**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

**FORM 10-Q**

 
| **(Mark One)** |
|----------------|
| **ý**     | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
| ** **     | ** ** | **FOR THE QUARTERLY PERIOD ENDED JUNE 30,  2005** |
|           |   |   |
| **o**          | ** ** | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT** |

 

**CommissionFile No. 0-31267**

 

**IWT TESORO CORPORATION**

(Exactname of registrant as specified in its charter)

 
| **Nevada**                                                       | ** ** | **91-2048019**                           |
|------------------------------------------------------------------|------------|------------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification Number) |

 

**101 PostRoad West, Suite 10, Westport, CT 06880**

(Address of principal executive offices)

 

**(203) 221-2770**

(Registrant’s telephone number, includingarea code)

 

Indicate by check, mark whether the registrant:(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days:

 
| ýYes |   | oNo |
|-----------|--------|-----|

 

Indicate by check mark whether the registrantis an accelerated files (as defined in Rule 12b-2 of the Exchange Act)oYes             ýNo

 

Statethe number of shares outstanding of each of the issuer’s class of commonequity, as of August 12, 2005: 11,701,102 shares

 

 

----

 

**IWT TESORO CORPORATION ANDSUBSIDIARIES**

**FORM 10-Q**

**For the Six Months Ended June 30,2005**

**INDEX**

 
| **PART I**  | **FINANCIAL INFORMATION**                                                                                                               | ** ** |
|------------------|-----------------------------------------------------------------------------------------------------------------------------------------|------------|
|             |                                                                                                                                    |       |
| Item I.          | Financial Statements                                                                                                                    |       |
|             |                                                                                                                                    |       |
|             | Consolidated Balance Sheets as of  June 30, 2005 (unaudited) and December 31, 2004                                            |       |
|             | Consolidated Statements of Operations  for the Three Months and Six Months Ended June 30, 2005 and 2004 (as  restated) (unaudited) |       |
|             | Consolidated Statement of Stockholders’ Equity  for the Six Months Ended June 30, 2005 (unaudited)                            |       |
|             | Consolidated Statements of Cash  Flows for the Six Months Ended June 30, 2005 and 2004 (as restated)  (unaudited)                  |       |
|             | Notes to the Consolidated Interim  Financial Statements                                                                                 |       |
|             |                                                                                                                                    |       |
| Item 2.          | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                             |       |
| Item 3.          | Quantitative and Qualitative Disclosures  About Market Risk                                                                             |       |
| Item 4.          | Controls and Procedures                                                                                                                 |       |
|             |                                                                                                                                    |       |
|             |                                                                                                                                    |       |
| **PART II** | OTHER INFORMATION                                                                                                                       |       |
|             |                                                                                                                                    |       |
| Item 1.          | Legal Proceedings                                                                                                                       |       |
| Item 6.          | Exhibits                                                                                                                                |       |

 

2

----

 

PART I – FINANCIAL INFORMATION

 

ITEM1:  FINANCIAL STATEMENTS

 

**IWT TESOROCORPORATION AND SUBSIDIARIES**

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 
| ** **                                                                                                       | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                       | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| ** **                                                                                                       | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| ASSETS                                                                                                           |       |              |       |                  |       |
| Current Assets:                                                                                                  |       |              |       |                  |       |
| Cash                                                                                                             |       | $                 | 636,921    |                  | $          | 507,677 |   |
| Accounts receivable, net allowance for  doubtful accounts and returns of $288,909 and $270,013                   |       | 9,055,652         |       | 7,883,756             |       |
| Inventories                                                                                                      |       | 26,604,745        |       | 21,578,829            |       |
| Deposit on purchase of inventories                                                                               |       | 383,057           |       | 366,667               |       |
| Prepaid expenses                                                                                                 |       | 300,773           |       | 271,104               |       |
| Total current assets                                                                                             |       | 36,981,148        |       | 30,608,033            |       |
|                                                                                                             |       |              |       |                  |       |
| Property and equipment, net                                                                                      |       | 1,746,338         |       | 1,762,065             |       |
|                                                                                                             |       |              |       |                  |       |
| Other assets                                                                                                     |       | 742,361           |       | 758,997               |       |
|                                                                                                             |       | $                 | 39,469,847 |                  | $          | 33,129,095 |   |
|                                                                                                             |       |              |       |                  |       |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                       |       |              |       |                  |       |
|                                                                                                             |       |              |       |                  |       |
| Current Liabilities:                                                                                             |       |              |       |                  |       |
| Accounts payable                                                                                                 |       | $                 | 15,530,686 |                  | $          | 15,282,653 |   |
| Accrued expenses and other liabilities                                                                           |       | 1,180,377         |       | 997,432               |       |
| Current portion of capital lease  obligations                                                                    |       | 74,442            |       | 80,943                |       |
| Current portion of notes payable, other                                                                          |       | 16,438            |       | 18,218                |       |
| Total current liabilities                                                                                        |       | 16,801,943        |       | 16,379,246            |       |
|                                                                                                             |       |              |       |                  |       |
| Long-Term Debt:                                                                                                  |       |              |       |                  |       |
| Note payable, revolving line of credit                                                                           |       | 21,751,541        |       | 16,047,220            |       |
| Capital lease obligations                                                                                        |       | 135,576           |       | 170,425               |       |
| Subordinated notes payable, stockholders                                                                         |       | 338,662           |       | 338,662               |       |
| Notes payable, other                                                                                             |       | 59,677            |       | 37,487                |       |
| Total long-term debt                                                                                             |       | 22,285,456        |       | 16,593,794            |       |
| Total liabilities                                                                                                |       | 39,087,399        |       | 32,973,040            |       |
|                                                                                                             |       |              |       |                  |       |
| Commitments and Contingencies                                                                                    |       | —            |       | —                |       |
|                                                                                                             |       |              |       |                  |       |
| Stockholders’ Equity:                                                                                       |       |              |       |                  |       |
| Preferred stock, $0.001 par value,  25,000,000 authorized; none issued                                           |       | —            |       | —                |       |
| Common stock, $0.001 par value, 100 million  shares authorized; 11,701,102 and 11,697,102 issued and outstanding |       | 11,701            |       | 11,697                |       |
| Additional paid in capital                                                                                       |       | 4,189,396         |       | 4,178,800             |       |
| Accumulated deficit                                                                                              |       | (3,818,649        | )          | (4,034,442            | )          |
|                                                                                                             |       | 382,448           |       | 156,055               |       |
|                                                                                                             |       | $                 | 39,469,847 |                  | $          | 33,129,095 |   |

 

See notes to the consolidatedinterim financial statements.

 

3

----

 

**IWT TESOROCORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OFOPERATIONS

(Unaudited)

 
| ** **                                  | ** ** | **The three months ended** | ** ** | **The six months ended** | ** ** |
|---------------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| ** **                                  | ** ** | **June 30,**          | ** ** | **June 30,**        | ** ** |
| ** **                                  | ** ** | **2005**                   | ** ** | **2004**                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | ** **                 | ** ** | **(Restated)**           | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
|                                        |       |                       |       |                     |       |   |   |   |   |
| Net Sales                                   |       | $                          | 14,441,721 |                     | $          | 11,585,016 |   | $ | 28,134,699 |   | $ | 21,119,648 |   |
| Cost of Goods Sold                          |       | 8,602,396                  |       | 7,144,406                |       | 17,165,389 |   | 12,954,820 |   |
| Gross Profit                                |       | 5,839,325                  |       | 4,440,610                |       | 10,969,310 |   | 8,164,828 |   |
| Operating Expenses:                         |       |                       |       |                     |       |   |   |   |   |
| Warehouse and distribution                  |       | 1,925,995                  |       | 1,327,688                |       | 3,611,386 |   | 2,588,744 |   |
| Sales and marketing                         |       | 1,768,142                  |       | 1,535,385                |       | 3,457,820 |   | 3,135,300 |   |
| General and administrative                  |       | 1,687,400                  |       | 1,529,035                |       | 3,228,236 |   | 2,916,973 |   |
|                                        |       | 5,381,537                  |       | 4,392,108                |       | 10,297,442 |   | 8,641,017 |   |
| Income (Loss) from Operations               |       | 457,788                    |       | 48,502                   |       | 671,868 |   | (476,189 | ) |
| Other Expenses:                             |       |                       |       |                     |       |   |   |   |   |
| Interest expense                            |       | (335,170                   | )          | (139,111                 | )          | (604,760 | ) | (261,377 | ) |
| Other                                       |       | 41,694                     |       | 23,823                   |       | 148,685 |   | 30,276 |   |
|                                        |       | (293,476                   | )          | (115,288                 | )          | (456,075 | ) | (231,101 | ) |
| Income (Loss) Before Income Taxes           |       | 164,312                    |       | (66,786                  | )          | 215,793 |   | (707,290 | ) |
|                                        |       |                       |       |                     |       |   |   |   |   |
| Income Tax Benefit (Expense)                |       | —                     |       | —                   |       | — |   | — |   |
| Net Income (Loss)                           |       | $                          | 164,312    |                     | $          | (66,786 | ) | $ | 215,793 |   | $ | (707,290 | ) |
| Earnings (Loss) Per Share:                  |       |                       |       |                     |       |   |   |   |   |
| Basic                                       |       | $                          | 0.01       |                     | $          | (0.01 | ) | $ | 0.02 |   | $ | (0.06 | ) |
| Diluted                                     |       | $                          | 0.01       |                     | $          | (0.01 | ) | $ | 0.02 |   | $ | (0.06 | ) |
|                                        |       |                       |       |                     |       |   |   |   |   |
| Weighted Average Common Shares Outstanding: |       |                       |       |                     |       |   |   |   |   |
|                                        |       |                       |       |                     |       |   |   |   |   |
| Basic                                       |       | 11,698,333                 |       | 11,687,377               |       | 11,697,721 |   | 11,661,050 |   |
| Diluted                                     |       | 12,161,081                 |       | 11,687,377               |       | 12,160,469 |   | 11,661,050 |   |

 

See notes to the consolidatedinterim financial statements.

 

4

----

 

**IWT TESORO CORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENT OFSTOCKHOLDERS’ EQUITY

(Unaudited)

 

 
| ** **                                       | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|------------------|------------|-------------|------------|----------------|------------|-----------------|------------|------------|------------|
| ** **                                       | ** ** | **Common Stock** | ** ** | **Paid in** | ** ** | **Earnings**   | ** ** | ** **      | ** ** |
| ** **                                       | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Deficit**     | ** ** | **Total**  | ** ** |
|                                             |       |             |       |        |       |           |       |            |       |       |       |
| Balance, December 31, 2004                  |       | 11,697,102       |       | $           | 11,697     |           | $          | 4,178,800       |       | $          | (4,034,442 | ) | $ | 156,055 |   |
|                                             |       |             |       |        |       |           |       |            |       |       |       |
| Issuance of shares to employees                  |       | 4,000            |       | 4           |       | 10,596         |       | —          |       | 10,600     |       |
|                                             |       |             |       |        |       |           |       |            |       |       |       |
| Net income, six months ended June 30,  2005 |       | —           |       | —      |       | —         |       | 215,793         |       | 215,793    |       |
|                                             |       |             |       |        |       |           |       |            |       |       |       |
| Balance, June 30, 2005                      |       | 11,701,102       |       | $           | 11,701     |           | $          | 4,189,396       |       | $          | (3,818,649 | ) | $ | 382,448 |   |

 

See notes to the consolidatedinterim financial statements.

 

5

----

 

**IWT TESOROCORPORATION AND SUBSIDIARIES**

 

CONSOLIDATED STATEMENTS OFCASH FLOWS

(Unaudited)

 
| ** **                                                                            | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                            | ** ** | **June 30,**    | ** ** | **June 30,** | ** ** |
| ** **                                                                            | ** ** | **2005**             | ** ** | **2004** | ** ** |
| ** **                                                                            | ** ** | ** **           | ** ** | **(Restated)** | ** ** |
| Cash flows from operating activities:                                                 |       |                 |       |   |   |
| Net income (loss)                                                                     |       | $                    | 215,793    |   | $ | (707,290 | ) |
| Adjustments to reconcile net income (loss) to  net cash used in operating activities: |       |                 |       |   |   |
| Depreciation and amortization                                                         |       | 188,619              |       | 128,859 |   |
| Loss (Gain) on disposal of property and  equipment                                    |       | 16,900               |       | (21,533 | ) |
| Common stock issued for services and  compensation                                    |       | 10,600               |       | 140,300 |   |
| Provision for doubtful accounts and reserve  for returns                              |       | 18,896               |       | 97,966 |   |
| Changes in operating assets and  liabilities:                                         |       |                 |       |   |   |
| (Increase) Decrease in:                                                               |       |                 |       |   |   |
| Accounts receivable                                                                   |       | (1,190,792           | )          | (2,460,414 | ) |
| Inventories                                                                           |       | (4,952,291           | )          | (2,369,087 | ) |
| Deposit on purchase of inventories                                                    |       | —               |       | (550,000 | ) |
| Prepaid expenses and other assets                                                     |       | (96,293              | )          | 40,491 |   |
| Increase in:                                                                          |       |                 |       |   |   |
| Accounts payable                                                                      |       | 248,033              |       | 2,233,146 |   |
| Accrued expenses                                                                      |       | 182,945              |       | 273,080 |   |
| Net cash used in operating activities                                                 |       | (5,357,590           | )          | (3,194,482 | ) |
|                                                                                  |       |                 |       |   |   |
| Cash flows from investing activities:                                                 |       |                 |       |   |   |
| Acquisitions of property and equipment                                                |       | (107,562             | )          | (473,214 | ) |
| Proceeds from sale of equipment                                                       |       | —               |       | 25,000 |   |
| Net cash used in investing activities                                                 |       | (107,562             | )          | (448,214 | ) |
|                                                                                  |       |                 |       |   |   |
| Cash flows from financing activities:                                                 |       |                 |       |   |   |
| Proceeds from revolving line of credit                                                |       | 32,783,331           |       | 21,330,000 |   |
| Payments on revolving line of credit                                                  |       | (27,079,010          | )          | (18,518,046 | ) |
| Collection on notes receivable arising from  sale of stock                            |       | —               |       | 550,000 |   |
| Proceeds from issuance of stock                                                       |       | —               |       | 147,875 |   |
| Payments of long-term debt                                                            |       | (74,271              | )          | (73,350 | ) |
| Loan financing costs                                                                  |       | (35,654              | )          | — |   |
| Net cash provided by financing activities                                             |       | 5,594,396            |       | 3,436,479 |   |
|                                                                                  |       |                 |       |   |   |
| Net Increase (decrease) in Cash                                                       |       | 129,244              |       | (206,217 | ) |
|                                                                                  |       |                 |       |   |   |
| Cash, Beginning                                                                       |       | 507,677              |       | 867,361 |   |
| Cash, Ending                                                                          |       | $                    | 636,921    |   | $ | 661,144 |   |
|                                                                                  |       |                 |       |   |   |
| Cash Paid During the Period for:                                                      |       |                 |       |   |   |
| Interest expense                                                                      |       | $                    | 604,760    |   | $ | 246,876 |   |
| Income tax                                                                            |       | $                    | 8,000      |   | $ | — |   |
| Non-Cash Operating Activities:                                                        |       |                 |       |   |   |
| Inventory acquired through deposit with  vendor                                       |       | $                    | 73,625     |   | $ | — |   |
| Non-Cash Investing and Financing  Activities:                                         |       |                 |       |   |   |
| Acquisition of property and equipment  financed through long-term debt                |       | $                    | 53,331     |   | $ | 6,095 |   |

 

See notes to the consolidatedinterim financial statements.

 

6

----

 

IWT TESORO CORPORATION ANDSUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

SIX MONTHS ENDED JUNE 30,2005

 

###### **NOTE 1.**                SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

###### ** **

#### ***Principles of Consolidation***

#### ** **

The consolidated financialstatements include IWT Tesoro Corporation and its wholly owned subsidiariesInternational Wholesale Tile, Inc., IWT Tesoro International, Ltd, IWTTesoro Transport, Inc., The Tile Club, Inc. and The Tile Club, Inc.’swholly owned subsidiary Import Flooring Group, Inc. All significantinter-company balances and transactions have been eliminated in consolidation.

 

#### **B*asis of Presentation***

#### ** **

The interim financial information includedherein is unaudited; however, such information reflects all adjustments, whichare, in the opinion of management, necessary for a fair presentation of theCompany’s financial position, results of operations, changes in stockholders’equity and cash flows for the interim periods. All such adjustments are of anormal, recurring nature. The results of operations for the first six months ofthe year are not necessarily indicative of the results of operations whichmight be expected for the entire year.

 

Theaccompanying consolidated financial statements of the Company have beenprepared in accordance with accounting principles generally accepted in theUnited States of America and with the instructions to Form 10-Q and Rule 10-10of Regulation S-X of the Securities and Exchange Commission. Accordinglycertain information and footnote disclosure required by accounting principlesgenerally accepted in the United States of America for complete financialstatements have been omitted. These condensed financial statements should beread in conjunction with the Company’s financial statements and notes theretoincluded in the Company’s audited financial statements on Form 10-K, forthe fiscal year ended December 31, 2004.

 

TheConsolidated Balance Sheet at December 31, 2004 has been derived from theaudited financial statements of IWT Tesoro Corporation at that date, but doesnot include all of the information and footnotes required by U.S. generallyaccepted accounting principles for complete financial statements.

 

#### ***Stock-Based Compensation***

#### ** **

The Company has elected to follow AccountingPrinciples Board Opinion No. 25, “*Accounting for StockIssued to Employees*” (APB No. 25), and related interpretations,in accounting for its employee and board of director stock options rather thanthe alternative fair value accounting allowed by SFAS No. 123, “*Accounting for Stock-Based Compensation*”.  As amended by SFAS 148 “Accounting forStock-Based Compensation Transition and Disclosure” APB No. 25 providesthat the compensation expense relative to the Company’s employee stock optionsis measured based on the intrinsic value of the stock option.

 

SFAS No. 123 requires companies that continueto follow APB No. 25 to provide pro forma disclosure of the impact ofapplying the fair value method of SFAS No. 123.  The Company follows SFAS No. 123 in accountingfor stock options issued to non-employees.

 

Pro forma informationregarding net income and earnings per share is required by SFAS No. 123, “*Accounting forStock-Based Compensation*,” and has beendetermined as if the Company had accounted for its stock options under the fairvalue method of that Statement. The fair value for these options wasestimated at the grant date using the Black-Scholes option-pricing model usingthe following weighted average assumptions for 2005 and 2004, respectively:risk-free interest rates of3.58%, and 2.20%, dividend yields of 0% and 0%, volatility factors ofthe expected market price of the Company’s common stock of 60.79% and 21.51%and expected lives of ten years. Using these assumptions, the weighted averagegrant-date fair value per share of options granted in 2005 was $1.57 and in2004 it was $1.21.

 

7

----

 

The Black-Scholes option valuation model wasdeveloped for use in estimating the fair value of traded options, which have novesting restrictions and are fully transferable. In addition, option valuationmodels require the input of highly subjective assumptions including theexpected stock price volatility. Because the Company’s employee stock optionshave characteristics significantly different from those of traded options, andbecause changes in the subjective input assumptions can materially affect thefair value estimate, in management’s opinion, the existing models do notnecessarily provide a reliable single measure of the fair value of its employeestock options.  For purposes of pro formadisclosures, the estimated fair value of the options is amortized to expenseover the options’ vesting period.

 

A total of 50,000 options were granted todirectors of the Company during the six months ended June 30, 2005. Duringthe six months ended June 30, 2004 a total of 45,000 options were grantedto directors of the Company and 5,000 options were granted to employees. Theeffect on net income (loss) and earnings (loss) per share if the Company hadapplied the fair value recognition provision of the SFAS No. 123, ispresented below:

 

| ** **                                                                                                                                   | ** ** | **For the six months ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| ** **                                                                                                                                   | ** ** | ** **                                 | ** ** | **(Restated)** | ** ** |
| Net income (loss) as reported                                                                                                                |       | $                                          | 215,793    |   | $ | (707,290 | ) |
| Deduct: Stock-based employee compensation expense  determined under the fair value based method for all options, net of related  tax effects |       | (37,902                                    | )          | (54,563 | ) |
|                                                                                                                                         |       |                                       |       |   |   |
| Pro forma net income (loss)                                                                                                                  |       | $                                          | 177,891    |   | $ | (761,853 | ) |
|                                                                                                                                         |       |                                       |       |   |   |
| Earnings (loss) per share - Basic                                                                                                            |       |                                       |       |   |   |
| As reported                                                                                                                                  |       | $                                          | 0.02       |   | $ | (0.07 | ) |
| Pro forma                                                                                                                                    |       | $                                          | 0.01       |   | $ | (0.07 | ) |
| Earnings (loss) per share - Diluted                                                                                                          |       |                                       |       |   |   |
| As reported                                                                                                                                  |       | $                                          | 0.02       |   | $ | (0.06 | ) |
| Pro forma                                                                                                                                    |       | $                                          | 0.01       |   | $ | (0.06 | ) |

 

***Earnings per Share***

 

Basic and diluted loss per share for thethree month period ended June 30, 2004 are equal as the effect of thecommon stock options and warrants were antidilutive.

 

8

----

 

***Income Taxes***

 

The Company recognizesincome taxes under the asset and liability method. Under this method, deferredtax assets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases, and losscarryforwards. Deferred tax assets and liabilities are measured using enactedtax rates expected to apply to taxable income in the years in which thosetemporary differences are expected to be recovered or settled. The effect ondeferred tax assets and liabilities of a change in tax rates is recognized inincome in the period that includes the enactment date. Deferred tax assets arereduced by a valuation allowance when, in the opinion of management, it is morelikely than not that some portion or all of the deferred tax assets will not berealized.

 

***Reclassifications***

 

Certain amounts in the 2004 financial statementshave been reclassified for comparative purposes to conform to the 2005presentation. These reclassifications had no effect on net income (loss).

 

###### **NOTE 2.**                RESTATEMENT OF FINANCIAL STATEMENTS

###### ** **

The Company has restated the consolidated balancesheet as of June 30, 2004 and the consolidated statements of operations,stockholders’ equity and cash flows for the six months then ended as describedbelow:

 

***Accounts Receivable***

 

Management determined that the Company had beenincorrectly calculating the allowances for product returns.  Management revised this calculation anddetermined that accounts receivable was overstated by approximately $108,000 atJune 30, 2004 and net sales were overstated by approximately $31,200 forthe three months ended June 30, 2004 and $52,800 for the six months ended June 30,2004.

 

***Accrued Expenses***

 

Management determined that the Company had beenincorrectly calculating the accruals for sales commissions.  Management revised this calculation anddetermined that accrued expenses were understated by approximately $600,400 asof June 30, 2004.

 

***Sample and Display Boards***

 

Management reassessed its methodology for accountingfor sample and display boards and determined that this promotional merchandiseshould have been expensed when distributed rather than capitalized anddepreciated.  The adjustments resultingfrom the restatement increased the net loss for the three months ended June 30,2004 by approximately $254,000 and for the six months ended June 30, 2004by approximately $666,000. This change also reduced property and equipment asof June 30, 2004 by approximately $3,646,500.

 

***Deferred Taxes***

 

In connection with the restatements for accounts receivable,accrued expenses and sample and display boards described above, the related taxeffect was recorded resulting in gross deferred tax assets and the Companyrecorded a valuation allowance, as needed, to reduce net deferred tax assets toan amount considered by management more likely than not to be realized.

 

9

----

 

***Additional Paid In Capital***

 

As part of therecapitalization transaction of IWT effective October 1, 2002, the Companyand each of the three stockholders of International Wholesale Tile, Inc.entered into a repurchase agreement to commence on January 1, 2003. Themaximum number of redeemable shares under the repurchase agreement was 450,000.On June 26, 2003, the Company voted to cancel the repurchase agreement.The transaction was accounted for by reducing additional paid in capital to theextent a balance existed with the remaining portion of the transaction appliedto accumulated deficit as of December 31, 2002.

 

The effects of these changesare summarized as follows:

 

| ** **                  | ** ** | **June 30, 2004** | ** ** |
|-----------------------------|------------|------------------------|------------|
| ** **                  | ** ** | **As**                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Previously**         | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                  | ** ** | **Reported**           | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Consolidated Balance Sheet: |       |                   |       |   |   |   |   |
| Accounts receivable         |       | $                      | 7,322,910  |   | $ | (107,757 | ) | $ | 7,215,153 |   |
| Property and equipment, net |       | 5,271,853              |       | (3,646,547 | ) | 1,625,306 |   |
| Deferred tax assets         |       | 76,972                 |       | (76,972 | ) | — |   |
| Accrued expenses            |       | 209,644                |       | 600,399 |   | 810,043 |   |
| Deferred tax liability      |       | 13,768                 |       | (13,768 | ) | — |   |
| Additional paid in capital  |       | 5,260,923              |       | (1,088,871 | ) | 4,172,052 |   |
| Retained earnings (deficit) |       | $                      | (203,300   | ) | $ | (3,329,036 | ) | $ | (3,532,336 | ) |

 
| ** **                            | ** ** | **For the Quarter Ended June 30, 2004** | ** ** | **For the Year Ended June 30, 2004** | ** ** |
|---------------------------------------|------------|----------------------------------------------|------------|-------------------------------------------|------------|
| ** **                            | ** ** | **As**                                       | ** ** | ** **                                | ** ** | ** ** | ** ** | **As** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | **Previously**                               | ** ** | ** **                                | ** ** | **As** | ** ** | **Previously** | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                            | ** ** | **Reported**                                 | ** ** | **Adjustments**                           | ** ** | **Restated** | ** ** | **Reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Consolidated Statement of Operations: |       |                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Net Sales                             |       | $                                            | 11,616,257 |                                      | $          | (31,241 | ) | 11,585,016 |   | $ | 21,172,404 |   | $ | (52,756 | ) | $ | 21,119,648 |   |
| Gross profit                          |       | 4,471,851                                    |       | (31,241                                   | )          | 4,440,610 |   | 8,217,584 |   | (52,756 | ) | 8,164,828 |   |
| Operating expenses                    |       | 4,010,729                                    |       | 381,379                                   |       | 4,392,108 |   | 7,774,037 |   | 866,980 |   | 8,641,017 |   |
| Income (loss) before                  |       |                                         |       |                                      |       | — |   |   |   |   |   | — |   |
| income taxes                          |       | 345,834                                      |       | (412,620                                  | )          | (66,786 | ) | 212,446 |   | (919,736 | ) | (707,290 | ) |
| Income tax benefit                    |       | 84,400                                       |       | (84,400                                   | )          | — |   | (35,600 | ) | 35,600 |   | — |   |
| Net Income (loss)                     |       | $                                            | 430,234    |                                      | $          | (497,020 | ) | $ | (66,786 | ) | $ | 176,846 |   | $ | (884,136 | ) | $ | (707,290 | ) |
|                                  |       |                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Earnings (loss) per share:            |       |                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Basic & diluted              |       | $                                            | 0.04       |                                      | (0.05      | ) | $ | (0.01 | ) | $ | 0.02 |   | (0.08 | ) | $ | (0.06 | ) |

 

10

----

 

**NOTE 3**                 INVENTORIES

 

Inventories consisted of the following:

 
| ** **           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------|------------|-------------------|------------|-----------------------|------------|
| ** **           | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| ** **           | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
|                 |       |              |       |                  |       |
| Tiles                |       | $                 | 23,700,299 |                  | $          | 17,034,540 |   |
| Inventory in transit |       | 2,904,446         |       | 4,544,289             |       |
| Total Inventories    |       | $                 | 26,604,745 |                  | $          | 21,578,829 |   |

 

Inventory in transit consists of merchandisepurchased overseas, which is not yet received in the warehouse. The Companyobtains legal title at the shipping point.

 

#### **NOTE 4**                 PROPERTYAND EQUIPMENT

#### ** **

Property and equipment consisted of thefollowing:

 
| ** **                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| ** **                    | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
|                          |       |              |       |                  |       |
| Furniture and fixtures        |       | $                 | 416,560    |                  | $          | 412,316 |   |
| Machinery and equipment       |       | 700,806           |       | 634,531               |       |
| Vehicles                      |       | 265,974           |       | 233,501               |       |
| Computer equipment            |       | 344,640           |       | 447,866               |       |
| Leasehold improvements        |       | 662,494           |       | 730,534               |       |
|                          |       | 2,390,474         |       | 2,458,748             |       |
| Less accumulated depreciation |       | 644,138           |       | 696,683               |       |
|                          |       | $                 | 1,746,338  |                  | $          | 1,762,065 |   |

 

Depreciation expense for the three months ended June30, 2005 and 2004 was approximately $79,200 and $70,300, respectively.  Depreciation expense for the six months endedJune 30, 2005 and 2004 was approximately $157,300 and $128,900,respectively.

 

#### **NOTE 5**                 NOTESPAYABLE, REVOLVING LINE OF CREDIT

#### ** **

On December 31, 2004, the Company amended andrestated the existing revolving line of credit agreement providing up to$25,000,000 with interest rates of either (1) LIBOR plus 3.00% or (2) thebase rate plus 0.50% (interest rates ranging from 6.125% to 7.875% at June 30,2005) payable monthly.  The line ofcredit is limited by a borrowing base which is comprised of a percentage ofeligible accounts receivable and eligible inventories, as defined, and iscollateralized by substantially all the assets of the Company. The balance dueat June 30, 2005 and December 31, 2004 was $21,751,541 and$16,047,220, respectively. The line matures September 10, 2006 andcontains certain covenants requiring the Company to maintain a certain leverageratio, a required minimum fixed charge coverage ratio, and certain inventoryturnover ratio. At June 30, 2005 the Company was not in compliance withthe leverage and fixed charge coverage ratio requirement. The Company wasgranted a waiver of these covenants by our commercial lender.

 

For the three months ended June 30, 2005 and 2004,interest expense related to the credit line amounted to $320,676 and $119,787respectively.  For the six monthsended June 30, 2005 and 2004, interest expense related to the credit lineamounted to $576,301 and $220,643 respectively.

 

11

----

 

#### **NOTE 6**                 STOCKHOLDERS’EQUITY

#### ** **

**Common Stock**

 

During the six months ended June 20, 2005, theCompany issued 4,000 shares of common stock to several employees under theStock Incentive Plan for services rendered, based on the trading price at thedate of issuance, for a total of $10,600, resulting in an immediate charge tooperations.

 

#### **NOTE 7**                 SEGMENTINFORMATION

#### ** **

The Company manages its operations as onesegment and all revenue is derived from customers in the United States.

 

#### **NOTE 8**                 INCOMETAXES

#### ** **

Income tax expense for the three month period ended June 30,2005 was $-0-as the provision for income taxes, computed by applying theFederal statutory rate to income before income taxes, was reduced by thedecrease in the deferred tax valuation allowance during the period, resultingfrom the utilization of a portion of the Company’s net operating losscarryforward.

 

Income tax expense for the three month period ended June 30,2004 was $-0- as the benefit for income taxes, computed by applying the Federalstatutory rate to loss before income taxes, was reduced by the increase in thedeferred tax valuation allowance during the period, to adjust deferred taxes tothe amount considered by management more likely than not to be realized

 

**NOTE 9****                ****NEW SUBSIDIARIES**

 

On June 6th, 2005, the Companyorganized the Import Flooring Group, Inc. (IFG).  IFG will provideagency services by directly importing tile from the foreign factories towholesale tile distributors within the United States. There was no activity asof period ended June 30th, 2005.

 

12

----

 

ITEM 2:  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Thefollowing discussion should be read along with our financial statements, whichare included in another section of this filing.

 

Somestatements made in this Quarterly Report are “forward-looking statements” andare not historical facts.  For example,statements regarding our financial position, business strategy and other plansand objectives for future operations, and assumptions and predictions aboutfuture demand for our services and products, supply, costs, marketing andpricing factors are all forward-looking statements. When we use words like “intend,”“would”, “anticipate,” “believe,” “estimate,” “plan” or “expect” or thenegative of these terms and similar expressions we are making forward- lookingstatements.  You should be aware thatthese forward-looking statements are subject to risks and uncertainties.  Additionally, our forward-looking statementsspeak only as of the date of this report. Other than as required by law, we undertake no obligation to update orrevise these statements, whether as a result of new information, future eventsor otherwise.  New factors emerge fromtime to time that may cause our business not to develop as we expect, and it isnot possible for us to predict all of them. Factors that may cause our actual results, performance or achievementsto be materially different from the results, performance or achievementsexpressed or implied by the forward-looking statements include, among otherthings:

 

•                  Ourability to successfully implement our business plan, including expanding ourmarkets, increasing our product lines, and maintaining high quality customerservice;

•                  Continuingand cultivating our relationships with current and new vendors;

•                  Fundingour growth in a manner that is beneficial to our stockholders;

•                  Trendsaffecting our financial condition or results of operations, the impact ofcompetition, the start-up of certain operations, roll out of products andservices and acquisition opportunities;

•                  Restraintson pricing flexibility due to competitive conditions in the flooring industry,while taking into consideration factors beyond our control such as increases infreight and tariff charges, currency risks, and political conditions;

•                  Dependingon third party suppliers outside the United States;

•                  Theimpact of adverse weather conditions, both in our targeted markets, as well aswith respect to our foreign suppliers; and

•                  Otherrisks referenced from time to time in our SEC filings.

 

Apart of preparing its Form 10-K, filed on April 15, 2005, managementconcluded it should restate its previously issued financial statements from thefiscal year ended December 31, 2002 through September 30, 2004.  The restatements are the result of managementreassessing its methodology for accounting for certain transactions.  The Consolidated Financial Statements for theyear ended December 31, 2004 have been prepared according to the newmethodology and may be relied upon. Tesoro is working diligently to complete the restated financialstatements, but as of the date of filing this Form 10-Q for the quarterended June 30, 2005 the restated Financial Statements have not be filed.  Accordingly, Tesoro’s Consolidated FinancialStatements previously filed for the years ended 2003 and 2002 and for theinterim periods within those years should no longer be relied upon.

 

# **General**

# ** **

IWTTesoro Corporation (the Company) was organized in Nevada on May 3rd, 2000,originally under the name “Ponca Acquisition Corporation”.  Effective October 1, 2002, Tesoroacquired all of International Wholesale Tile, Inc.’s (IWT) common stockfrom IWT’s three shareholders. IWT was organized in Florida and has been incontinuous operations since 1994. In exchange for the IWT stock, the IWTshareholders each received 3.0 million Tesoro shares, representing 87% ofTesoro’s then outstanding common stock.

 

In addition to IWT, Tesoro’s primary operatingsubsidiary, Tesoro has three additional wholly owned subsidiaries.  These include IWT Tesoro Transport, IWTTesoro International, Ltd and The Tile Club, Inc. The Tile Club, Inc has awholly owned subsidiary named Import Flooring Group, Inc.

 

•                  IWTTesoro Transport, a USDOT licensed common carrier, organized to act as ourfreight carrier outside of Florida and to back haul non-household goods intoFlorida to help generate outside revenue, which has been insignificant through June 30,2005;

 

•                  IWTTesoro International, Ltd., a Bermuda corporation to act as a holdingcompany for activities and assets such as agency agreements and investments inforeign operations; and

 

•                  TheTile Club, Inc., formed in 2004, was organized to acquire licensing,manufacturing and distribution rights for high-end

 

13

----

 

designer and artistic baseddecorative tiles and to also act as an agent for foreign manufacturers fromwhom IWT has acquired exclusive distribution rights.

 

•                  ImportFlooring Group, Inc., formed in June 2005, was organized to support theCompany’s growth strategy with an agent- oriented business model in the floorcovering market.

 

Ourprincipal executive office is located at 191 Post Road West, Suite 10,Westport, CT 06880.  Our telephone numberis(203) 221-2770.  Our web site can befound at*http://www.iwttesoro.com*.  Information contained on our web site is notpart of this report.

 

*Resultsof Operations for the three months ended June 30, 2005, 2004 and 2003*

 

The following discussion andanalysis should be read in conjunction with the financial statements and notesthereto that appear elsewhere in this document. The table below sets forthcertain operating data for the periods indicated. Percentages are relative to total revenue for the periods indicated.

 
| ** **              | ** ** | **Quarter ending June 30,** | ** ** |
|-------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **June 30,**                | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **              | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **              | ** ** | ** **                       | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
|                    |       |                             |       |   |   |   |   |
| Revenues                |       | $                                | 14,441,721 |   | $ | 11,585,016 |   | $ | 8,477,575 |   |
| Cost of Goods Sold      |       | 8,602,396                        |       | 7,144,406 |   | 5,011,999 |   |
| Gross Margin            |       | 5,839,325                        |       | 4,440,610 |   | 3,465,576 |   |
| Gross Margin Percentage |       | 40.43                            | %          | 38.33 | % | 40.88 | % |
| Operating Expenses      |       | $                                | 5,381,537  |   | $ | 4,392,108 |   | $ | 3,067,820 |   |

 

*Quarterended June 30, 2005 Compared to Quarter June 30, 2004*

 

Net sales for the three monthsended June 30, 2005 increased $2,856,705 or approximately 24.7%over the reported net sales for the three months ended June 30, 2004. Thisgrowth follows a 36.7% increase in net sales for the three months ended June 30,2004 over the three months ended June 30, 2003. The Company’s continuedgrowth rate exceeds industry growth rates. We believe we will continue toexceed industry growth rates as a result of continued expansion into nationalmarkets.

 

Gross profit for the three months ended June 30, 2005 was $5,839,325(40.4% of net sales) compared to $4,440,610 (38.3% of net sales) for the threemonths ended June 30, 2004. The second quarter 2005 gross profit increasedwas a direct result of a new pricing structure implemented in March 2005.  This new pricing structure will enable us tomaintain an approximate gross margin of 38%.

 

Our operating expenses for the three months ended June 30, 2005 were$5,381,537 (37.3% of net sales) compared to $4,392,108 (37.9% of net sales) forthe three months ended June 30, 2004. The decrease in the currentpercentage of operating expenses was a result of the Company’s continuedrealization of economies of scale.

 

Income from operations for the three months ended June 30, 2005 were$457,788 (3.2% of sales) compared to $48,502 (.4% of sales) for the threemonths ended June 30, 2004. The 2.8% increase is attributed to continuedgrowth in sales distribution channels and process efficiencies gained indelivering these services.

 

*Results of Operations for the Six Monthsended June 30, 2005, 2004 and 2003*

 

The following discussion andanalysis should be read in conjunction with the financial statements and notesthereto that appear elsewhere in this document. The table below sets forth certainoperating data for the periods indicated. Percentages are relative to total revenue for the periods indicated.

 

14

----

 
| ** **              | ** ** | **Six Months Ending June 30,** | ** ** |
|-------------------------|------------|-------------------------------------|------------|
| ** **              | ** ** | **June 30,**                   | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|                    |       |                                |       |   |   |   |   |
| Revenues                |       | $                                   | 28,134,699 |   | $ | 21,119,648 |   | $ | 15,191,385 |   |
| Cost of Goods Sold      |       | 17,165,389                          |       | 12,954,820 |   | 9,091,607 |   |
| Gross Margin            |       | 10,969,310                          |       | 8,164,828 |   | 6,099,778 |   |
| Gross Margin Percentage |       | 38.99                               | %          | 38.66 | % | 40.15 | % |
| Operating Expenses      |       | $                                   | 10,297,442 |   | $ | 8,641,017 |   | $ | 5,686,637 |   |

 

 *Six Months ended June 30, 2005 Comparedto Six Months ended June 20, 2004 and 2003*

 

Sales for the six months ended June 30, 2005 were $28,134,699, a33.2% increase over sales for the six months ended June 30, 2004. Thisgrowth follows a 39.0% increase for the same period ended in 2004 compared with2003. The Company’s growth rate continues to exceed industry growthrates. We believe we will continue to exceed industry growth rates as a resultof our continued expansion into national markets.

 

The gross margin for the six months ended June 30, 2005 was$10,969,310 (39.0% of net sales) compared to $8,164,828 (38.7% of net sales)for the six months ended June 30, 2004. The slightly higher gross marginfor the six months ended June 30, 2005 is a result of the March 2005new pricing structure. This new price structure was implemented as a directresult of increasing material and import costs.

 

Our operating expenses for the six months ended June 30, 2005 haveincreased by $1,656,425 over the same period in 2004, an increase of 19.2%.This compares with a 52.0% increase for the period ended June 30, 2004from 2003.  The decrease in the currentpercentage of operating expenses was a result of the Company’s continuedrealization of economies of scale.

 

Income (loss) from operations for the six months ended June 30,2005 was $671,868 (2.4% of sales) compared to ($476,189), (-2.3% of sales) forthe six months ended June 30, 2004.  The 4.7% increase is attributed to continuedgrowth in sales distribution channels and process efficiencies gained indelivering these services.

 

**Changes in Financial Position for the sixmonths ended June 30, 2005 from the year ended December 31, 2004**

 

Accounts receivable andinventory have increased by $1,171,896 and $5,025,916 respectively during thesix month period ended June 30, 2005 from the year ended December 31,2004.  The increases in these accountbalances relate primarily to our growth in sales and the expansion of ourdistribution channels. Our accounts receivable balance at June 30, 2005represented approximately 1.93 months of sales. The inventory turns for thesame period was 1.55 times.

 

We had a net decrease in our investment in property and equipment of $15,727net of depreciation for the six months ended June 30, 2005 from the yearended December 31, 2004.  The netdecrease was primarily due to the disposal of capitalized leasehold improvementcosts.

 

Our liabilities for accounts payable increased $248,033 and long termdebt increased $5,704,321 for the six months ended June 30, 2005 from theyear ended December 31, 2004.  Thenet increase in our liabilities relates directly to the financing of our salesgrowth and expansion into national markets.

 

# **Liquidity and CapitalResources**

# ** **

We had cash balances of approximately $636,900 at June 30,2005 and $507,700 at December 31, 2004. We have financed our growth with new equity capital and increasedborrowings from our commercial lender.

 

Our line of credit is $25 million; an amount theCompany expects to be sufficient to support its growth in accounts receivableand inventory through 2005. Our rapid growth is expected to continue requiringthe Company to seek outside capital to supplement earnings and strengthen ourbalance sheet. We believe that the working capital required to finance thenecessary growth in inventory will be provided by our existing line of credit.We expect to raise additional capital, either debt or equity through both thepublic and private markets during 2005. However, we cannot assure anyone that we will be able to obtain outsidecapital, or if we do, that it will be on terms beneficial to us.

 

15

----

 

The balance due at June 30, 2005 to ourcommercial lender for the use of the revolving line of credit was approximately$21.8 million. The loan and security agreement contains certain covenants,which include financial covenants that require us to maintain a certainleverage ratio, limit our unfunded capital expenditures, a required minimumfixed charge coverage ratio, and a certain inventory turnover ratio. At June 30,2005 the Company was not in compliance with the leverage and fixed chargecoverage ratio requirement. The Company was granted a waiver of these covenantsby our commercial lender. We believe that our relationship with our commerciallender is good and that they will continue to support the Company.

 

# **Critical AccountingPolicies**

# ** **

In preparing the consolidated financial statements in conformity withaccounting principles generally accepted in the United States of America, theCompany must make decisions which impact the reported amounts of assets,liabilities, revenues and expenses, and related disclosures. Such decisionsinclude the selection of appropriate accounting principles to be applied andthe assumptions on which to base accounting estimates. In reaching suchdecisions, the Company applies judgment based on its understanding and analysisof the relevant circumstances and historical experience. Actual amounts coulddiffer from those estimated at the time the consolidated financial statementsare prepared.

 

The Company’s significant accounting policies are described in Note 1to the consolidated financial statements included in the Company’s AnnualReport on Form 10-K, for the year ended December 31, 2004. Some ofthose significant accounting policies require the Company to make subjective orcomplex judgments or estimates. Critical accounting policies are defined asthose that are both most important to the portrayal of a company’s financialcondition and results and require management’s most difficult, subjective, orcomplex judgment, often as a result of the need to make estimates about theeffect of matters that are inherently uncertain and may change in subsequentperiods.

 

The Company believes the following accounting policies require it touse judgments and estimates in preparing its consolidated financial statementsand could represent critical accounting policies.

 

•                  Accountsreceivable and revenue recognition. Revenues are recognized when goods areshipped and legal title passes to the customer. The Company provides anallowance for expected doubtful accounts based upon historical bad debt andclaims experience and periodic evaluation of specific customer accounts and theaging of accounts receivable. If the financial condition of the Company’scustomers were to deteriorate, resulting in an impairment of their ability tomake payments, additional allowances may be required.

 

•                  Inventoriesare stated at the average landed cost, which matches current costs with currentrevenues. Inventories on hand are compared against anticipated future usage,which is a function of historical usage and anticipated future selling price,in order to evaluate obsolescence, excessive quantities, and expected salesbelow cost. Actual results could differ from assumptions used to valueobsolete, excessive inventory or inventory expected to be sold below cost.

 

•                  Deferredtax assets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases. Deferred taxassets and liabilities are measured using enacted tax rates expected to applyto taxable income in the years in which the temporary differences are expectedto be recovered or settled. The effect on deferred tax assets and liabilitiesof a change in the tax rates is recognized in earnings (loss) in the periodthat includes the enactment date. Additionally, taxing jurisdictions couldretroactively disagree with the Company’s tax treatment of certain items, andsome historical transactions have income tax effects going forward. Accounting rules requirethese future effects to be evaluated using current laws, rules andregulations, each of which can change at any time and in an unpredictablemanner.

 

# **Segment Information**

# ** **

We manage our operations in onesegment and all revenue is derived from customers in the United States.

 

16

----

 

**ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS**

 

**Quantitativeand Qualitative Disclosures About Market Risk**

 

Information about theCompany’s exposure to market risk was disclosed in its Annual Report on Form 10-Kfor the year ended December 31, 2004, which was filed with the Securitiesand Exchange Commission on April 15, 2005. No material quantitative or qualitative changes in market risk exposurehas occurred since the date of that filings

 

**ITEM 4 – CONTROLS AND PROCEDURES**

 

As of the end of theperiod covered by this Quarterly Report on Form 10-Q, Tesoro’smanagement, with participation of the Company’s principal executive officer andprincipal financial officer, have performed an evaluation of the Company’s disclosurecontrols and procedures, (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (“Exchange Act”) to ensure thatinformation required to be disclosed by Tesoro in the reports that Tesoro filesor submits under the Exchange Act is recorded, processed, summarized, andreported within the time periods specified by the SEC’s rules and forms.

 

Based onthat evaluation, Tesoro’s principal executive officer and principal financialofficer have concluded that its disclosure controls and procedures were noteffective in ensuring that information required to be disclosed by the Companyin the reports that it files or submits under the Exchange Act is recorded,processed, summarized, and reported within the time periods specified by theSEC’s rules and forms. At this time, management has determined that theCompany’s current system of disclosure controls and procedures may not besufficient i) to ensure that data errors, control problems, or acts of fraudare detected and ii) to confirm that appropriate corrective action, includingprocess improvements, is undertaken in a timely manner.

 

Attached as Exhibits31.1 and 31.2 to this Quarterly Report are certifications of the CEO and theCFO, which are required in accordance with Rule 13a-14 of the SecuritiesExchange Act of 1934 (the Exchange Act). This Controls and Procedures section includesthe information concerning the controls evaluation referred to in thecertifications and it should be read in conjunction with the certifications.

 

*Definitionof Disclosure Controls*

 

Disclosurecontrols are controls and procedures designed to ensure that informationrequired to be disclosed in Tesoro’s reports filed under the Exchange Act isrecorded, processed, summarized and reported timely. Disclosure Controls arealso designed to ensure that such information is accumulated and communicatedto our management, including the CEO and CFO, as appropriate to allowtimely decisions regarding required disclosure.

 

*Limitationson the Effectiveness of Controls*

 

Our management,including the CEO and CFO, does not expect that its disclosure controls willprevent all errors and all fraud. A control system, no matter how well designedand operated, can provide only reasonable, not absolute, assurance that thecontrol system’s objectives will be met. Further, the design of a controlsystem must reflect the fact that there are resource constraints, and thebenefits of controls must be considered relative to their costs. Because of theinherent limitations in all control systems, no evaluation of controls canprovide absolute assurance that all control issues and instances of fraud, ifany, within Tesoro have been detected. These inherent limitations include therealities that judgments in decision-making can be faulty, and that breakdownscan occur because of simple error or mistake. Controls can also be circumventedby the individual acts of some persons, by collusion of two or more people, orby management override of the controls. Because of the inherent limitations ina cost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

**Deficienciesin the Company’s Controls and Procedures**

 

In connection withpreparing its Annual Report on Form 10-K for the fiscal year ended December 31,2004,  Tesoro’s management identifieddeficiencies in its methodologies that it considered being material weaknessesin the effectiveness of Tesoro’s internal disclosure controls pursuant tostandards established by the American Institute of Certified PublicAccountants. A “material weakness” is a reportable condition in which thedesign or operation of one or more of the specific internal control componentshas a defect or defects that could have a material adverse effect on the Company’sability to record, process, summarize and report financial data in thefinancial statements in a timely manner. The material weaknesses identified byTesoro include the following:

 

•                                                                  Promotional merchandise should have beenexpensed when distributed rather than capitalized and depreciated;

 

17

----

 

•                                                                  Tesoro had incorrectly estimated the accrualsfor sales related expenses; and

 

•                                                                  Incorrectly estimated its allowances forproduct returns and the allowances.

 

**As aresult, Tesoro’s management concluded that certain accounting errors occurredin its previously issued financial statements for the fiscal year ended December 31,2002, each of the three fiscal quarters ended June 30, 2003, June 30,2003 and September 30, 2003, the fiscal year ended December 31, 2003and each of the three fiscal quarters ended June 30, 2004, June 30,2004 and September 30, 2004.**

** **

Based upon the resultsof management’s investigation of the accounting errors, the Company’s principalexecutive officer and principal financial officer concluded that the accountingerrors resulted from material weaknesses in the Company’s disclosure controlsand procedures, particularly in the areas of documented policies and proceduresalong with competent personnel. Detailed validation work was performed by theCompany’s internal personnel in order to substantiate the financial informationcontained in the Company’s consolidated financial statements and relateddisclosures that are contained in financial statements noted above.

 

**Management’sResponse and Plan for Improvement**

 

**Managementdiscussed the proposed restatement of the specified financial statements andinformation with Tesoro’s Audit Committee, financial consultants and bothcurrent and former independent auditors who concur with management’sassessments. On March 19, 2005, the Audit Committee reported on itsdiscussions with its management and the current auditors to Tesoro’s Board ofDirectors with respect to the restatements who supported their conclusions.  On March 21, 2005, Tesoro filed a reporton Form 8-K concerning these errors and advised that its ConsolidatedFinancial Statements for the years ended 2003 and 2002 and for the interimperiods should no longer be relied upon and that the restatement would not haveany effect on the Company’s gross revenue for any periods or on its cash flow**.

** **

As a result managementhas responded to these deficiencies by developing a plan to implement thefollowing controls and procedural enhancements, designed to improve the Company’sdisclosure controls:

 

•                                                                  Capitalization and amortization of assetbalances - i) regular detailed analyses of fixed assets and accumulateddepreciation accounts should be performed by preparing detailed accountreconciliations, and ii) on a timely basis, account reconciliations and othersignificant transactions should be reviewed by an appropriate member ofmanagement;

 

•                                                                  Recording and processing transactions -transactions must be supported by i) appropriate transaction documentation andii) appropriate documentation of review by management;

 

•                                                                  Reconciliation of accounts - detailedreconciliations of subsidiary accounts to the general ledger must be performedon a regular basis, and quarterly accounting review procedures must be enhancedby requiring an appropriate member of management to perform an independentreview of material general ledger accounts and reserves;

 

•                                                                  Management review of journal entries, accountbalances and financial statements - all material journal entries must bereviewed and approved by an appropriate member of management;

 

•                                                                  Internal audit function - an internal auditfunction should conduct audit procedures and test internal controls in order toensure that the Company’s policies and procedures for transactional recording,transactional review, segregation of duties, and review of significanttransactions at the appropriate level of management are both effective andbeing followed; and

 

•                                                                  Competent personnel - staffing should beenhanced to provide sufficient resources to accomplish the foregoingobjectives.

 

**Statusof Management’s Plan for Improvement**

 

As of June 30,2005, Tesoro has made the following progress in the implementation of its planfor improvement: 

 

18

----

 

•                                                                  Recording and processing transactions -controls have been implemented which require transactions to be supported by i)appropriate transaction documentation and ii) documentation that thetransaction has been reviewed and approved by an appropriate member ofmanagement;

 

•                                                                  Reconciliation of accounts - policies andcontrols have been implemented which require regular reconciliations ofsubsidiary accounts to the general ledger, with timely review by an appropriatemember of management. Procedures regarding the quarterly accounting review havebeen enhanced by requiring independent reviews of account reconciliations,material general ledger accounts, and reserves;

 

•                                                                  Management review of journal entries, accountbalances and financial statements - controls and procedures are beingimplemented which require that all material journal entries are reviewed andapproved by an appropriate member of management;

 

•                                                                  Internal audit function - the Company hasengaged a registered public accounting firm, which is not affiliated with theCompany’s independent registered public accounting firm, to perform theinternal audit function (the “Internal Auditor”). The Internal Auditor hasconducted, and will continue to conduct, internal audit procedures and tests ofinternal controls to ensure that the Company’s controls and procedures fortransactional recording, transactional review, segregation of duties, andreview of significant transactions at the appropriate level of management areboth effective and being followed; and

 

•                                                                  Competent personnel - the Company has made,and will continue to make, appropriate staffing enhancements in order toprovide sufficient resources to accomplish the Company’s objectives ofrecording, processing, summarizing and reporting, on a timely basis, Tesoro’sfinancial information.

 

Management believesthat the disclosure controls and procedures, which have been, and arecontinuing to be, implemented, are addressing the identified deficiencies inTesoro’s system of disclosure controls. Management will, on an ongoing basis,further monitor and assess the implementation of its plan to improve theeffectiveness of its disclosure controls and procedures, and will take actionas appropriate.

 

Exclusive ofimplementing the changes in Tesoro’s procedures and control resulting frommanagement’s improvements described above, there have been no significantchanges in our internal controls or in other factors that could significantlyaffect these controls subsequent to the date of the evaluation described in thepreceding section

 

We are in the processof implementing the requirements of Section 404 of the Sarbanes-Oxley Actof 2002 which requires our management to assess the effectiveness of ourinternal control over financial reporting and include an assertion in our 2005annual report as to the effectiveness of our internal controls over financialreporting. Subsequently, our independent registered public accounting firm,McGladrey & Pullen LLP, will be required to attest to whether ourassessment of the effectiveness of our internal controls over financialreporting is fairly stated in all material respects and separately report onwhether it believes we maintained, in all material respects, effective internalcontrol over financial reporting as of December 31, 2006. We are in theprocess of performing the system and process documentation, evaluation andtesting required for management to make this assessment and for the registeredpublic accounting firm to provide its attestation report. We have not completedthis process or its assessment, and this process will require significantamounts of management time and resources. In the course of evaluation andtesting, management may identify deficiencies that would need to be addressedand remediate.

 

**PART II**

 

###### **ITEM 1:**LEGALPROCEEDINGS

###### ** **

Weare not a party to any material pending legal proceedings and, to the best ofour knowledge; no such action by or against us is contemplated, threatened orexpected.

 

19

----

 

 

**ITEM 6:********EXHIBITS AND REPORTS ON FORM 10-Q**

 

(a)          **Exhibits**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                     |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Articles of Incorporation (filed as an Exhibit to the Company’s  Form 10-SB, filed with the Securities and Exchange Commission on  August 7, 2000)                                                                                                                                                                              |
| 3.1.1               |       | Articles of Amendment to Articles of Incorporation dated  September 23, 2002 (filed as an Exhibit to the Company’s Report on  Form 8-K, filed with the Securities and Exchange Commission on  October 1, 2002)                                                                                                             |
| 3.2.2               |       | Amended and Restated Bylaws (filed as an Exhibit to the  Company’s Report on Form 8-K, filed with the Securities and Exchange  Commission on February 4, 2003)                                                                                                                                                                  |
| 3.3.2               |       | Audit Committee Charter (filed as an Exhibit to the Company’s  Report on Form 8-K, filed with the Securities and Exchange Commission on  February 4, 2003)                                                                                                                                                                      |
| 3.3.3               |       | Compensation Committee Charter (filed as an Exhibit to the  Company’s Report on Form 8-K, filed with the  Securities and Exchange Commission on  February 4, 2003)                                                                                                                                                         |
| 3.3.4               |       | Nominating And Governing Committee Charter (filed as an  Exhibit to the Company’s Report on Form 8-K, filed with the  Securities and Exchange Commission on February 4, 2003)                                                                                                                                                   |
| 3.4.1               |       | Code of Ethics for Senior Financial Officers (filed as an  Exhibit to the Company’s Registration Statement, filed with the  Securities and Exchange Commission on April 11, 2003)                                                                                                                                                    |
| 4.1.1               |       | Form of Warrant Agreement (filed as an Exhibit to the  Company’s Registration Statement, filed with the Securities and Exchange  Commission on April 11, 2003)                                                                                                                                                                  |
| 4.1.2               |       | Form of Stock Certificate (filed as an  Exhibit to the Company’s Registration Statement, filed with the  Securities and Exchange Commission on April 11, 2003)                                                                                                                                                                  |
| 10.3                |       | 2001 Ponca Acquisition Corporation Stock Incentive Plan. (filed as an  Exhibit to the Company’s Report on Form 8-K, filed with the  Securities and Exchange Commission on September 11, 2002)                                                                                                                                   |
| 10.4                |       | Employment Agreement Between Ponca Acquisition  Corporation And Henry Jr. Boucher, Jr. Dated As Of December 29,  2002 (filed as an Exhibit to the Company’s Report on Form 8-K,  filed with the Securities and Exchange Commission on September 11, 2002)                                                             |
| 10.5                |       | Memorandum Of Understanding Between Ponca Acquisition Corporation And  The Stockholders Of International Wholesale Tile, Inc. (filed as an  Exhibit to the Company’s Report on Form 8-K, filed with the  Securities and Exchange Commission on September 11, 2002)                                                         |
| 10.6                |       | Stock Purchase Agreement Among The Stockholders Of International  Wholesale Tile, Inc., and Ponca Acquisition Corporation effective  October 1, 2002 (filed as an Exhibit on Form 8-K, filed with  the Securities and Exhibit Commission on October 15, 2002).                                                             |
| 10.9                |       | Form of Indemnity Agreement (filed as an Exhibit to the  Company’s Registration Statement, filed with the Securities and Exchange  Commission on April 11, 2003)                                                                                                                                                                |
| 10.10               |       | Employment Agreement between International Wholesale Tile, Inc.  and Forrest Jordan (exhibits omitted) (filed as an Exhibit to the  Company’s Registration Statement, filed with the Securities and Exchange  Commission on May 21, 2003)                                                                                       |
| 10.11               |       | Employment Agreement between International Wholesale Tile, Inc.  and Paul F. Boucher (this document is omitted as it is substantially similar  to Forrest Jordan’s Employment Agreement with the exception of the employee’s  name and address)                                                                                      |
| 10.12               |       | Employment Agreement between International Wholesale Tile, Inc.  and Grey Perna (this document is omitted as it is substantially similar to  Forrest Jordan’s Employment Agreement with the exception of the employee’s  name and address)                                                                                           |
| 10.13               |       | Subordination Agreement between Congress Financial Corporation  (Florida). and Forrest Jordan (filed as an Exhibit to the Company’s  Registration Statement, filed with the Securities and Exchange Commission on  May 21, 2003)                                                                                                     |
| 10.14               |       | Subordination Agreement between Congress Financial Corporation  (Florida). and Paul F. Boucher (this document is omitted as it is  substantially similar to Forrest Jordan’s Subordination Agreement with the  exception of the employee’s name and address)                                                                              |
| 10.15               |       | Subordination Agreement between Congress Financial Corporation  (Florida). and Grey Perna (this document is omitted as it is substantially  similar to Forrest Jordan’s Subordination Agreement with the exception of the  employee’s name and address)                                                                                   |
| 10.16               |       | Amended and Restated Loan and Security  Agreement between by and between Fleet Capital Corporation, IWT Tesoro Corporation  and International Wholesale Tile, Inc. effective December 31, 2004  (filed as an exhibit to  the Company Report on Form 10-K filed with the Securities and Exchange  Commission on April 14, 2005). |
| 13                  |       | Annual report to security holders (filed as an exhibit to the Company Report  on Form 10-K filed with the Securities and Exchange Commission on  April 14, 2005).                                                                                                                                                                         |
| 16                  |       | Letter from Kantor Sewell & Oppenheimer, P.A., concurring  with statements concerning their resignation (filed as an exhibit to the  Company Report on Form 8-K filed with the Securities and Exchange  Commission on September 14, 2004).                                                                                       |

 

20

----

 
| 21   |   | Subsidiaries of Registrant (filed as an exhibit to the Company Report  on Form 10-K filed with the Securities and Exchange Commission on  April 14, 2005). |
|------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1 |   | Certification of Henry  J. Boucher, Jr., Chief Executive Officer pursuant to Section 302 of  the Sarbanes-Oxley Act.*                                      |
| 31.2 |   | Certification of Forrest Jordan, Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act.*                                                   |
| 32.1 |   | Certification of Henry J.  Boucher, Jr., Chief Executive Officer pursuant to Section 906 of  the Sarbanes-Oxley Act.*                                      |
| 32.2 |   | Certification of Forrest Jordan, Chief  Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act.*                                                   |

 

----

| *      |   | Included in this filing.   Exhibits are available without charge, upon request of IWT Tesoro. |
|--------|--------|----------------------------------------------------------------------------------------------------|
|   |   |                                                                                               |
| (6)    |   | Reports on Form 8-K.                                                                          |

 

(b)   Reports on Form 8-K

 

Form 8-K, filed on May 9, 2005, regarding the Company’s results of Operations for the first quarter of 2005 ended March 31, 2005 and the approval of proposals at the 2005 Annual Stockholders Meeting.

 

Form 8-K, filed on June 27, 2005, regarding The Tile Club and The Weir Farm Trust entering into a license agreement and the formation of Import Flooring Group, a subsidiary of The Tile Club.

 

21

----

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 
|                 |   |   | IWT TESORO CORPORATION                     |
|----------------------|--------|--------|--------------------------------------------|
|                 |   |   |                                       |
|                 |   |   |                                       |
| August 12, 2005 |   |   | /s/ Henry J. Boucher, Jr.             |   |
|                 |   |   | Henry J. Boucher, Jr., President      |
|                 |   |   |                                       |
| August 12, 2005 |   |   | /s/ Forrest P. Jordan                      |   |
|                 |   |   | Forrest P. Jordan, Chief Financial Officer |

 

22

----