** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

**FORM 10-Q-A**

 

**(Mark One)**
| **ý**                                                  | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------------------------------------------------------------|--------------------------------------------------------------------------------------------------------|
|                                                        |
| **For the quarterly period ended  September 30, 2004** |
|                                                        |
| **o**                                                       | **TRANSITION REPORT UNDER SECTION 13 OR  15(d) OF THE EXCHANGE ACT**                         |

 

**CommissionFile No. 0-31267**

 

**IWT TESORO CORPORATION**

(ExactName of Registrant in its Charter)

 
| **Nevada**                       | ** ** | **91-2048019**         |
|----------------------------------|------------|------------------------|
| (State or Other  Jurisdiction of |       | (I.R.S. Employer       |
| Incorporation or Organization)   |       | Identification Number) |

 

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

(Address of principal executive offices)

 

**(203) 221-2770**

(Issuer’s Telephone Number, including areacode)

 

 

(Former Name, Former Address and FormerFiscal Year, if Changed Since Last Report)

 

Securitiesregistered pursuant to Section 12(b) of the Exchange Act:  **NONE**

 

Securitiesregistered pursuant to Section 12(g) of the Exchange Act: **Common Stock, $.001 Per Share**

 

Checkwhether the issuer: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days:

ýYes             oNo

 

Indicateby check mark whether the registrant is an accelerated files (as defined in Rule 12b-2of the Exchange Act)   oYes   ýNo

 

Statethe number of shares outstanding of each of the issuer’s class of commonequity, as of November 5, 2004: 11,697,102 shares

 

TransitionalSmall Business Disclosure Format:   oYes            ýNo

 

 

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EXPLANATORY NOTE

 

IWT Tesoro Corporation (Tesoro) has restatedthe consolidated balance sheets as of September 30, 2004 and December 31,2003, the consolidated statements of operations for the three and nine monthsended September 30, 2003 and 2004 and the stockholders’ equity and cashflows for the nine months ended September 30, 2004 and 2003,respectively.  In particular, Managementdetermined that Tesoro had been incorrectly calculating the accruals for salescommissions and rebates. Management revised this calculation and determinedthat accrued expenses were understated by approximately $583,000 as of September 30,2004. Commission and rebate expenses were overstated for the three month periodended September 30, 2004 by approximately $18,000 and understated for thethree month period ended September 30, 2003 by approximately $48,000.Commission and rebate expenses were understated for the nine month period endedSeptember 30, 2004 and 2003 by approximately $183,000 and $227,000,respectively. Management also determined that the Company had been incorrectlycalculating the allowances for product returns. Management revised thiscalculation and determined that accounts receivable was overstated byapproximately $106,000 as of September 30, 2004. Net sales wereunderstated for the three months ended September 30, 2004 by approximately$2,000 and overstated by approximately $14,000 for the three months ended September 30,2003. Net sales were overstated for the nine months ended September 20,2004 and 2003 by approximately $51,000 and $63,000, respectively.

 

Additionally, management reassessed itsmethodology for accounting for sample and display boards and determined thatthis promotional merchandise should have been expensed when distributed ratherthan capitalized and depreciated. The adjustments resulting from therestatement increased net loss by approximately $231,000 and $149,000 for thethree months ended September 30, 2004 and 2003, respectively. Theadjustments resulting from the restatement increased the net loss byapproximately $897,000 and $492,000 for the nine months ended September 30,2004 and 2003, respectively. This change also reduced property and equipment asof September 30, 2004 by approximately $3,877,000.

 

Finally, as part of the recapitalizationtransaction of IWT effective October 1, 2002 (see Note 1), the Company andeach of the three stockholders of International Wholesale Tile, Inc.entered into a repurchase agreement to commence on January 1, 2004. Themaximum number of redeemable shares under the repurchase agreement was 450,000.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, 2003.

 

PART 1

 

**ITEM 1:****                                              ****FINANCIAL STATEMENTS**

 

**IWT TESOROCORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

**NINE MONTHSENDED SEPTEMBER 30, 2004**

 

**TABLE OFCONTENTS**

 
|                                                                                                                                                                                        | **Page No.** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------|
|                                                                                                                                                                                        |         |
| Consolidated Balance  Sheets September 30, 2004 (as restated) (unaudited) and  December 31, 2003 (as restated)                                                                    | 2            |
|                                                                                                                                                                                        |         |
| Consolidated  Statements of Operations for the three months and nine months ended  September 30, 2004 and 2003(as restated) (unaudited)                                                | 3            |
|                                                                                                                                                                                        |         |
| Consolidated  Statements of Stockholders’ Equity for the year ended December 31, 2003  (as restated) and the nine months ended September 30, 2004 (as restated)  (unaudited) | 4            |
|                                                                                                                                                                                        |         |
| Consolidated  Statements of Cash Flows for the nine months ended September 30, 2004  and 2003 (as restated) (unaudited)                                                                | 5            |
|                                                                                                                                                                                        |         |
| Notes to  Consolidated Financial Statements (as restated) (unaudited)                                                                                                                       | 6-12         |

 

1

----

 

**IWT TESOROCORPORATION AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 

**ASSETS**

 
| ** **                                                                                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                     | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| ** **                                                                                     | ** ** | **(Restated)**         | ** ** | **(Restated)**        | ** ** |
| ** **                                                                                     | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current assets:                                                                                |       |                   |       |                  |       |
| Cash                                                                                           |       | $                      | 563,543    |                  | $          | 867,361 |   |
| Accounts receivable, net allowance for  doubtful accounts and returns of $225,923 and $175,000 |       | 7,125,507              |       | 4,852,705             |       |
| Inventory                                                                                      |       | 17,094,832             |       | 13,058,839            |       |
| Note receivable arising from sale of stock                                                     |       | —                 |       | 550,000               |       |
| Prepaid expenses                                                                               |       | 368,208                |       | 754,281               |       |
| Exclusive agreement, related party                                                             |       | 503,378                |       | —                |       |
| Total current assets                                                                           |       | 25,655,468             |       | 20,083,186            |       |
|                                                                                           |       |                   |       |                  |       |
| Property and equipment, net                                                                    |       | 1,652,646              |       | 1,236,979             |       |
|                                                                                           |       |                   |       |                  |       |
| Intangible assets, net                                                                         |       | —                 |       |                  |       |
|                                                                                           |       |                   |       |                  |       |
| Other assets                                                                                   |       | 650,849                |       | 382,101               |       |
|                                                                                           |       | $                      | 27,958,963 |                  | $          | 21,702,266 |   |

 

**LIABILITIES AND STOCKHOLDERS’ EQUITY**

 
| ** **                                                                                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                       | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| ** **                                                                                                       | ** ** | **(Restated)**         | ** ** | **(Restated)**        | ** ** |
| ** **                                                                                                       | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                             |       |                   |       |                  |       |
| Accounts payable                                                                                                 |       | $                      | 11,914,458 |                  | $          | 9,859,161 |   |
| Accrued expenses and other liabilities                                                                           |       | 866,769                |       | 536,963               |       |
| Current portion of lease obligation                                                                              |       | 75,800                 |       | 63,152                |       |
| Current portion of notes payable, other                                                                          |       | 23,526                 |       | 42,719                |       |
| Total current liabilities                                                                                        |       | 12,880,553             |       | 10,501,995            |       |
|                                                                                                             |       |                   |       |                  |       |
| Note payable, revolving line of credit                                                                           |       | 14,329,695             |       | 9,599,340             |       |
| Capital lease obligations                                                                                        |       | 155,067                |       | 149,183               |       |
| Subordinated notes payable, stockholders                                                                         |       | 338,662                |       | 338,662               |       |
| Notes payable, other                                                                                             |       | 49,953                 |       | 42,560                |       |
| Total long-term debt                                                                                             |       | 14,873,377             |       | 10,129,745            |       |
| Total liabilities                                                                                                |       | 27,753,930             |       | 20,631,740            |       |
|                                                                                                             |       |                   |       |                  |       |
| Stockholders’ equity                                                                                        |       |                   |       |                  |       |
| Preferred stock, $0.001 par value,  25,000,000 authorized; none issued                                           |       | —                 |       | —                |       |
| Common stock, $0.001 par value, 100 million  shares authorized, 11,697,102 and 11,622,702 issued and outstanding |       | 11,697                 |       | 11,623                |       |
| Additional paid in capital                                                                                       |       | 4,178,800              |       | 3,883,949             |       |
| Accumulated deficit                                                                                              |       | (3,985,464             | )          | (2,825,046            | )          |
|                                                                                                             |       | 205,033                |       | 1,070,526             |       |
|                                                                                                             |       |                   |       |                  |       |
|                                                                                                             |       | $                      | 27,958,963 |                  | $          | 21,702,266 |   |

 

See Notes to Consolidated Interim Financial Statements.

 

2

----

 

**IWT TESOROCORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                                | ** ** | **For the period ended September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                | ** ** | **Three months ended**                      | ** ** | **Nine months ended** | ** ** |
| ** **                                                                | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                | ** ** | **(Restated)**                              | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Revenue                                                                   |       |                                        |       |   |   |   |   |   |   |
| Sales, net of discounts and returns                                       |       | $                                           | 11,052,268 |   | $ | 8,955,693 |   | $ | 32,171,915 |   | $ | 24,147,078 |   |
| Cost of goods sold                                                        |       | 6,733,909                                   |       | 5,373,248 |   | 19,688,729 |   | 14,464,855 |   |
|                                                                      |       |                                        |       |   |   |   |   |   |   |
| Gross profit                                                              |       | 4,318,359                                   |       | 3,582,445 |   | 12,483,186 |   | 9,682,223 |   |
|                                                                      |       |                                        |       |   |   |   |   |   |   |
| Expenses                                                                  |       |                                        |       |   |   |   |   |   |   |
| Depreciation and amortization                                             |       | 90,500                                      |       | 61,322 |   | 215,214 |   | 161,621 |   |
| Payroll and related expenses                                              |       | 2,137,650                                   |       | 1,536,324 |   | 5,652,950 |   | 3,939,553 |   |
| General and administrative                                                |       | 2,412,076                                   |       | 1,927,381 |   | 7,413,081 |   | 5,110,490 |   |
|                                                                      |       | 4,640,226                                   |       | 3,525,027 |   | 13,281,245 |   | 9,211,664 |   |
| Income (loss) from operations                                             |       | (321,867                                    | )          | 57,418 |   | (798,059 | ) | 470,559 |   |
|                                                                      |       |                                        |       |   |   |   |   |   |   |
| Other income/(expenses)                                                   |       |                                        |       |   |   |   |   |   |   |
| Interest expense                                                          |       | (150,806                                    | )          | (175,885 | ) | (412,183 | ) | (350,466 | ) |
| Other income                                                              |       | 19,548                                      |       | 727 |   | 28,291 |   | 2,462 |   |
| Other expense                                                             |       | —                                      |       | — |   | — |   | (5,723 | ) |
| Gain (loss) on disposal                                                   |       | —                                      |       | — |   | 21,533 |   | (5,352 | ) |
|                                                                      |       | (131,258                                    | )          | (175,158 | ) | (362,359 | ) | (359,079 | ) |
|                                                                      |       |                                        |       |   |   |   |   |   |   |
| Net income (loss) before taxes                                            |       | (453,125                                    | )          | (117,740 | ) | (1,160,418 | ) | 111,480 |   |
|                                                                      |       |                                        |       |   |   |   |   |   |   |
| Income tax benefit                                                        |       | —                                      |       | 8,819 |   | — |   | 65,123 |   |
|                                                                      |       |                                        |       |   |   |   |   |   |   |
| Net income (loss)                                                         |       | $                                           | (453,125   | ) | $ | (108,921 | ) | $ | (1,160,418 | ) | $ | 176,603 |   |
|                                                                      |       |                                        |       |   |   |   |   |   |   |
| Earnings (loss) per common share - basic                                  |       | $                                           | (0.04      | ) | $ | (0.01 | ) | $ | (0.10 | ) | $ | 0.02 |   |
|                                                                      |       |                                        |       |   |   |   |   |   |   |
| Weighted-average common shares outstanding                                |       | 11,695,906                                  |       | 11,216,961 |   | 11,672,754 |   | 11,167,720 |   |
|                                                                      |       |                                        |       |   |   |   |   |   |   |
| Earnings (loss) per common share - diluted                                |       | $                                           | (0.04      | ) | $ | (0.01 | ) | $ | (0.10 | ) | $ | 0.02 |   |
|                                                                      |       |                                        |       |   |   |   |   |   |   |
| Weighted-average common and dilutive  potential common shares outstanding |       | *11,695,906                                 |       | 11,560,143 |   | 11,733,087 |   | 11,510,902 |   |

 

----

*The effect of stock options and warrantshave not been included for the three month period ended September 30,2004, as their effect would have been anti-dilutive

 

See Notes to Consolidated Interim FinancialStatements.

 

3

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**IWT TESORO CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**

**(Unaudited)**

**NINE MONTHS ENDED SEPTEMBER 30, 2004**

 
| ** **                                                           | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------|------------|------------------|------------|-------------|------------|----------------|------------|-----------------|------------|------------|------------|
| ** **                                                           | ** ** | **Common Stock** | ** ** | **Paid in** | ** ** | **Earnings**   | ** ** | ** **      | ** ** |
| ** **                                                           | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Deficit**     | ** ** | **Total**  | ** ** |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Balance, December 31, 2002, as  restated                        |       | 10,587,834       |       | 10,588      |       | —         |       | (1,362,532      | )          | (1,351,944 | )          |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Issuance of shares - private offering                                |       | 236,668          |       | 237         |       | 959,764        |       | —          |       | 960,001    |       |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Exercise of warrants                                                 |       | 80,000           |       | 80          |       | 239,920        |       | —          |       | 240,000    |       |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Issuance of shares to employees and  directors for services rendered |       | 18,200           |       | 18          |       | 55,441         |       | —          |       | 55,459     |       |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Issuance of shares - public offering                                 |       | 250,000          |       | 250         |       | 1,292,250      |       | —          |       | 1,292,500  |       |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Cancellation of stock repurchase agreement                           |       | 450,000          |       | 450         |       | 669,907        |       | 402,803         |       | 1,073,160  |       |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Issuance of shares officer’s performance  based stock options   |       |             |       |        |       | 666,667        |       |            |       | 666,667    |       |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Net loss, twelve months ended  December 31, 2003           |       | —           |       | —      |       | —         |       | (1,865,317      | )          | (1,865,317 | )          |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Balance, December 31, 2003, as  restated                        |       | 11,622,702       |       | 11,623      |       | 3,883,949      |       | (2,825,046      | )          | 1,070,526  |       |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Exercise of warrants                                                 |       | 45,500           |       | 45          |       | 147,830        |       | —          |       | 147,875    |       |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Issuance of shares to consultant for  services rendered              |       | 17,000           |       | 17          |       | 98,333         |       | —          |       | 98,350     |       |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Issuance of shares to employees and directors  for services rendered |       | 10,400           |       | 10          |       | 44,065         |       | —          |       | 44,075     |       |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Issuance of shares to customers                                      |       | 1,500            |       | 2           |       | 4,623          |       | —          |       | 4,625      |       |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Net loss, nine months ended  September 30, 2004                 |       |             |       |        |       |           |       | (1,160,418      | )          | (1,160,418 | )          |
|                                                                 |       |             |       |        |       |           |       |            |       |       |       |
| Balance, September 30, 2004, as  restated                       |       | 11,697,102       |       | 11,697      |       | $              | 4,178,800  |            | $          | (3,985,464 | )          | $ | 205,033 |   |
|                                                                      |            |                  |            |             |            |                |            |                 |            |            |            |  |  |  |

 

SeeNotes to Consolidated Interim Financial Statements.

 

4

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**IWT TESORO CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                                 | ** ** | **2003** | ** ** |
| ** **                                                                         | ** ** | **(Restated)**                           | ** ** | **(Restated)** | ** ** |
| Cash flows from operating activities:                                              |       |                                     |       |   |   |
| Net income (loss)                                                                  |       | $                                        | (1,160,418 | ) | $ | 176,603 |   |
|                                                                               |       |                                     |       |   |   |
| Adjustments to reconcile net income to net cash  used in operating activities      |       |                                     |       |   |   |
| Depreciation and amortization (including  amortization of deferred financing fees) |       | 215,214                                  |       | 161,621 |   |
| (Gain) loss on disposal of property and  equipment                                 |       | (21,533                                  | )          | 5,352 |   |
| Deferred income taxes                                                              |       | —                                   |       | (97,124 | ) |
| Common stock issued for services or  promotions                                    |       | 147,050                                  |       | 43,360 |   |
| Provision for doubtful accounts and reserve  for returns                           |       | 123,065                                  |       | 99,253 |   |
| Other non-cash items affecting earnings                                            |       | (15,976                                  | )          | — |   |
| Changes in operating assets and liabilities                                        |       |                                     |       |   |   |
| Receivables                                                                        |       | (2,395,867                               | )          | (2,385,699 | ) |
| Inventories                                                                        |       | (4,035,993                               | )          | (6,112,344 | ) |
| Other assets and prepaid expenses                                                  |       | (289,328                                 | )          | (436,041 | ) |
| Accounts payable                                                                   |       | 2,055,297                                |       | 5,852,650 |   |
| Accrued expenses and other liabilities                                             |       | 329,806                                  |       | 500,106 |   |
| Net cash used in operating activities                                              |       | (5,048,693                               | )          | (2,192,263 | ) |
|                                                                               |       |                                     |       |   |   |
| Cash flows from investing activities:                                              |       |                                     |       |   |   |
| Additions to property and equipment                                                |       | (611,097                                 | )          | (844,535 | ) |
| Proceeds from sale of equipment                                                    |       | 25,000                                   |       | — |   |
| Net cash used in investing activities                                              |       | (586,097                                 | )          | (844,535 | ) |
|                                                                               |       |                                     |       |   |   |
| Cash flows from financing activities:                                              |       |                                     |       |   |   |
| Proceeds from revolving line of credit                                             |       | 34,530,000                               |       | 31,466,902 |   |
| Repayment on  revolving line of credit                                             |       | (29,799,645                              | )          | (28,722,817 | ) |
| Repayments of long-term debt                                                       |       | (99,628                                  | )          | (82,214 | ) |
| Proceeds from the issuance of long-term  debt                                      |       | 106,360                                  |       | — |   |
| Loan financing costs                                                               |       | (10,000                                  | )          | — |   |
| Proceeds from issuance of stock                                                    |       | 147,875                                  |       | 558,565 |   |
| Collection on notes receivable arising from  sale of stock                         |       | 550,000                                  |       | — |   |
| Repayment of subordinated debt                                                     |       | —                                   |       | (110,050 | ) |
| Costs related to stock purchase activities                                         |       | (94,000                                  | )          | — |   |
| Net cash provided by financing activities                                          |       | 5,330,962                                |       | 3,110,386 |   |
|                                                                               |       |                                     |       |   |   |
| Net increase (decrease) in cash                                                    |       | (303,818                                 | )          | 73,588 |   |
| Cash, beginning of period                                                          |       | 867,361                                  |       | 574,046 |   |
|                                                                               |       |                                     |       |   |   |
| Cash, end of period                                                                |       | $                                        | 563,543    |   | $ | 647,634 |   |
|                                                                               |       |                                     |       |   |   |
| Cash paid (received) during the period for:                                        |       |                                     |       |   |   |
| Interest expense                                                                   |       | $                                        | 412,183    |   | $ | 273,213 |   |
| Income taxes                                                                       |       | $                                        | —     |   | $ | 65,123 |   |

 

See Notes to Consolidated Interim FinancialStatements.

 

5

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IWT TESORO CORPORATION AND SUBSIDIARIES

NOTESTO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NINE MONTHS ENDED SEPTEMBER 30, 2004

 

#### **NOTE 1**                                                 PRINCIPLES OF CONSOLIDATION

 

The accompanying consolidated financialstatements include the accounts of the Company and its wholly ownedsubsidiaries, International Wholesale Tile, Inc. (IWT), IWT TesoroInternational, Inc. (International), IWT Tesoro Transport, Inc.(Transport) and The Tile Club, Inc. (TTC), (collectively the “Company”).All significant inter-company balances and transactions have been eliminated.

 

#### **NOTE 2**                                                 BASIS OF PRESENTATION

 

Theinterim financial information included herein is unaudited; however, suchinformation reflects all adjustments, which are, in the opinion of management,necessary for a fair presentation of the Company’s financial position, resultsof operations, changes in stockholders’ equity and cash flows for the interimperiods. All such adjustments are of a normal, recurring nature. The results ofoperations for the first nine months of the year are not necessarily indicativeof the results of operations which might be expected for the entire year.

 

The accompanying consolidated financialstatements of the Company have been prepared in accordance with accountingprinciples generally accepted in the United States of America and with theinstructions to Form 10-Q and Rule 10-10 of Regulation S-X of theSecurities and Exchange Commission. Accordingly certain information andfootnote disclosure required by accounting principles generally accepted in theUnited States of America for complete financial statements have been omitted.These condensed financial statements should be read in conjunction with theCompany’s financial statements and notes thereto included in the Company’saudited financial statements on Form 10-KSB, as restated for the fiscalyear ended December 31, 2003.

 

#### **NOTE 3**                                                 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

# **Stock Options**

 

TheCompany accounts for stock options under the provisions of AccountingPrinciples Board Opinion (APB) No. 25 *AccountingFor Stock Issued To Employees* and related interpretations.Accounting for the issuance of stock options under the provisions of APB No. 25typically does not result in compensation expense for the Company since theexercise price of options is normally established at the market price of theCompany’s common stock on the date granted. Statement of Financial AccountingStandards (SFAS) No. 123 *Accounting forStock-Based**Compensation*provides that the related expense may be recorded in the basic financialstatements or the pro forma effect on earnings may be disclosed in thefinancial statements.

 

Atotal of 50,000 options were granted to directors of the Company during thenine months ended September 30, 2004. No options were granted during thenine months ended September 30, 2003.

 

6

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Theeffect on net (loss) income and (loss) earnings per share if the Company hadapplied the fair value recognition provision of the SFAS No. 123, ispresented below:

 
| ** **                                                                                                                                   | ** ** | **For the period ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **Three months ended**                 | ** ** | **Nine months ended** | ** ** |
| ** **                                                                                                                                   | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                                   | ** ** | **(as  restated)**                     | ** ** | **(as  restated)** | ** ** | **(as  restated)** | ** ** | **(as  restated)** | ** ** |
|                                                                                                                                         |       |                                   |       |   |   |   |   |   |   |
| Net income (loss) as reported                                                                                                                |       | $                                      | (453,125   | ) | $ | (108,921 | ) | $ | (1,160,418 | ) | $ | 176,603 |   |
| Deduct: Stock-based employee compensation expense  determined under the fair value based method for all options, net of related  tax effects |       | —                                 |       | — |   | (36,012 | ) | (40,459 | ) |
| Pro forma net income (loss)                                                                                                                  |       | $                                      | (453,125   | ) | $ | (108,921 | ) | $ | (1,196,430 | ) | $ | 136,144 |   |
|                                                                                                                                         |       |                                   |       |   |   |   |   |   |   |
| Basic earnings per share                                                                                                                     |       |                                   |       |   |   |   |   |   |   |
| As reported                                                                                                                                  |       | $                                      | (0.04      | ) | $ | (0.01 | ) | $ | (0.10 | ) | $ | 0.02 |   |
| Pro-forma                                                                                                                                    |       | $                                      | (0.04      | ) | $ | (0.01 | ) | $ | (0.10 | ) | $ | 0.02 |   |
|                                                                                                                                         |       |                                   |       |   |   |   |   |   |   |
| Diluted earnings per share                                                                                                                   |       |                                   |       |   |   |   |   |   |   |
| As reported                                                                                                                                  |       | $                                      | (0.04      | ) | $ | (0.01 | ) | $ | (0.10 | ) | $ | 0.02 |   |
| Pro-forma                                                                                                                                    |       | $                                      | (0.04      | ) | $ | (0.01 | ) | $ | (0.10 | ) | $ | 0.02 |   |

 

For the pro-forma net income calculation inthe preceding table, the fair value of each option on the date of grant wasestimated using the Black-Scholes option-pricing model and the followingassumptions for awards in 2004: dividend yields of .0 percent; expectedvolatility of 21.51 percent; risk-free interest rates of 2.20 percent; andexpected lives of five years. Using these assumptions, the weighted averagegrant-date fair value per share of options granted in 2004 was $1.21.

 

Earnings per Share

 

Basicearnings (loss) per share are computed based on the weighted average number ofcommon shares outstanding during each year. Diluted earnings (loss) per shareis computed based on the weighted average number of common shares outstandingplus all potentially dilutive common shares outstanding (stock options) duringeach period unless the effect is anti-dilutive.

 
| ** **                                                                | ** ** | **For the period ended September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                | ** ** | **Three months ended**                      | ** ** | **Nine months ended** | ** ** |
| ** **                                                                | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                | ** ** | **(as  restated)**                          | ** ** | **(as restated)** | ** ** | **(as  restated)** | ** ** | **(as  restated)** | ** ** |
|                                                                      |       |                                        |       |   |   |   |   |   |   |
| Earnings(loss) per common share - basic                                   |       | $                                           | (0.04      | ) | $ | (0.01 | ) | $ | (0.10 | ) | $ | 0.02 |   |
|                                                                      |       |                                        |       |   |   |   |   |   |   |
| Weighted-average common shares outstanding                                |       | 11,695,906                                  |       | 11,216,961 |   | 11,672,754 |   | 11,167,720 |   |
|                                                                      |       |                                        |       |   |   |   |   |   |   |
| Earnings(loss) per common share - diluted                                 |       | $                                           | (0.04      | ) | $ | (0.01 | ) | $ | (0.10 | ) | $ | 0.02 |   |
|                                                                      |       |                                        |       |   |   |   |   |   |   |
| Weighted-average common and dilutive  potential common shares outstanding |       | 11,756,240                                  |       | 11,560,143 |   | 11,733,087 |   | 11,510,902 |   |

 

7

----

 

## Income Taxes

 

TheCompany accounts for income taxes in accordance with the asset and liabilitymethod. Tax provisions and credits are recorded at statutory rates for taxableitems included in the consolidated statements of operations regardless of theperiod for which such items are reported for tax purposes. Under this method,deferred income taxes are recognized for the expected utilization of netoperating loss carry forwards, tax credit carry forwards and the net taxeffects of temporary differences between the carrying amount of assets andliabilities for financial reporting purposes and the amounts used for incometax purposes. Deferred tax benefit is the result of changes in the deferred taxasset and liability. Deferred tax assets are reduced by a valuation allowancewhen, in the opinion of management, it is more likely than not that all or someportion of the deferred tax assets will not be realized.

 

**NOTE 4**                                               INVENTORIES

 

Inventories consisted of thefollowing:

 
| ** **            | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------|------------|------------------------|------------|-----------------------|------------|
| ** **            | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| ** **            | ** ** | **(as  restated)**     | ** ** | **(as  restated)**    | ** ** |
| Tiles                 |       | $                      | 15,626,237 |                  | $          | 11,102,115 |   |
| Inventory in  transit |       | 1,468,595              |       | 1,956,724             |       |
|                  |       |                   |       |                  |       |
|                  |       | $                      | 17,094,832 |                  | $          | 13,058,839 |   |

 

Inventory in transit consists of merchandisepurchased overseas, which is not yet received in the warehouse. The Companyobtains legal title at the shipping point. Inventory cost includes purchase price and in-bound freight.

 

#### **NOTE 5**                                                 EXCLUSIVE AGREEMENT

 

DuringFebruary 2004, the Company entered into an agreement with an Italiansupplier and stockholder to develop an exclusive line of tile. The agreementrequired a deposit of $550,000 which will be reduced at a rate of 10% of eachshipment for this exclusive line.  Thefirst shipment was received on September 9th, 2004. On September 30,2004 the deposit balance is $503,378.

 

#### **NOTE 6**                                                 PROPERTY AND EQUIPMENT

 

Property and equipment consisted of thefollowing:

 
| ** **                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| ** **                     | ** ** | **(as  restated)**     | ** ** | **(as  restated)**    | ** ** |
| Furniture  and fixtures        |       | $                      | 442,297    |                  | $          | 307,247 |   |
| Machinery  and equipment       |       | 537,053                |       | 477,996               |       |
| Vehicles                       |       | 233,501                |       | 211,215               |       |
| Office and  computer equipment |       | 364,190                |       | 329,747               |       |
| Leasehold  improvements        |       | 700,022                |       | 409,125               |       |
|                           |       |                   |       |                  |       |
|                           |       | 2,277,063              |       | 1,735,330             |       |
| Less  accumulated depreciation |       | (624,417               | )          | (498,351              | )          |
|                           |       | $                      | 1,652,646  |                  | $          | 1,236,979 |   |

 

Depreciationexpense for the nine months ended September 30, 2004 and 2003 is $191,963and $161,621, respectively.

 

8

----

 

#### **NOTES 7**                                          LOANS PAYABLE

 

TheCompany has a loan and security agreement with a financial institution for arevolving line of credit with a maximum limit of $17,000,000. The agreementspecifies that proceeds from this revolving credit loan be used for generalworking capital needs. All present and future assets of the Companycollateralize this loan. The rate of interest in effect for this agreement iscalculated with reference to the Base Rate and/or LIBOR (London InterbankOffered Rate). The balance due at September 30, 2004 and December 31,2003 was $14,329,695 and $9,599,340, respectively.

 

BaseRate advances bear a fluctuating interest rate per annum equal to prime plus0.50%. LIBOR advances bear a fixed rate per annum equal to 3.00% plus the LIBORfor the applicable interest period. At September 30, 2004 and December 21,2003, the Base Rate and the LIBOR rate were 5.25% and 4.59%, respectively.

 

Theloan and security agreement contains certain covenants, which include financialcovenants that require the Company to maintain a certain leverage ratio, arequired minimum fixed charge coverage ratio, and certain inventory turnoverratio.

 

Forthe nine months ended September 30, 2004 and 2003, interest expenserelated to the credit line amounted to $391,511 and $148,626 respectively.

 

#### **NOTE 8**                                                 STOCKHOLDERS’ EQUITY

 

### **Common Stock**

 

Duringthe nine months ended September 30, 2004, the Company issued 45,500 sharesof common stock pursuant to warrants exercised at $3.25 per share, for a totalof $147,875.

 

Duringthe nine months ended September 30, 2004, the Company issued 17,000 sharesof common stock to consultants for services rendered, based on the tradingprice at the date of issuance, for a total of $98,350, resulting in anequivalent charge to operations.

 

OnMay 26, 2004, the Company issued 10,000 shares of common stock to adirector under the Stock Incentive Plan for services rendered, based on thecontemporaneous trading price, for a total of $42,500, resulting in anequivalent charge to operations.

 

In March 2004, the Company received$550,000 as full payment on a subscription receivable outstanding at December 2003.

 

OnApril 15th, 2004, the Company cancelled 100 shares of commonstock issued to an employee, based on the trading price at the date ofissuance, for a total of $550, resulting in an equivalent reduction in chargeto operations.

 

OnJuly 20th, 2004, the Company issued 500 shares of common stockto an employee under the original terms of an employment agreement, based onthe trading price at the date of issuance, resulting in an equivalent charge tooperations of $2,125.

 

Duringthe nine months ended September 30, 2004, the Company issued 1,500 sharesof common stock to existing customers as a promotional project, based on thetrading price at the dates of issuance for a total of $4,625, resulting in anequivalent charge to operations.

 

#### **NOTE 9**                                                 SEGMENT INFORMATION

 

TheCompany manages its operations as one segment and all revenue is derived fromcustomers in the United States.

 

#### **NOTE 10**                                          NEW SUBSIDIARY

 

TheCompany organized The Tile Club, Inc. (TTC) on March 31, 2004. TTCwill license the distribution rights to designer and artistic based decorativewall tiles.

 

9

----

 

#### **NOTE 11**                                          INCOME TAXES

 

Income tax expense for the three and ninemonth period ended September 30, 2004 was $-0- as the provision for incometaxes, computed by applying the Federal statutory rate to income before taxes,was reduced by the increase in the deferred tax valuation allowance during theperiod.  For the three and nine monthperiods ended September 30, 2003, the Company recorded a benefit for income taxof $8,819 and 65,123, respectively, resulting from the recognition of the taxbenefit of operating loss carryforwards.

 

#### **NOTE 12**                                          RESTATEMENT

 

TheCompany has restated the consolidated balance sheet as of September 30,2004, and the consolidated statements of operations for the three and ninemonths then ended and stockholders’ equity and cash flows for the nine monthsthen ended as described below:

 

***Accounts Receivable***

 

Managementdetermined that the Company had been incorrectly calculating the allowances forproduct returns.  Management revised thiscalculation and determined that net sales were understated for the three monthsended September 30, 2004 by approximately $2,000 and overstated byapproximately $14,000 for the three months ended September 30, 2003. Netsales were overstated for the nine months ended September 20, 2004 and2003 by approximately $51,000 and $63,000, respectively. Accounts receivablewas overstated by approximately $106,000 for the period ended September 30,2004.

 

***Accrued Expenses***

 

Managementdetermined that the Company had been incorrectly calculating the accruals forsales commissions and rebates.  Management revised this calculation anddetermined that accrued expenses were understated by approximately $583,000 asof September 30, 2004. Commission and rebate expenses were overstated forthe three month period ended September 30, 2004 by approximately $18,000and understated for the three month period ended September 30, 2003 byapproximately $48,000. Commission and rebate expenses were understated for thenine month period ended September 30, 2004 and 2003 by approximately$183,000 and $227,000, respectively.

 

10

----

 

***Sample and Display Boards***

 

Management reassessed its methodology foraccounting for sample and display boards and determined that this promotionalmerchandise should have been expensed when distributed rather than capitalizedand depreciated. The adjustments resulting from the restatement increased net lossby approximately $231,000 and $149,000 for the three months ended September 30,2004 and 2003, respectively. The adjustments resulting from the restatementincreased net loss by approximately $897,000 and $492,000 for the nine monthsended September 30, 2004 and 2003, respectively.  This change also reduced property andequipment as of September 30, 2004 by approximately $3,877,000.

 

***Deferred Taxes***

 

In connection with the restatements foraccounts receivable, accrued expenses and sample and display boards describedabove, the related taxeffect was recorded resulting in a net deferred tax asset for the period ended September 30,2003 of approximately $694,000.  For theperiod ended September 30, 2004, the related tax effect was recordedresulting in a net deferred tax asset and the Company recorded a valuationallowance, as needed, to reduce net deferred tax asset to an amount consideredby management more likely than not to be realized.

 

***Additional Paid In Capital***

 

As part of the recapitalization transactionof IWT effective October 1, 2002 the Company and each of the threestockholders of International Wholesale Tile, Inc. entered into arepurchase agreement to commence on January 1, 2003. The maximum number ofredeemable shares under the repurchase agreement was 450,000. On June 26,2003, the Company voted to cancel the repurchase agreement. The transaction wasaccounted for by reducing additional paid in capital to the extent a balanceexisted with the remaining portion of the transaction applied to accumulateddeficit as of December 31, 2002. As a result of the restatements describedabove, the recording of the cancellation of the repurchase agreement was alsorestated based on the restated balance in accumulated deficit and additionalpaid in capital.

 

11

----

 

Theeffects of these changes are summarized as follows:

 
| ** **                  | ** ** | **September 31, 2004** | ** ** |
|-----------------------------|------------|-----------------------------|------------|
| ** **                  | ** ** | **As**                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Previously**              | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                  | ** ** | **Reported**                | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Consolidated Balance Sheet: |       |                        |       |   |   |   |   |
| Accounts receivable         |       | $                           | 7,231,416  |   | $ | (105,909 | ) | $ | 7,125,507 |   |
| Property and equipment, net |       | 5,530,049                   |       | (3,877,403 | ) | 1,652,646 |   |
| Deferred tax assets         |       | 163,781                     |       | (163,781 | ) | — |   |
| Accrued expenses            |       | 283,818                     |       | 582,951 |   | 866,769 |   |
| Deferred tax liability      |       | 32,106                      |       | (32,106 | ) | — |   |
| Additional paid in capital  |       | 5,267,671                   |       | (1,088,871 | ) | 4,178,800 |   |
| Retained earnings (deficit) |       | (376,397                    | )          | (3,609,067 | ) | (3,985,464 | ) |
|                             |            |                             |            |  |  |  |  |  |  |  |

 
| ** **                            | ** ** | **For the Three Months Ended September 30, 2004** | ** ** | **For the Three Months Ended September 30, 2003** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                            | ** ** | **As**                                                 | ** ** | ** **                                             | ** ** | ** ** | ** ** | **As** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | **Previously**                                         | ** ** | ** **                                             | ** ** | **As** | ** ** | **Previously** | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                            | ** ** | **Reported**                                           | ** ** | **Adjustments**                                        | ** ** | **Restated** | ** ** | **Reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Consolidated Statement of Operations: |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| Net Sales                             |       | $                                                      | 11,050,421 |                                                   | $          | 1,847 |   | $ | 11,052,268 |   | $ | 8,969,586 |   | $ | (13,893 | ) | $ | 8,955,693 |   |
| Gross profit                          |       | 4,316,512                                              |       | 1,847                                                  |       | 4,318,359 |   | 3,596,338 |   | (13,893 | ) | 3,582,445 |   |
| Operating expenses                    |       | 4,426,824                                              |       | 213,402                                                |       | 4,640,226 |   | 3,327,076 |   | 197,951 |   | 3,525,029 |   |
| Income (loss) before - income taxes   |       | (241,570                                               | )          | (211,555                                               | )          | (453,125 | ) | 94,104 |   | (211,844 | ) | (117,740 | ) |
| Income tax benefit (expense           |       | 68,473                                                 |       | (68,473                                                | )          | — |   | 11,314 |   | (2,495 | ) | 8,819 |   |
| Net Income (loss)                     |       | $                                                      | (173,097   | )                                                      | $          | (280,028 | ) | $ | (453,125 | ) | $ | 105,418 |   | $ | (214,339 | ) | $ | (108,921 | ) |
|                                  |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| Earnings (loss) per share:            |       |                                                   |       |                                                   |       |   |   |   |   |   |   |   |   |
| Basic                                 |       | $                                                      | (0.01      | )                                                      | (0.02      | ) | $ | (0.04 | ) | $ | 0.01 |   | $ | (0.02 | ) | $ | (0.01 | ) |
| Diluted                               |       | $                                                      | (0.01      | )                                                      | (0.02      | ) | $ | (0.04 | ) | $ | 0.01 |   | $ | (0.02 | ) | $ | (0.01 | ) |

 
| ** **                            | ** ** | **For the Nine Months Ended September 30, 2004** | ** ** | **For the Nine Months Ended September 30, 2003** | ** ** |
|---------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                            | ** ** | **As**                                                | ** ** | ** **                                            | ** ** | ** ** | ** ** | **As** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | **Previously**                                        | ** ** | ** **                                            | ** ** | **As** | ** ** | **Previously** | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                            | ** ** | **Reported**                                          | ** ** | **Adjustments**                                       | ** ** | **Restated** | ** ** | **Reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Consolidated Statement of Operations: |       |                                                  |       |                                                  |       |   |   |   |   |   |   |   |   |
| Net Sales                             |       | $                                                     | 32,222,825 |                                                  | $          | (50,910 | ) | 32,171,915 |   | $ | 24,209,576 |   | $ | (62,498 | ) | $ | 24,147,078 |   |
| Gross profit                          |       | 12,534,096                                            |       | (50,910                                               | )          | 12,483,186 |   | 9,744,721 |   | (62,498 | ) | $ | 9,682,223 |   |
| Operating expenses                    |       | 12,200,861                                            |       | 1,080,384                                             |       | 13,281,245 |   | 8,492,779 |   | 718,885 |   | $ | 9,211,664 |   |
| Income (loss) before - income taxes   |       | (29,124                                               | )          | (1,131,294                                            | )          | (1,160,418 | ) | 892,704 |   | (781,224 | ) | 111,480 |   |
| Income tax benefit (expense           |       | 32,873                                                |       | (32,873                                               | )          | — |   | (43,790) |   | 108,913 |   | 65,123 |   |
| Net Income (loss)                     |       | $                                                     | 3,749      |                                                  | $          | (1,164,167 | ) | $ | (1,160,418 | ) | $ | 848,914 |   | $ | (672,311 | ) | $ | 176,603 |   |
|                                  |       |                                                  |       |                                                  |       |   |   |   |   |   |   |   |   |
| Earnings (loss) per share:            |       |                                                  |       |                                                  |       |   |   |   |   |   |   |   |   |
| Basic                                 |       | $                                                     | 0.00       |                                                  | (0.10      | ) | $ | (0.10 | ) | $ | 0.08 |   | $ | (0.06 | ) | $ | 0.02 |   |
| Diluted                               |       | $                                                     | 0.00       |                                                  | (0.10      | ) | $ | (0.10 | ) | $ | 0.08 |   | $ | (0.06 | ) | $ | 0.02 |   |

 

12

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| **ITEM 2:** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|-------------|-------------------------------------------------------------------------------------------------|

 

The followingdiscussion should be read along with our financial statements, which areincluded in another section of this filing.

 

*ForwardLooking Statements*

 

Some of the statementsmade constitute “forward-looking statements”. For example, statements includedin this Form 10-Q regarding our financial position, business strategy andother plans and objectives for future operations, and assumptions andpredictions about future demand for our services and products, supply, costs,marketing and pricing factors are all forward-looking statements. When we usewords like “intend,” “anticipate,” “believe,” “estimate,” “plan” or “expect,”we are making forward- looking statements. These forward-looking statements are subject to risks and uncertaintiesand other factors that may cause our actual results, performance orachievements to be materially different from the results, performance orachievements expressed or implied by the forward-looking statements. You shouldnot unduly rely on these statements. Forward-looking statements involveassumptions and describe our plans, strategies, and expectations. This reportcontains forward-looking statements that address, among other things,

 

•ourbusiness and financing plans;

•environmentsin which we operate or plan to operate; and

•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.

 

Factors, risks, anduncertainties that could cause actual results to differ materially from thosein the forward-looking statements (Cautionary Statements) include, amongothers,

 

•ourability to raise capital;

•ourability to continue distributing our products;

•ourability to provide our products at competitive rates;

•ourability to execute our business strategy in a competitive environment;

•ourdegree of financial leverage;

•regulatoryconsiderations and risks related to international economics,

•risksrelated to market acceptance and demand for our products and services;

•ourdependence on third party suppliers;

•theimpact of competitive services; and

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

 

We believe that theassumptions and expectations reflected in this Form 10-Q are reasonable,based on information available to us in this report.  However, we cannot assure anyone that theseassumptions and expectations will prove to have been correct or that we willtake any action that we may presently be planning. We assume no obligation toupdate forward-looking statements or reflect unanticipated future events.

 

# **General**

 

Wewere incorporated on May 5, 2000 as a Nevada corporation.  Our principal office is located at 191 PostRoad West, Suite 10, Westport, CT 06880. Any reference in this “Management’s Discussion and Analysis or Plan ofOperations” discussion to “the company”, “our”, “we” or “us” refers to IWTTesoro Corporation, Inc. (Tesoro).

 

EffectiveOctober 1, 2002, we acquired International Wholesale Tile, Inc. (IWT)through a share exchange and IWT became our wholly owned subsidiary.  We issued a total of nine million shares ofour common stock in exchange for all of the IWT shares.  Tesoro has three additional wholly owned subsidiaries.  The first is IWT Tesoro International, Ltd.,which was created to own and manage assets relating to any of the Company’spotential future overseas activities. The second is IWT Transport, Inc., organized to handle our domesticfreight operations.  The Tile Club, Inc.,formed in 2004, was organized to acquire licensing, manufacturing anddistribution rights for high-end designer and artistic based decorative tilesand will also act as an agent for foreign manufacturers from whom IWT hasacquired exclusive distribution rights.

 

13

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ThroughIWT, we provide hard floor and wall covering materials primarily ceramic,porcelain and stone tiles to the new construction and remodeling industries forthe commercial and residential marketplaces. We distribute our products througha network of independently owned dealers and distributors, buying groups andhome center retailers. We currently purchase our products predominately fromforeign manufacturers.

 

# **Company Overview**

 

TheCompany is a value added distributor of imported ceramic, porcelain and stoneflooring and decorative wall tile.  Ourwarehousing and distribution center contains over 220,000 square feet ofstorage space and over seven million square feet of product ready for immediateshipment to our customers.  In 2004, wesigned an agreement to realign our distribution center facility.  Realigning our distribution facilities willconsolidate approximately 80,000 square feet of warehouse space currently inmultiple small warehouses into one single facility adjacent to its primarywarehouse.  The Company’s primarystrategy is to be a reliable supplier and not a competitor to its customers.

 

Managementbelieves that the critical success factors to the Company’s business are itsability to:

 

•                  Maintainrelationships with and serve a growing base of independent dealers,distributors and wholesalers by providing adequate stocks of in demand productat reasonable and competitive prices

•                  Stayahead of the trends in color, texture and format that drive demand for ourfashion based products

•                  Makethe correct investments in product inventories, relationships with suppliersand logistics and support services to ensure our continuing capability to meetour customers’ expectations

 

Ourprimary source of revenue is the sale of hard flooring and wall coveringmaterials and our primary costs relate to the acquisition, warehousing anddelivery of those products.  While salesare made throughout the United States, the majority of our sales are in thesoutheastern quadrant of the country. The primary sources of working capital are a $ 17.0 million (US)revolving line of credit from a large US commercial bank, our suppliers whoextend us terms and our stockholders’ equity.

 

OnDecember 17, 2003 we began trading our stock on the OTCBB under the symbolIWTT.  During 2004 and 2005, we expect toraise additional equity through both the public and private markets.  Any new capital raised will be used tostrengthen our balance sheet and to provide capital for continued growth.

 

Duringthe quarter ended September 30, 2004, the Company continued to expand itsdistribution channels beyond its traditional small and mid sized floor coveringdealers in the southeastern United States. These channels included largerregional distributors outside the southeastern United States, home centerstores and floor-covering dealers that focus on the builders of newconstruction units.

 

In2004, we formed a new wholly owned subsidiary, The Tile Club, Inc.(TTC).  TTC is a Delawarecorporation.  TTC will serve as alicensor and distributor of specialty tiles. It will also act as an agent for some of our foreign manufactures fromwhom we have exclusive distribution rights in the United States and Canada.

 

*Resultsof Operations for the Quarters ended September 30, 2003 and 2004.*

 

The following discussion and analysis shouldbe read in conjunction with the financial statements and notes thereto thatappear elsewhere in this document. The table below sets forth certain operatingdata, percentage numbers are relative to total revenue for the periodsindicated.

 
| ** **               | ** ** | **Quarter Ending September  30,** | ** ** |
|--------------------------|------------|----------------------------------------|------------|
| ** **               | ** ** | **2002**                               | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **               | ** ** | **(as restated)**                      | ** ** | **(as restated)** | ** ** | **(as restated)** | ** ** |
| Revenues                 |       | $                                      | 6,383,982  |   | $ | 8,955,693 |   | $ | 11,052,268 |   |
| Cost of  Goods Sold      |       | 3,787,716                              |       | 5,373,248 |   | 6,733,909 |   |
| Gross Margin             |       | 2,596,266                              |       | 3,582,445 |   | 4,318,359 |   |
| Gross Margin  Percentage |       | 40.67                                  | %          | 40.00 | % | 39.07 | % |
| Operating  Expenses      |       | 1,485,990                              |       | 3,525,027 |   | 4,640,226 |   |
|                          |            |                                        |            |  |  |  |  |  |  |  |

 

14

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*Quarterended September 30, 2004 Compared to Quarter September 30, 2003*

 

Sales for the quarter ended September 30,2004 were $11,052,268 a 23% increase over sales for the quarter ended September 30,2003. This growth follows a 40% growth from 2002 to 2003. The violent weatherexperienced in Florida and the Gulf Coast during August and September 2004had a dampening impact on our sales for the quarter ended September 30,2004.  While we sustained little or nophysical damage from the storms, the storms themselves and the resulting poweroutages that forced us to close our warehouses, coupled with the physicallosses sustained by our dealer customers, temporarily slowed our growth.   We believe that over the next few months, wewill recover a majority of the lost sales.

 

Thehard flooring and wall covering market in which we participate continues togrow at a pace well beyond the growth in the U.S. GDP. We continue to enter newmarkets and add new products; therefore, we expect to be able to grow fasterthan the market as a whole for the next several years. Our share of this marketis approximately 1.5%. According to Floor Covering Weekly, the tile market inthe United States was approximately $2.54 billion in 2003. This is an 8.5%growth over 2002.  United Stateswholesale floor covering sales in 2003 were $20.9 billion and grew 2.9% from2002.  Tile’s shares of the floorcovering market grew from 11.6% in 2002 to 12.2% in 2003.

 

Thegross margin percentage has remained fairly constant for the last three years.The gross margin percentage decreased less than 1% during the three monthsended September 30th, 2002 to the three months ended September 30th,2003 and decreased less than 1% during the three months ended September 30th,2003 to the three months ended September 30th, 2004. We havebeen able to maintain a fairly consistent product purchase price by monitoringour costs and adjusting our selling price.

 

Thegross margin for the quarter ended September 30, 2004 was $4,318,359, a 21%increase over gross margin for the quarter ended September 30, 2003.  This compares with a 38% growth rate from thethree months ending September 30, 2003 to the same period in 2002.  The slow down in growth of gross marginresulted from the same storm related factors outlined above.

 

Ouroperating expenses for the quarter ended September 30, 2004 have increasedby $1,115,199 over the same period in 2003, an increase of 31.6%.  Our commission expense and outbound freightcosts vary with sales and represent approximately $208,000 of thisincrease.  The balance of the costincrease relates to the expansion of our distribution channels to include homecenter stores and builder-based dealers.

 

InMay 2003, we commenced bulk sales of products, made exclusively for IWT,to wholesale distributors throughout the United States.  The sales ofthese products are made in full truckload or container load volumes, with someproduct being delivered directly to the customer from the factory(drop-shipped).  The gross margin on these sales could be lower than ourtraditional business; however, we believe that the lower handling costs mayoffset the lost gross margin.  In September 2003, we began theinstallation of sample racks for our products in home center stores in SouthFlorida.  As of September 30, 2004, our displays were installed inone hundred and twenty locations.

 

*Resultsof Operations for the Nine Months ended September 30, 2003 and 2004.*

 

The following discussion and analysis shouldbe read in conjunction with the financial statements and notes thereto thatappear elsewhere in this document. The table below sets forth certain operatingdata, percentage numbers are relative to total revenue for the periodsindicated.

 
| ** **               | ** ** | **Nine Months Ending September  30,** | ** ** |
|--------------------------|------------|--------------------------------------------|------------|
| ** **               | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **               | ** ** | **(as restated)**                          | ** ** | **(as restated)** | ** ** | **(as restated)** | ** ** |
| Revenues                 |       | $                                          | 19,201,468 |   | $ | 24,147,078 |   | $ | 32,171,915 |   |
| Cost of  Goods Sold      |       | 11,593,515                                 |       | 14,464,855 |   | 19,688,729 |   |
| Gross Margin             |       | 7,607,953                                  |       | 9,682,223 |   | 12,483,186 |   |
| Gross Margin  Percentage |       | 39.62                                      | %          | 40.10 | % | 38.80 | % |
| Operating  Expenses      |       | 5,166,068                                  |       | 9,211,664 |   | 13,281,245 |   |
|                          |            |                                            |            |  |  |  |  |  |  |  |

 

*NineMonths ended September 30, 2004 Compared to Nine Months September 30,2003*

 

Sales for the nine months ended September 30,2004 were $32,171,915 a 33% increase over sales for the nine months ended September 30,2003. This growth follows a 26% growth from 2002 to 2003. The violent weather,experienced in Florida and the Gulf Coast during August and September 2004,had a dampening impact on our sales for the nine months ending September 30,2004.  While we sustained

 

15

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little or no physical damage from the storms,the storms themselves and the resulting power outages that forced us to closeour warehouses for several days, coupled with the physical losses sustained byour dealer customers, temporarily slowed our growth.   We believe that over the next few months, wewill recover a majority of the lost sales.  The growth in our nation wide wholesale-to wholesale sales channelduring the nine months ending September 30, 2004 partially offset thestorm related issues.

 

Thegross margin percentage has remand fairly constant for the last three years.The gross margin percentage increased less than .5% during the nine monthsended September 30th, 2002 to the nine months ended September 30th,2003 and decreased less than 1.5% during the nine months ended September 30th,2003 to the nine months ended September 30th, 2004. We havebeen able to maintain a fairly consistent product purchase price by monitoringour costs and adjusting our selling price.

 

Thegross margin for the nine months ended September 30, 2004 was $12,483,186,a 29% increase over gross margin for the nine months ended September 30,2003.  This compares with a 27% growthrate from the nine months ending September 30, 2003 to the same period in2002.

 

Ouroperating expenses, consisting of payroll and related expenses, depreciationand amortization and general and administrative, for the nine months ended September 30,2004 increased by $4,069,581 over the same period in 2003, an increase of 44.1%.  Our commission expense and outbound freightcosts vary with sales and represent approximately $370,808 of thisincrease.  The remainder of the increaserelates to the personnel, facilities and marketing costs incurred to expand ourdistribution channels to include home center stores and builder-based dealers.Depreciation and amortization expense increased by $53,593 during the ninemonths ended September 30, 2004 as compared to the nine months ended September 30,2003.  General and administrativeexpenses increased by approximately $2,300,000 primarily due to the newoccupancy costs relating to the increased warehouse capacity to support the newchannels of distribution and the associated advertising and marketing costs.

 

InSeptember 2003, we began the installation of sample racks for our productsin home center stores in Florida.  As of September 30, 2004, ourdisplays were installed in one hundred and twenty locations.

 

Makingit easy for our customers to sell product is also a key success factor for us.We have an extensive sampling and display program that augments the trainingand marketing support we provide our customers.

 

**Changes in Financial Position for the nine months ended September 30,2004 from the year ended December 31, 2003**

 

Accounts receivable and inventory haveincreased by $2,272,802 and $4,035,993 respectively at the nine months periodended September 30, 2004 from the year ended December 31, 2003.  The increases in these account balancesrelate primarily to our growth in sales during the nine months ended September 30,2004.  Our accounts receivable balancefor the nine months ended September 30, 2004 represented approximately1.96 months of sales and the inventory turns for the same period was 1.57times.  Both of these ratios wereimpacted by the storms that struck Florida and the Gulf Coast resulting in aslow down of our sales during the months of August and September of2004.  We expect to regain these lostsales in the up coming months.

 

Wealso have increased our investment in property and equipment by $541,733 net ofdepreciation $126,066 for the nine months ended September 30, 2004 fromthe year ended December 31, 2003. During the nine months ending September 30, 2004, we increased thesquare footage of our administrative offices by adding a second floor to ourexisting space (approximately 5,000 additional square feet) within the currentwarehouse facility, at a cost of approximately $450,000.  The balance of the increase relates to costof sample boards and displays for the new sales channels for our dealer basedbuilders and home center stores.

 

Ourliabilities for accounts payable and long tem loan payable have increased$2,055,297 and $4,730,355 respectively for the nine months ended September 30,2004 from the year ended December 31, 2003.  Our accounts payable balance represents thevalue of inventory supplied to us by our manufacturers that are within paymentterms and the increase is related to our sales growth.  Our long term loan payable is the outstandingbalance of the revolving line of credit extended to us buy our financialinstitution and is related directly to the value of our accounts receivable andinventory balances.  The growth in ourlong-term loan payable is also related to our sales growth.

 

# **Liquidity and CapitalResources**

 

Wehad cash balances of $563,543 and $867,361 at the end of September 30,2004 and December 31, 2003, respectively. We have financed our growth with new equity capital and increasedborrowings from our commercial lender.

 

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During2004 and 2005, we expect to raise additional equity through both the public andprivate markets. We do not expect the realignment of our warehouse facilitiesto require working capital beyond that already committed to the currentfacilities.  New capital raised will beused to strengthen our balance sheet and to provide working capital forcontinued growth.  However, we cannotassure any one that we will be able to obtain outside capital or if we do, thatit will be on terms beneficial to us.

 

Duringthe nine months ended September 30, 2004, Tesoro issued 45,500 shares ofcommon stock in connection with warrants exercised at $3.25 per share for atotal of $147,875.  The purchasers wereaccredited investors and were provided with or had access to, information aboutthe company, including financial information. The transaction was exempt pursuant to Section 4(2) of theSecurities Act.

 

In August 2004, we issued a total of 500shares to one accredited investor who is an IWT customer, with a fair marketvalue of $3.75 per share, in consideration for past loyalty.  In September these shares were includedin Tesoro’s selling stockholders’ registration statement on Form S-1effective October 19, 2004.   In September 2004,we issued an additional 1,000 shares to two accredited investors (500 shareseach) who are IWT customers, based on a fair market value of $2.75 per share onthe date of issuance, in consideration for past loyalty, which shares have notbeen registered with the Securities and Exchange Commission.

 

Thebalance due at September 30, 2004 to our commercial lender for the use ofthe revolving line of credit was approximately $14.3 million.  The loan and security agreement containscertain covenants, which include financial covenants that require us tomaintain a certain leverage ratio, a required minimum fixed charge coverageratio, and a certain inventory turnover ratio.

 

# **Critical AccountingPolicies**

 

Inpreparing the consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America, the Company mustmake decisions which impact the reported amounts of assets, liabilities,revenues and expenses, and related disclosures. Such decisions include theselection of appropriate accounting principles to be applied and theassumptions on which to base accounting estimates. In reaching such decisions,the Company applies judgment based on its understanding and analysis of therelevant circumstances and historical experience. Actual amounts could differfrom those estimated at the time the consolidated financial statements areprepared.

 

TheCompany’s significant accounting policies are described in Note 1 to theconsolidated financial statements included in the Company’s Annual Report on Form 10-KSB,as restated for the year ended December 31, 2003. Some of thosesignificant 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.

 

TheCompany believes the following accounting policies require it to use judgmentsand estimates in preparing its consolidated financial statements and couldrepresent 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.

 

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# **Segment Information**

 

We manage our operations in one segment andall revenue is derived from customers in the United States.

 

**ITEM 3:****                                              ****QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISKS**

 

**Quantitativeand Qualitative Disclosures About Market Risk**

 

TheCompany is exposed to market risk from changes in interest rates and foreigncurrency exchange rates since it funds its operations through short-terminvestments and has business transactions in Euros. A summary of the Company’smarket risk exposures is presented below.

 

*Interest Rate Risk*

 

Tesorohas fixed income investments consisting of cash equivalents and short-terminvestments, which may be affected by changes in market interest rates. TheCompany does not use derivative financial instruments in its investmentportfolio. The Company places its cash equivalents and short-term investmentswith high-quality financial institutions, limits the amount of credit exposureto any one institution and has established investment guidelines relative todiversification and maturities designed to maintain safety and liquidity.Investments are reported at amortized cost, which approximates fair value.

 

*Foreign Currency Risk*

 

Wecurrently purchase our products from foreign manufacturers in U.S.dollars.  Our fund transfers are relatively large.  The Office of theComptroller of the Currency (USOCC) monitors these activities.  Should theEURO continue to strengthen against the US dollar, we could see an increase inour cost of product that could, in time, pass on to our customers andtherefore have a detrimental impact on our profitability.  Our competitorsrely as heavily on imported product as we do.  Therefore, we do not seeany change in the competitive landscape for ceramic tile as a result of thestrength of the EURO.  Tesoro does not currently hedge against the risk ofexchange rate fluctuations.

 

**ITEM 4:****                                              ****CONTROLS AND PROCEDURES**

 

*DisclosureControls and Procedures*

 

Inconnection with preparing its Annual Report on Form 10-K for the fiscalyear ended December 31, 2004,  on Form 10-Q,Tesoro’s management, with participation of the Company’s principal executiveofficer and principal financial officer, have performed an evaluation of theCompany’s disclosure controls and procedures, (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (“ExchangeAct”) to ensure that information required to be disclosed by Tesoro in thereports that Tesoro files or submits under the Exchange Act is recorded,processed, summarized, and reported within the time periods specified by theSEC’s rules and forms.

 

Basedon that evaluation, Tesoro’s principal executive officer and principalfinancial officer have concluded that its disclosure controls and procedureswere not effective in ensuring that information required to be disclosed by theCompany in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized, and reported within the time periods specifiedby the SEC’s rules and forms. At this time, management has determined thatthe Company’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.

 

Attachedas Exhibits 31.1 and 31.2 to this Quarterly Report are certifications of theCEO and the CFO, which are required in accordance with Rule 13a-14 of theSecurities Exchange Act of 1934 (the Exchange Act). This Controls andProcedures section includes the information concerning the controlsevaluation referred to in the certifications and it should be read inconjunction with the certifications.

 

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*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 theCompany’s ability to record, process, summarize and report financial data inthe financial statements in a timely manner. The material weaknesses identifiedby Tesoro include the following:

 

•              Promotionalmerchandise should have been expensed when distributed rather than capitalizedand depreciated;

 

•              Tesorohad incorrectly estimated the accruals for sales related expenses; and

 

•              Incorrectlyestimated its allowances for product returns.

 

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’s Responseand 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 theirconclusions.  On March 21, 2005,Tesoro filed a report on Form 8-K concerning these errors and advised thatits Consolidated Financial Statements for the years ended 2003 and 2002 and forthe interim periods should no longer be relied upon and that the restatementwould not have any effect on the Company’s gross revenue for any periods or onits cash flow.

 

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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 asset balances - i) regular  detailed analyses of fixed assets and accumulated depreciation accounts  should be performed by preparing detailed account reconciliations, and ii) on  a timely basis, account reconciliations and other significant transactions  should be reviewed by an appropriate member of management;                            |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| • |   | Recording and processing transactions - transactions must be  supported by i) appropriate transaction documentation and ii) appropriate  documentation of review by management;                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| • |   | Reconciliation of accounts - detailed reconciliations of subsidiary  accounts to the general ledger must be performed on a regular basis, and  quarterly accounting review procedures must be enhanced by requiring an  appropriate member of management to perform an independent review of material  general ledger accounts and reserves;                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| • |   | Management review of journal entries, account balances and financial  statements - all material journal entries must be reviewed and approved by an  appropriate member of management;                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| • |   | Internal audit function - an internal audit function should conduct  audit procedures and test internal controls in order to ensure that the  Company’s policies and procedures for transactional recording, transactional  review, segregation of duties, and review of significant transactions at the  appropriate level of management are both effective and being followed; and |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| • |   | Competent personnel - staffing should be enhanced to provide  sufficient resources to accomplish the foregoing objectives.                                                                                                                                                                                                                                                                |

 

**Statusof Management’s Plan for Improvement**

 

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

 
| • |   | Recording and processing transactions - controls have been  implemented which require transactions to be supported by i) appropriate  transaction documentation and ii) documentation that the transaction has been  reviewed and approved by an appropriate member of management;                                                                                                                                                                                                                                                                                                                                                                               |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| • |   | Reconciliation of accounts - policies and controls have been  implemented which require regular reconciliations of subsidiary accounts to  the general ledger, with timely review by an appropriate member of  management. Procedures regarding the quarterly accounting review have been  enhanced by requiring independent reviews of account reconciliations,  material general ledger accounts, and reserves;                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| • |   | Management review of journal entries, account balances and financial  statements - controls and procedures are being implemented which require that  all material journal entries are reviewed and approved by an appropriate  member of management;                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| • |   | Internal audit function - the Company has engaged a registered public  accounting firm, which is not affiliated with the Company’s independent  registered public accounting firm, to perform the internal audit function  (the “Internal Auditor”). The Internal Auditor has conducted, and will  continue to conduct, internal audit procedures and tests of internal controls  to ensure that the Company’s controls and procedures for transactional  recording, transactional review, segregation of duties, and review of  significant transactions at the appropriate level of management are both  effective and being followed; and |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| • |   | Competent personnel - the Company has made, and will continue to  make, appropriate staffing enhancements in order to provide sufficient  resources to accomplish the Company’s objectives of recording, processing,  summarizing and reporting, on a timely basis, Tesoro’s financial 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.

 

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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 2007annual 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, 2007. 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.

 

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**PART II– OTHER INFORMATION**

 

**ITEM 1:****                                            ****LEGAL PROCEEDINGS**

 

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.

 

**ITEM 2:****                                         ****CHANGES IN SECURITIES, USEOF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES.**

 

Duringthe nine months ended September 30, 2004, Tesoro issued 45,500 shares ofcommon stock in connection with warrants exercised at $3.25 per share for atotal of $147,875.  The purchasers wereaccredited investors, were provided with or had access to, information aboutthe Company, including financial information. The transaction was exempt pursuant to Section 4(2) of theSecurities Act.

 

OnFebruary 17, 2004, Tesoro issued 15,000 shares of common stock valued at$5.99 per share, based on the trading price of the shares on the date issued,for a total of $89,850 to a consultant.

 

OnMay 26, 2004, Tesoro issued 10,000 shares of common stock to a new outsidemember of our Board of Directors at a price of $4.25 per share, which was thethen fair market value, for a total of $42,500. On the same date, we also issued 2,000 shares of common stock to a consultantat a price of $4.25 per share for a total of $8,500.  Both the shares issued to the outsidedirector and the consultant was pursuant to Tesoro’s Stock Incentive Plan.

 

InAugust 2004, we issued a total of 500 shares to one accredited investorwho is an IWT customer, based on a fair market value of $3.75 per share, inconsideration for past loyalty.  In September theseshares were included in Tesoro’s selling stockholders’ registration statementon Form S-1 effective October 19, 2004.   In September 2004, we issued anadditional 1,000 shares to two accredited investors (500 shares each) who areIWT customers, based on a fair market value of $2.75 per share on the date ofissuance, in consideration for past loyalty. These shares have not beenregistered with the Securities and Exchange Commission.

 

**ITEM 3:****                                            ****DEFAULTS UPON SENIOR SECURITIES.**

 

Not applicable

 

**ITEM 4:****                                             SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

Not Applicable.

 

**ITEM 5:****                                            ****OTHER INFORMATION**

 

Not applicable

 

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**ITEM 6:****                                              ****EXHIBITS AND REPORTS ON FORM 8-K**

 

(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)                                                     |
| 3.2.1               |       | Bylaws (filed as an Exhibit to the Company’s Form 10-SB,  filed with the Securities and Exchange Commission on August 7, 2000)                                                                                                                                          |
| 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)                                                                                                          |
| 3.3.1               |       | Specimen Stock Certificate (filed as an Exhibit to the Company’s  Form 10-SB, filed with the Securities and Exchange Commission on  August 7, 2000)                                                                                                                     |
| 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)                                                                                                          |
| 4.1.3               |       | Form of Lock-Up Agreement (filed as an Exhibit to the  Company’s Registration Statement, filed with the Securities and Exchange  Commission on April 11, 2003)                                                                                                          |
| 10.1                |       | Agreement With Peter Goss (filed as an Exhibit to the Company’s  Form 10-SB, filed with the Securities and Exchange Commission on  August 7, 2000)                                                                                                                      |
| 10.2                |       | Stockholders Agreement (filed as an Exhibit to the Company’s  Form 10-SB, filed with the Securities and Exchange Commission on  August 7, 2000)                                                                                                                         |
| 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 IWT Tesoro Corporation, Effective  October 1, 2002 (filed as an Exhibit on Form 8-K, filed with  the Securities and Exhibit Commission on October 15, 2002).      |
| 10.7                |       | Termination Of Stockholders Agreement (filed as an Exhibit to  the Company’s Report on Form 8-K/A, filed with the Securities and  Exchange Commission on February 4, 2003)                                                                                              |
| 10.8                |       | Repurchase Agreement (filed as an Exhibit to the Company’s  Report on Form 8-K/A, filed with the Securities and Exchange Commission  on February 4, 2003)                                                                                                               |
| 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)                                                                                                        |
| 10.00               |       | Employment Agreement between International Wholesale Tile, Inc.  and Forrest P. 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 P. Jordan’s Employment Agreement with the exception of the  employee’s name and address)                           |

 

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| 10.12 |   | Employment Agreement between International Wholesale Tile, Inc.  and Grey Perna (this document is omitted as it is substantially similar to  Forrest P. 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 P. 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 P. 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 P. Jordan’s Subordination Agreement with the exception of  the employee’s name and address)                                                                                                                                                                |
| 10.16 |   | Termination of Repurchase Agreement dated June 26, 2003 between  IWT Tesoro Corporation and Forrest P. Jordan (filed as an Exhibit to the  Company’s Form 8-K, filed with the Securities and Exchange Commission on  June 26, 2003).                                                                                                                                                                      |
| 10.17 |   | Termination of Repurchase Agreement dated June 26, 2003 between  IWT Tesoro Corporation and Paul F. Boucher (this document is omitted as it is  substantially similar to Forrest P. Jordan’s Termination of Repurchase  Agreement with the exception of the name and address) (filed as an  Exhibit to the Company’s Form 8-K, filed with the Securities and  Exchange Commission on June 26, 2003). |
| 10.18 |   | Termination of Repurchase Agreement dated June 26, 2003 between  IWT Tesoro Corporation and Grey Perna (this document is omitted as it is substantially  similar to Forrest P. Jordan’s Termination of Repurchase Agreement with the  exception of the name and address) (filed as an Exhibit to the Company’s  Form 8-K, filed with the Securities and Exchange Commission on  June 26, 2003).      |
| 16.2  |   | Letter regarding change in Certifying Accountants (filed as an  Exhibit to the Company’s Report on Form 8-K/A filed with the  Securities and Exchange Commission on March 2, 2004).                                                                                                                                                                                                                            |
| 21.   |   | Subsidiaries of Registrant (filed as an Exhibit to the Company’s  Registration Statement, filed with the Securities and Exchange Commission on  April 11, 2003)                                                                                                                                                                                                                                                     |
| 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 P. 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 P. Jordan, Chief Financial Officer pursuant  to Section 906 of the Sarbanes-Oxley Act.*                                                                                                                                                                                                                                                                                                              |
| 99.1  |   | MRS’ Letter To The Securities And Exchange Commission. (filed as an  Exhibit to the Company’s Report on Form 8-K/A, filed with the  Securities and Exchange Commission on October 8, 2002)                                                                                                                                                                                                                |
| 99.2  |   | Letter from Peter Goss regarding fiscal year end (filed as an  Exhibit to the Company’s Report on Form 8-K, filed with the  Securities and Exchange Commission on October 15, 2002)                                                                                                                                                                                                                            |

 

Filed herewith.

 

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(b)  Reports on Form 8-K

 

Form 8-K, filed on September 14, 2004, regarding changes in the certifying accountants.

 

Form 8-K, filed on September 22, 2004, regarding a change in the Company’s Insider Trading Policy regard 10b5-1 Plans.

 

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SIGNATURES

 

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

 

 
|                   | IWT TESORO CORPORATION                     |
|------------------------|--------------------------------------------|
|                   |                                       |
|                   |                                       |
| November 10, 2005 | /s/ Henry J. Boucher, Jr.             |   |
|                   | Henry J. Boucher, Jr., President      |
|                   |                                       |
| November 10, 2005 | /s/ Forrest P. Jordan                      |   |
|                   | Forrest P. Jordan, Chief Financial Officer |

 

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