** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

**FORM 10-Q**

 

**(Mark One)**
| **ý**                                             | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|--------------------------------------------------------|----------------------------------------------------------------------------------------------|
|                                                   |                                                                                         |
| **For the quarterly  period ended September 30, 2004** |
|                                                   |                                                                                         |
| **o**                                                  | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT**                         |
|                                                   |                                                                                         |
| **Commission  File No. 0-31267**                       |
|                                                   |                                                                                         |
| **IWT TESORO CORPORATION**                             |
| (Exact Name of Registrant in its Charter)              |

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

 

**101 Post RoadWest, Suite 10, Westport, CT  06880**

(Address of principal executive offices)

 

**(203) 221-2770**

(Issuer’s Telephone Number, including area code)

 

 

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

 

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

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

 

Check whether the issuer: (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filing requirementsfor the past 90 days:
|   | ýYes | oNo |
|--------|-----------|-----|

 

Indicate by check mark whether the registrant is an accelerated files (asdefined in Rule 12b-2 of the Exchange Act)  oYes    ýNo

 

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

 

TransitionalSmall Business Disclosure Format:   oYes    ýNo

 

 

----

PART 1

 

ITEM 1:     FINANCIALSTATEMENTS

 

**IWT TESORO CORPORATIONAND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

**(Unaudited)**

 

**ASSETS**

 
| ** **                          | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                          | ** ** | **(Unaudited)**         | ** ** | **Restated**           | ** ** |
| Current assets:                     |       |                    |       |                   |       |
| Cash                                |       | $                       | 563,543    |                   | $          | 867,361 |   |
| Accounts receivable,  net           |       | 7,231,416               |       | 4,907,705              |       |
| Inventory                           |       | 17,094,832              |       | 13,058,839             |       |
| Deferred tax  asset                 |       | —                  |       | 146,193                |       |
| Due from shareholder                |       | —                  |       | 550,000                |       |
| Prepaid expenses                    |       | 368,208                 |       | 754,289                |       |
| Exclusive agreement,  related party |       | 503,378                 |       | —                 |       |
| Total current  assets               |       | 25,761,377              |       | 20,284,387             |       |
|                                |       |                    |       |                   |       |
| Property and  equipment, net        |       | 5,530,049               |       | 4,217,268              |       |
|                                |       |                    |       |                   |       |
| Other assets:                       |       |                    |       |                   |       |
| Deferred financing  costs, net      |       | 64,666                  |       | 77,917                 |       |
| Deposits                            |       | 189,345                 |       | 59,609                 |       |
| Other receivables                   |       | 91,185                  |       | 69,370                 |       |
| Deferred tax  asset                 |       | 163,781                 |       | 101,205                |       |
| Other assets                        |       | 305,653                 |       | 175,203                |       |
| Total assets                        |       | 814,630                 |       | 483,304                |       |
|                                |       |                    |       |                   |       |
|                                |       | $                       | 32,106,056 |                   | $          | 24,984,959 |   |

 

See notes to the consolidatedinterim financial statements.

 

2

----

 

**IWT TESORO CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 

**(Unaudited)**

**LIABILITIES AND STOCKHOLDERS’ EQUITY**

 
| ** **                                                                                                        | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                        | ** ** | **(Unaudited)**         | ** ** | **Restated**           | ** ** |
|                                                                                                              |       |                    |       |                   |       |
| Current liabilities:                                                                                              |       |                    |       |                   |       |
| Accounts payable                                                                                                  |       | $                       | 11,914,458 |                   | $          | 9,859,161 |   |
| Accrued expenses                                                                                                  |       | 283,818                 |       | 137,292                |       |
| Deferred tax  liability                                                                                           |       | 32,106                  |       | —                 |       |
| Current portion  of lease payable                                                                                 |       | 75,800                  |       | 63,151                 |       |
| Current portion  of notes payable                                                                                 |       | 23,526                  |       | 42,719                 |       |
| Total current  liabilities                                                                                        |       | 12,329,708              |       | 10,102,323             |       |
|                                                                                                              |       |                    |       |                   |       |
| Long term lease  payable                                                                                          |       | 155,067                 |       | 149,183                |       |
| Long term notes  payable - related parties                                                                        |       | 338,662                 |       | 338,662                |       |
| Long term notes  payable                                                                                          |       | 49,953                  |       | 42,560                 |       |
| Long term loan  payable                                                                                           |       | 14,329,695              |       | 9,599,340              |       |
| Deferred tax  liability                                                                                           |       | —                  |       | 148,594                |       |
| Total liabilities                                                                                                 |       | 27,203,085              |       | 20,380,662             |       |
|                                                                                                              |       |                    |       |                   |       |
| Stockholders’  equity                                                                                        |       |                    |       |                   |       |
| Preferred stock,  $0.001 par value, 25,000,000 authorized; none issued                                            |       | —                  |       | —                 |       |
| Common stock,  $0.001 par value, 100 million shares authorized, 11,697,102 and 11,622,702 issued  and outstanding |       | 11,697                  |       | 11,623                 |       |
| Additional paid  in capital                                                                                       |       | 5,267,671               |       | 4,972,820              |       |
| Accumulated deficit                                                                                               |       | (376,397                | )          | (380,146               | )          |
|                                                                                                              |       | 4,902,971               |       | 4,604,297              |       |
|                                                                                                              |       |                    |       |                   |       |
|                                                                                                              |       | $                       | 32,106,056 |                   | $          | 24,984,959 |   |

 

See notes to the consolidated interimfinancial statements.

 

3

----

 

**IWT TESORO CORPORATIONAND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                                | ** ** | **For the period ended September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                | ** ** | **Three months ended**                 | ** ** | **Nine months ended** | ** ** |
| ** **                                                                | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                                   |       |                                   |       |   |   |   |   |   |   |
| Sales, net of  discounts and returns                                      |       | $                                      | 11,050,421 |   | $ | 8,969,586 |   | $ | 32,222,825 |   | $ | 24,209,576 |   |
| Cost of goods  sold                                                       |       | 6,733,909                              |       | 5,373,248 |   | 19,688,729 |   | 14,464,855 |   |
|                                                                      |       |                                   |       |   |   |   |   |   |   |
| Gross profit                                                              |       | 4,316,512                              |       | 3,596,338 |   | 12,534,096 |   | 9,744,721 |   |
|                                                                      |       |                                   |       |   |   |   |   |   |   |
| Expenses                                                                  |       |                                   |       |   |   |   |   |   |   |
| Depreciation  and amortization                                            |       | 256,760                                |       | 174,278 |   | 703,253 |   | 469,404 |   |
| Payroll and related  expenses                                             |       | 2,144,134                              |       | 1,490,911 |   | 5,488,277 |   | 3,922,674 |   |
| General and administrative                                                |       | 2,025,930                              |       | 1,661,887 |   | 6,009,331 |   | 4,100,701 |   |
|                                                                      |       | 4,426,824                              |       | 3,327,076 |   | 12,200,861 |   | 8,492,779 |   |
| Income (loss)  from operations                                            |       | (110,312                               | )          | 269,262 |   | 333,235 |   | 1,251,942 |   |
|                                                                      |       |                                   |       |   |   |   |   |   |   |
| Other income/(expenses)                                                   |       |                                   |       |   |   |   |   |   |   |
| Interest expense                                                          |       | (150,806                               | )          | (175,885 | ) | (412,183 | ) | (350,465 | ) |
| Other income                                                              |       | 19,548                                 |       | 727 |   | 28,291 |   | 2,302 |   |
| Other expense                                                             |       | —                                 |       | — |   | — |   | (5,723 | ) |
| Gain (loss) on  disposal                                                  |       | —                                 |       | — |   | 21,533 |   | (5,352 | ) |
|                                                                      |       | (131,258                               | )          | (175,158 | ) | (362,359 | ) | (359,238 | ) |
|                                                                      |       |                                   |       |   |   |   |   |   |   |
| Net income (loss)  before taxes                                           |       | (241,570                               | )          | 94,104 |   | (29,124 | ) | 892,704 |   |
|                                                                      |       |                                   |       |   |   |   |   |   |   |
| Income tax benefit  (expense)                                             |       | 68,473                                 |       | 11,314 |   | 32,873 |   | (43,790 | ) |
|                                                                      |       |                                   |       |   |   |   |   |   |   |
| Net income (loss)                                                         |       | $                                      | (173,097   | ) | $ | 105,418 |   | $ | 3,749 |   | $ | 848,914 |   |
|                                                                      |       |                                   |       |   |   |   |   |   |   |
| Earnings (loss)  per common share - basic                                 |       | $                                      | (0.01      | ) | $ | 0.01 |   | $ | 0.00 |   | $ | 0.08 |   |
|                                                                      |       |                                   |       |   |   |   |   |   |   |
| Weighted-average  common shares outstanding                               |       | 11,695,906                             |       | 11,216,961 |   | 11,672,754 |   | 11,167,720 |   |
|                                                                      |       |                                   |       |   |   |   |   |   |   |
| Earnings (loss)  per common share - diluted                               |       | $                                      | (0.01      | ) | $ | 0.01 |   | $ | 0.00 |   | $ | 0.07 |   |
|                                                                      |       |                                   |       |   |   |   |   |   |   |
| Weighted-average  common and dilutive potential common shares outstanding |       | *11,695,906                            |       | 11,560,143 |   | 11,733,087 |   | 11,510,902 |   |

 

----

*The effect of stock options and warrants have not been includedfor the three month period ended September 30, 2004, as their effect wouldhave been anti-dilutive

 

See notes to the consolidated interimfinancial statements.

 

4

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**IWT TESORO CORPORATIONAND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**

**(Unaudited)**

**NINE MONTHS ENDEDSEPTEMBER 30, 2004**

 
| ** **                                                           | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **  | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------|------------|------------------|------------|-------------|------------|-----------------|------------|-------------|------------|------------|------------|
| ** **                                                           | ** ** | **Common Stock** | ** ** | **Paid in** | ** ** | **Accumulated** | ** ** | ** **  | ** ** |
| ** **                                                           | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit** | ** ** | **Total**  | ** ** |
|                                                                 |       |             |       |        |       |            |       |        |       |       |       |
| Balance, January  1, 2004, as restated                               |       | 11,622,702       |       | $           | 11,623     |            | $          | 4,972,820   |       | $          | (380,146   | ) | $ | 4,604,297 |   |
|                                                                 |       |             |       |        |       |            |       |        |       |       |       |
| Exercise of warrants                                                 |       | 45,500           |       | 45          |       | 147,830         |       | —      |       | 147,875    |       |
|                                                                 |       |             |       |        |       |            |       |        |       |       |       |
| Issuance of shares  to consultant for services rendered              |       | 17,000           |       | 17          |       | 98,333          |       |        |       | 98,350     |       |
|                                                                 |       |             |       |        |       |            |       |        |       |       |       |
| Issuance of shares  to employees and directors for services rendered |       | 10,400           |       | 10          |       | 44,065          |       |        |       | 44,075     |       |
|                                                                 |       |             |       |        |       |            |       |        |       |       |       |
| Issuance of shares  to customers                                     |       | 1,500            |       | 2           |       | 4,623           |       |        |       | 4,625      |       |
|                                                                 |       |             |       |        |       |            |       |        |       |       |       |
| Net income, nine  months ended September 30, 2004                    |       |             |       |        |       |            |       | 3,749       |       | 3,749      |       |
|                                                                 |       |             |       |        |       |            |       |        |       |       |       |
| Balance, September  30, 2004                                         |       | 11,697,102       |       | $           | 11,697     |            | $          | 5,267,671   |       | $          | (376,397   | ) | $ | 4,902,971 |   |

 

See notes to the consolidated interimfinancial statements.

 

5

----

 

**IWT TESORO CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| Cash flows from  operating activities:                                             |       |                                |       |   |   |
| Net income                                                                         |       | $                                   | 3,729      |   | $ | 848,914 |   |
|                                                                               |       |                                |       |   |   |
| Adjustments to  reconcile net income to net cash used in operating activities      |       |                                |       |   |   |
| Depreciation  and amortization (including amortization of deferred financing fees) |       | 703,253                             |       | 469,404 |   |
| (Gain) loss on  disposal of property and equipment                                 |       | (21,533                             | )          | 5,352 |   |
| Benefit from  deferred income taxes                                                |       | (32,873                             | )          | — |   |
| Common stock  issued for services or promotions                                    |       | 147,050                             |       | — |   |
| Provision for  bad debt                                                            |       | 72,156                              |       | 173,851 |   |
| Other non-cash  items affecting earnings                                           |       | (15,976                             | )          | — |   |
| Changes in operating  assets and liabilities                                       |       |                                |       |   |   |
| Receivables                                                                        |       | (2,395,867                          | )          | (2,385,700 | ) |
| Inventories                                                                        |       | (4,035,993                          | )          | (6,112,344 | ) |
| Other assets  and prepaid expenses                                                 |       | (289,299                            | )          | (512,167 | ) |
| Accounts payable                                                                   |       | 2,055,297                           |       | 5,989,911 |   |
| Accrued expenses                                                                   |       | 146,525                             |       | 135,439 |   |
| Net cash used  in operating activities                                             |       | (3,663,531                          | )          | (1,387,340 | ) |
|                                                                               |       |                                |       |   |   |
| Cash flows from  investing activities:                                             |       |                                |       |   |   |
| Additions to  property and equipment                                               |       | (1,996,250                          | )          | (1,649,457 | ) |
| Proceeds from  sale of equipment                                                   |       | 25,000                              |       | — |   |
| Net cash used  in investing activities                                             |       | (1,971,250                          | )          | (1,649,457 | ) |
|                                                                               |       |                                |       |   |   |
| Cash flows from  financing activities:                                             |       |                                |       |   |   |
| Proceeds from  revolving line of credit                                            |       | 34,530,000                          |       | 31,303,214 |   |
| Repayment on revolving line of credit                                              |       | (29,799,645                         | )          | (28,762,010 | ) |
| Proceeds from  the issuance of term-term debt                                      |       | 106,361                             |       | 163,688 |   |
| Repayments of  term-term debt                                                      |       | (99,628                             | )          | (43,021 | ) |
| Loan financing  costs                                                              |       | (10,000                             | )          |   |   |
| Proceeds from  issuance of stocks                                                  |       | 697,875                             |       | 558,564 |   |
| Payments on stockholder  loans                                                     |       | —                              |       | (110,050 | ) |
| Costs related  to stock purchase activities                                        |       | (94,000                             | )          | — |   |
| Net cash provided  by financing activities                                         |       | 5,330,963                           |       | 3,110,385 |   |
|                                                                               |       |                                |       |   |   |
| Net increase  (decrease) in cash                                                   |       | (303,818                            | )          | 73,588 |   |
| Cash, beginning  of period                                                         |       | 867,361                             |       | 574,046 |   |
| Cash, end of  period                                                               |       | $                                   | 563,543    |   | $ | 647,634 |   |
|                                                                               |       |                                |       |   |   |
| Cash paid (received)  during the period for:                                       |       |                                |       |   |   |
| Interest expense                                                                   |       | $                                   | 412,183    |   | $ | 350,465 |   |
| Income taxes                                                                       |       | $                                   | (359,400   | ) | $ | 170,900 |   |

 

See notes to the consolidated interimfinancial statements.

 

6

----

 

IWT TESORO CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIALSTATEMENTS

(Unaudited)

NINE MONTHS ENDED SEPTEMBER 30,2004

 

#### **NOTE 1**                                                    PRINCIPLESOF CONSOLIDATION

 

The accompanying consolidated financialstatements include the accounts of the Company and its wholly owned subsidiaries,International Wholesale Tile, Inc. (IWT), IWT Tesoro International, Inc. (International),IWT Tesoro Transport, Inc. (Transport) and The Tile Club, Inc. (TTC), (collectivelythe “Company”). All significant inter-company balances and transactions have beeneliminated.

 

#### **NOTE 2**                                                    BASISOF PRESENTATION

 

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

 

The accompanying consolidated financialstatements of the Company have been prepared in accordance with accounting principlesgenerally accepted in the United States of America and with the instructions toForm 10-Q and Rule 10-10 of Regulation S-X of the Securities and Exchange Commission.Accordingly certain information and footnote disclosure required by accounting principlesgenerally accepted in the United States of America for complete financial statementshave been omitted. These condensed financial statements should be read in conjunctionwith the Company’s financial statements and notes thereto included in the Company’saudited financial statements on Form 10-KSB, as restated for the fiscal year endedDecember 31, 2003.

 

#### **NOTE 3**                                                    SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

 

Stock Options

The Company accounts for stock options under the provisions of AccountingPrinciples Board Opinion (APB) No. 25 *AccountingFor Stock Issued To Employees* and related interpretations. Accountingfor the issuance of stock options under the provisions of APB No. 25 typically doesnot result in compensation expense for the Company since the exercise price of optionsis normally established at the market price of the Company’s common stock on thedate granted. Statement of Financial Accounting Standards (SFAS) No. 123 *Accounting for Stock-Based**Compensation* provides that the related expensemay be recorded in the basic financial statements or the pro forma effect on earningsmay be disclosed in the financial statements.

 

A total of 50,000 options were granted to directors of the Company duringthe nine months ended September 30, 2004. No options were granted during the ninemonths ended September 30, 2003.

 

7

----

 

The effect on net (loss) income and (loss) earnings per share if the Companyhad applied the fair value recognition provision of the SFAS No. 123, is presentedbelow:

 
| ** **                                                                                                                                   | ** ** | **For the period ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **Three months ended**                 | ** ** | **Nine months ended** | ** ** |
| ** **                                                                                                                                   | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                         |       |                                   |       |   |   |   |   |   |   |
| Net income (loss)  as reported                                                                                                               |       | $                                      | (173,097   | ) | $ | 105,418 |   | $ | 3,749 |   | $ | 848,914 |   |
| Deduct: Stock-based  employee compensation expense determined under the fair value based method for  all options, net of related tax effects |       | —                                 |       | — |   | (36,012 | ) | (40,459 | ) |
| Pro forma net  income (loss)                                                                                                                 |       | $                                      | (173,097   | ) | $ | 105,418 |   | $ | (32,263 | ) | $ | 808,455 |   |
|                                                                                                                                         |       |                                   |       |   |   |   |   |   |   |
| Basic earnings  per share                                                                                                                    |       |                                   |       |   |   |   |   |   |   |
| As reported                                                                                                                                  |       | $                                      | (0.01      | ) | $ | 0 .01 |   | $ | 0.00 |   | $ | 0.08 |   |
| Pro-forma                                                                                                                                    |       | $                                      | (0.01      | ) | $ | 0 .01 |   | $ | 0.00 |   | $ | 0.07 |   |
|                                                                                                                                         |       |                                   |       |   |   |   |   |   |   |
| Diluted earnings  per share                                                                                                                  |       |                                   |       |   |   |   |   |   |   |
| As reported                                                                                                                                  |       | $                                      | (0.01      | ) | $ | 0 .01 |   | $ | 0.00 |   | $ | 0.07 |   |
| Pro-forma                                                                                                                                    |       | $                                      | (0.01      | ) | $ | 0 .01 |   | $ | 0.00 |   | $ | 0.07 |   |

 

For the pro-forma net income calculationin the preceding table, the fair value of each option on the date of grant was estimatedusing the Black-Scholes option-pricing model and the following assumptions for awardsin 2004: dividend yields of .0 percent; expected volatility of 21.51 percent; risk-freeinterest rates of 2.20 percent; and expected lives of five years. Using these assumptions,the weighted average grant-date fair value per share of options granted in 2004was $1.21.

 

Earnings per Share

Basic earnings (loss) per share are computed based on the weighted averagenumber of common shares outstanding during each year. Diluted earnings (loss) pershare is computed based on the weighted average number of common shares outstandingplus all potentially dilutive common shares outstanding (stock options) during eachperiod unless the effect is anti-dilutive.

 
| ** **                                                                | ** ** | **For the period ended September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                | ** ** | **Three months ended**                 | ** ** | **Nine months ended** | ** ** |
| ** **                                                                | ** ** | **2004**                               | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                      |       |                                   |       |   |   |   |   |   |   |
| Earnings(loss)  per common share - basic                                  |       | $                                      | (0.01      | ) | $ | 0.01 |   | $ | 0.00 |   | $ | 0.08 |   |
|                                                                      |       |                                   |       |   |   |   |   |   |   |
| Weighted-average  common shares outstanding                               |       | 11,695,906                             |       | 11,216,961 |   | 11,672,754 |   | 11,167,720 |   |
|                                                                      |       |                                   |       |   |   |   |   |   |   |
| Earnings(loss)  per common share - diluted                                |       | $                                      | (0.01      | ) | $ | 0.01 |   | $ | 0.00 |   | $ | 0.07 |   |
|                                                                      |       |                                   |       |   |   |   |   |   |   |
| Weighted-average  common and dilutive potential common shares outstanding |       | 11,756,240                             |       | 11,560,143 |   | 11,733,087 |   | 11,510,902 |   |

 

8

----

 

## Income Taxes

The Company accounts for income taxes in accordance with the asset and liabilitymethod. Tax provisions and credits are recorded at statutory rates for taxable itemsincluded in the consolidated statements of operations regardless of the period forwhich such items are reported for tax purposes. Under this method, deferred incometaxes are recognized for the expected utilization of net operating loss carry forwards,tax credit carry forwards and the net tax effects of temporary differences betweenthe carrying amount of assets and liabilities for financial reporting purposes andthe amounts used for income tax purposes. Deferred tax benefit is the result ofchanges in the deferred tax asset and liability. Deferred tax assets are reducedby a valuation allowance when, in the opinion of management, it is more likely thannot that all or some portion of the deferred tax assets will not be realized.

 

**NOTE 4**                                                    INVENTORIES

 

Inventories consistedof the following:

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

 

Inventory in transit consists ofmerchandise purchased overseas, which is not yet received in the warehouse. TheCompany obtains legal title at the shipping point.

 

#### **NOTE 5**                                                    EXCLUSIVEAGREEMENT

 

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

 

#### **NOTE 6**                                                    PROPERTYAND EQUIPMENT

 

Property and equipment consisted of the following:

 
| ** **                     | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                     | ** ** | **(unaudited)**         | ** ** | **(as restated)**      | ** ** |
|                           |       |                    |       |                   |       |
| Furniture and  fixtures        |       | $                       | 442,297    |                   | $          | 313,965 |   |
| Machinery and  equipment       |       | 537,053                 |       | 477,996                |       |
| Vehicles                       |       | 233,501                 |       | 211,215                |       |
| Display boards                 |       | 1,872,243               |       | 1,098,199              |       |
| Sample boards                  |       | 3,625,051               |       | 3,013,950              |       |
| Computer equipment             |       | 364,190                 |       | 323,010                |       |
| Leasehold improvements         |       | 700,022                 |       | 409,125                |       |
|                           |       |                    |       |                   |       |
|                           |       | 7,774,357               |       | 5,847,460              |       |
| Less accumulated  depreciation |       | (2,244,308              | )          | (1,630,192             | )          |
|                           |       | $                       | 5,530,049  |                   | $          | 4,217,268 |   |

 

Depreciation expense for the nine months ended September 30, 2004 and 2003is $680,002 and $468,157, respectively.

 

9

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#### **NOTES 7**                                            LOANSPAYABLE

 

The Company has a loan and security agreement with a financial institutionfor a revolving line of credit with a maximum limit of $17,000,000. The agreementspecifies that proceeds from this revolving credit loan be used for general workingcapital needs. All present and future assets of the Company collateralize this loan.The rate of interest in effect for this agreement is calculated with reference tothe Base Rate and/or LIBOR (London Interbank Offered Rate). The balance due at September30, 2004 and December 31, 2003 was $14,329,695 and $9,599,340, respectively.

 

Base Rate advances bear a fluctuating interest rate per annum equal to primeplus 0.50%. LIBOR advances bear a fixed rate per annum equal to 3.00% plus the LIBORfor the applicable interest period. At September 30, 2004 and December 21, 2003,the Base Rate and the LIBOR rate were 5.25% and 4.59%, respectively.

 

The loan and security agreement contains certain covenants, which includefinancial covenants that require the Company to maintain a certain leverage ratio,a required minimum fixed charge coverage ratio, and certain inventory turnover ratio.

 

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

 

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

####  

### **Common Stock**

During the nine months ended September 30, 2004, the Company issued 45,500shares of common stock pursuant to warrants exercised at $3.25 per share, for atotal of $147,875.

 

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

 

On May 26, 2004, the Company issued 10,000 shares of common stock to a directorunder the Stock Incentive Plan for services rendered, based on the contemporaneoustrading price, for a total of $42,500, resulting in an equivalent charge to operations.

 

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

 

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

 

On July 20th, 2004, the Company issued 500 shares of common stockto an employee under the original terms of an employment agreement, based on thetrading price at the date of issuance, resulting in an equivalent charge to operationsof $2,125.

 

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

 

#### **NOTE 9**                                                    SEGMENTINFORMATION

 

The Company manages its operations as one segment and all revenue is derivedfrom customers in the United States.

 

#### **NOTE 10**                                             NEWSUBSIDIARY

 

The Company organized The Tile Club, Inc. (TTC) on March 31, 2004. TTC willlicense the distribution rights to designer and artistic based decorative wall tiles.

 

10

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**NOTE 11****                                             INCOMETAXES**

 

Deferred tax assets and liabilitiesare determined based on the estimated future tax effects of temporary differencesbetween the financial statement and tax bases of assets and liabilities, as measuredby the current enacted tax rates. Deferred tax expense (benefit) is the result ofchanges in the deferred tax asset and liability.

 

The tax effects of temporary differences that give rise to significant componentsof deferred tax assets and deferred tax liabilities at September 30, 2004 and December31, 2003 are presented below:

 

| ** **                           | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                           | ** ** | **(unaudited)**         | ** ** | **(as restated****)**  | ** ** |
| Deferred tax  asset                  |       |                    |       |                   |       |
| Loss carryforward                    |       | $                       | 445,998    |                   | $          | 230,143 |   |
| Accounts receivable                  |       | —                  |       | 40,800                 |       |
| Deferred compensation-stock  options |       | 101,205                 |       | 101,205                |       |
| Other                                |       | —                  |       | 3,390                  |       |
| Total deferred  tax asset            |       | 547,203                 |       | 375,538                |       |
|                                 |       |                    |       |                   |       |
| Deferred tax  liability              |       |                    |       |                   |       |
| Accelerated depreciation             |       | (415,528                | )          | (276,735               | )          |
| Total deferred  tax liability        |       | (415,528                | )          | (276,735               | )          |
| Net deferred  tax asset              |       | $                       | 131,675    |                   | $          | 98,803 |   |

 

ITEM 2:  MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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

 

*ForwardLooking Statements*

 

 Some of the statements made constitute “forward-lookingstatements”. For example, statements included in this Form 10-Q regarding our financialposition, business strategy and other plans and objectives for future operations,and assumptions and 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,” “anticipate,” “believe,” “estimate,” “plan” or“expect,” we are making forward- looking statements. These forward-looking statementsare subject to risks and uncertainties and other factors that may cause our actualresults, performance or achievements to be materially different from the results,performance or achievements expressed or implied by the forward-looking statements.You should not unduly rely on these statements. Forward-looking statements involveassumptions and describe our plans, strategies, and expectations. This report containsforward-looking statements that address, among other things,

 

•ourbusiness and financing plans;

•environmentsin which we operate or plan to operate; and

•trendsaffecting our financial condition or results of operations, the impact of competition,the start-up of certain operations, roll out of products and services and acquisitionopportunities.

 

11

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Factors, risks, and uncertaintiesthat could cause actual results to differ materially from those in the forward-lookingstatements (Cautionary Statements) include, among others,

 

•ourability to raise capital;

•ourability to continue distributing our products;

•ourability to provide our products at competitive rates;

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

•ourdegree of financial leverage;

•regulatoryconsiderations and risks related to international economics,

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

•ourdependence on third party suppliers;

•theimpact of competitive services; and

•other risks referenced from time to time in ourSEC filings.

 

We believe that the assumptionsand expectations reflected in this Form 10-Q are reasonable, based on informationavailable to us in this report. However, we cannot assure anyone that these assumptionsand expectations will prove to have been correct or that we will take any actionthat we may presently be planning. We assume no obligation to update forward-lookingstatements or reflect unanticipated future events.

 

# **General**

# ** **

We were incorporated on May 5, 2000 as a Nevada corporation. Our principaloffice is located at 191 Post Road West, Suite 10, Westport, CT 06880. Any referencein this “Management’s Discussion and Analysis or Plan of Operations” discussionto “the company”, “our”, “we” or “us” refers to IWT Tesoro Corporation, Inc. (Tesoro).

 

Effective October 1, 2002, we acquired International Wholesale Tile, Inc.(IWT) through a share exchange and IWT became our wholly owned subsidiary. We issueda total of nine million shares of our common stock in exchange for all of the IWTshares. Tesoro has three additional wholly owned subsidiaries. The first is IWTTesoro International, Ltd., which was created to own and manage assets relatingto any of the Company’s potential future overseas activities. The second is IWTTransport, Inc., organized to handle our domestic freight operations. The Tile Club,Inc., formed in 2004, was organized to acquire licensing, manufacturing and distributionrights for high-end designer and artistic based decorative tiles and will also actas an agent for foreign manufacturers from whom IWT has acquired exclusive distributionrights.

 

Through IWT, we provide hard floor and wall covering materials primarilyceramic, porcelain and stone tiles to the new construction and remodeling industriesfor the commercial and residential marketplaces. We distribute our products througha network of independently owned dealers and distributors, buying groups and homecenter retailers. We currently purchase our products predominately from foreignmanufacturers.

 

# **Company Overview**

# ** **

The Company is a value added distributor of imported ceramic, porcelainand stone flooring and decorative wall tile. Our warehousing and distribution centercontains over 220,000 square feet of storage space and over seven million squarefeet of product ready for immediate shipment to our customers. In 2004, we signedan agreement to realign our distribution center facility. Realigning our distributionfacilities will consolidate approximately 80,000 square feet of warehouse spacecurrently in multiple small warehouses into one single facility adjacent to itsprimary warehouse. The Company’s primary strategy is to be a reliable supplier andnot a competitor to its customers.

 

Management believes that the critical success factors to the Company’s businessare its ability to:

 

•                  Maintainrelationships with and serve a growing base of independent dealers, distributorsand wholesalers by providing adequate stocks of in demand product at reasonableand competitive prices

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

•                  Makethe correct investments in product inventories, relationships with suppliers andlogistics and support services to ensure our continuing capability to meet our customers’expectations

 

12

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Our primary source of revenue is the sale of hard flooring and wall coveringmaterials and our primary costs relate to the acquisition, warehousing and deliveryof those products. While sales are made throughout the United States, the majorityof our sales are in the southeastern quadrant of the country. The primary sourcesof working capital are a $ 17.0 million (US) revolving line of credit from a largeUS commercial bank, our suppliers who extend us terms and our stockholders’ equity.

 

On December 17, 2003 we began trading our stock on the OTCBB under the symbolIWTT. During 2004 and 2005, we expect to raise additional equity through both thepublic and private markets. Any new capital raised will be used to strengthen ourbalance sheet and to provide capital for continued growth.

 

During the quarter ended September 30, 2004, the Company continued to expandits distribution channels beyond its traditional small and mid sized floor coveringdealers in the southeastern United States. These channels included larger regionaldistributors outside the southeastern United States, home center stores and floor-coveringdealers that focus on the builders of new construction units.

 

In 2004, we formed a new wholly owned subsidiary, The Tile Club, Inc. (TTC).TTC is a Delaware corporation. TTC will serve as a licensor and distributor of specialtytiles. It will also act as an agent for some of our foreign manufactures from whomwe have exclusive distribution rights in the United States and Canada.

 

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

 

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

 

 
| ** **              | ** ** | **Quarter Ending September 30,** | ** ** |
|-------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **2002**                         | ** ** | **2003** | ** ** | **2004** | ** ** |
|                    |       |                             |       |   |   |   |   |
| Revenues                |       | $                                | 6,383,981  |   | $ | 8,969,586 |   | $ | 11,050,421 |   |
| Cost of Goods Sold      |       | 3,787,716                        |       | 5,373,248 |   | 6,733,909 |   |
| Gross Margin            |       | 2,596,265                        |       | 3,596,338 |   | 4,316,512 |   |
| Gross Margin Percentage |       | 40.67                            | %          | 40.09 |   | 39.06 | % |
| Operating Expenses      |       | 1,715,593                        |       | 3,327,076 |   | 4,426,824 |   |
|                         |            |                                  |            |  |  |  |  |  |  |  |

 

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

 

Sales for the quarter ended September30, 2004 were $11,050,421 a 23% increase over sales for the quarter ended September30, 2003. This growth follows a 38.5% growth from 2002 to 2003. The violent weather,experienced in Florida and the Gulf Coast during August and September 2004, hada dampening impact on our sales for the quarter ended September 30, 2004. Whilewe sustained little or no physical damage from the storms, the storms themselvesand the resulting power outages that forced us to close our warehouses, coupledwith the physical losses sustained by our dealer customers, temporarily slowed ourgrowth. We believe that over the next few months, we will recover a majority ofthe lost sales.

 

The hard flooring and wall covering market in which we participate continuesto grow at a pace well beyond the growth in the U.S. GDP. We continue to enter newmarkets and add new products; therefore, we expect to be able to grow faster thanthe market as a whole for the next several years. Our share of this market is approximately1.5%. According to Floor Covering Weekly, the tile market in the United States wasapproximately $2.54 billion in 2003. This is an 8.5% growth over 2002. United Stateswholesale floor covering sales in 2003 were $20.9 billion and grew 2.9% from 2002.Tile’s shares of the floor covering market grew from 11.6% in 2002 to 12.2% in 2003.

 

As we grow, we have been able to purchase product at lower prices and haveconsequently lowered our cost of goods to 60% in 2003 from 68% in 2000. While thereare certainly finite limits to improving our gross margin percentage, it is imperativethat we maintain these ratios as we grow. Our cost of good sold for the three monthsended September 30, 2004 was 61%.

 

The gross margin for the quarter ended September 30, 2004 was $4,316,512,a 20% increase over gross margin for the quarter ended September 30, 2003. Thiscompares with a 38% growth rate from the three months ending September 30, 2003to the same period in 2002. The slow down in growth of gross margin resulted fromthe same storm related factors outlined above.

 

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Our operating expenses for the quarter ended September 30, 2004 have increasedby $1,099,748 over the same period in 2003, an increase of 33.1%. Our commissionexpense and outbound freight costs vary with sales and represent approximately $208,008of this increase. The balance of the cost increase relates to the expansion of ourdistribution channels to include home center stores and builder-based dealers.

 

In May 2003, we commenced bulk sales of products, made exclusively for IWT,to wholesale distributors throughout the United States. The sales of these productsare made in full truckload or container load volumes, with some product being delivereddirectly to the customer from the factory (drop-shipped). The gross margin on thesesales could be lower than our traditional business; however, we believe that thelower handling costs may offset the lost gross margin. In September 2003, we beganthe installation of sample racks for our products in home center stores in SouthFlorida. As of September 30, 2004, our displays were installed in one hundred andtwenty locations.

 

Making it easy for our customers to sell product is also a key success factorfor us. We have an extensive sampling and display program that augments the trainingand marketing support we provide our customers. Our inventory of samples in thefield with our customers represents a significant investment that is capitalizedas property and equipment. The value, before depreciation, on September 30, 2004and December 31, 2003 was $5,497,294 and $4,112,149 respectively on our balancesheet.

 

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

 

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

 
| ** **              | ** ** | **Nine Months Ending September 30,** | ** ** |
|-------------------------|------------|--------------------------------------|------------|
| ** **              | ** ** | **2002**                             | ** ** | **2003** | ** ** | **2004** | ** ** |
|                    |       |                                 |       |   |   |   |   |
| Revenues                |       | $                                    | 19,201,468 |   | $ | 24,209,576 |   | $ | 32,222,825 |   |
| Cost of Goods Sold      |       | 11,593,514                           |       | 14,464,855 |   | 19,688,729 |   |
| Gross Margin            |       | 7,607,954                            |       | 9,744,721 |   | 12,534,096 |   |
| Gross Margin Percentage |       | 39.62                                | %          | 40.25 | % | 38.90 | % |
| Operating Expenses      |       | 5,268,760                            |       | 8,492,778 |   | 12,200,861 |   |
|                         |            |                                      |            |  |  |  |  |  |  |  |

 

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

 

Sales for the nine months endedSeptember 30, 2004 were $32,222,825 a 23% increase over sales for the nine monthsended September 30, 2003. This growth follows a 26% growth from 2002 to 2003. Theviolent weather, experienced in Florida and the Gulf Coast during August and September2004, had a dampening impact on our sales for the nine months ending September 30,2004. While we sustained little or no physical damage from the storms, the stormsthemselves and the resulting power outages that forced us to close our warehousesfor several days, coupled with the physical loses sustained by our dealer customers,temporarily slowed our growth. We believe that over the next few months, we willrecover a majority of the lost sales. The growth in our nation wide wholesale-towholesale sales channel during the nine months ending September 30, 2004 partiallyoffset the storm related issues.

 

As we grow, we have been able to purchase product at lower prices and asa result, have lowered our cost of goods sold to 61% in 2003 from 68% in 2000. Whilethere are certainly finite limits to improving our gross margin percentage, it isimperative that we maintain these ratios as we grow. Our cost of good sold for thenine months ended September 30, 2004 was 61%, compared to 60.8% for the same periodended September 30, 2003.

 

The gross margin for the nine months ended September 30, 2004 was $12,534,096,a 29% increase over gross margin for the nine months ended September 30, 2003. Thiscompares with a 28% growth rate from the nine months ending September 30, 2003 tothe same period in 2002.

 

14

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Our operating expenses for the nine months ended September 30, 2004 haveincreased by $3,708,082 over the same period in 2003, an increase of 43.7%. Ourcommission expense and outbound freight costs vary with sales and represent approximately$378,080 of this increase. The balance of the cost increase relates to the personnel,facilities and marketing costs incurred for expanding our distribution channelsto include home center stores and builder-based dealers.

 

Our operating expenses, consisting of payroll and related expenses, depreciationand amortization and general and administrative, for the nine months ended September30, 2004 increased by $3,708,082 over the same period in 2003, an increase of 43.7%.Our commission expense and outbound freight costs vary with sales and representapproximately $370,808 of this increase. The remainder of the increase relates tothe personnel, facilities and marketing costs incurred to expand our distributionchannels to include home center stores and builder-based dealers. Depreciation and amortization expense increased by $233,849 primarilydue to the growth in our sample and display boards that support our builder-baseddealer channel. The general and administrative expenses increased by approximately$1,900,000 primarily due to the new occupancy costs relating to the increased warehousecapacity to support the new channels of distribution and the associated advertisingand marketing costs.

 

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

 

Making it easy for our customers to sell product is also a key success factorfor us. We have an extensive sampling and display program that augments the trainingand marketing support we provide our customers. Our inventory of samples in thefield with our customers represents a significant investment that is capitalizedas property and equipment. The value, before depreciation, on September 30, 2004and December 31, 2003 was $5,497,294 and $4,112,149 respectively on our balancesheet.

 

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

 

Accounts receivable and inventoryhave increased by $2,323,711 and $4,035,993 respectively at the nine months periodended September 30, 2004 from the year ended December 31, 2003. The increases inthese account balances relate primarily to our growth in sales during the nine monthsended September 30, 2004. Our accounts receivable balance for the nine months endedSeptember 30, 2004 represented approximately 1.96 months of sales and the inventoryturns for the same period was 1.57 times. Both of these ratios were impacted bythe storms that struck Florida and the Gulf Coast resulting in a slow down of oursales during the months of August and September of 2004. We expect to regain theselost sales in the up coming months.

 

We also have increased our investment in property and equipment by $1,312,781net of depreciation ($680,002) for the nine months ended September 30, 2004) forthe nine months ended September 30, 2004 from the year ended December 31, 2003.During the nine months ending September 30, 2004, we increased the square footageof our administrative offices by adding a second floor to our existing space (approximately5,000 additional square feet) within the current warehouse facility, at a cost ofapproximately $450,000. The balance of the increase relates to cost of sample boardsand displays for the new sales channels for our dealer based builders and home centerstores.

 

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

 

# **Liquidity and Capital Resources**

 

We had cash balances of $563,543 and $867,361 at the end of September 30,2004 and December 31, 2003, respectively. We have financed our growth with new equitycapital and increased borrowings from our commercial lender.

 

During 2004 and 2005, we expect to raise additional equity through boththe public and private markets. We do not expect the realignment of our warehousefacilities to require working capital beyond that already committed to the currentfacilities. New capital raised will be used to strengthen our balance sheet andto provide working capital for continued growth. However, we cannot assure any onethat we will be able to obtain outside capital or if we do, that it will be on termsbeneficial to us.

 

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During the nine months ended September 30, 2004, Tesoro issued 45,500 sharesof common stock in connection with warrants exercised at $3.25 per share for a totalof $147,875. The purchasers were accredited investors and were provided with orhad access to, information about the company, including financial information. Thetransaction was exempt pursuant to Section 4(2) of the Securities Act.

 

In August 2004, we issued a totalof 500 shares to one accredited investor who is an IWT customer, with a fair marketvalue of $3.75 per share, in consideration for past loyalty. In September theseshares were included in Tesoro’s selling stockholders’ registration statement onForm S-1 effective October 19, 2004. In September 2004, we issued an additional1,000 shares to two accredited investors (500 shares each) who are IWT customers,based on a fair market value of $2.75 per share on the date of issuance, in considerationfor past loyalty, which shares have not been registered with the Securities andExchange Commission.

 

The balance due at September 30, 2004 to our commercial lender for the useof the revolving line of credit was approximately $14.3 million. The loan and securityagreement contains certain covenants, which include financial covenants that requireus to maintain a certain leverage ratio, a required minimum fixed charge coverageratio, and a certain inventory turnover ratio.

 

# **Critical Accounting Policies**

 

In preparing the consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America, the Company mustmake decisions which impact the reported amounts of assets, liabilities, revenuesand expenses, and related disclosures. Such decisions include the selection of appropriateaccounting principles to be applied and the assumptions on which to base accountingestimates. In reaching such decisions, the Company applies judgment based on itsunderstanding and analysis of the relevant circumstances and historical experience.Actual amounts could differ from those estimated at the time the consolidated financialstatements are prepared.

 

The Company’s significant accounting policies are described in Note 1 tothe consolidated financial statements included in the Company’s Annual Report onForm 10-KSB, as restated for the year ended December 31, 2003. Some of those significantaccounting policies require the Company to make subjective or complex judgmentsor estimates. Critical accounting policies are defined as those that are both mostimportant to the portrayal of a company’s financial condition and results and requiremanagement’s most difficult, subjective, or complex judgment, often as a resultof the need to make estimates about the effect of matters that are inherently uncertainand may change in subsequent periods.

 

The Company believes the following accounting policies require it to usejudgments and estimates in preparing its consolidated financial statements and couldrepresent critical accounting policies.

 

•                  Accountsreceivable and revenue recognition. Revenues are recognized when goods are shippedand legal title passes to the customer. The Company provides an allowance for expecteddoubtful accounts based upon historical bad debt and claims experience and periodicevaluation of specific customer accounts and the aging of accounts receivable. Ifthe financial condition of the Company’s customers were to deteriorate, resultingin an impairment of their ability to make payments, additional allowances may berequired.

•                  Inventoriesare stated at the average landed cost, which matches current costs with currentrevenues. Inventories on hand are compared against anticipated future usage, whichis a function of historical usage and anticipated future selling price, in orderto evaluate obsolescence, excessive quantities, and expected sales below cost. Actualresults could differ from assumptions used to value obsolete, excessive inventoryor inventory expected to be sold below cost.

•                  Deferredtax assets and liabilities are recognized for the future tax consequences attributableto differences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. Deferred tax assets and liabilitiesare measured using enacted tax rates expected to apply to taxable income in theyears in which the temporary differences are expected to be recovered or settled.The effect on deferred tax assets and liabilities of a change in the tax rates isrecognized in earnings (loss) in the period that includes the enactment date. Additionally,taxing jurisdictions could retroactively disagree with the Company’s tax treatmentof certain items, and some historical transactions have income tax effects goingforward. Accounting rules require these future effects to be evaluated using currentlaws, rules and regulations, each of which can change at any time and in an unpredictablemanner.

 

# **Segment Information**

 

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

 

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

 

**Quantitativeand Qualitative Disclosures About Market Risk**

 

The Company’s exposuresto market risk have not changed significantly since December 31, 2003.

 

**ITEM 4 – CONTROLS AND PROCEDURES**

 

*Disclosure Controls and Procedures*

 

Based on an evaluationof the effectiveness of the Company’s disclosure controls and procedures (as definedin Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended)as of the end of the period covered by this report, the Company’s Chief ExecutiveOfficer and Chief Financial Officer have concluded that such controls and procedureswere effective for the period covered by this report. No change in the Company’sinternal control over financial reporting occurred during the period covered bythis report that materially affected, or is reasonably likely to materially affect,the Company’s internal control over financial reporting.

 

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**PARTII**

 
| **ITEM 1:** | **LEGAL PROCEEDINGS** |
|-------------|-----------------------|

 

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

 
| **ITEM 2:** | **CHANGES IN SECURITIES,  USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES.** |
|-------------|----------------------------------------------------------------------------------------|

 

During the nine months ended June 20, 2004, Tesoro issued 45,500 sharesof common stock in connection with warrants exercised at $3.25 per share for a totalof $147,875. The purchasers were accredited investors, were provided with or hadaccess to, information about the Company, including financial information. The transactionwas exempt pursuant to Section 4(2) of the Securities Act.

 

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

 

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

 

In August 2004, we issued a total of 500 shares to one accredited investorwho is an IWT customer, based on a fair market value of $3.75 per share, in considerationfor past loyalty. In September these shares were included in Tesoro’s selling stockholders’registration statement on Form S-1 effective October 19, 2004. In September 2004,we issued an additional 1,000 shares to two accredited investors (500 shares each)who are IWT customers, based on a fair market value of $2.75 per share on the dateof issuance, in consideration for past loyalty. These shares have not been registeredwith the Securities and Exchange Commission.

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

 

Not applicable

 
| **ITEM 4:** | **SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS** |
|-------------|----------------------------------------------------------|

 

Not Applicable.

 
| **ITEM 5:** | **OTHER INFORMATION** |
|-------------|-----------------------|

 

Not applicable

 

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

 

(a)                                  Exhibits

 
| **EXHIBIT  NUMBER** | ** ** | **DESCRIPTION**                                                                                                                                                                                                                                                         |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Articles of Incorporation (filed as an Exhibit to the Company’s Form 10-SB,  filed with the Securities and Exchange Commission on August 7, 2000)                                                                                                                  |
| 3.1.1               |       | Articles of Amendment to Articles of Incorporation dated September 23,  2002 (filed as an Exhibit to the Company’s Report on Form 8-K, filed with the  Securities and Exchange Commission on October 1, 2002)                                                      |
| 3.2.1               |       | Bylaws (filed as an Exhibit to the Company’s Form 10-SB, filed with the  Securities and Exchange Commission on August 7, 2000)                                                                                                                                     |
| 3.2.2               |       | Amended and Restated Bylaws (filed as an Exhibit to the Company’s Report  on Form 8-K, filed with the Securities and Exchange Commission on February 4,  2003)                                                                                                     |
| 3.3.1               |       | Specimen Stock Certificate (filed as an Exhibit to the Company’s Form  10-SB, filed with the Securities and Exchange Commission on August 7, 2000)                                                                                                                 |
| 3.3.2               |       | Audit Committee Charter (filed as an Exhibit to the Company’s Report on  Form 8-K, filed with the Securities and Exchange Commission on February 4, 2003)                                                                                                          |
| 3.3.3               |       | Compensation Committee Charter (filed as an Exhibit to the Company’s Report  on Form 8-K, filed with the Securities and Exchange Commission on February 4,  2003)                                                                                                  |
| 3.3.4               |       | Nominating And Governing Committee Charter (filed as an Exhibit to the  Company’s Report on Form 8-K, filed with the Securities and Exchange Commission  on February 4, 2003)                                                                                      |
| 3.4.1               |       | Code of Ethics for Senior Financial Officers (filed as an Exhibit to the  Company’s Registration Statement, filed with the Securities and Exchange Commission  on April 11, 2003)                                                                                  |
| 4.1.1               |       | Form of Warrant Agreement (filed as an Exhibit to the Company’s Registration  Statement, filed with the Securities and Exchange Commission on April 11, 2003)                                                                                                      |
| 4.1.2               |       | Form of Stock Certificate (filed as an Exhibit to the Company’s Registration  Statement, filed with the Securities and Exchange Commission on April 11, 2003)                                                                                                      |
| 4.1.3               |       | Form of Lock-Up Agreement (filed as an Exhibit to the Company’s Registration  Statement, filed with the Securities and Exchange Commission on April 11, 2003)                                                                                                      |
| 10.1                |       | Agreement With Peter Goss (filed as an Exhibit to the Company’s Form 10-SB,  filed with the Securities and Exchange Commission on August 7, 2000)                                                                                                                  |
| 10.2                |       | Stockholders Agreement (filed as an Exhibit to the Company’s Form 10-SB,  filed with the Securities and Exchange Commission on August 7, 2000)                                                                                                                     |
| 10.3                |       | 2001 Ponca Acquisition Corporation Stock Incentive Plan. (filed as an  Exhibit to the Company’s Report on Form 8-K, filed with the Securities and Exchange  Commission on September 11, 2002)                                                                      |
| 10.4                |       | Employment Agreement Between Ponca Acquisition Corporation And Henry Jr.  Boucher, Jr. Dated As Of December 29, 2002 (filed as an Exhibit to the Company’s  Report on Form 8-K, filed with the Securities and Exchange Commission on September  11, 2002)          |
| 10.5                |       | Memorandum Of Understanding Between Ponca Acquisition Corporation And  The Stockholders Of International Wholesale Tile, Inc. (filed as an Exhibit to  the Company’s Report on Form 8-K, filed with the Securities and Exchange Commission  on September 11, 2002) |
| 10.6                |       | Stock Purchase Agreement Among The Stockholders Of International Wholesale  Tile, Inc., and IWT Tesoro Corporation, Effective October 1, 2002 (filed as an  Exhibit on Form 8-K, filed with the Securities and Exhibit Commission on October  15, 2002).                |
| 10.7                |       | Termination Of Stockholders Agreement (filed as an Exhibit to the Company’s  Report on Form 8-K/A, filed with the Securities and Exchange Commission on February  4, 2003)                                                                                         |
| 10.8                |       | Repurchase Agreement (filed as an Exhibit to the Company’s Report on Form  8-K/A, filed with the Securities and Exchange Commission on February 4, 2003)                                                                                                           |
| 10.9                |       | Form of Indemnity Agreement (filed as an Exhibit to the Company’s Registration  Statement, filed with the Securities and Exchange Commission on April 11, 2003)                                                                                                    |
| 10.00               |       | Employment Agreement between International Wholesale Tile, Inc. and Forrest  P. Jordan (exhibits omitted) (filed as an Exhibit to the Company’s Registration  Statement, filed with the Securities and Exchange Commission on May 21, 2003)                        |
| 10.11               |       | Employment Agreement between International Wholesale Tile, Inc. and Paul  F. Boucher (this document is omitted as it is substantially similar to Forrest  P. Jordan’s Employment Agreement with the exception of the employee’s name and  address)            |

 

19

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| 10.12 |   | Employment Agreement between International Wholesale Tile, Inc. and Grey  Perna (this document is omitted as it is substantially similar to Forrest P. Jordan’s  Employment Agreement with the exception of the employee’s name and address)                                                                                                                                                        |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.13 |   | Subordination Agreement between Congress Financial Corporation (Florida)  and Forrest P. Jordan (filed as an Exhibit to the Company’s Registration Statement,  filed with the Securities and Exchange Commission on May 21, 2003)                                                                                                                                                                        |
| 10.14 |   | Subordination Agreement between Congress Financial Corporation (Florida)  and Paul F. Boucher (this document is omitted as it is substantially similar to  Forrest P. Jordan’s Subordination Agreement with the exception of the employee’s  name and address)                                                                                                                                      |
| 10.15 |   | Subordination Agreement between Congress Financial Corporation (Florida)  and Grey Perna (this document is omitted as it is substantially similar to Forrest  P. Jordan’s Subordination Agreement with the exception of the employee’s name  and address)                                                                                                                                           |
| 10.16 |   | Termination of Repurchase Agreement dated June 26, 2003 between IWT Tesoro  Corporation and Forrest P. Jordan (filed as an Exhibit to the Company’s Form 8-K,  filed with the Securities and Exchange Commission on June 26, 2003).                                                                                                                                                                      |
| 10.17 |   | Termination of Repurchase Agreement dated June 26, 2003 between IWT Tesoro  Corporation and Paul F. Boucher (this document is omitted as it is substantially  similar to Forrest P. Jordan’s Termination of Repurchase Agreement with the exception  of the name and address) (filed as an Exhibit to the Company’s Form 8-K, filed  with the Securities and Exchange Commission on June 26, 2003). |
| 10.18 |   | Termination of Repurchase Agreement dated June 26, 2003 between IWT Tesoro  Corporation and Grey Perna (this document is omitted as it is substantially similar  to Forrest P. Jordan’s Termination of Repurchase Agreement with the exception  of the name and address) (filed as an Exhibit to the Company’s Form 8-K, filed  with the Securities and Exchange Commission on June 26, 2003).      |
| 16.2  |   | Letter regarding change in Certifying Accountants (filed as an Exhibit  to the Company’s Report on Form 8-K/A filed with the Securities and Exchange Commission  on March 2, 2004).                                                                                                                                                                                                                      |
| 21.   |   | Subsidiaries of Registrant (filed as an Exhibit to the Company’s Registration  Statement, filed with the Securities and Exchange Commission on April 11, 2003)                                                                                                                                                                                                                                           |
| 31.1  |   | Certification of Henry J. Boucher, Jr., Chief Executive Officer pursuant  to Section 302 of the Sarbanes-Oxley Act.*                                                                                                                                                                                                                                                                                          |
| 31.2  |   | Certification of Forrest P. Jordan, Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act.*                                                                                                                                                                                                                                                                                              |
| 32.1  |   | Certification of Henry J. Boucher, Jr., Chief Executive Officer pursuant  to Section 906 of the Sarbanes-Oxley Act.*                                                                                                                                                                                                                                                                                          |
| 32.2  |   | Certification of Forrest P. Jordan, Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act.*                                                                                                                                                                                                                                                                                              |
| 99.1  |   | MRS’ Letter To The Securities And Exchange Commission. (filed as an Exhibit  to the Company’s Report on Form 8-K/A, filed with the Securities and Exchange  Commission on October 8, 2002)                                                                                                                                                                                                          |
| 99.2  |   | Letter from Peter Goss regarding fiscal year end (filed as an Exhibit  to the Company’s Report on Form 8-K, filed with the Securities and Exchange Commission  on October 15, 2002)                                                                                                                                                                                                                      |

 

Filed herewith.

 

20

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(b)         Reports on Form 8-K

 

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

 

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

 

21

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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 19, 2004 |   |   | /s/ Henry J. Boucher, Jr.                  |   |
|              |   |   | Henry J. Boucher, Jr., President           |
|              |   |   |                                       |
| November 19, 2004 |   |   | /s/Forrest P. Jordan                       |   |
|              |   |   | Forrest P. Jordan, Chief Financial Officer |

 

22

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