** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

 

----

 

**FORM 10-Q**

 

**(Mark One)**
| **x**      | ** ** | **QUARTERLY REPORT PURSUANT  TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|------------|---------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                        |
| ** ** | ** ** | **FOR THE QUARTERLY PERIOD  ENDED SEPTEMBER 30, 2007**                                            |
|       |       |                                                                                              |
| **o**      | ** ** | **TRANSITION REPORT UNDER  SECTION 13 OR 15(d) OF THE EXCHANGE ACT**                              |

** **

**Commission File No. 0-31267**

** **

**IWT TESORO CORPORATION**

(Exact name ofregistrant as specified in its charter)

 

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

 

**101Post Road West, Suite 10, Westport, CT 06880**

(Address ofprincipal executive offices)

 

**(203)221-2770**

(Registrant’stelephone number, including area code)

 

Indicate by check,mark whether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days:

 

x  Yes                   o  No

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.

 

| Large accelerated filer  o |   | Accelerated filer  o |   | Non-accelerated  filer.  x |
|--------------------------------------|--------|--------------------------------|--------|--------------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act)

 

o  Yes                   x  No

 

APPLICABLE ONLY TOISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS

DURING THEPRECEDING FIVE YEARS:

 

Indicate by checkmarket whether the registrant has filed all documents and reports required tobe filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934subsequent to the distribution of securities under a plan confirmed by thecourt.

 

o  Yes                   x  No

 

Indicate the number ofshares outstanding of each of the issuer’s class of common equity, as ofNovember 6, 2007: 13,185,567 shares

 

----

 

**IWTTESORO CORPORATION AND SUBSIDIARIES**

 

**(DEBTOR-IN-POSSESSION)**

**FORM10-Q**

**For thenine months ended September 30, 2007**

**INDEX**

** **
| **PART I**  | **FINANCIAL  INFORMATION**                                                                              | ** ** | ** ** | ** ** |
|-------------|---------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** **  | ** **                                                                                              | ** ** | ** ** | ** ** |
| Item 1.     | Financial Statements                                                                                    |       | 3          |       |
|        | Consolidated  Balance Sheets as of September 30, 2007 and December 31, 2006                             |       | 3          |       |
|        | Consolidated  Statements of Operations for the three and nine months ended September 30,  2007 and 2006 |       | 4          |       |
|        | Consolidated  Statements of Stockholders’ Deficit for the nine months ended September 30,  2007    |       | 5          |       |
|        | Consolidated  Statements of Cash Flows for the nine months ended September 30, 2007 and  2006           |       | 6          |       |
|        | Notes to the  Consolidated Interim Financial Statements                                                 |       | 8          |       |
| Item 2.     | Management’s  Discussion and Analysis of Financial Condition and Results of Operations             |       | 21         |       |
| Item 3.     | Quantitative  and Qualitative Disclosures About Market Risk                                             |       | 27         |       |
| Item 4.     | Controls and  Procedures                                                                                |       | 27         |       |
|        |                                                                                                    |       |       |       |
|        |                                                                                                    |       |       |       |
| **PART II** | **OTHER  INFORMATION**                                                                                  | ** ** | ** ** | ** ** |
|        |                                                                                                    |       |       |       |
| Item 1.     | Legal Proceedings                                                                                       |       | 28         |       |
| Item  1/A.  | Risk  Factors                                                                                           |       | 28         |       |
| Item 2.     | Unregistered  Sales of Equity Securities and Use of Proceeds                                            |       | 28         |       |
| Item 3.     | Default Upon  Senior Securities                                                                         |       | 28         |       |
| Item 4.     | Submission of  Matters to a vote of Security Holders                                                    |       | 28         |       |
| Item 5.     | Other Information                                                                                       |       | 28         |       |
| Item 6.     | Exhibits                                                                                                |       | 29         |       |

 

2

----

 

 

PART 1 — FINANCIAL INFORMATION

 

ITEM 1:FINANCIAL STATEMENTS

 

**IWT TESORO CORPORATION AND SUBSIDIARIES**

(DEBTOR-IN-POSSESSION)

CONSOLIDATEDBALANCE SHEETS

 
| ** **                                                                                                                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                                                     | ** ** | **2007**          | ** ** | **2006**         | ** ** |
| ** **                                                                                                                     | ** ** | **(Unaudited)**   | ** ** | ** **       | ** ** |
| ASSETS                                                                                                                         |       |              |       |             |       |
| Current Assets:                                                                                                                |       |              |       |             |       |
| Cash                                                                                                                           |       | $                 | 580,701    |             | $          | 157,729 |   |
| Accounts receivable, net of allowance for doubtful accounts and  returns of $518,605 and $477,674, respectively                |       | 8,302,821         |       | 9,780,039        |       |
| Inventories, net of allowance for obsolescence of $299,443 and  $525,000, respectively                                         |       | 19,325,157        |       | 30,674,860       |       |
| Deposit on purchases of inventories                                                                                            |       | 149,521           |       | 167,693          |       |
| Prepaid expenses                                                                                                               |       | 243,879           |       | 210,345          |       |
| Total current assets                                                                                                           |       | 28,602,079        |       | 40,990,666       |       |
| Property and Equipment, net                                                                                                    |       | 1,942,322         |       | 2,264,762        |       |
| Other Assets                                                                                                                   |       | 772,824           |       | 1,016,250        |       |
| Total assets                                                                                                                   |       | $                 | 31,317,225 |             | $          | 44,271,678 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                     |       |              |       |             |       |
| Current Liabilities:                                                                                                           |       |              |       |             |       |
| Accounts payable                                                                                                               |       | $                 | 552,085    |             | $          | 17,014,921 |   |
| Accrued expenses and other liabilities                                                                                         |       | 790,131           |       | 2,040,593        |       |
| Debtor in possession financing                                                                                                 |       | 1,446,390         |       | $                | —     |   |
| Current portion of equipment leases                                                                                            |       | —            |       | 55,889           |       |
| Current portion of equipment notes                                                                                             |       | —            |       | 30,499           |       |
| Note payable, revolving line of credit                                                                                         |       | —            |       | 24,400,378       |       |
| Current portion of convertible debt                                                                                            |       | —            |       | 800,007          |       |
| Note payable, other (net of discounts of $74,273)                                                                              |       | —            |       | 1,925,727        |       |
| Total current liabilities                                                                                                      |       | 2,788,606         |       | 46,268,014       |       |
|                                                                                                                           |       |              |       |             |       |
| Liabilities Subject To Compromise                                                                                              |       | 39,949,719        |       | —           |       |
|                                                                                                                           |       |              |       |             |       |
| Long-Term Debt:                                                                                                                |       |              |       |             |       |
|                                                                                                                           |       |              |       |             |       |
| Capital leases, equipment, net of current portion                                                                              |       | —            |       | 41,098           |       |
| Notes payable, equipment, net of current portion                                                                               |       | —            |       | 47,297           |       |
| Note payable, revolving line of credit (net of discounts of  $2,777,792)                                                       |       | —            |       | 2,222,208        |       |
| Convertible debt, net of current portion (net of discounts of  $741,408)                                                       |       | —            |       | 125,252          |       |
| Total long-term debt                                                                                                           |       | —            |       | 2,435,855        |       |
| Total liabilities                                                                                                              |       | 42,738,325        |       | 48,703,869       |       |
| Stockholders’ Equity:                                                                                                     |       |              |       |             |       |
| Preferred stock, $0.001 par value, 25,000,000 authorized; none issued                                                          |       | —            |       | —           |       |
| Common stock, $0.001 par value, 100 million shares authorized; 12,185,567  and 11,928,600 issued and outstanding, respectively |       | 12,186            |       | 11,929           |       |
| Additional paid in capital                                                                                                     |       | 7,911,917         |       | 7,383,305        |       |
| Accumulated deficit                                                                                                            |       | (19,325,123       | )          | (11,817,278      | )          |
|                                                                                                                           |       | (11,401,020       | )          | (4,422,044       | )          |
| Treasury stock, 10,584 and 6,105 shares at cost, respectively                                                                  |       | (20,080           | )          | (10,147          | )          |
| Total stockholders’ deficit                                                                                               |       | (11,421,100       | )          | (4,432,191       | )          |
|                                                                                                                           |       | $                 | 31,317,225 |             | $          | 44,271,678 |   |

 

Seenotes to the consolidated interim financial statements.

 

3

----

 

**IWT TESOROCORPORATION AND SUBSIDIARIES**

(DEBTOR-IN-POSSESSION)

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

 
| ** **                                                                                               | ** ** | **The  three months ended** | ** ** | **The nine  months ended** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **                                                                                               | ** ** | **September  30,**          | ** ** | **September  30,**         | ** ** |
| ** **                                                                                               | ** ** | **2007**                    | ** ** | **2006**                   | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                                                     |       |                        |       |                       |       |   |   |   |   |
| Net Sales                                                                                                |       | $                           | 10,795,603 |                       | $          | 15,173,449 |   | $ | 40,268,664 |   | $ | 48,145,483 |   |
| Cost of Goods Sold                                                                                       |       | 6,699,621                   |       | 9,578,329                  |       | 25,693,656 |   | 30,544,590 |   |
| Gross Profit                                                                                             |       | 4,095,982                   |       | 5,595,120                  |       | 14,575,008 |   | 17,600,893 |   |
| Operating Expenses:                                                                                      |       |                        |       |                       |       |   |   |   |   |
| Warehouse and distribution                                                                               |       | 2,219,728                   |       | 2,579,239                  |       | 7,335,602 |   | 7,572,091 |   |
| Sales and marketing                                                                                      |       | 872,268                     |       | 1,333,839                  |       | 3,532,968 |   | 4,291,838 |   |
| General and administrative                                                                               |       | 1,446,302                   |       | 1,757,293                  |       | 5,398,233 |   | 5,672,372 |   |
| Restructuring charge                                                                                     |       | —                      |       | —                     |       | — |   | 585,680 |   |
|                                                                                                     |       | 4,538,298                   |       | 5,670,371                  |       | 16,266,803 |   | 18,121,981 |   |
| Loss from Operations                                                                                     |       | (442,316                    | )          | (75,251                    | )          | (1,691,795 | ) | (521,088 | ) |
| Other Expenses:                                                                                          |       |                        |       |                       |       |   |   |   |   |
| Interest expense (Contractual interest $1,288,919, $1,612,093,  $4,228,018 and $4,030,140, respectively) |       | (1,088,919                  | )          | (1,612,093                 | )          | (4,028,018 | ) | (4,030,140 | ) |
| Change in fair value of derivative                                                                       |       | —                      |       | 261,589                    |       | — |   | 4,608,822 |   |
| Other income (expense)                                                                                   |       | (80,059                     | )          | 18,651                     |       | (77,325 | ) | (122,757 | ) |
| Loss Before Reorganization Items                                                                         |       | (1,168,978                  | )          | (1,331,853                 | )          | (4,105,343 | ) | 455,925 |   |
| and Income Tax Expense                                                                                   |       | (1,611,294                  | )          | (1,407,104                 | )          | (5,797,138 | ) | (65,163 | ) |
|                                                                                                     |       |                        |       |                       |       |   |   |   |   |
| Reorganization items:                                                                                    |       |                        |       |                       |       |   |   |   |   |
| Professional fees                                                                                        |       | 190,221                     |       | —                     |       | 190,221 |   | — |   |
| Loss on debt revaluation                                                                                 |       | 2,127,918                   |       | —                     |       | 2,127,918 |   | — |   |
| Interest accrued                                                                                         |       | (620,513                    | )          | —                     |       | (620,513 | ) | — |   |
|                                                                                                     |       | 1,697,626                   |       | —                     |       | 1,697,626 |   | — |   |
| Loss Before Income Tax Expenses                                                                          |       | (3,308,920                  | )          | (1,407,104                 | )          | (7,494,764 | ) | (65,163 | ) |
|                                                                                                     |       |                        |       |                       |       |   |   |   |   |
| Income Tax Expense                                                                                       |       | (1,030                      | )          | —                     |       | (13,081 | ) | — |   |
| Net Loss                                                                                                 |       | $                           | (3,309,950 | )                          | $          | (1,407,104 | ) | $ | (7,507,845 | ) | $ | (65,163 | ) |
| Loss Per Share:                                                                                          |       |                        |       |                       |       |   |   |   |   |
| Basic and Diluted                                                                                        |       | $                           | (0.28      | )                          | $          | (0.12 | ) | $ | (0.62 | ) | $ | (0.01 | ) |
|                                                                                                     |       |                        |       |                       |       |   |   |   |   |
| Weighted Average Common Shares Outstanding:                                                              |       |                        |       |                       |       |   |   |   |   |
|                                                                                                     |       |                        |       |                       |       |   |   |   |   |
| Basic and Diluted                                                                                        |       | 11,988,572                  |       | 11,928,600                 |       | 12,053,342 |   | 11,845,553 |   |

 

Seenotes to the consolidated interim financial statements.

 

4

----

**IWT TESOROCORPORATION AND SUBSIDIARIES**

(DEBTOR-IN-POSSESSION)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT

(Unaudited)

 
| ** **                                                          | ** ** | **Common Stock** | ** ** | **Treasury** | ** ** | **Additional  Paid in** | ** ** | **Accumulated   Earnings** | ** ** | ** **  | ** ** |
|---------------------------------------------------------------------|------------|------------------|------------|--------------|------------|-------------------------|------------|----------------------------|------------|-------------|------------|
| ** **                                                          | ** ** | **Shares**       | ** ** | **Amount**   | ** ** | **Stock**               | ** ** | **Capital**                | ** ** | **Deficit** | ** ** | **Total** | ** ** |
| Balance, December 31, 2006                                |       | 11,928,600       |       | $            | 11,929     |                    | $          | (10,147                    | )          | $           | 7,383,305  |   | $ | (11,817,278 | ) | $ | (4,432,191 | ) |
|                                                                |       |             |       |         |       |                    |       |                       |       |        |       |   |   |
| Issuance of shares to employees and directors for services rendered |       | 66,800           |       | 67           |       | —                  |       | 110,883                    |       | —      |       | 110,950 |   |
|                                                                |       |             |       |         |       |                    |       |                       |       |        |       |   |   |
| Issuance of shares to consultant for services rendered              |       | 190,167          |       | 190          |       | —                  |       | 330,769                    |       | —      |       | 330,959 |   |
|                                                                |       |             |       |         |       |                    |       |                       |       |        |       |   |   |
| Stock option compensation expense                                   |       | —           |       | —       |       | —                  |       | 86,960                     |       | —      |       | 86,960 |   |
|                                                                |       |             |       |         |       |                    |       |                       |       |        |       |   |   |
| Treasury stock at cost                                              |       | —           |       | —       |       | (9,933                  | )          | —                     |       | —      |       | (9,933 | ) |
|                                                                |       |             |       |         |       |                    |       |                       |       |        |       |   |   |
| Net loss, nine months ended September 30, 2007            |       | —           |       | —       |       | —                  |       | —                     |       | (7,507,845  | )          | (7,507,845 | ) |
|                                                                |       |             |       |         |       |                    |       |                       |       |        |       |   |   |
| Balance, September 30, 2007                               |       | 12,185,567       |       | $            | 12,186     |                    | $          | (20,080                    | )          | $           | 7,911,917  |   | $ | (19,325,123 | ) | $ | (11,421,100 | ) |

 

Seenotes to the consolidated interim financial statements.

 

5

----

 

**IWT TESOROCORPORATION AND SUBSIDIARIES**

(DEBTOR-IN-POSSESSION)

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 
| ** **                                                                     | ** ** | **Nine  Months Ended** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                     | ** ** | **September  30,**     | ** ** | **September  30,** | ** ** |
| ** **                                                                     | ** ** | **2007**               | ** ** | **2006** | ** ** |
| Cash flows from operating activities:                                          |       |                   |       |   |   |
| Net loss                                                                       |       | $                      | (7,507,845 | ) | $ | (65,163 | ) |
| Adjustments to reconcile net income to net cash used in operating  activities: |       |                   |       |   |   |
| Non-cash restructuring charge                                                  |       | —                 |       | 478,794 |   |
| Depreciation and amortization                                                  |       | 476,479                |       | 542,225 |   |
| Amortization of loan discount                                                  |       | 1,590,399              |       | 1,903,071 |   |
| Change in fair value of embedded derivative                                    |       | —                 |       | (4,608,822 | ) |
| Common stock issued for services and compensation                              |       | 441,909                |       | 12,792 |   |
| Stock option compensation expense                                              |       | 86,960                 |       | 88,438 |   |
| Provision for doubtful accounts and reserve for returns                        |       | 192,600                |       | 112,160 |   |
| Loss on disposal of property and equipment                                     |       | 1,864                  |       | 80,156 |   |
| Reorganization charges                                                         |       | 1,697,626              |       | — |   |
| Changes in operating assets and liabilities:                                   |       |                   |       |   |   |
| (Increase) Decrease in:                                                        |       |                   |       |   |   |
| Accounts receivable                                                            |       | 1,284,618              |       | (2,227,013 | ) |
| Inventories                                                                    |       | 11,349,703             |       | (2,176,158 | ) |
| Deposit on purchase of inventories                                             |       | 18,172                 |       | 415,408 |   |
| Prepaid expenses and other assets                                              |       | (34,059                | )          | (177,509 | ) |
| Increase (Decrease) in:                                                        |       |                   |       |   |   |
| Accounts payable                                                               |       | (1,699,662             | )          | (1,171,372 | ) |
| Accrued expenses and other liabilities                                         |       | 445,542                |       | 233,095 |   |
| Net cash provided by (used in) operating activities                            |       | 8,344,306              |       | (6,559,898 | ) |
|                                                                           |       |                   |       |   |   |
| Cash flows from investing activities:                                          |       |                   |       |   |   |
| Acquisitions of property and equipment                                         |       | (71,597                | )          | (609,261 | ) |
| Proceeds from sale of equipment                                                |       | 34,800                 |       | 17,300 |   |
| Net cash used in investing activities                                          |       | (36,797                | )          | (591,961 | ) |
|                                                                           |       |                   |       |   |   |
| Cash flows from financing activities:                                          |       |                   |       |   |   |
| Proceeds from revolving line of credit                                         |       | 32,232,733             |       | 53,202,232 |   |
| Payments on revolving line of credit                                           |       | (41,023,369            | )          | (50,224,250 | ) |
| Proceeds from debtor in possession facility                                    |       | 1,446,390              |       | — |   |
| Proceeds from issuance of convertible debt and warrant                         |       | —                 |       | 4,000,000 |   |
| Debt issuance costs                                                            |       | —                 |       | (156,000 | ) |
| Repayment of convertible debt                                                  |       | (473,500               | )          | (133,334 | ) |
| Proceeds from long-term debt and capital lease obligations                     |       | 39,613                 |       | — |   |
| Payments of long-term debt and capital lease obligations                       |       | (96,471                | )          | (78,937 | ) |
| Purchase of Treasury stock                                                     |       | (9,933                 | )          | (9,894 | ) |
| Net cash (used in) provided by financing activities                            |       | (7,884,537             | )          | 6,599,817 |   |
|                                                                           |       |                   |       |   |   |
| Net Increase (Decrease) in Cash                                                |       | 422,972                |       | (552,042 | ) |
|                                                                           |       |                   |       |   |   |
| Cash, Beginning                                                                |       | 157,729                |       | 552,042 |   |
| Cash, Ending                                                                   |       | $                      | 580,701    |   | $ | — |   |

 

Seenotes to the consolidated interim financial statements.

 

6

----

 

**IWT TESOROCORPORATION AND SUBSIDIARIES**

(DEBTOR-IN-POSSESSION)

CONSOLIDATED STATEMENTSOF CASH FLOWS

(Unaudited)

 
| ** **                                                                                          | ** ** | **Nine  Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                          | ** ** | **September  30,**     | ** ** | **September  30,** | ** ** |
| ** **                                                                                          | ** ** | **2007**               | ** ** | **2006** | ** ** |
| Cash Paid During the Period for:                                                                    |       |                   |       |   |   |
| Interest expense                                                                                    |       | $                      | 2,305,437  |   | $ | 1,945,183 |   |
| Income tax                                                                                          |       | $                      | 13,081     |   | $ | — |   |
| Non-Cash Operating Activities:                                                                      |       |                   |       |   |   |
| Inventory acquired through deposit with vendor                                                      |       | $                      | 58,511     |   | $ | 243,412 |   |
| Non-Cash Investing and Financing Activities:                                                        |       |                   |       |   |   |
| Payment of interest expense through the issuance of common stock                                    |       | $                      | 132,182    |   | $ | 181,886 |   |
| Reclassification of embedded derivative liability into equity in  connection with debt modification |       | $                      | —     |   | $ | 1,345,640 |   |
|                                                                                                |       |                   |       |   |   |
| Reorganization Period:                                                                              |       |                   |       |   |   |
| Cash Received During the Reorganization Period from:                                                |       |                   |       |   |   |
| Cash received from customers                                                                        |       | $                      | 2,877,504  |   | $ | — |   |
| Proceeds received from Debtor-In-Possession facility                                                |       | $                      | 1,405,000  |   | $ | — |   |
| Cash Paid During the Reorganization Period for:                                                     |       |                   |       |   |   |
| Cash paid to employees and employee related expenses                                                |       | $                      | (485,935   | ) | $ | — |   |
| Cash paid to vendors                                                                                |       | $                      | (877,161   | ) | $ | — |   |
| Repayment of convertible debt                                                                       |       | $                      | (73,500    | ) | $ | — |   |
| Payment of interest on DIP facility                                                                 |       | $                      | (41,390    | ) | $ | — |   |
| Payments on revolving line of credit                                                                |       | $                      | (2,623,202 | ) | $ | — |   |

 

Seenotes to the consolidated interim financial statements.

 

7

----

IWTTESORO CORPORATION AND SUBSIDIARIES

(DEBTOR-IN-POSSESSION)

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NINE MONTHS ENDEDSEPTEMBER 30, 2007

###### **NOTE 1.               ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

#### ***Organizationand Nature of Operations***

The consolidated financial statements include IWTTesoro Corporation and its wholly owned subsidiaries (collectively the “Company”).

IWT Tesoro Corporation “Tesoro” was incorporated inthe state of Nevada on May 3, 2000.  OnOctober 1, 2002, IWT Tesoro Corporation acquired 100% of the outstanding stockof International Wholesale Tile, Inc. (IWT) in exchange for 83% of itsoutstanding common stock in a transaction accounted for as a recapitalizationof IWT. A total of 9,000,000 shares of common stock were issued for theacquisition. For accounting purposes, the acquisition has been treated as acapital transaction and as a recapitalization of International Wholesale Tile,Inc. The financial statements became those of International Wholesale Tile,Inc., with adjustments to reflect the changes in equity structure.

International Wholesale Tile, Inc. is principally avalue added reseller of ceramic floor and wall covering products (primarilyceramic, porcelain and stone tile) to the new construction and remodelingindustries for commercial and residential marketplaces. In addition to IWT,Tesoro’s primary operating subsidiary, Tesoro, has five additional wholly-ownedsubsidiaries. The Tile Club, Inc., formed in 2004, organized to acquirelicensing, manufacturing and distribution rights; Tesoro Direct, Inc., formallyknown as Import Flooring Group, Inc. a wholly-owned subsidiary of The Tile Clubformed in 2005 to develop an agency business; and American Gres, Inc. formed inNovember 2006, organized to produce domestic ceramic tile. The remaining two,IWT Tesoro Transport, Inc. and IWT Tesoro International, LTD., a Bermudacorporation are inactive.

#### ***Principlesof Consolidation***

The consolidated financial statements include IWTTesoro Corporation and its wholly-owned subsidiaries: International WholesaleTile, Inc., IWT Tesoro International, Ltd, IWT Tesoro Transport, Inc., AmericanGres, Inc. and The Tile Club, Inc., and The Tile Club, Inc.’s wholly-ownedsubsidiary Tesoro Direct, Inc., formerly known as Import Flooring Group, Inc. Allsignificant inter-company balances and transactions have been eliminated inconsolidation.

#### ***Basis ofPresentation***

The interim financialinformation included herein is unaudited; however, such information reflectsall adjustments, which are, in the opinion of management, necessary for a fairpresentation of the Company’s financial position, results of operations,changes in stockholders’ deficit and cash flows for the interim periods. Allsuch adjustments are of a normal, recurring nature. The results of operationsfor the first nine months of the year are not necessarily indicative of theresults of operations which might be expected for the entire year. See Note 2,Reorganization under Chapter 11 of the US Bankruptcy Code for a fulldescription of the impact the reorganization has on the basis of presentationof our financial statements.

The accompanyingconsolidated financial statements of the Company have been prepared inaccordance with accounting principles generally accepted in the United Statesof America and with the instructions to Form 10-Q and Rule 10-10 of RegulationS-X of the Securities and Exchange Commission. Accordingly certain informationand footnote disclosure required by accounting principles generally accepted inthe United States of America for complete financial statements have beenomitted. These condensed financial statements should be read in conjunctionwith the Company’s financial statements and notes thereto included in theCompany’s audited financial statements on Form 10-K, for the fiscal year endedDecember 31, 2006.

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The ConsolidatedBalance Sheet at December 31, 2006 has been derived from the audited financialstatements of IWT Tesoro Corporation at that date, but does not include all ofthe information and footnotes required by U.S. generally accepted accountingprinciples for complete financial statements.

***Adoption of New Accounting Policy***

In July 2006, the FASBissued Interpretation No. 48 (“FIN 48”), *Accounting for Uncertaintyin Income Taxes*.  FIN 48applies to all tax positions related to income taxes subject to SFAS No. 109, *Accounting for Income Taxes*. This includes tax positions considered to be “routine” as well as thosewith a high degree of uncertainty.  FIN48 utilizes a two-step approach for evaluating tax positions.  Recognition (step one) occurs when anenterprise concludes that a tax position, based solely on its technical merits,is more-likely-than-not to be sustained upon examination.  Measurement (step two) is only addressed ifstep one has been satisfied (i.e., the position is more-likely-than-not to besustained).  FIN 48 clarifies theaccounting for income taxes by prescribing the minimum recognition threshold atax position must meet before being recognized in the financialstatements.  FIN 48 also providesguidance on derecognition, measurement, classification, interest and penalties,accounting in interim periods, disclosure and transition.

Effective January 1,2007, the Company has adopted the provisions of FIN 48 and has analyzed itsfederal and significant state filing positions. The periods subject to examination for the Company’s federal returns arethe tax years 2004 through 2006.  Theperiods subject to examination for the Company’s significant state returns, arethe tax years 2004 through 2006.  TheCompany believes that its income tax filing positions and deductions will besustained on examination and does not anticipate any adjustments that willresult in a material change on its financial statements.  As a result, no reserves for uncertain incometax positions have been recorded pursuant to FIN 48 nor were there a cumulativeeffect related to adopting FIN 48 recorded.

The Company’s policy forrecording interest and penalties related to uncertain tax positions is torecord such items as part of its provision for federal and state income taxes.

There have been no other material changes toour significant accounting policies and estimates from the information providedin Note 1 of our Consolidated Financial Statements included in our Form 10-Kfor the year ended December 31, 2006.

***Recent Accounting Pronouncements***

In September 2006, theFASB issued SFAS No. 157, “Fair Value Measurements” (FAS 157). FAS 157 definesfair value, establishes the framework for measuring fair value in generallyaccepted accounting principals and expands disclosures about fair valuemeasurements. This Statement applies only to fair value measurements that arealready required or permitted by other accounting standards. Accordingly, thisStatement does not require any new fair value measurements. SFAS No. 157 iseffective for fiscal years beginning after December 15, 2007. The Company iscurrently evaluating the impact, if any the adoption of SFAS No. 157 will haveon our consolidated financial statements.

In September 2006, theFASB issued SFAS No. 158, “Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans” (“SFAS No. 158”). SFASNo. 158 requires companies to recognize in their statement of financialposition an asset for a plan’s over funded status or a liability for a plan’sunder funded status and to measure a plan’s assets and its obligations thatdetermine its funded status as of the end of the company’s fiscal year.Additionally, SFAS No. 158 requires companies to recognize changes in thefunded status of a defined benefit postretirement plan in the year that thechanges occur and those changes will be reported in comprehensive income. SFASNo. 158 is effective for fiscal years ending after December 31, 2006.The adoption of SFAS No. 158 did not have an impact on our consolidatedfinancial statements.

**NOTE 2                 REORGANIZATION UNDER CHAPTER 11OF THE US BANKRUPTCY CODE**

On September 6, 2007(Filing Date), IWT Tesoro Corporation and two of its wholly-owned domesticsubsidiaries, International Wholesale Tile, Inc. and American Gres, Inc., filedvoluntary petitions for reorganization under the Bankruptcy Code in the UnitedStates Bankruptcy Court in the Southern District of New York (the Bankruptcy Court)under lead case no. 07-12841. These Chapter 11 cases are collectively referredto as the “Bankruptcy Cases.”

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Tesoro Direct, Inc., awholly-owned subsidiary of IWT Tesoro Corporation did not file a voluntarypetition for reorganization however its assets and liabilities were included inthe Schedules of Assets and Liabilities filed by International Wholesale Tile,Inc.

IWT Tesoro Transport,Inc. and The Tile Club, Inc., wholly-owned domestic subsidiaries and IWT TesoroInternational, LTD a wholly-owned foreign subsidiary of IWT Tesoro Corporationdid not file a voluntary petition for reorganization because their total assetsequaled less than .04% of the Company’s total consolidated assets. In additionthese entities had no liabilities. However they are represented in theConsolidated Financial Statements.

IWT Tesoro Corporationand all of its subsidiaries are collectively the Debtors.

The Bankruptcy Cases arebeing jointly administered, with the Debtors managing their businesses in theordinary course as debtors in possession subject to the supervision of theBankruptcy Court. The Debtors intend to continue, normal business operationsduring the Bankruptcy Cases while they evaluate their businesses both from afinancial and an operational perspective. Management is working with several financial partners to cosponsor aplan to reorganize and refinance the Debtors. While we cannot predict with precision how long the reorganizationprocess will take, we expect it to take at least 4 to 6 months from the FilingDate.  Under an order entered by theBankruptcy Court on September 11, 2007, the Debtors were given the optionto  file on or before November 19, 2007either a plan of reorganization or a motion to sell substantially all of itsassets. The Company has not yet selected its course of action but notes thateven if a motion to sell its assets is filed, the Debtors still have anexclusive right to subsequently file a plan of reorganization during its 120day exclusive period which, absent extension by the Bankruptcy Court, expireson or about January 3, 2008.

Our continuation as agoing concern is contingent upon, amongst other things, our ability (i) tocomply with the terms and conditions of the Debtor-In-Possession (“DIP”) CreditAgreement described below; (ii) to obtain confirmation of a plan ofreorganization under the Bankruptcy Code; (iii) to reduce administrative,warehouse and interest costs and liabilities through the bankruptcy process;(iv) to return to profitability; and (v) to generate sufficient cash flow fromoperations. These matters create uncertainty relating to our ability tocontinue as a going concern. The accompanying consolidated financial statementsdo not reflect any adjustments relating to the recoverability of assets andclassification of liabilities that might result from the outcome of theseuncertainties. In addition, a plan of reorganization could materially changethe amounts reported in our consolidated financial statements. Our consolidatedfinancial statements as of September 30, 2007 do not give effect to all theadjustments to the carrying value of assets and liabilities that may becomenecessary as a consequence of reorganization under Chapter 11.

Our bankruptcy filingtriggered the immediate acceleration of certain direct financial obligations,including, among others, an aggregate of $26,541,685 outstanding on the FilingDate, of secured and unsecured notes issued on December 31, 2004 and August 25,2005 (Note 5), February 10, 2006 (Note 6) and May 3, 2006 (Note 7). Suchamounts are characterized as secured debt for purposes of the reorganizationproceedings but no determination has yet been made as to whether the value ofthe secured assets is sufficient to cover the secured liabilities. The relatedobligations have been classified as liabilities subject to compromise in ourconsolidated balance sheet as of September 30, 2007.  In addition, the Chapter 11 filing forreorganization created an event of default under certain of our leaseagreements. The ability of our creditors to seek remedies to enforce theirrights under the agreements described above is automatically stayed as a resultof our bankruptcy filing and the creditors’ rights of enforcement are subjectto the applicable provisions of the Bankruptcy Code.

As required by SOP 90-7, *“Financial Reporting by Entities in ReorganizationUnder the Bankruptcy Code*”, we recorded the Debtors’ pre-petitiondebt instruments at the allowed claim amount, as defined by SOP 90-7. Accordingly,we accelerated the amortization of the related deferred debt issuance costs,the remaining discounts for the conversion feature and warrant and thediscounts for the detachable warrant which resulted in a pre-tax expense of$2,127,918 included in reorganization items in our consolidated statement ofoperations for the three and nine months ended September 30, 2007.

An official committee ofthe Debtors’ unsecured creditors has been appointed in the Bankruptcy Cases andaccording to the provisions of the Bankruptcy Code, will have the right to beheard on all matters that come before the Bankruptcy Court. The Debtors arerequired to bear certain of the committees’ fees, costs and expenses, includingthose of their counsel and financial advisors.

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While we continue ourreorganization under Chapter 11, investments in our securities will be highlyspeculative. Although shares of our common stock continue to trade on the Overthe Counter Bulletin Board under the symbol “IWTT.OB”, the trading prices ofthe shares may have little or no relationship to the actual recovery, if any,by the holders under any eventual disposition or outcome of the BankruptcyCases. The opportunity for any recovery by holders of our common stock underthe Bankruptcy Cases is uncertain and shares of our common stock may becancelled without any compensation pursuant to such plan.

Under the BankruptcyCode, the Debtors have the right to assume or reject executory contracts (i.e.,contracts that are to be performed by the contract parties after the FilingDate) and unexpired leases, subject to Bankruptcy Court approval and otherlimitations. In this context, “assuming” an executory contract or unexpiredlease generally means that the Debtor will agree to perform its obligations andcure certain existing defaults under the contract or lease and “rejecting” itmeans that the Debtor will be relieved of its obligations to perform furtherunder the contract or lease, which will give rise to an unsecured pre-petitionclaim for damages for the breach thereof. The Bankruptcy Court has authorizedthe Debtors to reject certain unexpired leases and executory contracts. As ofthe beginning of November 2007 the Company had not made any decisions on assumingor rejecting its leases and contracts.

On October 22, 2007, theDebtors filed their summary schedules of the assets and liabilities existing onthe Filing Date with the Bankruptcy Court. The Bankruptcy Court has set atentative general bar date of January 11, 2008 for non governmental agenciesand March 4, 2008 for governmental agencies. This is the date by which mostentities that assert a pre-petition claim against a Debtor must file a proof ofclaim in writing and in accordance with the order of the Bankruptcy Court.Differences between amounts recorded by the Debtors and claims filed by thecreditors will be investigated and resolved as part of the proceedings in theBankruptcy Cases. The ultimate number of allowed amounts of claims is notpresently known.

The Debtors have receivedapproval from the Bankruptcy Court to pay or otherwise honor certain of theirpre-petition obligations, subject to certain restrictions, including employeewages, salaries, certain benefits and other employee obligations.

We anticipate thatsubstantially all of the Debtors’ liabilities as of the Filing Date will beaddressed under, and treated in accordance with, a plan of reorganization to beproposed to and voted on by their creditors in accordance with the provisionsof the Bankruptcy Code. Although we intend to file and seek confirmation ofsuch a plan, there can be no assurance as to when the plan will be filed orthat the plan will be confirmed by the Bankruptcy Court and consummated. Norcan there be any assurance that we will be successful in achieving ourrestructuring goals, or that any measures that are achievable will result insufficient improvement to our financial position. Accordingly, until the timethat the Debtors emerge from bankruptcy, there will be no certainty about ourability to continue as a going concern. If a restructuring is not completed, wecould be forced to sell a significant portion of our assets to retire debtoutstanding or, under certain circumstances, to cease operations.

**Debtor-In-PossessionFinancing Agreement**

On September 11, 2007,the Bankruptcy Court approved a $3.6 million Senior Secured Super-PriorityDebtor-In-Possession Credit Agreement (DIP Credit Agreement). This DIP creditfacility provides funding to continue our operations without disruption bymeeting our obligations to suppliers, customers, employees, and to fundbankruptcy related costs including professional fees incurred during theChapter 11 reorganization process. See Note 5 for additional information.

**FinancialStatement Presentation**

Our consolidatedfinancial statements have been prepared in accordance with SOP 90-7, *“Financial Reporting by Entities in ReorganizationUnder the Bankruptcy Code*” and on a going-concern basis, whichcontemplates continuity of operations, realization of assets and liquidation ofliabilities in the ordinary course of business. However, as a result of ourbankruptcy filing, such realization of assets and liquidation of liabilitiesare subject to uncertainty. While operating as debtors in possession under theprotection of Chapter 11 of the Bankruptcy Code all or some of the Debtors maysell or otherwise dispose of assets and liquidate or settle liabilities foramounts other than those reflected in the consolidated financial statements,subject to Bankruptcy Court approval or otherwise as permitted in the ordinarycourse of business. Further, a plan of reorganization filed in its BankruptcyCases could 

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materially change theamounts and classifications of items reported in our historical consolidatedfinancial statements.

Substantially all of theDebtors’ pre-petition debt is now in default due to the bankruptcy filing. Asdescribed below, the accompanying consolidated financial statements present theDebtors’ pre-petition debt of $23,916,914 within Liabilities Subject toCompromise. In accordance with SOP 90-7, following the Filing Date, wediscontinued accruing interest expense that we were not required to pay underthe terms of or Debtor-In-Possession financing agreement on debt classified asLiabilities Subject to Compromise. Contractual interest on all debt, includingthe portion classified as Liabilities Subject to Compromise, amounted toapproximately $4.2 million for the nine months ended September 30, 2007. Asrequired by SOP 90-7, the amount of the Liabilities Subject to Compromiserepresents our estimate of known or potential pre-petition claims to beaddressed in connection with the Bankruptcy Cases. Such claims are subject tofuture adjustments. Adjustments may result from, among other things, normalongoing payments to the secured lenders under the terms of the DIP agreement,negotiations with creditors, rejection of executory contracts and unexpiredleases, and others of the Bankruptcy Court. Payment terms and amounts for theseclaims will be established in connection with the Bankruptcy Cases.

The liabilities subjectto compromise in the consolidated balance sheet consisted of the followingitems at September 6, 2007 and September 30, 2007:

| ** **                             | ** ** | **September 6,** | ** ** | **September 30,** | ** ** |
|----------------------------------------|------------|------------------|------------|-------------------|------------|
| ** **                             | ** ** | **2007**         | ** ** | **2007**          | ** ** |
|                                   |       |             |       |              |       |
| Accounts payable                       |       | $15,071,542      |       | $14,953,395       |       |
| Revolving Line  of Credit (Note 5)     |       | 18,275,018       |       | 15,723,748        |       |
| Revolving Note  Payable (Note 5)       |       | 5,000,000        |       | 5,000,000         |       |
| Convertible Debt  (Note 6)             |       | 1,266,667        |       | 1,193,166         |       |
| Term Note (Note  7)                    |       | 2,000,000        |       | 2,000,000         |       |
|                                   |       | 26,541,685       |       | 23,916,914        |       |
| Other                                  |       | —           |       | 1,079,410         |       |
| **Liabilities  Subject to Compromise** | ** ** | $41,613,227      |       | $39,949,719       |       |

 

Other includes accruedliabilities of $139,685 in interest, $131,359 in foreign currency ratefluctuations for transactions in accounts payable,  $690,442 for operating leases and $117,924 innotes and capital leases.

Professional advisoryfees and other costs directly associated with the reorganization are separatelyreported pursuant to SOP 90-7 as reorganization items. Professional feesinclude fees paid in connection with the DIP Credit Agreement, which wereexpensed in their entirety. Also included in reorganization items areprovisions and adjustments to reflect the carrying value of certainpre-petition liabilities at their estimated allowable claim amounts. The debtvaluation adjustments and the fees related to the DIP Credit Agreement areassociated with the initial phase of the reorganization and generally representone-time charges.

The reorganization itemsin the consolidated statement of operations for the three and nine months endedSeptember 30, 2007 consisted of the following items:

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| ** **                                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                              | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                              | ** ** | **2007**               | ** ** | **2007**              | ** ** |
| Debt valuation adjustments                              |       |                   |       |                  |       |
| Discounts on the fair value of conversion feature       |       | $                      | 712,786    |                  | $          | 712,786 |   |
| Discounts on the fair value of the warrants and options |       | 1,181,058              |       | 1,181,058             |       |
| Prepaid interest with common stock                      |       | 109,230                |       | 109,230               |       |
| Accured Interest                                        |       | (620,513               | )          | (620,513              | )          |
| Unamortized Loan Costs                                  |       | 124,844                |       | 124,844               |       |
|                                                    |       | 1,507,405              |       | 1,507,405             |       |
| Professional fees                                       |       | 190,221                |       | 190,221               |       |
|                                                    |       | $                      | 1,697,626  |                  | $          | 1,697,626 |   |

 

Management estimates that the Company couldemerge from bankruptcy protection during the 1st quarter of 2008,assuming a plan of reorganization is approved. Management believes that reorganization under bankruptcy protectioncombined with additional cost reductions could allow the Company to emerge frombankruptcy in early 2008 and be profitable in 2008.

 

The Company is working with a businesspartner on co-sponsoring a reorganization plan to be submitted to theBankruptcy Court and its creditors for approval.  Under an order entered by the BankruptcyCourt on September 11, 2007, the Debtors were given the option to  file on or before November 19, 2007 either aplan of reorganization or a motion to sell substantially all of its assets. TheCompany has not yet selected its course of action but notes that even if amotion to sell its assets is filed, the Debtors still have an exclusive rightto subsequently file a plan of reorganization during its 120 day exclusiveperiod which, absent extension by the Bankruptcy Court, expires on or aboutJanuary 3, 2008.  If an acceptablereorganization plan has not been agreed upon by November 19, 2007 then theCompany will continue to move forward with the “363” Sales Process(Section  363 of the Bankruptcy Code permits a company to sell all or partof its assets outside of the ordinary course of business. The Section furthergoverns treatment of lien holders and other claim or interest holders under asale, which sale is under the supervision of and subject to approval of theBankruptcy Court.). As required as part of its DIP Credit Agreement, theCompany also has engaged a management group to oversee the “363”Sale Process,which could mean a sale of the Company’s business. However, if the Company isunable to find funding for a reorganization plan or does not obtain a “363”Sales offer then the Company could be forced into Chapter 7 liquidation.

 

**NOTE 3                 INVENTORIES**

Inventories consisted of the following:

 

| ** **                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------|------------|-------------------|------------|------------------|------------|
| ** **                 | ** ** | **2007**          | ** ** | **2006**         | ** ** |
|                       |       |              |       |             |       |
| Tiles                      |       | $                 | 19,308,439 |             | $          | 30,033,507 |   |
| Inventory in transit       |       | 316,161           |       | 1,166,353        |       |
|                       |       | 19,624,600        |       | 31,199,860       |       |
| Allowance for obsolescence |       | 299,443           |       | 525,000          |       |
|                       |       | $                 | 19,325,157 |             | $          | 30,674,860 |   |

 

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

 

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

Property and equipment consisted of thefollowing:

 

| ** **                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                    | ** ** | **2007**          | ** ** | **2006**         | ** ** |
|                          |       |              |       |             |       |
| Furniture and fixtures        |       | $                 | 319,052    |             | $          | 318,128 |   |
| Machinery and equipment       |       | 1,193,623         |       | 1,154,913        |       |
| Vehicles                      |       | 256,580           |       | 321,572          |       |
| Office and computer equipment |       | 752,178           |       | 720,216          |       |
| Leasehold improvements        |       | 888,533           |       | 888,533          |       |
|                          |       | 3,409,966         |       | 3,403,362        |       |
| Less accumulated depreciation |       | 1,467,644         |       | 1,138,600        |       |
|                          |       | $                 | 1,942,322  |             | $          | 2,264,762 |   |

 

Depreciation expense for the three monthsended September 30, 2007 and 2006 was $117,500 and $99,700, respectively andfor the nine months ended September 30, 2007 and 2006 was approximately$357,400 and $308,600, respectively.

 

#### **NOTE 5                 NOTEPAYABLE, REVOLVING LINES OF CREDIT**

***Revolving Line of Credit***

 

On September 5, 2006, the Company amended andrestated the existing revolving line of credit agreement with its senior lenderproviding up to $26,500,000 of available borrowings with interest rates ofeither (1) LIBOR plus 3.00% or (2) the base rate plus 0.50% (interest ratesranging from 8.34375% to 8.375% at September 30, 2007) payable monthly.  The line of credit is limited by a borrowingbase which is comprised of a percentage of eligible accounts receivable andeligible inventories, as defined, and is collateralized by substantially allthe assets of the Company. The balance due at September 30, 2007 and December31, 2006 was $15,723,748 (excluding DIP Financing) and $24,370,278,respectively. At September 10, 2006 the Company was not in compliance with theminimum fixed charge coverage ratio and the minimum adjusted EBITDA covenantsand received a notice of default from its primary lender on October 25, 2006.On November 2, 2006, the primary lender and the Company entered into aforbearance agreement whereby the bank agreed to forbear the exercise of itsrights to demand payment until December 10, 2006, provided that the Company isnot in default of any of its other obligations and the Company engages amanagement consultant to provide a comprehensive business analysis of theCompany’s operations. The Company continues to operate under the November 2nd,2006 forbearance agreement. Effective June 9th, 2007, the Company entered intothe Eighth Amendment to the Amended and Restated Loan Agreement with its seniorcredit Facility, Bank of America, N.A.  The Eighth Amendment extended theterm of its $26.5 million line of credit to September 10, 2007 and containedmonthly minimum adjusted EBITDA covenant. The Company was not in compliance with its monthly EBITDA covenantduring the first nine months of 2007.

 

In November 2006, the Company entered into anunsecured revolving line of credit agreement for its newly created subsidiaryAmerican Gres, Inc., with its primary lender providing up to $95,000 ofavailable borrowings with an interest rate ranging from 11.24% to 24.76% atSeptember 30, 2007 payable monthly. The balance due at September 30, 2007 andDecember 31, 2006 was $77,160 and $30,100, respectively.

 

***Debtor-In-Possession Financing Agreement***

 

On September 11, 2007, the Company enteredinto a Ratification and Amendment Agreement with Bank of America, N.A. toprovide up to $3.6 million, plus and additional $1.0 contingency fund, inSenior Secured Super-priority Debtor-In-Possession (DIP) Credit Agreement. Theagreement matures on December 19, 2007.  TheDIP Credit Agreement, as amended, was approved by the Bankruptcy Court onOctober 3, 2007.

 

The facility provides funding to continue ouroperations without disruption and to meet our obligations to our suppliers,customers and employees during the Chapter 11 reorganization process. The Companyfurnished Bank of America, N.A. a thirteen week budget projecting sales, cashreceipts, inventory levels, operating cash disbursements, loan balance and loanavailability. The agreement requires weekly budget to actual reporting andcertification from the Company’s CFO that no Material Budget Deviation hasoccurred. The Company is required to stay within 105% 

 

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of the cumulative budget to actual operatingexpenses. On September 30, 2007 the Company was in compliance with the budgetto actual reporting and within the 105% cumulative budget to actual operatingexpense requirement.

 

***Revolving Note Payable***

 

On August 25, 2005, the Company issued asecured convertible revolving note in the aggregate amount of $5,000,000resulting in net proceeds of $4,733,000 after debt issuance costs of$267,000.  Interest accrued on theprincipal balance of the note at an annual interest rate equal to prime plus1.5%.  The note matures on August 25,2008.  The note was convertible intocommon stock of the Company at an initial conversion rate of $2.74 pershare.  Because the related loandocumentation contained certain non-standard anti-dilution provisions andrequirements to settle any conversion option with registered shares, theCompany was required to account for the conversion option as an embeddedderivative requiring separate accounting treatment in accordance with *SFAS No. 133 Accounting for Derivative Instruments and HedgingActivities*.  Based upon theclosing price per share of the Company’s common stock on the date of issuance,the Company estimated the fair value of the embedded conversion option andclassified $2,068,317 as a derivative liability that was adjusted to fair valueat each reporting date with changes in fair value reported in earnings.  In connection with the convertible notes, theCompany issued to the holder of the note a five-year warrant to purchase511,883 shares of the Company’s common stock at an exercise price of $3.15 pershare and an option to purchase 1,170,110 shares of the Company’s common stockat an exercise price of $0.001 per share. Based upon the closing price per share of the Company’s common stock onthe date of issuance, the Company estimated the fair value of the warrant andoption and classified $3,099,835 and $692,334, respectively, as derivativeliabilities that were adjusted to fair value at each reporting date withchanges in fair value reflected in operations. The fair values of the options,warrants, and embedded conversion option was estimated at the date of issuanceusing the Black-Scholes option-pricing model using the following weightedaverage assumptions: risk-free rate of 4.06%, dividend yields of 0%, andvolatility factors of the expected market price of the Company’s common stockof 60.79%.

 

On March 31, 2006, the parties entered intoan amendment to certain agreements, dated August 25, 2005. As a result of theAmendment, the Company is no longer required to make any modifications to thefixed conversion price, or issue additional securities in the event the Companyissues common stock at a price less than $2.74 per share

 

On July 21, 2006, the Company amended andrestated the secured revolving note dated August 25, 2005 removing allconversion features of the original note. In addition the interest rate wasmodified as follows: August 25, 2006 thru July 20, 2006, annual interest rateequal to prime plus 1.5%; July 21, 2006 thru August 25, 2008, annual interestrate equal to 8.5%.   A securedconvertible minimum borrowing note, dated August 25, 2005 was voided.  An amendment to the registration rightsagreement removed all references to the convertibility of the Secured RevolvingNote, removed all references to the secured convertible minimum borrowing noteand removed the provision for liquidating damages as a remedy in the event theCompany is unable to deliver registered shares. As a result, the provisions that required derivative liabilityclassification in accordance with *SFAS No. 133 — “Accountingfor Derivative Instruments and Hedging Activities:”*no longer exist*.*The holder of the note no longer has the right to convertany portion of principal or interest into common shares of the Company. Theregistration rights agreement was modified to remove all “uneconomical”provisions that previously resulted in the requirement to classify the warrantsand options to purchase common shares covered by the registration rightsagreement as derivative liabilities.  Asamended, the registration rights agreement does not preclude equityclassification of the warrants and options in accordance with EITF 00-19.

 

Therefore, the fair value of the embeddedderivative liability on July 21, 2006 in the amount of $1,646,269 waseliminated and the $1,345,640 relating to fair value of the options andwarrants on the date of modification was recorded as additional paid in capitaland the remaining $300,629, representing the fair value of the conversionfeature was credited to operations.

 

The note is secured by a lien onsubstantially all the assets of the Company, subject to a first priority lienof the Company’s primary financial lender.

 

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The holder of the note had agreed that itwill not convert the note, or exercise any warrant or option, into common stockin amounts that would cause the holder’s aggregate beneficial ownership of theCompany’s common stock to exceed 4.99%, without 120 days prior notice, or19.199%, without stockholder approval.

 

The balance of the note net of unamortized discountsas of September 30, 2007 and December 31, 2006 are as follows:

 

| ** **                                                                                                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                                               | ** ** | **2007**          | ** ** | **2006**         | ** ** |
|                                                                                                                     |       |              |       |             |       |
| Principal amount of notes                                                                                                |       | $                 | 5,000,000  |             | $          | 5,000,000 |   |
| Fair value - Conversion feature                                                                                          |       | (1,764,629        | )          | (1,764,629       | )          |
| Fair value - Warrants and options                                                                                        |       | (3,235,371        | )          | (3,235,371       | )          |
| Accretion of discount into interest expense                                                                              |       | 3,333,312         |       | 2,222,208        |       |
| Reorganization item - Debt valuation                                                                                     |       | 1,666,688         |       | —           |       |
| Balance, net of unamortized discounts (at September 30, 2007, balance  is included in Liabilities Subject to Compromise) |       | $                 | 5,000,000  |             | $          | 2,222,208 |   |

 

For the three months ended September 30, 2007and 2006, interest expense related to the revolving credit line amounted to$426,650 and $729,270, respectively. For the nine months ended September 30,2007 and 2006, interest expense related to the revolving credit line amountedto $1,436,435 and $1,641,333, respectively. On September 6, 2007 the accruedand unpaid default interest of $208,674 was credited to reorganization items asrequired by SOP 90-7 to revalue the debt instrument to the allowed claimamount.

 

Interest expense related to the securedrevolving note for the three months ended September 30, 2007 and 2006 amountedto $234,624 and $112,541, respectively. Interest expense related to the securedrevolving note for the nine months ended September 30, 2007 and 2006 amountedto $778,610 and $342,889, respectively. On September 6, 2007 the accrued andunpaid interest of $331,006 was credited to reorganization items as required bySOP 90-7 to revalue the debt instrument to the allowed claim amount.

 

Accretion of discounts for the conversionfeature and warrant related to the secured revolving note resulted in chargesto interest expense totaling $98,034 and $147,051 for the three months endedSeptember 30, 2007 and 2006, respectively. Accretion of discounts for theconversion feature and warrant related to the secured revolving note resultedin charges to interest expense totaling $392,136 and $441,153 for the ninemonths ended September 30, 2007 and 2006, respectively. On September 6, 2007the remaining unamortized discounts for the conversion feature and warrant of$588,221 were charged to reorganization items as required by SOP 90-7 torevalue the debt instrument to the allowed claim amount.

 

Accretion of discounts for the detachablewarrant related to the secured revolving note resulted in charges to interestexpense totaling $179,742 and $269,613 for three months ended September 30,2007 and 2006, respectively. Accretion of discounts for the detachable warrantrelated to the secured revolving note resulted to charges to interest expensetotaling $718,968 and $808,839 for nine months ended September 30, 2007 and2006, respectively. On September 6, 2007 the remaining unamortized discountsfor the detachable warrant of $1,078,467 was charged to reorganization items asrequired by SOP 90-7 to revalue the debt instrument to the allowed claimamount.

 

**NOTE 6                 NOTES PAYABLE—CONVERTIBLEDEBT**

 

On February 10, 2006, the Company issued asecured convertible term note in the amount of $2,000,000 resulting in netproceeds of $1,919,500.  Interest accrueson the principal balance of the note at an annual interest rate equal to primeplus 2.0%, payable monthly in arrears commencing on March 1, 2006.  On September 30, 2007, the interest rate was10.25%.  The note requires monthlyprincipal payments of $66,667 that commenced on August 1, 2006 and continuinguntil maturity.  The note matures onFebruary 10, 2009.    The note isconvertible into common stock of the Company at a fixed conversion rate of$2.17 per share.  Based upon the closingprice per share of the Company’s common stock on the date of issuance, therewas a beneficial conversion feature with an estimated intrinsic value of$553,593, which is presented as a discount on the note to be amortized intoexpense over the three year term of the loan using the effective interestmethod.  In connection with theconvertible note, the Company issued to the holder of the note a seven-yearwarrant to purchase 460,829 shares of the Company’s common stock at an exerciseprice of $2.39 per share.  The Companyestimated the fair value of the warrant and allocated $455,943 of the proceedsof the debt to the warrant which is presented as a discount on the note to beamortized into interest expense over the three-year term of the note using theeffective interest method. The aggregate discount allocated to the beneficialconversion feature and the options and warrants was recorded as additional paidin capital at the date of issuance. The fair value of 

 

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the warrant was estimated at the date ofissuance using the Black-Scholes option-pricing model using the followingassumptions: risk-free rate of 4.59%, dividend yields of 0%, and a volatilityfactor of the expected market price of the Company’s common stock of58.2%.  The Company also issued to theholder, 221,198 shares of the Company’s common stock as prepayment of interestin the amount of $486,636, which was calculated based upon the closing priceper share of the Company’s common stock on the date of issuance of $2.20 pershare. The prepaid interest is presented as a discount on the note to beamortized into interest expense over the three year term using the effectiveinterest method.

 

The note is secured by a lien onsubstantially all the assets of the Company, subject to a first priority lienof the Company’s primary financial lender. The holder of the note has agreed that it will not convert the note, orexercise any warrant or option, into common stock in amounts that would causethe holder’s aggregate beneficial ownership of the Company’s common stock toexceed 4.99%, without 120 days prior notice, or 19.199%, without stockholderapproval.

 

The balance of the note, net of unamortizeddiscounts as of September 30, 2007 and December 31, 2006 are as follows:

 

| ** **                                                                                                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                                               | ** ** | **2007**          | ** ** | **2006**         | ** ** |
|                                                                                                                     |       |              |       |             |       |
| Principal amount of notes                                                                                                |       | $                 | 1,193,166  |             | $          | 1,666,667 |   |
| Fair value - Conversion feature                                                                                          |       | (553,593          | )          | (553,593         | )          |
| Fair value - Warrants                                                                                                    |       | (942,579          | )          | (942,579         | )          |
| Accretion of discount to interest expense                                                                                |       | 1,159,786         |       | 754,764          |       |
| Reorganization item - Debt valuation                                                                                     |       | 336,386           |       | —           |       |
|                                                                                                                     |       |              |       |             |       |
| Balance, net of unamortized discounts (at September 30, 2007, balance  is included in Liabilities Subject to Compromise) |       | $                 | 1,193,166  |             | $          | 925,259 |   |
| Current                                                                                                                  |       | —            |       | 800,007          |       |
| Non-current                                                                                                              |       | —            |       | 125,252          |       |
|                                                                                                                     |       | $                 | —     |             | $          | 925,259 |   |

 

Interest expense related to the note for thethree months ended September 30, 2007 and 2006 was $30,981 and $70,673,respectively. Interest expense related to the note for the nine months endedSeptember 30, 2007 and 2006 was $132,182 and $181,886, respectively.  On September 6, 2007 the unamortized non cashinterest of $109,230 was charged to reorganization items as required by SOP90-7 to revalue the debt instrument to the allowed claim amount.

 

Accretion of discounts for the beneficialconversion feature and warrant resulted in charges to interest expense totaling$32,630 and $80,266 for the three months ended September 30, 2007 and 2006,respectively. Accretion of discounts for the beneficial conversion feature andwarrant resulted in charges to interest expense totaling $149,616 and $207,476for the nine months ended September 30, 2007 and 2006, respectively. OnSeptember 6, 2007 the remaining unamortized discounts for the conversionfeature and warrant of $124,565 was charged to reorganization items as requiredby SOP 90-7 to revalue the debt instrument to the allowed claim amount.

 

Accretion of discounts for the detachablewarrant resulted to charges to interest expense totaling $26,874 and $66,108for the three months ended September 30, 2007 and 2006, respectively. Accretionof discounts for the detachable warrant resulted to charges to interest expensetotaling $123,224 and $170,881 for the nine months ended September 30, 2007 and2006, respectively. On September 6, 2007 the remaining unamortized discountsfor the detachable warrant of $102,591 was charged to reorganization items asrequired by SOP 90-7 to revalue the debt instrument to the allowed claimamount.

 

**NOTE 7                 NOTESPAYABLE—OTHER**

On May 3, 2006, the Company issued a securedterm note in the amount of $2,000,000 resulting in net proceeds of$1,924,500.  Interest accrues on theprincipal balance of the note at an annual interest rate equal to 15%, payablemonthly in arrears commencing on June 1, 2006. The note matured on May 3, 2007and has been extended to June 3, 2007. In connection with the term note, the Company issued to the holder ofthe note a seven-year warrant to purchase 

 

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333,333 shares of the Company’s common stockat an exercise price of $1.12 per share. The Company estimated the fair value of the warrant and allocated$222,809 of the proceeds of the debt to the warrant, which is presented as adiscount on the note to be amortized into expense over the one-year term of thenote.  The fair value of the warrant wasestimated at the date of issuance using the Black-Scholes option-pricing modelusing the following assumptions: risk-free rate of 5.06%, dividend yields of0%, and a volatility factor of the expected market price of the Company’scommon stock of 59.18%.

 

The note is secured by a lien onsubstantially all the assets of the Company, subject to a first priority lienof the Company’s primary financial lender.

 

The holder of the note has agreed that itwill not convert the note, or exercise any warrant or option, into common stockin amounts that would cause the holder’s aggregate beneficial ownership of theCompany’s common stock to exceed 4.99%, without 120 days prior notice, or19.199%, without stockholder approval.

 

The balance of the note as of September 30,2007 and December 31, 2006, net of unamortized discounts is a follows:

 

| ** **                                                                                                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                                               | ** ** | **2007**          | ** ** | **2006**         | ** ** |
|                                                                                                                     |       |              |       |             |       |
| Principal amount of notes                                                                                                |       | $                 | 2,000,000  |             | $          | 2,000,000 |   |
| Fair value - Warrants                                                                                                    |       | (222,809          | )          | (222,809         | )          |
| Accretion of discount into interest expense                                                                              |       | 222,809           |       | 148,536          |       |
| Balance, net of unamortized discounts (at September 30, 2007, balance  is included in Liabilities Subject to Compromise) |       | $                 | 2,000,000  |             | $          | 1,925,727 |   |

 

Interest expense related to the note amountedto $55,833 and $76,666 for the three months ended September 30, 2007 and 2006,respectively. Interest expense related to the note amounted to $206,666 and$124,999 for the nine months ended September 30, 2007 and 2006, respectively.On September 6, 2007 the accrued and unpaid interest of $80,833 was credited toreorganization items as required by SOP 90-7 to revalue the debt instrument tothe allowed claim amount.

 

Accretion of discounts for the detachablewarrant resulted in charges to interest expense totaling $0 and $37,134 for thethree months ended September 30, 2007 and 2006, respectively. Accretion ofdiscounts for the detachable warrant resulted in charges to interest expensetotaling $74,273 and $92,835 for the nine months ended September 30, 2007 and2006, respectively.

 

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

**Common Stock**

 

During the nine months ended September 30,2007, the Company issued 256,967 shares of common stock to several employeesand consultants under the Stock Incentive Plan for services rendered, based onthe closing stock price at the date of issuance, for a total of $441,909, resultingin an equivalent charge to operations.

 

On March 28, 2007, the Company signed a $2.0million media campaign agreement with a third party consultant. Over a threeyear period the Company is to receive $5.0 million of advertising, eventplanning and sponsorship, convention support and other marketing supportservices at this third party’s “rate card rates”. In return the Company issuedone (1) million shares of its common stock (875,000 restricted shares issued toGlobal Media Funds and 125,000 unrestricted shares issued to an individualassociated with Global Media Funds). The agreement has a default provisionwhich could require the third party to return shares under certain conditionsthus requiring the shares to be accounted for as if they had not been issued.Recognition of the shares will occur as services are rendered, at which pointthe Company will recognize advertising expense and the corresponding capitalbased on the fair market value of the Company’s stock on the date the servicesare rendered. The one (1) million shares issued are not included on theCompany’s balance sheet or basic EPS (are included in diluted EPS to the extentthey are not anti-dilutive) until the services have been rendered andrecognized in the Company’s financial statements. During the three and ninemonths ended September 30, 2007 no shares were recognized.

 

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On April 9, 2007, the Company entered into anagreement with Mercatus & Partners, Limited, and issued 1,818,182 shares toan affiliate of Mercatus at a price to be determined at a later date. The fundswere to be delivered within 45 days of issuance otherwise the Company mayrecall the shares and terminate the agreement at its discretion after the 45days. At September 30, 2007 the Company has not received the purchase priceunder the agreement however has extended the payment date. The shares issuedare not included on the Company’s balance sheet or basic EPS (are included indiluted EPS to the extent they are not anti-dilutive) until the payment isreceived and recognized in the Company’s financial statements. As discussed inthe Note 11, the 1,818,182 shares were recalled on October 30, 2007.

 

**Treasury Stock**

 

On June 26, 2006, the Company’s board ofdirectors authorized an employee stock purchase program whereby the Companywould purchase up to 150,000 shares of IWT Tesoro’s stock for resale toemployees participating in the program. During the nine months ended September30, 2007, the Company purchased 4,479 shares of IWT Tesoro common stock for atotal cost of $9,933, at fair market value in the open market. On March 17,2007 the Company’s board of directors terminated the employee stock purchaseplan and the 10,584 shares will be retired.

 

#### **NOTE 9                 INCOMETAXES**

At September 30, 2007, the Company had netoperating loss carry forwards for federal income tax purposes of approximately$15,800,000 which are available to offset future federal taxable income through2027.

 

**NOTE 10               STOCK-BASED COMPENSATION**

On January 10, 2007, the Company granted tonon-employee members of the Board of Directors, an aggregate of 50,000 optionsto purchase shares of its common stock with an exercise price equal to the fairmarket value of the Company’s stock at the close of trading on January 10,2007. These options have a contractual life of ten years and vest 50%immediately and 50% one year after the date of grant.

 

The fair value of each option awarded isestimated on the date of grant using a Black-Scholes option-pricing model.Expected volatilities are based on historical volatility of the Company’s stockand historical volatility of the stock of similar companies, and other factors.The Company uses historical data to estimate option exercises and employeeterminations within the valuation model. The expected life of options grantedrepresents the period of time that options granted are expected to beoutstanding. The risk-free rate for periods within the life of the option isbased on the U.S. Treasury yield curve in effect at the time of grant.

 

The following assumptions were used tocalculate the Company’s options on the date of grant during the nine monthsended September 30, 2007 and 2006, respectively:

 

| ** **                             | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------|------------|-------------------------------------|------------|
| ** **                             | ** ** | **2007**                            | ** ** | **2006** | ** ** |
| Dividend yield                         |       | 0                                   | %          | 0 | % |
| Expected volatility                    |       | 72.2                                | %          | 58.8 | % |
| Risk-free interest rate                |       | 4.7                                 | %          | 4.4 | % |
| Expected life of options (in years)    |       | 5.5                                 |       | 5.5 |   |
| Weighted-average grant-date fair value |       | $                                   | 1.31       |   | $ | 1.42 |   |
|                                        |            |                                     |            |  |  |  |  |

 

During the three month periods endedSeptember 30, 2007 and 2006, the Company recognized additional compensationcosts of $31,254 and $28,286, respectively. During the nine month period endedSeptember 30, 2007 and 2006, the Company recognized additional compensationcosts of $86,960 and $88,438, respectively.

 

As of September 30, 2007, there was $120,707of unrecognized compensation cost related to share-based payments which isexpected to be recognized over a weighted-average period of .92 years.

 

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As of September 30, 2007 there were 806,082shares granted and 652,249 shares outstanding.

 

Shares available for future stock optiongrants to employees and directors under the existing plan were 3,193,918 and3,243,918, respectively, at September 30, 2007 and 2006.  The aggregate intrinsic value of sharesoutstanding as of September 30, 2007 and 2006 were $1,160,711 and $1,095,211,respectively. The aggregate intrinsic value of options exercisable as ofSeptember 30, 2007 and 2006 were $977,392 and $863,005, respectively.

 

#### **NOTE 11              ****SUBSEQUENTEVENT**

On August 3, 2007 the Company notifiedMercatus & Partners Limited that the shares were recalled for failure toremit the purchase price within 45 days as required under the agreement. OnOctober 30, 2007 the Company received notification from its transfer agent thatthe 1,818,182 shares issued on April 9, 2007 to an affiliate of Mercatus &Partners Limited were voided.

 

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

The consolidatedfinancial statements include IWT Tesoro Corporation and its wholly-ownedsubsidiaries (collectively the “Company”).

IWT TesoroCorporation was incorporated in the state of Nevada on May 3, 2000.  On October 1, 2002, IWT Tesoro Corporationacquired 100% of the outstanding stock of International Wholesale Tile, Inc.(IWT) in exchange for 83% of its outstanding common stock in a transactionaccounted for as a recapitalization of IWT. A total of 9,000,000 shares ofcommon stock were issued for the acquisition. For accounting purposes, theacquisition has been treated as a capital transaction and as a recapitalizationof International Wholesale Tile, Inc. The financial statements became those ofInternational Wholesale Tile, Inc., with adjustments to reflect the changes inequity structure.

InternationalWholesale Tile, Inc. is principally a value added reseller of ceramic floor andwall covering products (primarily ceramic, porcelain and stone tile) to the newconstruction and remodeling industries for commercial and residentialmarketplaces. In addition to IWT, Tesoro’s primary operating subsidiary,Tesoro, has five additional wholly-owned subsidiaries. The Tile Club, Inc.,formed in 2004, organized to acquire licensing, manufacturing and distributionrights; Tesoro Direct, Inc., formally known as Import Flooring Group, Inc. awholly-owned subsidiary of The Tile Club formed in 2005 to develop an agency business;and American Gres, Inc. formed in November 2006, organized to produce domesticceramic tile.  The remaining two, IWTTesoro Transport, Inc. and IWT Tesoro International, LTD., a Bermudacorporation are inactive.  

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

**REORGANIZATIONUNDER CHAPTER 11 OF THE US BANKRUPTCY CODE**

On September 6,2007 (Filing Date), IWT Tesoro Corporation and two of its wholly-owned domesticsubsidiaries, International Wholesale Tile, Inc. and American Gres, Inc., filedvoluntary petitions for reorganization under the Bankruptcy Code in the UnitedStates Bankruptcy Court in the Southern District of New York (the BankruptcyCourt) under lead case no. 07-12841. These Chapter 11 cases are collectivelyreferred to as the “Bankruptcy Cases.”

Tesoro Direct,Inc., a wholly-owned subsidiary of IWT Tesoro Corporation did not file avoluntary petition for reorganization however its assets and liabilities wereincluded in the Schedules of Assets and Liabilities filed by InternationalWholesale Tile, Inc.

IWT TesoroTransport, Inc. and The Tile Club. Inc., wholly-owned domestic subsidiaries andIWT Tesoro International, LTD a wholly-owned foreign subsidiary of IWT TesoroCorporation did not file a voluntary petition for reorganization because theirtotal assets equaled less than .04% of the Company’s total consolidated assets.In addition these entities had no liabilities. However they are represented inthe Consolidated Financial Statements. 

IWT TesoroCorporation and all of its subsidiaries are collectively the Debtors.

The BankruptcyCases are being jointly administered, with the Debtors managing theirbusinesses in the ordinary course as debtors in possession subject to thesupervision of the Bankruptcy Court. The Debtors intend to continue, normalbusiness operations during the Bankruptcy Cases while they evaluate theirbusinesses both from a financial and an operational perspective.  Management is working with several financialpartners to cosponsor a plan to reorganize and refinance the Debtors.  While we cannot predict with precision how longthe reorganization process will take, we expect it to take at least 4 to 6months from the Filing Date.  Under anorder entered by the Bankruptcy Court on September 11, 2007, the Debtors weregiven the option to  file on or beforeNovember 19, 2007 either a plan of reorganization or a motion to sellsubstantially all of its assets. The Company has not yet selected its course ofaction but notes that even if a motion to sell its assets is filed, the Debtorsstill have an exclusive right to subsequently file a plan of reorganizationduring its 120 day exclusive period which, absent extension by the BankruptcyCourt, expires on or about January 3, 2008.

Our continuationas a going concern is contingent upon, amongst other things, our ability (i) tocomply with the terms and conditions of the Debtor-In-Possession (“DIP”) CreditAgreement described below; (ii) to obtain confirmation of a plan of 

 

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reorganizationunder the Bankruptcy Code; (iii) to reduce administrative, warehouse andinterest costs and liabilities through the bankruptcy process; (iv) to returnto profitability; (v) to generate sufficient cash flow from operations. Thesematters create uncertainty relating to our ability to continue as a goingconcern. The accompanying consolidated financial statements do not reflect anyadjustments relating to the recoverability of assets and classification ofliabilities that might result from the outcome of these uncertainties. Inaddition, a plan of reorganization could materially change the amounts reportedin our consolidated financial statements. Our consolidated financial statementsas of September 30, 2007 do not give effect to all the adjustments to thecarrying value of assets and liabilities that may become necessary as aconsequence of reorganization under Chapter 11.

Our bankruptcyfiling triggered the immediate acceleration of certain direct financialobligations, including, among others, an aggregate of $26,541,685 currentlyoutstanding at September 6, 2007 on secured and unsecured notes issued onDecember 31, 2004 and August 25, 2005 (Note 5), February 10, 2006 (Note 6) andMay 3, 2006 (Note 7). Such amounts are characterized as secured debt forpurposes of the reorganization proceedings but no determination has yet beenmade as to whether the value of the secured assets is sufficient to cover thesecured liabilities. The related obligations have been classified asliabilities subject to compromise in our consolidated balance sheet as ofSeptember 30, 2007.  In addition, theChapter 11 filing for reorganization created an event of default under certainof our lease agreements. The ability of our creditors to seek remedies toenforce their rights under the agreements described above is automaticallystayed as a result of our bankruptcy filing and the creditors’ rights ofenforcement are subject to the applicable provisions of the Bankruptcy Code.

As required by SOP90-7, *“Financial Reporting by Entities inReorganization Under the Bankruptcy Code*”, we recorded the Debtors’pre-petition debt instruments at the allowed claim amount, as defined by SOP90-7. Accordingly, we accelerated the amortization of the related deferred debtissuance costs, the remaining discounts for the conversion feature and warrantand the discounts for the detachable warrant which resulted in a pre-taxexpense of $2,127,919 included in reorganization items in our consolidatedstatement of operations for the three and nine months ended September 30, 2007.

An officialcommittee of the Debtors’ unsecured creditors has been appointed in theBankruptcy Cases and according to the provisions of the Bankruptcy Code, willhave the right to be heard on all matters that come before the BankruptcyCourt. The Debtors are required to bear certain of the committees’ fees, costsand expenses, including those of their counsel and financial advisors.

While we continueour reorganization under Chapter 11, investments in our securities will behighly speculative. Although shares of our common stock continue to trade onthe Over the Counter Bulletin Board under the symbol “IWTT.OB”, the tradingprices of the shares may have little or no relationship to the actual recovery,if any, by the holders under any eventual disposition or outcome of the BankruptcyCases. The opportunity for any recovery by holders of our common stock underthe Bankruptcy Cases is uncertain and shares of our common stock may becancelled without any compensation pursuant to such plan.

Under theBankruptcy Code, the Debtors have the right to assume or reject execurtorycontracts (i.e., contracts that are to be performed by the contract partiesafter the Filing Date) and unexpired leases, subject to Bankruptcy Courtapproval and other limitations. In this context, “assuming” an executorycontract or unexpired lease generally means that the Debtor will agree toperform its obligations and cure certain existing defaults under the contractor lease and “rejecting” it means that the Debtor will be relieved of itsobligations to perform further under the contract or lease, which will giverise to an unsecured pre-petition claim for damages for the breach thereof. TheBankruptcy Court has authorized the Debtors to reject certain unexpired leasesand executory contracts. As of the beginning of November the Company had notmade any decisions on assuming or rejecting its leases and contracts.

On October 22,2007, the Debtors filed their summary schedules of the assets and liabilitiesexisting on the Filing Date with the Bankruptcy Court. The Bankruptcy Court hasset a tentative general bar date of January 11, 2008 for non governmentalagencies and March 4, 2008 for governmental agencies. This is the date by whichmost entities that assert a pre-petition claim against a Debtor must file aproof of claim in writing and in accordance with the order of the BankruptcyCourt. Differences between amounts recorded by the Debtors and claims filed bythe creditors will be investigated and resolved as part of the proceedings inthe Bankruptcy Cases. The ultimate number of allowed amounts of claims is notpresently known.

The Debtors havereceived approval from the Bankruptcy Court to pay or otherwise honor certainof their pre-petition obligations, subject to certain restrictions, includingemployee wages, salaries, certain benefits and other employee obligations.

 

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We anticipate thatsubstantially all of the Debtors’ liabilities as of the Filing Date will beaddressed under, and treated in accordance with, a plan of reorganization to beproposed to and voted on by their creditors in accordance with the provisionsof the Bankruptcy Code. Although we intend to file and seek confirmation ofsuch a plan, there can be no assurance as to when the plan will be filed orthat the plan will be confirmed by the Bankruptcy Court and consummated. Norcan there be any assurance that we will be successful in achieving ourrestructuring goals, or that any measures that are achievable will result insufficient improvement to our financial position. Accordingly, until the timethat the Debtors emerge from bankruptcy, there will be no certainty about ourability to continue as a going concern. If a restructuring is not completed, wecould be forced to sell a significant portion of our assets to retire debtoutstanding or, under certain circumstances, to cease operations.

**Debtor-In-PossessionFinancing Agreement**

On September 11,2007, the Bankruptcy Court approved a $3.6 million Senior SecuredSuper-Priority Debtor-In-Possession Credit Agreement (DIP Credit Agreement).This DIP credit facility provides funding to continue our operations withoutdisruption by meeting our obligations to suppliers, customers, employees, andto fund bankruptcy related costs including professional fees during the Chapter11 reorganization process. See Note 5 for additional information.

***IWTTesoro’s  Market***

Overall, the buildingmaterial and flooring market have slowed considerably in the last year as aresult of the declining new housing and remodeling markets in Florida and theSoutheast where the company is primarily located.  In addition the recent turmoil in thesub-prime mortgage markets is also negatively impacting the new housing andremodeling activity as a result of the inability of consumers to access fundsto pay for new houses or significant remodeling projects.   Although the Company continues to expectlong term above average growth in the housing and flooring tile market, theCompany cannot predict when or if the market will begin to improve.  

***BusinessStrategy***

The Company ispursuing several strategies to emerge from Bankruptcy protection.  The options range from restructuring thecurrent operating structure to a 363 sale of the business to a third party.  The Company believes that a key to anystrategy will be to continue the cost reduction program in order to help movethe Company back to being profitable. However, the Company makes no assurances that its strategies will besuccessful or be profitable, or if successful, that it’s profitably will beattained within its projected time frame.    

***Profitability***

The Company’s netloss for the three months ended September 30, 2007 is approximately $ 3.3million compared to a $1.4 million loss for the three months ended September30, 2006. The Company’s net loss for the nine months ended September 30, 2007is approximately $7.5 million versus a $0.1 million net loss for the ninemonths ended September 30, 2006. The 2007 results include $1.7 millionreorganization charges in the third quarter of 2007 related to theBankruptcy.  The 2006 results include a4.6 million gain from the change in the fair value of a derivativesecurity.   This follows net losses ofapproximately $3.4 million, $4.3 million and $1.2 million for the years endedDecember 31, 2006, 2005 and 2004, respectively.

Revenue in thethird quarter 2007 decreased 29% to $10.8 million from $15.2 million in the2006 third quarter. Revenue decreased 16.4% to $40.3 million for the ninemonths ended September 30, 2007 from $48.1 million for the nine months endedSeptember 30, 2006. The decrease in revenue is primarily the result of theslower housing market in Florida and the Southeast.  Some of the decline in sales is alsoattributable to the uncertainty created from the Company’s bankruptcy filing.  Also as a result of the Company’s difficultfinancial condition in the third quarter we were unable to secure enoughproducts from many key vendors and out-of-stock positions have occurred in anumber of key product lines in the last three months.  However, the DIP Credit Agreement securedprovided the ability to purchase product but it typically takes four to eightweeks to get the product from suppliers to the Company’s warehouses.   

Gross margin forthe three months ended September 30, 2007 was 37.9% of net sales compared to36.9 % for the three months ended September 30, 2006. Gross margin for the ninemonths ended September 30, 2007 remained consistent with the prior quarter at36.3% of net sales compared to 36.6% for the same nine months of 2006.  During the nine months ending September 30,2007 the Company has been able to offset the increased sales of its lowermargin discontinued products and 

 

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the decreasedsales of its lower margin truckload sales with continued sales of its highermargin lines.  However in the threemonths ended September 30, 2007 the Company had a decrease in both discontinuedproduct lines and truckload sales, which resulted in a significant increase inthe gross margin.

***Cost Reduction Program***

OnJune 18, 2007, the Company announced salary and cost reductions totaling $1.3million annually.  As of August 1, 2007these reductions were implemented.  TheCompany has identified an additional $1.2 million of potential cost reductionopportunities primarily associated with reducing the size of its presence insome of its locations. As a result of the $11.3 million reduction in inventoryin 2007, the Company has created excess space in its warehouses. It currentlyis negotiating with certain of its leasors to reduce its commitments to spaceand rent, particularly in Florida.  Thelease for its Ohio space ends as of December 31, 2007 and will not berenewed.  The warehouse space the Companyleases in California is based on the amount of space actually used and thus isself liquidating.  In addition, on July2, 2007, the Company implemented, a per day handling fee that is expected togenerate approximately $1 million annually to offset the increased warehousingand distribution costs.   The Company isalso looking at additional cost saving opportunities associated with itsBankruptcy filing.  The Company expectsthat the savings associated with these additional changes will not commenceuntil the first quarter of 2008. 

***Liquidity***

As a result of the recent decline in sales and bettermanagement of inventory ($11.3 million reduction during the first nine monthsof 2007) the Company generated $8.3 million of cash from operations in thefirst nine months of 2007 versus a $6.6 million use of cash from operations inthe nine months of 2006.  Inventory turnsfor the first nine months of 2007 (on an annualized basis) increased to 1.8times versus 1.3 for the twelve months ended December 31, 2006. 

As more fullydiscussed in Note 5, on September 11, 2007 the Company secured up to $3.6million, plus a $1.0 million contingency fund, of DIP financing from its seniorcredit lender, Bank of America. The additional funds will allow the Company tocontinue to operate on an on-going basis and secure out-of-stock material fromits vendors. 

***Conclusions***

Managementestimates that the Company could emerge from bankruptcy protection during the 1stquarter of 2008, assuming a plan of reorganization is approved.  Management believes that reorganization underbankruptcy protection combined with additional cost reductions could allow theCompany to emerge from bankruptcy in early 2008 and be profitable in 2008.  

The Company is workingwith a business partner on co-sponsoring a reorganization plan to be submittedto the Bankruptcy Court and its creditors for approval.  Under an order entered by the BankruptcyCourt on September 11, 2007, the Debtors were given the option to  file on or before November 19, 2007 either aplan of reorganization or a motion to sell substantially all of its assets. TheCompany has not yet selected its course of action but notes that even if amotion to sell its assets is filed, the Debtors still have an exclusive rightto subsequently file a plan of reorganization during its 120 day exclusiveperiod which, absent extension by the Bankruptcy Court, expires on or aboutJanuary 3, 2008.  If an acceptablereorganization plan has not been agreed upon by November 19, 2007 then theCompany will continue to move forward with the “363” Sales Process (Section 363 of the Bankruptcy Code permits a company to sell all or part of its assetsoutside of the ordinary course of business. The Section further governstreatment of lien holders and other claim or interest holders under a sale,which sale is under the supervision of and subject to approval of theBankruptcy Court.). As required as part of its DIP Credit Agreement, theCompany also has engaged a management group to oversee the “363”Sale Process,which could mean a sale of the Company’s business. However, if the Company isunable to find funding for a reorganization plan or does not obtain a “363”Sales offer then the Company could be forced into Chapter 7 liquidation. 

 

*Results of Operations for the three months ended September30, 2007, 2006 and 2005.*

The following discussionand analysis should be read in conjunction with the financial statements andnotes thereto that appear elsewhere in this document. The table below setsforth certain operating data for the periods indicated. Percentages are relative to total revenue for the periods indicated.

 

24

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| ** **               | ** ** | **Results of Operations for the**    | ** ** |
|--------------------------|------------|--------------------------------------|------------|
| ** **               | ** ** | **Three Months Ended September 30,** | ** ** |
|                     |       | **2007**                             | ** ** | **2006** | ** ** | **2005** |   |
|                     |       |                                 |       |   |   |   |   |
| Revenues                 |       | $                                    | 10,795,603 |   | $ | 15,173,449 |   | $ | 14,006,762 |   |
| Cost of Goods  Sold      |       | 6,699,621                            |       | 9,578,329 |   | 8,277,926 |   |
|                     |       |                                 |       |   |   |   |   |
| Gross Margin             |       | 4,095,982                            |       | 5,595,120 |   | 5,728,836 |   |
| Gross Margin  Percentage |       | 37.9                                 | %          | 36.9 | % | 40.9 | % |
| Operating Expenses       |       | $                                    | 4,538,298  |   | $ | 5,670,371 |   | $ | 5,816,085 |   |
|                     |       | 42.0                                 | %          | 37.4 | % | 41.5 | % |
| Loss from  operations    |       | (442,316                             | )          | (75,251 | ) | (87,249 | ) |

 

* *

*Quarterended September 30, 2007 Compared to Quarter September 30, 2006*

Net sales for the threemonths ended September 30, 2007 decreased approximately $4,377,800 or 28.9%over the reported net sales for the three months ended September 30, 2006.Management believes that the decline in sales for the three months endedSeptember 30, 2007 was due primarily to the slowing housing market throughoutthe United States and the uncertainty surrounding its Bankruptcy filing. 

Gross margin forthe three months ended September 30, 2007 was approximately $4,096,000 or 37.9%of net sales compared to $5,595,000 or 36.9% of net sales for the three monthsended September 30, 2006. The increase in gross margin is a result of limitedsales of discontinued lower margin product lines, truckload and home centersales.

Our operatingexpenses for the three months ended September 30, 2007 were approximately $4,538,300or 42.0% of net sales compared to $5,670,000 or 37.4% of net sales for thethree months ended September 30, 2006. The increase in our operating expenseratio for the three months ended September 30, 2007 compared to the threemonths ended September 30, 2006, was caused by fixed overhead costs that couldnot be reduced at a rate equal to the 29% decrease in sales.

*Results of Operations for the nine months ended September30, 2007, 2006 and 2005.*

The following discussion and analysis should be readin conjunction with the financial statements and notes thereto that appearelsewhere in this document. The table below sets forth certain operating datafor the periods indicated. Percentagesare relative to total revenue for the periods indicated.

 

| ** **                     | ** ** | **Results of Operations for the**   | ** ** |
|--------------------------------|------------|-------------------------------------|------------|
| ** **                     | ** ** | **Nine Months Ended September 30,** | ** ** |
| ** **                     | ** ** | **2007**                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                           |       |                                |       |   |   |   |   |
| Revenues                       |       | $                                   | 40,268,664 |   | $ | 48,145,483 |   | $ | 42,141,461 |   |
| Cost of Goods  Sold            |       | 25,693,656                          |       | 30,544,590 |   | 25,443,315 |   |
|                           |       |                                |       |   |   |   |   |
| Gross Margin                   |       | 14,575,008                          |       | 17,600,893 |   | 16,698,146 |   |
| Gross Margin  Percentage       |       | 36.2                                | %          | 36.6 | % | 39.6 | % |
| Operating Expenses             |       | $                                   | 16,266,803 |   | $ | 18,121,981 |   | $ | 16,113,525 |   |
|                           |       | 40.4                                | %          | 37.6 | % | 38.2 | % |
| Income (loss) from  operations |       | $                                   | (1,691,795 | ) | $ | (521,088 | )  | $ | 584,621 |   |
|                                |            |                                     |            |  |  |  |  |  |  |  |  |

 

*Ninemonths ended September 30, 2007 Compared to the nine months ended September 30,2006*

Net sales for the ninemonths ended September 30, 2007 decreased approximately $7,876,800 or 16.4%over the reported net sales for the nine months ended September 30, 2006.Management believes that the decline in sales for the nine months ended September30, 2007 was due primarily to the slowing housing market throughout the UnitedStates.

 

25

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Gross margin for the ninemonths ended September 30, 2007 was approximately $14,575,000 or 36.2% of netsales compared to $17,600,900 or 36.6% of net sales for the nine months endedSeptember 30, 2006. The slight decline in gross margin is a result ofaggressively reducing our inventory levels including the sale of discontinuedlower margin product lines during the first half of 2007.

Our operatingexpenses for the nine months ended September 30, 2007 were approximately $16,266,800or 40.4% of net sales compared to $18,122,000 or 37.6% of net sales for the ninemonths ended September 30, 2006. The increase in our operating expense ratiofor the nine months ended September 30, 2007 compared to the nine months ended September30, 2006, was caused by fixed overhead costs that could not be reduced at arate equal to the 16.4% decrease in sales.

**Changesin Financial Position for the nine months ended September 30, 2007 from theyear ended December 31, 2006**

Current assets atSeptember 30, 2007 are approximately $28.6 million compared to $41.0 million atDecember 31, 2006, a decrease of approximately $12.4 million. The net decreaseis primarily attributable to a decrease in inventory of approximately $11.3,million and a decrease in accounts receivable of approximately $1.3million.   The decrease in inventoryrelates to our continued efforts to improve our inventory turnover rate andutilization of resources.

Total liabilitiesat September 30, 2007 are approximately $42.7 million compared to $48.7 millionat December 31, 2006, a decrease of approximately $6.0 million. The decrease isattributable to a decrease in accounts payable of approximately $2.7 and adecrease in our revolving line of credit of approximately $7.2 million. As aresult of the bankruptcy filing liabilities of approximately $2.0 millionassociated with unamortized discounts related to the Laurus debt were chargedto Reorganization Items in the Statement of Operations during the three andnine months ended September 30, 2007. The net decreases are consistent with ourdecrease in inventory, improving the turnover rate and utilization ofresources.

 

# **Liquidity and Capital Resources**

We had cash balances of approximately $580,701 atSeptember 30, 2007 and $157,700 at December 31, 2006.

The cash providedby operations during the nine months ended September 30, 2007 wereapproximately $8.3 million compared to the cash used in operations of $6.6million for the nine months ended September, 30 2006. The $14.9 millionincreased inflow is primarily attributable to a decrease in inventory.

Net cash used ininvesting activities during the nine months ended September 30, 2007 wasapproximately $37,000 compared to $592,000 for the nine months ended September30, 2006. Capital expenditures in the nine months ended September 30, 2006 werehigher than normal due to the purchase of tile finishing equipment.

# Net cash used in financingactivities during the nine months ended September 30, 2007 was approximately$7.9 million compared to the net cash provided of $6.6 million during the ninemonths ended September 30, 2006. The approximate $14.5 million change infinancing activities is attributable to no new financing arrangements in thenine months ended September 30, 2007 as compared to a $4.0 million financialarrangement during the nine months ended September 30, 2006 along with paymentsof approximately $7.4 million to our commercial lender in 2007 versus $3.0million of additional draw in 2006 in the same time period of 2006. 

# **Critical Accounting Policies**

Our financialstatements are prepared in accordance with U.S. generally accepted accountingprinciples, which require us to make estimates and assumptions about futureevents and their impact on amounts reported in our Consolidated FinancialStatements and related Notes. Specifically, for the period ended September 30,2007, the Company prepared its consolidated financial statements in accordancewith SOP 90-7, *“Financial Reporting byEntities in Reorganization Under the Bankruptcy Code”* and on agoing-concern basis, which considers the financial evolution of the bankruptcyproceedings and the ongoing operations of the business. Since future events andtheir impact cannot be determined with certainty, and estimates requiresubjectivity, the actual results will inevitably differ from our estimates.These differences could be material to the financial statements.

 

26

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We believe thatour application of accounting policies, and the estimates that are inherentlyrequired by these policies, are reasonable. We believe that significantaccounting policies are described in Note 1 to the consolidated financialstatements included in the Company’s Annual Report on Form 10-K, for the yearended December 31, 2006 and the FIN 48 “*Accountingfor Uncertainty in Income Taxes*” policy adopted January 1, 2007, asdescribed in Note 1 herein, may involve a higher degree of judgment andcomplexity.

**Forward-LookingInformation**

Some statements made in this Quarterly Report on Form 10-Q, are “forward-lookingstatements” and are not historical facts. For example, statements regarding our financial position, businessstrategy and other plans and objectives for future operations, and assumptionsand predictions about future demand for our services and products, supply,costs, marketing and pricing factors are all forward-looking statements.When we use words like “intend,” “would”, “anticipate,” “believe,” “estimate,”“plan” or “expect” or the negative of these terms and similar expressions, weare making forward- looking statements. You should be aware that these forward-looking statements aresubject to risks and uncertainties. Additionally, our forward-looking statements speak only as of the dateof this report.  Other than as requiredby law, we undertake no obligation to update or revise these statements,whether as a result of new information, future events or otherwise.   New factors emerge from time to time thatmay cause our business not to develop as we expect, and it is not possible forus to predict all of them.  Factors thatmay cause our actual results, performance or achievements to be materiallydifferent from the results, performance or achievements expressed or implied bythe forward-looking statements include, among other things are changes inthe industry, energy costs, timing and level of capital expenditures andintroduction of new products.

 

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

**Quantitative and QualitativeDisclosures about Market Risk**

Information about theCompany’s exposure to market risk was disclosed in its Annual Report on Form10-K and Form 10-K/A for the year ended December 31, 2006, which was filed withthe Securities and Exchange Commission on April 2, 2007.  No material quantitative or qualitativechanges in market risk exposure have occurred since the date of that filing.

 

**ITEM 4—CONTROLS AND PROCEDURES**

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

Basedon that evaluation, Tesoro’s principal executive officer and principalfinancial officer have concluded that its disclosure controls and proceduresare 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 aresufficient 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.

The Company is in theprocess of preparing its compliance with Section 404 of Sarbanes-Oxley withrespect to its Internal Control Evaluation and Report requirements. The Companyhas been focusing on those aspects of its controls that are most salient andwhich it can undertake. Additionally it is focusing on controls that maintainthe integrity of its financial statements. Attached as Exhibits 31.1 and 31.2to this Quarterly Report are certifications of the CEO and the CFO, which arerequired in accordance with Rule 13a-14 of the Securities Exchange Act of1934 (the Exchange Act). This Controls and Procedures section includes theinformation concerning the controls evaluation referred to in thecertifications and it should be read in conjunction with the certifications.

 

27

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**PART II**

** **

**ITEM 1.                  LEGALPROCEEDINGS.**

 

We are not a party to anymaterial pending legal proceedings and, to the best of our knowledge, no suchaction by or against us are contemplated, threatened or expected.

** **

**ITEM 1/A.             RISKFACTORS**

 

The risk factors are substantiallythe same as those included in our Annual Report of Form 10-K and Form 10-K/A,filed with the Securities and Exchange Commission on April 2 and April 3, 2007,respectively.

** **

**ITEM 2.                  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OFPROCEEDS**

 

**Unregistered Sales.**

 

In connection with a $2.0million media campaign agreement with Global Media Fund (GMF), the Companyissued 875,000 shares of its restricted stock to GMF. The sale of thesesecurities were deemed to be exempt from registration under the Securities actin reliance on Section 4(2) of the Securities Act, or Regulation D promulgatedthereafter, as transactions by an issuer not involving a public offering. GMFrepresented its intention to acquire the securities for investment only and notwith a view for sale in connection with any distribution thereof andappropriate legends were affixed to the share certificates and instrumentsissued in such transactions. The issuance of these securities was made withoutgeneral solicitation or advertising. GMF is an accredited investor and hadadequate access, through their relationship with the Company, to information,including financial, about the Company. This transaction did not involve anyunderwriters, underwriting discounts or commissions. 

 

On April 9, 2007, theCompany entered into an agreement with Antares Trading Fund Mercatech SA andissued 1,818,182 shares at a price to be determined at a later date. The fundswere to be delivered within 45 days of issuance and the Company may recall theshares and terminate the agreement at its discretion after the 45 days. AtSeptember 30, 2007 the Company has not received the purchase price under theagreement however has extended the payment date. The shares issued are notincluded on the Company’s balance sheet or basic EPS (are included in dilutedEPS to the extent they are not anti-dilutive) until the payment is received andrecognized in the Company’s financial statements. Subsequent to the end of thequarter, Tesoro notified all parties that the certificate representing theshares is to be returned immediately to our transfer agent. On October 30,2007, the certificate representing the 1,818,182 shares were voided andcanceled.  

** **

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

 

OnOctober 25, 2006, IWT Tesoro Corporation and its subsidiaries received a letterfrom its senior credit facility, Bank of America, N.A. stating that certainevents of default had occurred and are continuing under its credit facilityagreements including that the Company did not attain its minimum EBITDA for themonths ended August 2006 and September 2006, nor did the Company reach itsminimum fixed charge coverage ratio for the period ended September 30, 2006. OnNovember 2, 2006 the Company and Bank of America executed a forbearance agreement,whereby the Bank agreed to forbear the exercise of its rights to December 10,2006 provided (i) that the Company is not in default of any of its otherobligations, and (ii) the Company engages a management consultant to provide acomprehensive business analysis of the Company’s operations.  Effective June 9, 2007, the Company enteredinto the Eighth Amendment to the Amended and Restated Loan Agreement with itssenior credit Facility, Bank of America, N.A.  The Eighth Amendmentextends the term of its $26.5 million line of credit to September 10, 2007 andcontains monthly minimum adjusted EBITDA covenant. The Company was not incompliance with its monthly EBITDA covenant during the nine months endedSeptember 30, 2007.

 

**ITEM 4.                  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.**

 

None

 

**ITEM 5.                  OTHER INFORMATION**

 

None

28

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**ITEM 6:                 EXHIBITS**

 

                (a)           **Exhibits**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                             |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Articles of Incorporation (filed as an  Exhibit to the Company’s Form 10-SB, filed with the Securities and  Exchange Commission on August 7, 2000)                                                                                                                                                                                                                      |
| 3.1.1               |       | Articles of Amendment to Articles of Incorporation  dated September 23, 2002 (filed as an Exhibit to the Company’s  Report on Form 8-K, filed with the Securities and Exchange Commission on  October 1, 2002)                                                                                                                                                     |
| 3.2.2               |       | Amended and Restated Bylaws (filed as an  Exhibit to the Company’s Report on Form 8-K, filed with the  Securities and Exchange Commission on February 4, 2003)                                                                                                                                                                                                          |
| 3.3.2               |       | Audit Committee Charter (filed as an Exhibit to  the Company’s Report on Form 8-K, filed with the Securities and Exchange  Commission on February 4, 2003)                                                                                                                                                                                                              |
| 3.3.3               |       | Compensation Committee Charter (filed as an  Exhibit to the Company’s Report on Form 8-K, filed with the  Securities and Exchange Commission on February 4, 2003)                                                                                                                                                                                                       |
| 3.3.4               |       | Nominating And Governing Committee Charter (filed as  an Exhibit to the Company’s Report on Form 8-K, filed with the  Securities and Exchange Commission on February 4, 2003)                                                                                                                                                                                           |
| 3.4.1               |       | Code of Ethics for Senior Financial Officers (filed  as an Exhibit to the Company’s Registration Statement, filed with the  Securities and Exchange Commission on April 11, 2003)                                                                                                                                                                                            |
| 4.1.1               |       | Form of Warrant Agreement (filed as an  Exhibit to the Company’s Registration Statement, filed with the  Securities and Exchange Commission on April 11, 2003)                                                                                                                                                                                                          |
| 4.1.2               |       | Form of Stock Certificate (filed as an  Exhibit to the Company’s Registration Statement, filed with the  Securities and Exchange Commission on April 11, 2003)                                                                                                                                                                                                          |
| 10.3                |       | 2001 Ponca Acquisition Corporation Stock Incentive  Plan. (filed as an Exhibit to the Company’s Report on Form 8-K,  filed with the Securities and Exchange Commission on September 11, 2002)                                                                                                                                                                           |
| 10.4                |       | Employment Agreement Between Ponca Acquisition  Corporation And Henry Jr. Boucher, Jr. Dated As Of December 29,  2002 (filed as an Exhibit to the Company’s Report on Form 8-K,  filed with the Securities and Exchange Commission on September 11, 2002)                                                                                                     |
| 10.5                |       | Memorandum Of Understanding Between Ponca  Acquisition Corporation And The Stockholders Of International Wholesale  Tile, Inc. (filed as an Exhibit to the Company’s Report on  Form 8-K, filed with the Securities and Exchange Commission on  September 11, 2002)                                                                                                |
| 10.6                |       | Stock Purchase Agreement Among The Stockholders Of  International Wholesale Tile, Inc., and Ponca Acquisition Corporation  effective October 1, 2002 (filed as an Exhibit on Form 8-K,  filed with the Securities and Exhibit Commission on October 15,  2002).                                                                                               |
| 10.9                |       | Form of Indemnity Agreement (filed as an  Exhibit to the Company’s Registration Statement, filed with the  Securities and Exchange Commission on April 11, 2003)                                                                                                                                                                                                        |
| 10.10               |       | Employment Agreement between International Wholesale  Tile, Inc. and David W. Whitwell (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 David W. Whitwell’s Employment Agreement with the  exception of the employee’s name and address)                                                                                                                           |
| 10.12               |       | Employment Agreement between International Wholesale  Tile, Inc. and Grey Perna (this document is omitted as it is  substantially similar to David W. Whitwell’s Employment Agreement with the  exception of the employee’s name and address)                                                                                                                                |
| 10.13               |       | Subordination Agreement between Congress Financial  Corporation (Florida). and David W. Whitwell (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 David W. Whitwell’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 David W. Whitwell’s Subordination Agreement with the  exception of the employee’s name and address)                                                                                                                        |
| 10.16               |       | Amended and Restated Loan and Security Agreement  between by and between Fleet Capital Corporation, IWT Tesoro Corporation and  International Wholesale Tile, Inc. effective December 31, 2004  (filed as an Exhibit to the Company Annual Report on Form 10-K,  filed with the Securities and Exchange Commission on April 15, 2005).                             |
| 10.17               |       | Form of Security Agreement dated as of  August 25, 2005, by and between IWT Tesoro Corporation and International  Wholesale Tile, Inc., on the one hand, and Laurus Master Fund Ltd., on  the other hand (without exhibits). (filed as an exhibit to the Company’s  Report on Form 8-K filed with the Securities and Exchange Commission on  August 25, 2005) |

 

 

29

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| 10.18 |   | Form of Secured Term Note, dated as of  August 25, 2005, by Tesoro and IWT in favor of Laurus Master Fund, Ltd.  (filed as an exhibit to the Company’s Report on Form 8-K filed with the  Securities and Exchange Commission on August 25, 2005)                                                                                                                            |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.19 |   | Form of Subsidiary Guaranty, dated as of  August 25, 2005, by the Tesoro’s subsidiaries in favor of Laurus Master  Fund (filed as an exhibit to the Company’s Report on Form 8-K filed with  the Securities and Exchange Commission on August 25, 2005)                                                                                                                |
| 10.20 |   | Form of Common Stock Purchase Warrant, by  Tesoro in favor of Laurus Master Fund., Ltd. dated August 25, 2005  (filed as an exhibit to the Company’s Report on Form 8-K filed with the  Securities and Exchange Commission on August 25, 2005)                                                                                                                              |
| 10.21 |   | Form of Funds Escrow Agreement dated August 25,  2005 (filed as an exhibit to the Company’s Report on Form 8-K filed with  the Securities and Exchange Commission on August 25, 2005)                                                                                                                                                                                       |
| 10.23 |   | Minimum Borrowing Note in favor of Laurus date  August 25, 2005 (filed as an exhibit to the Company registration  statement on Form S-1, filed with the Securities and Exchange Commission  on September 21, 2005)                                                                                                                                                                    |
| 10.24 |   | Option Agreement to Laurus dated August 25,  2005 (filed as an exhibit to the Company registration statement on  Form S-1, filed with the Securities and Exchange Commission on  September 21, 2005)                                                                                                                                                                                  |
| 10.26 |   | Form of Securities Purchase Agreement dated as  of February 10, 2006, between IWT Tesoro Corporation and Laurus Master  Fund Ltd. (without exhibits) (filed as an exhibit to the Company periodic  report on Form 8-K, filed with the Securities and Exchange Commission on  February 14, 2006).                                                                                 |
| 10.27 |   | Form of Secured Term Note dated as of  February 10, 2006, in favor of Laurus Master Fund Ltd. (filed as an  exhibit to the Company periodic report on Form 8-K, filed with the  Securities and Exchange Commission on February 14, 2006).                                                                                                                                        |
| 10.28 |   | Form of Common Stock Purchase Warrant, by  Tesoro in favor of Laurus Master Fund, Ltd., dated as of February 10,  2006, (filed as an exhibit to the Company periodic report on Form 8-K,  filed with the Securities and Exchange Commission on February 14, 2006).                                                                                                               |
| 10.29 |   | Form of Registration Rights Agreement dated as  of February 10, 2006, between IWT Tesoro Corporation and Laurus Master  Fund Ltd. (filed as an exhibit to the Company periodic report on  Form 8-K, filed with the Securities and Exchange Commission on  February 14, 2006).                                                                                                    |
| 10.30 |   | Ratification and Reaffirmation Agreement by IWT  Tesoro Corporation and each of its subsidiaries dated February 10, 2006,  (filed as an exhibit to the Company periodic report on Form 8-K, filed  with the Securities and Exchange Commission on February 14, 2006).                                                                                                                 |
| 10.31 |   | Form of Registration Rights Agreement dated as  of August 25, 2005, by and between IWT Tesoro Corporation one hand, and  Laurus Master Fund Ltd., as amended December 9, 2005, and as further  amended on April 15, 2006 (filed as an exhibit to the Company’s periodic  report on Form 8-K/A, filed with the Securities and Exchange Commission  on May 8, 2006) |
| 10.32 |   | Amended and Restated Registration Rights Agreement  dated May 3, 2006 between IWT Tesoro Corporation and Laurus Master  Funds, Ltd. (filed as an exhibit to the Company’s periodic report on  Form 8-K, filed with the Securities and Exchange Commission on  May 8, 2006).                                                                                                      |
| 10.33 |   | Form of Securities Purchase Agreement dated  May 3, 2006 between Tesoro and Laurus Master Fund dated May 3, 2006  (filed as an exhibit to the Company’s periodic report on Form 8-K, filed  with the Securities and Exchange Commission on May 9, 2006).                                                                                                               |
| 10.34 |   | Form of Common Stock Purchase Warrant by Tesoro  in favor of Laurus Master Funds., Ltd. (filed as an exhibit to the Company’s  periodic report on Form 8-K, filed with the Securities and Exchange  Commission on May 9, 2006).                                                                                                                                                  |
| 10.35 |   | Amended and Restated Registration Rights Agreement  dated May 3, 2006 between IWT Tesoro Corporation and Laurus Master  Funds, Ltd. (filed as an exhibit to the Company’s periodic report on  Form 8-K, filed with the Securities and Exchange Commission on  May 9, 2006).                                                                                                      |
| 10.36 |   | Reaffirmation and Ratification Agreement dated  May 3, 2006 by Tesoro and its subsidiaries (filed as an exhibit to the  Company’s periodic report on Form 8-K, filed with the Securities and  Exchange Commission on May 9, 2006).                                                                                                                                               |
| 10.37 |   | Second Amended and Restated Senior Subordination  Agreement between Laurus Master Fund, Ltd. and Bank of America, N.A dated  May 3, 2006 (filed as an exhibit to the Company’s periodic report on  Form 8-K, filed with the Securities and Exchange Commission on  May 9, 2006).                                                                                                 |
| 10.38 |   | Amendment dated as of March 31, 2006 to the August  25, 2006 $3.0 million Minimum Borrowing Note (filed as an exhibit to the  Company’s periodic filing on Form 8-K, filed with the Securities and Exchange  Commission on May 9, 2006)                                                                                                                                                         |
| 10.39 |   | Amended and Restated Securities Agreement effective  July 21, 2006 (filed as an exhibit to the Company’s periodic filing on Form  8-K, filed with the Securities and Exchange Commission on August 21, 2006).                                                                                                                                                                                   |
| 10.40 |   | Amended and Restated $5.0 million revolving note  effective August 25, 2005, as amended and restated from time to time (filed  as an exhibit to the Company’s periodic filing on Form 8-K, filed with the  Securities and Exchange Commission on August 21, 2006).                                                                                                                              |

 

 

30

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| 10.41 |   | Amended and Amended and Restated Registration Rights  Agreement dated July 21, 2006 (filed as an exhibit to the Company’s periodic  filing on Form 8-K, filed with the Securities and Exchange Commission on  August 21, 2006).                                              |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.42 |   | Fifth Amendment to the Amended and Restated Loan and  Security Agreement dated as of September 5, 2006 (filed as an exhibit to the  Company’s periodic filing on Form 8-K, filed with the Securities and Exchange  Commission on September 6, 2006).                         |
| 10.43 |   | Form of Amended and Restated Credit Note in the  principal amount $26.5 million dated as of September 5, 2006 (filed as an  exhibit to the Company’s periodic filing on Form 8-K, filed with the  Securities and Exchange Commission on September 5, 2006).                  |
| 10.44 |   | Form of Forbearance Agreement between Bank of  America and Tesoro, dated December 2, 2006 (filed as an exhibit to the  Company’s periodic filing on Form 8-K, filed with the Securities and Exchange  Commission on December 3, 2006).                                       |
| 10.45 |   | Form of Project Development and Management Agreement  dated November 20, 2006 (filed as an exhibit to the Company’s periodic filing  on Form 8-K, filed with the Securities and Exchange Commission on November  21, 2006).                                                  |
| 10.46 |   | Form of Amended and Restated Loan Agreement with  Bank of America and the Revolving Line of Credit, each dated December 10,  2006 filed as an exhibit to the Company’s periodic filing on Form 8-K, (filed  with the Securities and Exchange Commission on January 8, 2007). |
| 10.47 |   | Form of Employment Agreement between David W.  Whitwell and Tesoro dated January 2, 2007 (filed as an exhibit to the  Company’s periodic filing on Form 8-K, (filed with the Securities and  Exchange Commission on January 8, 2007).                                        |
| 10.48 |   | Form of Amended and Restated Loan Agreement with  Bank of America and the Revolving Line of Credit, each dated March 10, 2007  filed as an exhibit to the Company’s periodic filing on Form 8-K, (filed with  the Securities and Exchange Commission on March 12, 2007).     |
| 10.49 |   | Form of Securities Purchase Agreement with Global  Media Fund, Inc., dated March 26, 2007 (filed as an exhibit to the Company’s  periodic filing on Form 8-K, filed with the Securities and Exchange  Commission on April 4, 2007).                                          |
| 10.50 |   | Form of Proposal/Memorandum of Understanding with  Mercatus & Partners, Limited, dated April 9, 2007 (filed as an exhibit to  the Company’s periodic filing on Form 8-K, filed with the Securities and  Exchange Commission on April 12, 2007).                          |
| 10.51 |   | Form of Amended and Restated Loan Agreement with  Bank of America and the Revolving Line of Credit, each dated June 9, 2007  filed as an exhibit to the Company’s periodic filing on Form 8-K, (filed with  the Securities and Exchange Commission on June 8, 2007).         |
| 10.52 |   | Form of Term Sheet between IWT Tesoro Corporation  and KMA Capital Partners, Inc. dated August 15 2007 (Exhibits omitted) (filed  as an exhibit to the Company’s periodic filing on Form 8-K, filed with the  Securities and Exchange Commission on August 16, 2007)         |
| 10.53 |   | Form of letter to suppliers and freight vendors  discussing the effect of having filed Chapter 11 of the Bankruptcy Code  (filed as an exhibit to the Company’s periodic filing on Form 8-K, filed with  the Securities and Exchange Commission on September 11, 2007))      |
| 10.54 |   | Form of letter to employees discussing the effect of  having filed Chapter 11 of the Bankruptcy Code (filed as an exhibit to the  Company’s periodic filing on Form 8-K, filed with the Securities and Exchange  Commission on September 11, 2007))                          |
| 10.55 |   | Form of letter to customers discussing the effect of  having filed Chapter 11 of the Bankruptcy Code (filed as an exhibit to the Company’s  periodic filing on Form 8-K, filed with the Securities and Exchange  Commission on September 11, 2007))                          |
| 16    |   | Letter from Kantor Sewell & Oppenheimer,  P.A., concurring with statements concerning their resignation (filed as an  exhibit to the Company Report on Form 8-K filed with the Securities and  Exchange Commission on September 14, 2004).                     |
| 21    |   | Subsidiaries of Registrant (filed as an  Exhibit to the Company registration statement on Form S-1, filed  with the Securities and Exchange Commission on September 21, 2005                                                                                       |
| 31.1  |   | Certification of Henry J. Boucher, Jr., Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act.*                                                                                                                                                    |
| 31.2  |   | Certification of David W. Whitwell, 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 David W. Whitwell, Chief Financial  Officer pursuant to Section 906 of the Sarbanes-Oxley Act.*                                                                                                                                                             |

 

 

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*                 Included in this filing. Exhibits are availablewithout charge, upon request of IWT Tesoro.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|              | IWT TESORO CORPORATION                     |
|-------------------|--------------------------------------------|
|              |                                       |
|              |                                       |
| November 15, 2007 | /s/ Henry J. Boucher, Jr.                  |   |
|              | Henry J. Boucher, Jr., President           |
|              |                                       |
| November 15, 2007 | /s/ David W. Whitwell                      |   |
|              | David W. Whitwell, Chief Financial Officer |

 

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