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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(MARK ONE)

For the quarterly period ended December 31, 2004

For the transition period from              to             

001-13815

Commission File Number

SUNTERRA CORPORATION

(Exact name of registrant as specified in its charter)

3865 West Cheyenne Avenue

North Las Vegas, Nevada 89032

(Address of principal executive offices, including zip code)

(702) 804-8600

(Registrant’s telephone number, including area code)

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.    x  Yes    ¨  No

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

Number of shares outstanding of the registrant’s common stock, par value $0.01 per share, at February 3, 2005: 18,968,849

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SUNTERRA CORPORATION AND SUBSIDIARIES

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SUNTERRA CORPORATION AND SUBSIDIARIES

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

The accompanying unaudited consolidated financial statements of Sunterra Corporation and its subsidiaries (the “Company”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and in accordance with the accounting policies described in our Transition Report on Form 10-K for the nine-month period ended September 30, 2004. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal, recurring nature. The accompanying unaudited consolidated financial statements should be reviewed in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 2 of this report. Operating results for the three months ended December 31, 2004 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2005.

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SUNTERRA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Three Months Ended December 31, 2004 and 2003

(In thousands, except per share amounts)

(Unaudited)

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

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SUNTERRA CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

December 31, 2004 and September 30, 2004

(In thousands, except per share amounts)

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

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SUNTERRA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Three Months Ended December 31, 2004 and 2003

(In thousands)

(Unaudited)

(Continued)

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SUNTERRA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS –Continued

Three Months Ended December 31, 2004 and 2003

(In thousands)

(Unaudited)

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

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SUNTERRA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except where stated and share/per share data)

(Unaudited)

Note 1—Background and Business

Sunterra Corporation, a Maryland corporation (together with its wholly owned subsidiaries hereafter referred to as “Sunterra” or the “Company”) was incorporated in May 1996 as KGK Resorts, Inc. and was later known as Signature Resorts, Inc. At the time of its August 1996 initial public offering, the Company owned nine vacation ownership resorts in Hawaii, Florida, South Carolina, Missouri and California and in the Caribbean. The Company became known as Sunterra Corporation in the second quarter of 1998. Sunterra has grown to become one of the world’s largest vacation ownership companies, as measured by the number of individual resort locations and owner families. At December 31, 2004, the Company had over 300,000 owner families vacationing at 93 resorts in 12 countries located in North America, Europe and the Caribbean. See Note 11 for detailed geographic segment information.

The operations of Sunterra include (i) marketing and selling vacation ownership interests at the Company’s 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 representing a beneficial interest in a trust which holds title to vacation property real estate for the benefit of purchasers of those 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”), (ii) leasing Vacation Intervals and selling Vacation Points at certain Caribbean locations, (iii) acquiring, developing, and operating vacation ownership resorts, (iv) providing consumer financing to individual purchasers of Vacation Interests at the Company’s resort locations and off-site sales centers, (v) providing resort rental, management and maintenance services to vacation ownership resorts, for which the Company receives fees paid by the resorts’ homeowners associations and (vi) operating the Company’s membership and exchange programs.

Effective October 1, 2004, the Company changed its fiscal year end for financial reporting purposes from a calendar year end to the 12-month period commencing October 1 and ending September 30 and as such, unaudited financial information for the three-month period ended December 31, 2004 is presented herein compared to unaudited financial information for the three-month period ended December 31, 2003.

Note 2—Basis of Presentation and Summary of Significant Accounting Policies

Reference to Transition Report on Form 10-K for the Transition Period Ended September 30, 2004

These unaudited consolidated financial statements were prepared using the requirements outlined by the Securities and Exchange Commission (“SEC”) for preparation of interim financial statements. It is presumed that users of the unaudited interim consolidated financial information have read or have access to the audited consolidated financial statements for the preceding fiscal year and that the adequacy of additional disclosure needed for a fair presentation, except in regard to material contingencies, may be determined in that context. Accordingly, footnote disclosures that would substantially duplicate the disclosure contained in the most recent annual report to security holders or latest audited consolidated financial statements, such as a statement of significant accounting policies and practices, details of accounts which have not changed significantly in amount or composition since the end of the most recently completed fiscal year may be omitted. Please review the accompanying unaudited consolidated financial statements in conjunction with the accounting policies and detailed disclosures contained in our Transition Report on Form 10-K for the Transition Period ended September 30, 2004, filed with the SEC on December 17, 2004, as well as all the financial information contained in interim and other reports filed with the SEC after that date.

Principles of Consolidation

The accompanying unaudited consolidated financial statements include all majority-owned subsidiaries in which the Company exercises control. Investments in which the Company exercises significant influence, but which it does not control (generally a 20% to 50% ownership interest), are accounted for under the equity method of accounting. The Company does not have any interests in any entity considered to be a variable interest entity for which the Company is considered the primary beneficiary under Financial Accounting Standards Board (“FASB”) Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, as amended in December 2003 by FASB Interpretation No. 46R. Under the equity method, original investments are recorded at cost and adjusted by the Company’s share of undistributed earnings or losses of these entities. The Company currently is a minority partner in one joint venture, as discussed in Note 12, and in July 2004 purchased the remaining 77% interest in West Maui Resort Partners, L.P. (“Ka’anapali”), as discussed below under “Acquisitions.” All significant intercompany transactions and balances have been eliminated from the unaudited consolidated financial statements.

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SUNTERRA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates used by the Company in preparation of its unaudited consolidated financial statements include: (i) mortgages and contracts receivable allowance for loan and contract losses, (ii) valuation of retained interests in mortgages and contracts receivable sold, (iii) estimated net realizable value of assets held for sale, (iv) future sales plans used to allocate certain Unsold Vacation Interests to Vacation Interest cost of sales under the relative sales value method, (v) impairment of long-lived assets including goodwill, and (vi) the valuation allowance recorded against deferred tax assets. It is at least reasonably possible that a material change in one of these estimates may occur in the near term and cause actual results to differ materially.

Net Income (Loss) Per Share

Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.

A reconciliation of net income (loss) available to common shareholders assuming dilution follows:

A reconciliation of weighted average common shares outstanding to weighted average common shares outstanding assuming dilution follows (in thousands):

For the three months ended December 31, 2004, a total of 1,790,148 shares attributable to the potential exercise of outstanding warrants and 1,591,687 shares of the Company’s common stock attributable to the potential exercise of outstanding options under the Sunterra Corporation 2002 Stock Option Plan were excluded from the calculation of diluted income per share because the exercise price of the warrants and options exceeded the average price of the Company’s common stock. For the three months ended December 31, 2003, a total of 1,790,148 shares attributable to the potential exercise of outstanding warrants and 1,391,821 shares of the Company’s common stock attributable to the potential exercise of outstanding options under the Sunterra Corporation 2002 Stock Option Plan were excluded from the calculation of diluted loss per share because the exercise price of the warrants and options exceeded the average price of the Company’s common stock.

During the three months ended December 31, 2004 and 2003, respectively, 7,486 shares and 449,813 shares of common stock were issued to certain creditors upon the completion of certain claims processes in connection with the Company’s Plan of Reorganization. An additional distribution of 1,101,638 shares of the Company’s common stock will be made to certain former creditors on a pro rata

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SUNTERRA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

basis for no cash consideration. In accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 128, Earnings per Share, these shares of common stock to be issued are considered to be outstanding and included in the computation of net income (loss) per share of the Company.

Stock-Based Compensation

The Company has adopted the disclosure provisions of SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123 (“SFAS No. 148”). This pronouncement requires prominent disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company accounts for stock compensation awards under the intrinsic value method of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees which requires compensation cost to be recognized based on the excess, if any, between the quoted market price of the stock at the date of grant and the amount an employee must pay to acquire the stock. All options awarded under the Company’s plan are granted with an exercise price equal to or greater than the fair market value on the date of the grant.

The following table presents the Company’s pro forma net income (loss) and the pro forma net income (loss) per share had the Company adopted the fair value method of accounting for stock-based compensation under SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), as amended by SFAS No. 148 (in thousands, except per share data):

The fair value of stock options used to compute pro forma net income (loss) and pro forma net income (loss) per share disclosures is estimated using the Black-Scholes option-pricing model, which was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, this model requires the input of subjective assumptions, including the expected price volatility of the underlying stock. Projected data related to the expected volatility and expected life of stock options is based upon historical and other information, and notably, the Company’s common stock has limited trading history. Changes in these subjective assumptions can materially affect the fair value of the estimate, and therefore the existing valuation models do not provide a precise measure of the fair value of the Company’s employee stock options. The following table summarizes the Black-Scholes option-pricing model assumptions used to compute the weighted average fair value of stock options granted during the periods:

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SUNTERRA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

As noted in the “Net Income (Loss) Per Share” paragraph above, the Company has also issued warrants for the purchase of 1,790,148 of the Company’s common shares to non-employee creditors. The Company accounts for these issuances under SFAS No. 123, as amended by SFAS No. 148, and related interpretations, which utilizes a fair-value method of accounting. The Company used the following assumptions in estimating the fair value of these warrants: expected life—5 years; interest rate—3.81%; expected dividends—$0; volatility—50%. As discussed in Note 7, the Company amended the exercise price of 1,190,148 of these warrants.

Each non-employee member of the Company’s Board of Directors is entitled to an annual grant of stock-based compensation equivalent to $0.04 million to be issued in advance on the first day of the fiscal year. The Company expects that if the proposed 2005 Incentive Plan is approved by stockholders at the 2005 Annual Meeting, each non-employee director will be granted approximately 4,275 shares of the Company’s common stock under the new plan (based on the Company’s common stock price on September 30, 2004). If the proposed 2005 Incentive Plan is not approved by the Company’s stockholders, the Company will reconsider its alternatives and may continue to grant stock options under its 2002 Stock Option Plan.

Income Taxes

The Company accounts for income taxes in accordance with the liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. Deferred tax assets and liabilities are measured by applying enacted statutory tax rates applicable to the future years in which the deferred tax assets or liabilities are expected to be realized or settled. Income tax expense consists of the taxes payable for the current period and the change during the period in deferred tax assets and liabilities. For the three months ended December 31, 2003, the tax basis operating income of the North American operations was offset by operating losses for prior years. For the current fiscal year, such tax basis operating income of the North American operations will be offset by operating losses from periods prior to the fresh start date. As such, the tax benefits will first reduce goodwill and once goodwill is exhausted, increase additional paid in capital.

Foreign Currency Translation

Assets and liabilities in foreign locations are translated into U.S. dollars using rates of exchange in effect at the end of the reporting period. Income and expense accounts are translated into U.S. dollars using average rates of exchange. The net gain or loss is shown as a translation adjustment and is included in other comprehensive income in stockholders’ equity. Gains and losses from foreign currency transactions are included in the unaudited consolidated statements of operations. During the quarter ended December 31, 2004, the Company’s European operations experienced a gain of $0.6 million related to holding Euros. There were no significant gains or losses on foreign currency transactions in the three months ended December 31, 2003.

Acquisitions

On October 7, 2003, the U.S. Bankruptcy Court for the District of Delaware approved the Company’s bid to acquire certain assets of Epic Resorts Group, and on October 30, 2003, the Company completed this purchase. On January 28, 2004, the Company completed the purchase of certain assets of Thurnham Leisure Group. On March 18, 2004, the Company completed the purchase of a loan portfolio from Prudential Securities Credit Corp. that included mortgages and contracts receivable secured by Vacation Interests in the Epic Vacation Club (the Company had previously acquired substantial amounts of Unsold Vacation Interests in the Epic Vacation Club as part of the October 30, 2003 acquisition). These transactions were accounted for as purchases under SFAS No. 141, Business Combinations (“SFAS No. 141”). Under the purchase method of accounting, the total purchase price is allocated to the net tangible and intangible assets based upon their estimated fair market values as of the date of the acquisition and the operating results of the acquired entity are included in the consolidated statement of operations from the date of acquisition. The tangible assets, intangible assets, liabilities and goodwill acquired in these transactions totaled $73.3 million, $1.2 million, $2.4 million and $2.0 million, respectively.

West Maui Resort Partners, L.P. (“Ka’anapali”) owns and operates Embassy Vacation Resort Ka’anapali on the Hawaiian island of Maui. On July 7, 2004, Sunterra completed the acquisition of the 76.7% majority interest of Ka’anapali that it did not own. Prior to the transaction, the Company owned 23.3% of Ka’anapali and accounted for its interest under the equity method of accounting. For periods prior to July 7, 2004, the Company’s 23.3% share of the results of Ka’anapali is included in “Income from investments in joint ventures” on the accompanying unaudited consolidated statement of operations. Since July 7, 2004, 100% of the operations of Ka’anapali are included in the consolidated results of the Company. The transaction was accounted for as a purchase under SFAS No. 141. Under the purchase method of accounting, the total purchase price is allocated to the net tangible and intangible assets based upon their estimated fair market values as of the date of the acquisition. During the three months ended December 31, 2004, the Company received the final independent third-party valuation of the net assets acquired and recorded an adjustment decreasing the Property and equipment recorded by $0.5 million and increasing the goodwill recorded by a similar amount. As a result of such adjustment, the tangible assets, liabilities and goodwill acquired totaled $108.0 million, $10.1 million and $19.4 million, respectively.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

The net assets recorded of $117.3 million were offset by the elimination of the existing Investment in Joint Venture at the date of acquisition of $11.4 million and cash drawn against the Company’s existing line of credit facility, as amended on July 7, 2004, of $105.9 million. With this transaction the Company acquired full ownership of Unsold Vacation Interests with an estimated retail value in excess of $210.0 million and acquired $46.2 million of mortgages receivable.

On October 21, 2004, the Company completed the purchase of Cluster G&A, S.A. consisting of a resort called Jardines del Sol. The transaction was accounted for as a purchase under SFAS No. 141. Under the purchase method of accounting, the total purchase price is allocated to the net tangible and intangible assets based upon their estimated fair market values as of the date of the acquisition and the operating results of the acquired entity are included in the consolidated statement of operations from the date of acquisition. The tangible assets, intangible assets, liabilities and goodwill acquired totaled $9.3 million, $0.0 million, $0.0 million and $0.0 million, respectively.

On October 26, 2004, the Company completed the purchase of the assets of Activity Warehouse from Jusdoit, Inc. for $0.8 million. Activity Warehouse engages in the sale of visitor activities, rental of recreation equipment and soliciting for timeshare prospects on the Hawaiian island of Maui. The transaction was accounted for as a purchase under SFAS No. 141 and the operating results of the acquired entity are included in the consolidated statement of operations from the date of acquisition.

The Company previously established a qualifying entity, Blue Bison Funding Corporation, through which it transferred mortgages and contracts receivable to Barton Capital Corporation (“Barton”) and related entities as part of a $100 million Mortgages Receivable Conduit Facility (the “Conduit Facility”). The Company sold undivided interests in mortgages and contracts receivable to Blue Bison Funding Corporation at 95% of face value without recourse to it as to collectibility. Blue Bison Funding Corporation financed those purchases through transfers to Barton of an undivided interest in the transferred mortgages and contracts receivable for cash consideration under the Conduit Facility. The Conduit Facility expired on December 17, 2001, leaving a substantial quantity of mortgages and contracts receivable still held by Barton. On December 17, 2004, the Company completed the purchase from Barton of its rights to the mortgages and contracts remaining in the loan portfolio at that date for approximately $16.1 million. Under the purchase method of accounting, the total purchase price is allocated to the net tangible and intangible assets based upon their estimated fair market values as of the date of the acquisition and the operating results of the acquired portfolio are included in the consolidated statement of operations from the date of acquisition. The tangible assets, intangible assets, liabilities and goodwill acquired totaled $15.1 million, $0.0 million, $(1.0) million and $0.0 million, respectively.

The goodwill from the business combinations has an indefinite life and will be considered when the Company conducts its annual review of goodwill for impairment to determine if goodwill with an indefinite life has been impaired. The Company has omitted pro forma disclosures to reflect the above business combinations, as the effects of such business combinations were deemed insignificant.

Recently Issued Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 152, Accounting for Real Estate Time-Sharing Transactions (“SFAS No. 152”). This Statement amends SFAS No. 66, Accounting for Sales of Real Estate, to reference the financial accounting and reporting guidance for real estate time-sharing transactions that is provided in American Institute of Certified Public Accountants Statement of Position (“SOP”) 04-2, Accounting for Real Estate Time-Sharing Transactions. This Statement also amends SFAS No. 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects, to state that the guidance for (a) incidental operations and (b) costs incurred to sell real estate projects does not apply to real estate time-sharing transactions. The accounting for those operations and costs is subject to the guidance in SOP 04-2.

SFAS No. 152 is effective for financial statements for fiscal years beginning after June 15, 2005. The Company will adopt SFAS No. 152 on October 1, 2005. The Company has not yet evaluated the impact that the adoption of SFAS No. 152 will have on its financial position and results of operations.

In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment-a revision to SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123(R)”) that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123(R) eliminates the ability to account for share-based compensation transactions using APB Opinion No. 25, Accounting for Stock Issued to Employees, and generally requires instead that such transactions be accounted for using a fair-value-based method.

SFAS No. 123(R) is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. SFAS 123(R) applies to all awards granted after the required effective date and to awards modified, repurchased, or cancelled after that date. The cumulative effect of initially applying SFAS No. 123(R), if any, is recognized as of the required effective date. As of the required effective date, all public entities that used the fair-value-based method for either recognition or disclosure under SFAS No. 123 will apply SFAS No. 123(R) using a modified version of prospective application. Under that transition method, compensation cost is recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under SFAS No. 123 for either recognition or pro forma disclosures. For periods before the required effective date, those entities may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by SFAS No. 123. The Company has not yet completed its evaluation of the impact SFAS No. 123(R) will have on its financial position and results of operations.

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SUNTERRA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29 (“SFAS No. 153”). SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets. It eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, Accounting for Nonmonetary Transactions, and replaces it with an exception for exchanges that do not have commercial substance. The provisions of SFAS No. 153 shall be effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date SFAS No. 153 was issued. The provisions of SFAS No. 153 shall be applied prospectively. The Company has not yet completed its evaluation of the impact SFAS No. 153 will have on its financial position and results of operations.

Reclassifications

Reclassifications were made to the 2003 unaudited consolidated financial statements to conform to the 2004 presentation.

Note 3—St. Maarten Transactions

Leases of Vacation Interests

The Company owns and operates two resorts in St. Maarten, Netherlands Antilles. Prior to March 2004, the Company conveyed Vacation Interests in these resorts under long-term leases for a period of ninety-nine years at one resort, and at the other, a term expiring in 2050 and subject to extension for an aggregate term not to exceed ninety-nine years. During the quarter ended March 31, 2004, the Company began to convey Vacation Points representing beneficial interests in a trust that holds title to the underlying resorts.

The leases entered into prior to the change during the quarter ended March 31, 2004 when the Company began to convey Vacation Points are deemed to be operating leases under current accounting pronouncements. As such, the sales value of the related Vacation Interests are recorded as deferred revenue at the date of execution of each transaction and amortized on a straight-line basis over the term of the related lease agreement. The unamortized balance of the sales value is included within the caption “Deferred revenues” on the accompanying unaudited consolidated balance sheets. The direct sales and marketing costs of these transactions are also deferred and amortized on a straight-line basis over the term of the related lease agreement. The unamortized balance of the direct sales and marketing costs are included within the caption “Prepaid expenses and other assets, net” on the accompanying unaudited consolidated balance sheets.

On a monthly basis, the Company recognizes a portion of the deferred revenue relating to these leases and includes this within the amounts captioned “Vacation Interest revenue” on the accompanying unaudited consolidated statements of operations. Likewise, the Company recognizes a portion of the deferred marketing and leasing expenses on a monthly basis and includes this expense within the amounts captioned “Advertising, Sales and Marketing expenses” on the accompanying unaudited consolidated statements of operations.

Current accounting guidance requires the related hard and soft construction costs of these Vacation Interests to be included within the caption “Property and Equipment, net” on the accompanying unaudited consolidated balance sheets and depreciated following the Company’s normal depreciation policies. At its other resorts, the Company capitalizes all of the hard and soft construction costs within the caption “Unsold Vacation Interests, net” and such costs are allocated to Vacation Interest cost of sales on the relative sales value method. During the quarter ended March 31, 2004, in conjunction with the change from long-term leases to Vacation Points, approximately $3.9 million of the hard and soft construction costs of the Vacation Interests were reclassified from Property and Equipment, net to Unsold Vacation Interests, net.

Similar to the mortgage financing issued to purchasers of Vacation Interests at the Company’s other resorts, the Company issues lease financing contracts to lessees of Vacation Interests at the St. Maarten resorts, subject to underwriting criteria. When a borrower under such a contract defaults, the Company cancels the loan agreement and the difference between the cumulative cash payments made on the financing contract and the cumulative amount of Vacation Interest revenue recognized on the related lease prior to such default is immediately recognized as Vacation Interest revenue.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

The following table summarizes the amounts on the accompanying unaudited consolidated balance sheets relating to the two St. Maarten resorts, as of the end of the reported periods:

The following table summarizes the amounts recognized in the accompanying unaudited consolidated statements of operations relating to the leases discussed above, for the periods indicated:

Homeowners’ Association Transactions

In the Company’s capacity as the homeowners’ association for these resorts, it collects maintenance fees from the lessees and the trust, which are accrued as earned, generally over a twelve-month period. The homeowners’ association will also periodically bill the lessees for capital projects assessments to repair and replace the amenities of these resorts, as well as special assessments to reserve the out-of-pocket deductibles for hurricanes and other natural disasters. These assessments are recognized as income by the reserve funds of the homeowners’ association during the period in which they are assessed.

The revenues relating to the homeowners transactions are included within the caption “Management services revenue” and the expenses, except for the provision for bad debt and depreciation expenses, are included in General and Administrative expenses.

Note 4—Mortgages and Contracts Receivable, Net

Mortgages and contracts receivable are recorded at amortized cost, including deferred loan and contract origination costs, less the related allowance for loan and contract losses. Loan and contract origination costs incurred in connection with providing financing for Vacation Interests have been capitalized and are being amortized over the term of the mortgages or contracts receivable as an adjustment to interest revenue on mortgages and contracts receivable using the effective interest method. Amortization of deferred loan and contract origination costs charged to interest revenue was $0.4 million and $0.5 million for the three months ended December 31, 2004 and 2003, respectively.

The Company recorded a $10.3 million premium at July 31, 2002 on mortgages and contracts receivable, which will be amortized over the life of the mortgages and contracts receivable portfolio. At December 31, 2004 and September 30, 2004, the net unamortized premium was $4.2 million and $4.5 million, respectively. During the three months ended December 31, 2004 and 2003, amortization of $0.3 million and $0.6 million, respectively, was recorded as an adjustment of interest revenue.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

The following summarizes the Company’s total mortgages and contracts receivable, net, as of the dates on the accompanying unaudited consolidated balance sheets:

The Company provides for estimated mortgages receivable cancellations and defaults at the time the Vacation Interest revenues are recorded by a charge to the provision for doubtful accounts and loan losses and an increase to the allowance for loan and contract losses. The Company periodically performs an analysis of factors such as economic conditions and industry trends, defaults, past due agings and historical write-offs of mortgages and contracts receivable to evaluate the adequacy of the allowance.

The Company charges off mortgages and contracts receivable upon default on the first scheduled principal and interest payment (first payment defaults) or after 180 days of contractual delinquency. Vacation Interests recovered on defaulted mortgages receivable are recorded in Unsold Vacation Interests, net, and as a reduction of loan charge-offs at the historical cost of Vacation Interests at the respective property. All collection costs are expensed as incurred.

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

Note 5—Unsold Vacation Interests, Net

Unsold Vacation Interests are valued at the lower of cost or fair value. Development costs include acquisition costs, both hard and soft construction costs and, together with real estate costs, are allocated to Unsold Vacation Interests, net. Interest, real estate taxes and other carrying costs incurred during the construction period are capitalized and such costs incurred on completed Vacation Interest inventory are expensed. Costs are allocated to Vacation Interest cost of sales based upon the relative sales value method. Unsold Vacation Interests, net also includes the value of Vacation Interests collateralizing delinquent mortgages and contracts receivable that have been charged-off, but for which the Company does not yet hold title pending completion of the foreclosure process.

Unsold Vacation Interests, net consists of the following as of the dates on the accompanying unaudited consolidated balance sheets:

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Note 6—Goodwill, Intangible and Other Assets, Net

The following table sets forth information concerning the Company’s goodwill:

Such goodwill has an indefinite life and will be considered when the Company conducts its annual review of goodwill for impairment on July 1, 2005 to determine if goodwill with an indefinite life has been impaired.

Intangible and other assets, net consists of the following as of the dates on the accompanying unaudited consolidated balance sheets:

Amortization expense relating to other intangible assets was $0.1 million for the three months ended December 31, 2004 and 2003, respectively.

Note 7—Borrowings

Line of Credit Agreements

On July 29, 2002, the Company entered into a two-year agreement for a $300 million senior secured working capital credit facility (“Senior Finance Facility”) with Merrill Lynch Mortgage Capital. The proceeds of the Senior Finance Facility were used to pay amounts payable under certain creditor agreements, provide mortgage receivable and other working capital financing to the Company and to pay fees and expenses related to the Senior Finance Facility. A portion of the proceeds from the initial funding drawn on the Senior Finance Facility was used to pay off amounts outstanding under the Company’s previous senior finance facility.

In February 2004, the Senior Finance Facility was amended, raising the maximum aggregate borrowing and extending the term to February 28, 2006. The interest rate on the portion of the line secured by the Company’s eligible mortgages and contracts receivable was reduced to the one-month LIBOR rate plus 2.25%, and, for the portion of the line secured by the Company’s eligible Unsold Vacation Interests, the rate was reduced to the one-month LIBOR rate plus 4.0%. The amendment reduced the exercise price of warrants to purchase 1,190,148 shares of the Company’s common stock from $15.25 per share to $14.00 per share. Additionally, the advance rate under loans secured by eligible mortgages and contracts receivable was increased to 85% from 80%. The amendment also expanded the ability of the Company to borrow against Vacation Points and contracts receivable collateralized by Vacation Points, including both assets acquired by the Company as part of the purchase of certain assets of Epic Resorts Group, as well as assets associated with the Company’s new multi-site clubs. The Company also agreed to pay Merrill Lynch Mortgage Capital, Inc. a commission equal to 1.5% of Vacation Interest revenue on the sale of inventory acquired from Epic Resorts Group.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

In July 2004, in conjunction with the July 7, 2004 acquisition of the remaining outstanding 77% partnership interests in Ka’anapali, the Company and Merrill Lynch Mortgage Capital, Inc. entered into a third amendment to the Senior Finance Facility. The amendment added Ka’anapali as a borrower on the Company’s Senior Finance Facility and provides for borrowings secured by Ka’anapali’s eligible mortgages receivable and eligible Unsold Vacation Interests.

At December 31, 2004, the maximum capacity to borrow, amounts outstanding, and remaining availability under the Senior Finance Facility were $257.2 million, $177.6 million and $79.6 million, respectively. The capacity and availability of borrowings under the Senior Finance Facility are based on the value of eligible mortgages and contracts receivable, the value of eligible Unsold Vacation Interests and the value of certain real property and other assets. The Senior Finance Facility is secured by a first priority lien on the mortgages and contracts receivable and Unsold Vacation Interests, as well as certain real property and other assets of the Company, subject to certain exceptions. Prior to the February 2004 amendment discussed above, borrowings under the Senior Finance Facility bore interest at an annual rate equal to one month LIBOR plus 3%, 5% or 7%, depending on the amounts outstanding and on the type of asset collateralizing various advances. The weighted average interest rate of these borrowings at December 31, 2004, was 5.29% per annum. Beginning in February 2003, the Senior Finance Facility also requires the Company to pay an additional cash interest amount monthly when certain conditions are not met. The total amount of such additional cash interest payments made during the three months ended December 31, 2004 and 2003 were $0 million and $0.7 million, respectively.

The Company’s Senior Finance Facility contains various restrictions and limitations that may affect its business and affairs. These include restrictions and limitations relating to its ability to incur indebtedness and other obligations, to make investments and acquisitions and to pay dividends. This facility also requires the Company to maintain certain financial ratios and comply with other financial covenants. The failure of the Company to comply with any of these provisions, or to pay its obligations under the Senior Finance Facility, or other loan agreements, could result in foreclosure by the lenders of their security interests in the Company’s assets, as discussed in the following paragraph, and could otherwise have a material adverse effect on the Company.

In addition to the facility fee (2.5% of $300 million) paid in connection with the commitment and the closing of the Senior Finance Facility and an anniversary fee of 1.5% due on the anniversary of the initial borrowing, the Company issued a warrant exercisable for 1,190,148 shares of common stock at an exercise price of $15.25 per share (the deemed value of the shares), subject to adjustment under certain anti-dilution provisions of the warrant and will pay an unused commitment fee of 0.25% per annum on the excess availability under the Senior Finance Facility. The $8.7 million value of the warrants issued to the Senior Finance Facility lender 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 and, as a result of the February 2004 amendment, an additional $0.4 million was recorded to reflect the decrease in exercise price to $14.00 per share. The value of the warrants was recorded as a capitalized financing cost that is amortized over the term of the financing agreement. The February 2004 amendment also stipulated that facility fees equal to 0.75% of $300.0 million were due and payable on July 29, 2004 and are due and payable on July 29, 2005, with the latter fee being prorated through the termination date of February 28, 2006. Amortization of debt issuance costs related to the Senior Finance Facility included in interest expense in the accompanying consolidated statements of operations was $1.1 million and $3.4 million for the three months ended December 31, 2004 and 2003, respectively.

The Company has capitalized interest related to ongoing construction projects of $0.2 million and $0.1 million for the three months ended December 31, 2004 and 2003, respectively.

Senior Subordinated Convertible Notes

On March 29, 2004, the Company issued $95.0 million in 3 ¾% Senior Subordinated Convertible Notes due 2024 (the “Notes”). The Notes were issued at a price of $1,000 per Note and pay interest semi-annually on March 29 and September 29 of each year, beginning on September 29, 2004 at the rate of 3.75% per annum. The Notes will mature on March 29, 2024. Under the terms of the indenture, the Company was required to use a portion of the proceeds from the offering to purchase a portfolio of U.S. government securities that are pledged to secure the first six scheduled interest payments on the Notes. This $10.4 million was recorded in Prepaid expenses and other assets, net and the balance on the accompanying unaudited consolidated balance sheets was $8.7 million as of December 31, 2004 and September 30, 2004. Other than this pledge, the Notes are unsecured obligations.

The Notes are initially convertible, at the option of the holder, into shares of the Company’s common stock at a conversion rate of 62.5027 shares per $1,000 principal amount of the Notes upon the price of the Company’s common stock reaching 110% of such implied conversion price of $16.00 per common share, if the Notes are called for redemption or if specified corporate transactions or significant distributions to holders of the Company’s common stock have occurred.

Holders of the Notes may require the Company to purchase for cash all or a portion of their Notes on March 29, 2011, March 29, 2014 and on March 29, 2019 at a price equal to $1,000 per $1,000 principal amount of the Notes, plus accrued and unpaid interest, if any, to the date of the purchase. In addition, if the Company experiences a change in control, each holder may require the Company to purchase all or a portion of such holder’s Notes at the same amount, plus, in certain circumstances, a make-whole premium.

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SUNTERRA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

The Company may redeem some or all of the Notes for cash at any time on or after March 29, 2007 if the closing price of the Company’s common stock has exceeded 150% of the conversion price then in effect for at least 20 trading days within a period of 30 consecutive trading days ending on the trading day before the mailing date of the corresponding redemption notice. On or after March 29, 2011, the Company may redeem some or all of the Notes for cash at any time at a price of $1,000 per $1,000 principal amount of the Notes, plus accrued and unpaid interest, if any, to the redemption date.

For the three months ended December 31, 2004 and 2003, amortization of $0.1 million and $0.0 million, respectively, of debt issuance costs related to the Notes was recorded and is included in interest expense in the accompanying unaudited consolidated statements of operations.

Securitization Notes

On September 30, 2004, the Company completed a $151.7 million private offering and sale of vacation ownership receivable-backed notes (the “2004 Securitization”). The $171.4 million (including $17.0 million in aggregate principal of vacation ownership receivables sold during the ninety day period commencing September 30, 2004) in aggregate principal of vacation ownership receivables that collateralize the notes were initially sold to Sunterra SPE 2004-1 LLC (“SPE 2004-1”), a wholly-owned, special purpose entity that deposited the vacation ownership receivables into the Sunterra Owner Trust 2004-1, which issued the notes and is included within Sunterra Corporation’s consolidated financial statements, without recourse to the Company or to SPE 2004-1, except for breaches of certain representations and warranties at the time of sale. The 2004 Securitization is secured by a first priority lien on the mortgages and contracts receivable sold to Sunterra Owner Trust 2004-1.

On October 27, 2004 and December 1, 2004, the Company completed pre-funding transactions with the Sunterra Owner Trust 2004-1. On October 27, 2004, $11.1 million in vacation ownership receivables were sold to Sunterra Owner Trust 2004-1 and on December 1, 2004, $5.9 million of vacation ownership receivables were sold to Sunterra Owner Trust 2004-1. As a result of these two transactions, the $17.0 million classified as restricted cash as of September 30, 2004 was effectively released ratably on these two dates and transferred to the Company in exchange for these vacation ownership receivables.

The $151.7 million private offering consists of: $66.0 million class A notes ‘AAA’, $18.4 million class B notes ‘AA’, $17.6 million class C notes ‘A’ and $49.7 million class D notes ‘BBB’. The notes carry various fixed interest rates ranging from 3.6% to 4.9% and have legal stated maturities of October 2020. The actual maturity of the notes could be significantly earlier than the stated maturity, and the average life of the notes could be significantly shorter than anticipated, in the event of certain occurrences. Interest and principal payments are due monthly. In addition, the notes contain a “clean up” call provision that allows the notes to be called and mortgages receivable to be transferred back to the Company when the remaining principal value of the notes reaches 10% of the original principal value.

Under the terms of the indenture, Sunterra Financial Services, Inc., a direct wholly owned subsidiary of the Company, in exchange for a monthly fee, will service and administer the vacation ownership receivables in Sunterra Owner Trust 2004-1. All monthly fees are eliminated as part of the Company’s consolidation of the Sunterra Owner Trust 2004-1.

The proceeds were used to pay down balances due under the Company’s Senior Finance Facility with Merrill Lynch Mortgage Capital, Inc., pay fees associated with the transaction to third parties and deposit initial amounts in a required cash reserve account. The Company also retained a subordinated interest in future cash flows from the 2004 Securitization.

For the three months ended December 31, 2004, amortization of $0.1 million of debt issuance costs related to the 2004 Securitization was recorded and is included in interest expense in the accompanying unaudited consolidated statements of operations.

Note 8—Accrued Liabilities

The Company records estimated amounts for certain accrued liabilities at each period-end. Accrued liabilities are probable future sacrifices of economic benefits arising from present obligations to transfer assets or provide services to other entities in the future as a result of past transactions or events.

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SUNTERRA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

The following table summarizes the balances in accrued liabilities as of the dates on the accompanying unaudited consolidated balance sheets:

Note 9— Deferred Revenues

The Company records deferred revenues for payments received or billed but not earned for various activities, including those described here-in and summarized below. The largest and primary component relates to leases of Vacation Interests at the Company’s two resorts in St. Maarten. See Note 3—St. Maarten Transactions for further discussion of this component.

Deferred Club Sunterra revenue- annual Club Sunterra membership fees paid or billed to members and amortized ratably over a one-year period, one-time conversion fees paid by owners to convert to Club Sunterra and amortized ratably over a 10-year period (the estimated life of the membership) and the remaining portion of an advance on renewal fees amortized ratably commensurate with Club Sunterra members renewing memberships with an external exchange service.

Unearned mini-vacations—sold but unused trial Vacation Interests, ranging from three days to one week. This revenue is recognized when the purchaser completes their respective stay at one of the Company’s resorts.

Unearned management services revenue—maintenance fees billed but unearned in the Company’s capacity as the homeowners’ association for the two resorts in St. Maarten. See Note 3 for further discussion.

The following table summarizes the balances in deferred revenues as of the dates on the accompanying unaudited consolidated balance sheets:

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SUNTERRA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Note 10—Comprehensive Income (Loss)

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

Note 11—Segment and Geographic Information

The Company currently operates in two geographic segments, the North America and Europe segments. Both 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. The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 2 of this filing and further in Note 3 to the Company’s transition report on Form 10-K for the period ended September 30, 2004. No single customer accounts for a significant amount of the Company’s revenues. Information about the Company’s operations in different geographic locations is shown below:

Included in the eliminations column are the effects of transactions between segments. Currently, the Europe segment has a note payable to the North America segment. The related interest income and expense is being eliminated as part of the profit and loss elimination entries, and the inter-segment note is being eliminated as part of the balance sheet elimination entries.

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SUNTERRA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Note 12—Related Party Transactions

Joint Venture

The Company owns a 30% interest in Poipu Resort Partners, L.P. (“Poipu”) and accounts for its investment in the joint venture under the equity method. On July 7, 2004, the Company completed the acquisition of the remaining outstanding 77% partnership interest in West Maui Resort Partners, L.P. (“Ka’anapali”). For the three months ended December 31, 2004 and 2003, the Company received $0.6 million and $0.2 million, respectively, in cash distributions from Poipu. For the three months ended December 31, 2003, the Company received $0.9 million in cash distributions from Ka’anapali. The Company also receives fees from both Poipu and Ka’anapali for providing property management as well as oversight of the sales and marketing functions, which are included in the totals for management services revenue. See “Management Services” paragraph below.

Management Services

Included within the amounts reported as management services revenue are revenues from property management services provided to the homeowners’ associations of the resorts wherein the Company owns either Unsold Vacation Interests or is a minority owner, as well as fees earned for management of sales and marketing functions at certain resorts. These amounts totaled $4.6 million and $4.9 million for the three-month periods ended December 31, 2004 and 2003, respectively.

Under contracts approved by the Boards of Trustees of the homeowners’ association for certain resorts, the Company serves as the property manager for these resorts. Additionally, the Company has contractual agreements with the homeowners’ associations of certain resorts to provide telephone services to the property. Accounts receivable due from the homeowners’ associations, generally for management fees and other operating and maintenance expenses, are reported net of amounts payable to homeowners’ associations, consisting primarily of maintenance fees for unsold Vacation Interests. The Company also periodically advances funds to the joint venture entity in which the Company maintains minority interest (see “Joint Venture” above). The following table shows the balances outstanding from related parties on the accompanying unaudited consolidated balance sheets:

Note 13—Commitments and Contingencies

The Company licensed certain computer software under a software license granted by RCI Technology Corp. (“RCITC”), formerly known as Resort Computer Corporation. That software was the foundation for the Company’s former integrated computer system (known as “SWORD”), which until recently managed a wide range of hospitality functions, such as reservations, inventory control, sales commissions, Club Sunterra operations, housekeeping and marketing. RCITC filed a motion in the Chapter 11 proceedings alleging that the license agreement should be deemed rejected, which RCITC asserts would have the effect of terminating the license. Sunterra opposed the motion, and the Bankruptcy Court ruled in favor of Sunterra and denied RCITC’s motion. On June 14, 2002, RCITC filed a notice of appeal of the Court’s decision. On January 10, 2003, the United States District Court of Maryland affirmed the order of the Bankruptcy Court, denying the motion of RCITC. RCITC further appealed that decision to the United States Court of Appeals, Fourth Circuit, which granted RCITC’s appeal on March 18, 2004. The Company’s new “ATLAS” computer system fully replaces the SWORD software, which was based on the RCITC system, and therefore the Company does not believe that RCITC’s successful appeal in this litigation will have a material adverse effect on the Company, even if RCITC were to assert a claim for illegitimate use of SWORD for the period between the date of emergence and the conversion to ATLAS.

The Company owns a partnership interest in the Embassy Vacation Resort at Poipu Point, Koloa on the island of Kauai, Hawaii. Under the terms of the partnership agreement, the Company could be required to purchase the other partner’s interest. At December 31, 2004, the Company does not believe that the events requiring such purchase have occurred.

On April 29, 2004, an irrevocable standby letter of credit in the amount of $6.6 million was issued on the Company’s behalf to an affiliated homeowners’ association securing certain maintenance fee obligations due from the Company. This standby letter of credit expires one year from the date of issuance. Restricted cash of approximately the same amount secures such standby letter of credit. During July 2004, two additional standby letters of credit in the combined amount of approximately $1.6 million were issued on behalf of the Company for similar purposes and on similar terms. During August 2004, one of the two additional standby letters of credit issued on behalf of the Company in July 2004 in the amount of $0.6 million was cancelled as it was replaced with a surety bond issued in July 2004 as described in the next paragraph. Also, in August 2004 the standby letter of credit issued in April 2004 on behalf of the Company for $6.6 million was cancelled and replaced with a new one for $7.8 million. In October 2004, an additional standby letter of credit in the amount of $1.5 million was issued on the Company’s behalf.

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SUNTERRA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

On February 25, 2003, a surety bond in the amount of $0.6 million was issued on the Company’s behalf to an affiliated homeowners’ association securing certain maintenance fee obligations due from the Company. This surety bond has been amended several times and amounted to $1.5 million as of December 31, 2004. Restricted cash of approximately fifty percent of this amount secures such surety bond. During July 2004, an additional surety bond in the amount of $0.6 million was issued on behalf of the Company for similar purposes with no restricted cash required as security and replaced an irrevocable standby letter of credit of $0.6 million previously issued as discussed in the preceding paragraph. The Company has approximately $1.8 million of additional surety bonds issued on its behalf as of December 31, 2004 for various other business purposes.

In addition, the Company is also currently subject to litigation and claims regarding employment, tort, contract, construction, sales taxes and commission disputes, among others. Much of such litigation and claims were pre-petition and were treated as general unsecured creditors under the Company’s plan of reorganization. In the judgment of management, none of such litigation or claims against the Company is likely to have a material adverse effect on the Company’s financial statements.

Note 14—Subsequent Events

TerraSun, LLC — On January 25, 2005, the Company completed a transaction resulting in the acquisition of a loan portfolio held by TerraSun, LLC, a special purpose entity created to hold a loan portfolio and issue collateralized debt to third-party investors, for approximately $7.8 million. This transaction was the result of the exercise of the “clean up” call provision contained in the notes issued by TerraSun, LLC that allows the notes to be called and mortgages and contracts receivable to be transferred back to the Company when the remaining principal value of the notes reaches 10% of the original principal value. Under the purchase method of accounting, the total purchase price is allocated to the net tangible and intangible assets based upon their estimated fair market values as of the date of the acquisition and the operating results of the acquired portfolio are included in the consolidated statement of operations from the date of acquisition.

Dutch Elm, LLC – On January 21, 2005, the Company issued a notice of redemption to the holders of notes issued by Dutch Elm, LLC, a special purpose entity created to hold a loan portfolio and issue collateralized debt to third-party investors, in conjunction with its exercise of the “clean up” call provision that allows the notes to be called and mortgages and contracts receivable to be transferred back to the Company when the remaining principal value of the notes reaches 10% of the original principal value. This transaction is expected to close on February 25, 2005.

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

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, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934, 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 Transition Report on Form 10-K for the nine months ended September 30, 2004 under the headings “Business-Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in that report. Any or all of these factors could cause our actual results and financial or legal status for future periods 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.

The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and related notes in Item 1 of this report. Unless the context otherwise requires, the terms “Company,” “we,” “our,” and “us” refer to Sunterra Corporation, a Maryland corporation, and its subsidiaries.

RESULTS OF OPERATIONS

Change in Fiscal Year End

Effective October 1, 2004, we changed our fiscal year end for financial reporting purposes from a calendar year-end to the 12-month period commencing October 1 and ending September 30. As a result of this change, for purposes of discussion of results of operations, the three-month period ended December 31, 2004 is compared to the three-month period ended December 31, 2003.

Overview

Sunterra Corporation, through its subsidiaries, joint venture and affiliated resorts, is one of the largest companies in the vacation ownership industry, our single reportable operating segment. Through a network of ninety-three owned or affiliated resorts located around the globe, our operations consist of:

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Comparison of the Three Months Ended December 31, 2004 to the Three Months Ended December 31, 2003: