the Chapter 11 proceedings, the Company operated in three segments, North American Debtor Entities, North American Non-Debtor Entities and foreign entities. All of these segments operate in one industry segment that includes the development, marketing, sales, financing and management of vacation ownership resorts. The Company’s areas of operation outside of North America include the United Kingdom, Italy, Spain, Portugal, Austria, Germany and France. The Company’s management evaluates performance of each segment based on profit or loss from operations before income taxes not including extraordinary items and the cumulative effect of change in accounting principles. No single customer accounts for a significant amount of the Company’s sales. Information about the Company’s operations in different geographic locations is shown below:

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Note 12 – Commitments and Contingencies

On November 13, 2000, a consolidated amended class action complaint (the Complaint) was filed in the United States District Court for the Middle District of Florida (Orlando Division) (the District Court), relating to a putative securities fraud class action brought on behalf of purchasers of common stock of Sunterra for the period from October 8, 1998 through January 19, 2000 (the Class Period). Shortly after the Class Period, fifteen cases were filed in the District Court and were consolidated (the Consolidated Cases). Originally, Sunterra and several of its officers and directors were named as defendants in the Consolidated Cases. Following the filing of the Chapter 11 Cases, the Consolidated Cases were automatically stayed against Sunterra pursuant to Bankruptcy Code Section 362. The Complaint named former officers and directors of Sunterra as defendants, as well as Arthur Andersen LLP, Sunterra’s independent auditors during the Class Period. In or about the spring of 2001, all of the defendants moved to dismiss the Complaint. On March 12, 2002, the District Court entered an order dismissing the Complaint against each of the defendants without prejudice. On July 3, 2002 the plaintiffs filed a second consolidated amended class action complaint with the District Court. The Company was not named as a defendant in this amended complaint. The action is currently pending in the District Court. The Company believes that, pursuant to the discharge granted under the Bankruptcy Code, Debtor Entities cannot be held liable to the plaintiffs if the Debtors are named in the lawsuit. However, certain indemnity rights may be owed by the Debtor Entities to the defendant officers and directors.

The Company uses certain computer software under a software license granted by RCI Technology Corp., formerly known as Resort Computer Corporation (RCC). That software is the foundation for the Company’s integrated computer system, which manages a wide range of hospitality functions, such as reservations, inventory control, sales commissions, Club Sunterra operations, housekeeping and marketing. RCC filed a motion in the Chapter 11 cases alleging that the license agreement should be deemed rejected, which RCC asserts would have the effect of terminating the license. The Company opposed the motion, and the Court ruled in favor of Sunterra and denied RCC’s motion. On June 14, 2002, RCC filed a notice of appeal of the Court’s decision. Although the Company believes that RCC faces several obstacles in this appeal, if RCC was ultimately successful and able to effectively cause the termination of the license, such a result could have a material adverse effect on the Company.

We are also currently subject to other litigation and claims regarding employment, tort, contract, construction, sales taxes and commission disputes, among others. Much of such litigation and claims is pre-petition and was stayed under the

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Company’s Chapter 11 proceeding. In our judgment, none of such litigation or claims against the Company is likely to have a material adverse effect on the Company’s financial statements or its business.

Note 13 – Related Party Transactions

In October 2001, the Company entered into a contract with Westpac Resort Group LLC (Westpac), a company 60% owned by a senior vice president of the Company. Westpac arranges tours of vacation residences for potential customers. Management believes that the terms of the agreement are comparable to those of an arms-length transaction. Total payments to Westpac under this agreement were $1.4 million for the nine months ended September 30, 2002.

The Company sells vacation points under a franchising agreement to a company which is 50% owned by the spouse of the former director of franchise operations for Sunterra Europe. The director of franchise operations left the Company in May 2002, and the Company is still selling vacation points under the franchising agreement. Management believes the terms of the franchising agreement are comparable to those of an agreement with an unrelated third party. In 2002, sales through May under the financing agreement were approximately $0.7 million. Sales under the financing agreement for the nine months ended September 30, 2001 were approximately $1.2 million.

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

The accompanying condensed consolidated financial statements set forth certain data with respect to the financial position, results of operations, and cash flows of the Company which should be read in conjunction with the following discussion and analysis. The terms “Company,” “we,” “our,” and “us” refer to Sunterra Corporation and its subsidiaries. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those contained in our Annual Report on Form 10-K for the year ended December 31, 2001 under the headings “Business-Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in that report. See the Safe Harbor Statement at the beginning of this report.

Overview

We are a vacation ownership (timeshare) company with resort locations in North America, Europe, the Caribbean, Hawaii and Latin America and approximately 250,000 owner families. Our operations consist of:

Reorganization Under Chapter 11

As a result of the defaults on our senior unsecured notes and our secured credit facilities, on May 31, 2000 we sought protection under Chapter 11 of the Bankruptcy Code in order to restructure existing debt and maximize existing cash.

Following a hearing on June 20, 2002, the Bankruptcy Court entered an order on June 21, 2002 confirming our Plan of Reorganization filed on January 31, 2002, as amended (the Plan). We subsequently fulfilled the conditions to the effectiveness of the Plan and on July 29, 2002 emerged from Chapter 11. See Note 2 to the accompanying condensed consolidated financial statements for a summary of certain provisions of the Plan, which is qualified in its entirety by reference to the Plan filed as an exhibit to our Report on Form 8-K, and to the Confirmation Order of the Bankruptcy Court filed as an exhibit to our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on May 28, 2002 and June 28, 2002, respectively.

Also on July 29, 2002, and in connection with the consummation of the Plan, the following actions, among others, occurred:

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Further, on July 29, 2002, all existing members of our Board of Directors were deemed to have resigned and the new Board of Directors designated pursuant to the Plan took office.

Fresh Start Reporting and Factors Affecting Comparability of Financial Information

The Debtor Entities emerged from Chapter 11 on July 29, 2002. However, for financial reporting purposes, the Company deemed the Effective Date of the Plan to have occurred on July 31, 2002. Fresh start reporting has been implemented as of July 31, 2002, and accordingly, all assets and liabilities were restated to reflect their respective fair values. See Note 2 to the condensed consolidated financial statements included elsewhere in this Quarterly Report for a discussion of the fresh start adjustments. References to “Predecessor” refer to Sunterra and its subsidiaries through July 31, 2002. References to “Successor” refer to Sunterra and its subsidiaries on or after August 1, 2002, after giving effect to the implementation of fresh start reporting. Successor consolidated financial statements are not comparable to Predecessor consolidated financial statements.

RESULTS OF OPERATIONS

For purposes of discussion of results of operations, the combined results of operations for two months ended September 30, 2002 and the month ended July 31, 2002 have been compared to the three months ended September 30, 2001. Similarly, the combined results of operations for two months ended September 30, 2002 and the seven months ended July 31, 2002 have been compared to the nine months ended September 30, 2001. The following table shows the combined 2002 periods in comparison to the corresponding 2001 periods and is presented solely for use in comparative analysis of results of operations and to complement management’s discussion and analysis.

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Comparison of the Combined Three Months Ended September 30, 2002 to the Three Months Ended September 30, 2001

We achieved total revenues of $81.1 million for the three months ended September 30, 2002, compared to $70.1 million for the three months ended September 30, 2001, an increase of 15.8%. Overall revenues for domestic operations increased 17.5% to $53.0 million for the three months ended September 30, 2002 compared to $45.1 million for the three months ended September 30, 2001, and revenues from foreign operations increased 12.5% to $28.1 million for the three months ended September 30, 2002.

In November 2000, the Bankruptcy Court issued an order for the Company to provide certain consumers with renewed rescission rights with respect to the sale of timeshare transactions entered into but not consummated fully prior to the Petition Date. The Company sent registered letters to customers that met this criterion providing a new rescission period. As such, certain sales initially recorded in 2000 were deferred pending receipt from the customers of a reconfirmation of acceptance of the sales agreement. Accordingly, Vacation Interest sales of $0.3 million were recognized for the three months ended September 30, 2001 for such customers that reconfirmed their acceptance of the sales agreements during that period (the “reconfirmed 2000 sales”).

Vacation Interest sales of $53.7 million for the three months ended September 30, 2002 increased by $10.2 million or 23.4%, compared to sales of $43.5 million for the three months ended September 30, 2001. Excluding the effect of the $0.3 million of reconfirmed 2000 sales recorded during the three months ended September 30, 2001, Vacation Interest sales increased by $10.5 million or 24.4% due primarily to the impact of our Chapter 11 proceedings and the events of September 11 on sales in the prior year.

Club Sunterra membership fees earned of $1.7 million for the three months ended September 30, 2002 were $0.3 million higher than membership fees earned of $1.4 million for the three months ended September 30, 2001 due to an increase in club memberships.

Interest income, primarily from financing provided to purchasers and lessees of Vacation Interests, decreased 2.4% to $7.4 million for the three months ended September 30, 2002 from $7.6 million for the three months ended September 30, 2001. The decrease largely resulted from a net decrease in the Company’s portfolio of mortgages and contracts receivable.

Vacation Interest cost of sales of $12.1 million for the three months ended September 30, 2002 increased $2.7 million, or 29.0%, from $9.4 million for the three months ended September 30, 2001. This increase is primarily attributable to the $10.2 million increase in Vacation Interest sales. As a percentage of Vacation Interest sales for the three months ended September 30, 2002 and 2001, Vacation Interest cost of sales were 22.5% and 21.5%, respectively.

For the three months ended September 30, 2002, advertising, sales and marketing costs were $33.2 million or 61.8% of Vacation Interest sales compared to $27.1 million or 62.3%, respectively, for the three months ended September 30, 2001. This represents a $6.1 million or 22.5% increase from the three months ended September 30, 2001 and is due to the increase in revenues during the period.

Maintenance fee and subsidy expense increased 2.0%, or $0.1 million, to $3.9 million for the three months ended September 30, 2002 from $3.8 million for the three months ended September 30, 2001 and totaled 7.2% of Vacation Interest sales for the three months ended September 30, 2002 as compared to 8.7% for the three months ended September 30, 2001. The increase

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is attributable to special assessments at certain Florida properties and was offset by a decrease in the number of Company-owned Vacation Interests (due to ongoing sales and the disposition of certain resort properties in 2001) and decreases in developer subsidies and guarantees.

The provision for doubtful accounts and loan losses was $2.1 million for the three months ended September 30, 2002 compared to $3.7 million for the three months ended September 30, 2001. Of these amounts, $1.5 million and $3.2 million for the three months ended September 30, 2002 and 2001, respectively, related to mortgages and contracts receivable. The resulting allowance for mortgages and contracts receivable at September 30, 2002 was $32.1 million, representing approximately 16.0% of the total portfolio outstanding at that date compared to $36.2 million and 17.3%, respectively, at December 31, 2001. The decreases in the provision for doubtful accounts and the allowance for mortgages and contracts receivable reflect improved performance resulting from several Company initiatives, including: standardization of underwriting procedures (including higher levels of purchasers’ overall creditworthiness), more timely correspondence with customers whose mortgages and contracts are in danger of becoming delinquent, and higher down payments being obtained upon initial sales and leases. The Company has also benefited from customers prepaying their receivables at higher rates than in the past. The remainder of the provision for doubtful accounts of $0.6 million for the three months ended September 30, 2002 and $0.5 million for the three months ended September 30, 2001 represents estimated uncollectible amounts due from homeowner associations and other receivables.

Loan portfolio expenses increased 26.3% to $3.6 million for the three months ended September 30, 2002 from $2.8 million for the three months ended September 30, 2001. The overall increase is attributable to efforts to maximize collections on delinquent accounts and recovering Vacation Interests from defaulted loans and contracts, as well as improving loans and contract administration.

General and administrative expenses increased $1.6 million or 7.7% to $22.3 million for the three months ended September 30, 2002 from $20.7 million for the three months ended September 30, 2001. As a percentage of total revenues, general and administrative expenses were 27.7% and 29.5% for the three months ended September 30, 2002 and 2001, respectively.

Depreciation and amortization expense decreased 48.8%, or $2.8 million, to $2.9 million for the three months ended September 30, 2002 from $5.7 million for the three months ended September 30, 2001. In accordance with SFAS No. 142, the Company ceased amortizing its goodwill on January 1, 2002. The decrease is also the result of the disposition of certain properties in 2001.

Reorganization costs for the three months ended September 30, 2002 included $345.4 million in income from adjustments related to the implementation of fresh start accounting upon the Company’s emergence from Chapter 11, primarily attributable to the cancellation of pre-petition liabilities. Excluding the effect of these adjustments, reorganization costs were $12.3 million, representing an increase of $0.6 million or 10.3% compared to $11.7 million for the three months ended September 30, 2001. The increase is due to increases in professional fees and other reorganization costs, offset by a $6.5 million gain on debt restructuring recorded in July 2002.

During the three months ended September 30, 2002, the Company incurred $1.6 million of restructuring costs related to the relocation of its corporate headquarters from Orlando, Florida to Las Vegas, Nevada.

Interest expense for the three months ended September 30, 2002, net of capitalized interest of $0.04 million, was $5.0 million, compared to $5.7 million, net of capitalized interest of $0.09 million, for the three months ended September 30, 2001. The decrease was primarily attributable to the settlement of the Finova Loans in January 2002 that were outstanding in 2001.

Comparison of the Combined Nine Months Ended September 30, 2002 to the Nine Months Ended September 30, 2001

We achieved total revenues of $212.5 million for the nine months ended September 30, 2002, compared to $205.1 million for the nine months ended September 30, 2001, an increase of 3.6%. Overall revenues for domestic operations decreased 0.4% to $138.5 million for the nine months ended September 30, 2002 compared to $139.0 million for the nine months ended September 30, 2001, and revenues from foreign operations increased 11.9% to $74.0 million for the nine months ended September 30, 2002. Included in total revenues for the nine months ended 2001 are $15.7 million of reconfirmed 2000 sales.

Vacation Interest sales of $135.1 million for the nine months ended September 30, 2002 increased by $9.7 million or 7.7%, compared to sales of $125.4 million for the nine months ended September 30, 2001. Excluding the effect of the $15.7 million of reconfirmed 2000 sales recorded in 2001, Vacation Interest sales increased by $25.4 million or 23.2% due primarily to the impact of our Chapter 11 proceedings on sales in the prior year.

Club Sunterra membership fees earned of $5.3 million for the nine months ended September 30, 2002 were $1.1 million higher than membership fees earned of $4.2 million for the nine months ended September 30, 2001 due to an increase in club memberships.

Interest income, primarily from financing provided to purchasers and lessees of Vacation Interests, decreased 4.6% to $21.8 million for the nine months ended September 30, 2002 from $22.8 million for the nine months ended September 30, 2001. The decrease largely resulted from a net decrease in the Company’s portfolio of mortgages and contracts receivable.

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Other income, which mainly consists of sampler vacation program revenues, travel service revenue, resort amenity income and finance commissions, fell by 15.4% to $16.2 million for the nine months ended September 30, 2002 from $19.1 million for the nine months ended September 30, 2001. This decrease is primarily due to the phase-out of the Encore sampler program and the disposition of certain resorts in 2001.

Vacation Interest cost of sales of $29.6 million for the nine months ended September 30, 2002 increased $3.7 million, or 14.1%, from $26.0 million for the nine months ended September 30, 2001. This increase is primarily attributable to the increase in Vacation Interest sales. As a percentage of Vacation Interest sales for the nine months ended September 30, 2002 and 2001, Vacation Interest cost of sales was 21.9% and 20.7%, respectively.

For the nine months ended September 30, 2002, advertising, sales and marketing costs were $86.3 million or 63.9% of Vacation Interest sales compared to $77.7 million or 62.0%, for the nine months ended September 30, 2001. This represents an $8.6 million or 11.1% increase from the nine months ended September 30, 2001 and is due to increased increased revenues in the current period.

Maintenance fee and subsidy expense decreased 16.2%, or $1.7 million, to $9.0 million for the nine months ended September 30, 2002 from $10.7 million for the nine months ended September 30, 2001 and represented 6.6% of Vacation Interest sales for the nine months ended September 30, 2002 as compared to 8.5% for the nine months ended September 30, 2001. The decrease was primarily the result of a decrease in the number of Company-owned Vacation Interests (due to ongoing sales and the disposition of certain resort properties in 2001) and decreases in developer subsidies and guarantees.

The provision for doubtful accounts and loan losses was $5.1 million for the nine months ended September 30, 2002 compared to $10.4 million for the nine months ended September 30, 2001. The decrease in the provision is due to the Company initiatives discussed in the quarterly analysis above. Of these amounts, $4.1 million and $8.7 million for the nine months ended September 30, 2002 and 2001, respectively, related to mortgages and contracts receivable. The remainder of the provision for doubtful accounts of $1.0 million for the nine months ended September 30, 2002 and $1.7 million for the nine months ended September 30, 2001 represents estimated uncollectible amounts due from homeowner associations and other receivables.

Loan portfolio expenses increased 27.8% to $10.0 million for the nine months ended September 30, 2002 from $7.9 million for the nine months ended September 30, 2001. The overall increase is attributable to efforts to maximize collections on delinquent accounts and recovering Vacation Interests from defaulted loans and contracts, as well as improving loans and contract administration.

General and administrative expenses increased $6.1 million or 11.2% to $60.1 million for the nine months ended September 30, 2002 from $54.0 million for the nine months ended September 30, 2001. As a percentage of total revenues, general and administrative expenses were 28.3% and 26.3% for the nine months ended September 30, 2002 and 2001, respectively. Professional fees account for $3.3 million of the increase and are primarily attributable to the enhancement of the Company’s existing resort management and financial systems. Excluding professional fees, general and administrative expenses for the nine months ended September 30, 2002 increased by 5.2% over the same period in 2001.

Depreciation and amortization expense decreased 31.9%, or $4.6 million, to $9.7 million for the nine months ended September 30, 2002 from $14.3 million for the nine months ended September 30, 2001. In accordance with SFAS No. 142, the Company ceased amortizing its goodwill on January 1, 2002. The decrease is also the result of the disposition of certain properties in 2001.

Reorganization costs for the nine months ended September 30, 2002 included $345.4 million in income from adjustments related to the implementation of fresh start accounting upon the Company’s emergence from Chapter 11, primarily attributable to the cancellation of pre-petition liabilities. Excluding the effect of these adjustments, reorganization costs were $17.7 million, representing a decrease of $11.9 million or 40.2% compared to $29.6 million for the nine months ended September 30, 2001. This decrease is primarily attributable to $21.2 million in gains on debt restructurings in 2002, offset by increases in professional fees and other reorganization costs.

Interest expense for the nine months ended September 30, 2002, net of capitalized interest of $0.28 million, was $13.1 million, compared to $15.9 million, net of capitalized interest of $0.24 million, for the nine months ended September 30, 2001. The decrease was primarily attributable to the settlement of the Finova Loans in January 2002 that were outstanding in 2001.

LIQUIDITY AND CAPITAL RESOURCES

We generate cash principally from:

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During the nine months ended September 30, 2002, net cash provided by operating activities was $15.0 million and was primarily the result of the net income of $314.3 million plus non-cash expenses totaling $18.3 million offset by the non-cash gain on settlement and cancellation of debt of $267.2 million, non-cash fresh start adjustments of $112.7 million and other non-cash gains of $7.8 million. Cash provided by operating activities was also impacted by changes in operating assets and liabilities, including a reduction of $56.5 million in cash in escrow and restricted cash due to implementation of the Plan, a reduction in real estate and development costs of $15.0 million, an increase in deferred revenue of $7.9 million and net collections of receivables totaling $7.3 million offset by an increase in prepaid expenses and other assets of $7.9 million and a decrease in operating liabilities of $6.8 million.

During the nine months ended September 30, 2002, net cash used in investing activities was $13.7 million, with proceeds from sale of assets of $7.2 million offset by capital expenditures of $16.5 million and an increase in intangibles of $5.7 million due to goodwill recorded on an acquisition by our European subsidiary. The goodwill was subsequently eliminated as a portion of the non-cash fresh start adjustments.

During the nine months ended September 30, 2002, net cash used in financing activities was $10.3 million. Payments on notes payable and related accrued interest totaled $313.0 million, including payments of $170.2 million to payoff the DIP financing facility upon emergence from bankruptcy. These payments were funded primarily through borrowings on the DIP financing facility and Exit Financing Facility totaling $305.8 million.

We currently anticipate spending approximately $0.9 million for real estate and development costs at existing resort locations during the remainder of 2002. We plan to fund these expenditures with cash generated from operations and borrowings under the Exit Financing Facility. We believe that, with respect to our current operations, cash generated from operations and future borrowings will be sufficient to meet our working capital and capital expenditure needs through the end of 2002. If these are not sufficient, we have the ability to adjust our spending on real estate and development costs.

The allowance for loan losses at September 30, 2002 was $32.1 million, or 16.0% of the total portfolio of mortgages and contracts receivable outstanding at that date. Management believes the allowance is adequate. However, if the amount of mortgages and contracts receivable that is ultimately written off materially exceeds the related allowances, our business, results of operations and financial condition could be adversely affected.

Our plan for meeting our liquidity needs may be affected by, but not limited to, the following: demand for our product, our ability to borrow funds under our current financing arrangements, an increase in prepayment speeds and default rates on our mortgages and contracts receivable, the threat and/or effects on the travel and leisure industry of future terrorists’ attacks and limitations on our ability to conduct marketing activities.

Complete units at various resort properties are acquired or developed in advance and we finance a significant portion of the purchase price of Vacation Intervals. Thus, we continually need funds to acquire and develop property, to carry mortgages receivable contracts and to provide working capital. We anticipate being able to borrow against our mortgages receivable at terms favorable to us. If we are unable to borrow against or sell our mortgages receivable in the future, particularly if we suffer any significant decline in the credit quality of our mortgages receivable, our ability to acquire additional resort units will be adversely affected and our profitability from sales of Vacation Interests may be reduced or eliminated.

Corporate Finance

On average, we finance approximately 80% of domestic Vacation Interest revenues. Accordingly, we do not generate sufficient cash from sales to provide the necessary capital to pay the costs of developing additional resorts and to replenish working capital. We believe that revenues together with amounts available under the Exit Financing Facility consummated on July 29, 2002 will be sufficient to fund operations for the next twelve months.

During the term of the Chapter 11 cases, the Debtor Entities maintained DIP financing facilities to finance Vacation Interests and provide working capital. A portion of proceeds from the initial funding drawn on the Exit Financing Facility was used to pay in full the amounts outstanding under the DIP facility on July 29, 2002.

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