** **

**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, 2005** |
|            |   |   |
| **o**           | ** ** | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT** |

 

**Commission File No. 0-31267**

 

**IWT TESORO CORPORATION**

(Exactname of registrant as specified in its charter)

 

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

 

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

(Address of principal executive offices)

 

**(203) 221-2770**

(Registrant’s telephone number, includingarea code)

 

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

ýYes                oNo

 

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

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).   oYes                                    ýNo

 

Statethe number of shares outstanding of each of the issuer’s class of commonequity, as of November 14, 2005: 11,701,102 shares

 

 

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**IWT TESORO CORPORATIONAND SUBSIDIARIES**

**FORM 10-Q**

**For the Nine monthsEnded September 30, 2005**

**INDEX**

 
| **PART I**  | **FINANCIAL  INFORMATION**                                                                                          | **3**      |
|------------------|---------------------------------------------------------------------------------------------------------------------|------------|
| ** **       | ** **                                                                                                          | ** ** |
| Item I.          | Financial Statements                                                                                                | 3          |
|             |                                                                                                                |       |
|             | Consolidated Balance Sheets as of  September 30, 2005 and December 31, 2004                               | 3          |
|             | Consolidated Statements of  Operations for the Three Months and Nine months Ended September 30, 2005  and 2004 | 4          |
|             | Consolidated Statement of  Stockholders’ Equity for the Nine months Ended September 30, 2005              | 5          |
|             | Consolidated Statements of  Cash Flows for the Nine months Ended September 30, 2005 and 2004                   | 6          |
|             | Notes to the Consolidated  Interim Financial Statements                                                             | 7          |
|             |                                                                                                                |       |
|  Item 2.    | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                         | 12         |
|  Item 3.    | Quantitative and Qualitative  Disclosures About Market Risk                                                         | 16         |
|  Item 4.    | Controls and Procedures                                                                                             | 16         |
|             |                                                                                                                |       |
| **PART II** | OTHER INFORMATION                                                                                                   | 17         |
|  Item 1.    | Legal Proceedings                                                                                                   | 17         |
|  Item 2.    | Unregistered Sales of Equity  Securities and Use of Proceeds                                                        | 17         |
|  Item 6.    | Exhibits                                                                                                            | 17         |

 

2

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PART 1 – FINANCIAL INFORMATION

 

ITEM 1:     FINANCIAL STATEMENTS

** **

**IWT TESORO CORPORATION AND SUBSIDIARIES**

CONSOLIDATEDBALANCE SHEETS

(Unaudited)

 
| ** **                                                                                                       | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                           |       |                         |       |                        |       |
| Current Assets:                                                                                                  |       |                         |       |                        |       |
| Cash                                                                                                             |       | $                            | 712,961    |                        | $          | 507,677 |   |
| Accounts receivable, net of allowance for  doubtful accounts and returns of $323,246 and $270,013                |       | 9,354,416                    |       | 7,883,756                   |       |
| Inventories                                                                                                      |       | 29,034,469                   |       | 21,578,829                  |       |
| Deposit on purchase of inventories                                                                               |       | 374,332                      |       | 366,667                     |       |
| Prepaid expenses                                                                                                 |       | 784,786                      |       | 271,104                     |       |
| Total current assets                                                                                             |       | 40,260,964                   |       | 30,608,033                  |       |
|                                                                                                             |       |                         |       |                        |       |
| Property and equipment, net                                                                                      |       | 1,842,354                    |       | 1,762,065                   |       |
|                                                                                                             |       |                         |       |                        |       |
| Other assets                                                                                                     |       | 820,901                      |       | 758,997                     |       |
|                                                                                                             |       | $                            | 42,924,219 |                        | $          | 33,129,095 |   |
|                                                                                                             |       |                         |       |                        |       |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                       |       |                         |       |                        |       |
|                                                                                                             |       |                         |       |                        |       |
| Current Liabilities:                                                                                             |       |                         |       |                        |       |
| Accounts payable                                                                                                 |       | $                            | 15,271,542 |                        | $          | 15,282,653 |   |
| Accrued expenses and other liabilities                                                                           |       | 1,253,205                    |       | 997,432                     |       |
| Current portion of capital lease  obligations                                                                    |       | 71,595                       |       | 80,943                      |       |
| Current portion of notes payable, other                                                                          |       | 29,415                       |       | 18,218                      |       |
| Note payable, revolving line of credit                                                                           |       | 21,461,097                   |       | —                      |       |
| Total current liabilities                                                                                        |       | 38,086,854                   |       | 16,379,246                  |       |
|                                                                                                             |       |                         |       |                        |       |
| Long-Term Debt:                                                                                                  |       |                         |       |                        |       |
| Note payable, revolving line of credit                                                                           |       | —                       |       | 16,047,220                  |       |
| Note payable, convertible debt net of  discounts                                                                 |       | 1,045,000                    |       | —                      |       |
| Capital lease obligations                                                                                        |       | 115,888                      |       | 170,425                     |       |
| Subordinated notes payable, stockholders                                                                         |       | —                       |       | 338,662                     |       |
| Notes payable, other                                                                                             |       | 84,909                       |       | 37,487                      |       |
| Total long-term debt                                                                                             |       | 1,245,797                    |       | 16,593,794                  |       |
| Total liabilities                                                                                                |       | 39,332,651                   |       | 32,973,040                  |       |
|                                                                                                             |       |                         |       |                        |       |
| Commitments and Contingencies                                                                                    |       | —                       |       | —                      |       |
|                                                                                                             |       |                         |       |                        |       |
| Stockholders’ Equity:                                                                                       |       |                         |       |                        |       |
| Preferred stock, $0.001 par value,  25,000,000 authorized; none issued                                           |       | —                       |       | —                      |       |
| Common stock, $0.001 par value, 100 million  shares authorized; 11,701,102 and 11,697,102 issued and outstanding |       | 11,701                       |       | 11,697                      |       |
| Additional paid in capital                                                                                       |       | 8,016,396                    |       | 4,178,800                   |       |
| Accumulated deficit                                                                                              |       | (4,436,529                   | )          | (4,034,442                  | )          |
|                                                                                                             |       | 3,591,568                    |       | 156,055                     |       |
|                                                                                                             |       | $                            | 42,924,219 |                        | $          | 33,129,095 |   |

 

See notes to the consolidated interim financial statements.

 

3

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**IWT TESOROCORPORATION AND SUBSIDIARIES**

CONSOLIDATEDSTATEMENTS OF OPERATIONS

(Unaudited)

 
| ** **                                  | ** ** | **The three months ended  September 30,** | ** ** | **The nine months ended  September 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                       | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                        |       |                                           |       |                                          |       |   |   |   |   |
| Net Sales                                   |       | $                                              | 14,006,762 |                                          | $          | 11,052,268 |   | $ | 42,141,461 |   | $ | 32,171,915 |   |
| Cost of Goods Sold                          |       | 8,277,926                                      |       | 6,733,909                                     |       | 25,443,315 |   | 19,688,729 |   |
| Gross Profit                                |       | 5,728,836                                      |       | 4,318,359                                     |       | 16,698,146 |   | 12,483,186 |   |
| Operating Expenses:                         |       |                                           |       |                                          |       |   |   |   |   |
| Warehouse and distribution                  |       | 2,206,240                                      |       | 1,389,693                                     |       | 5,817,625 |   | 3,972,777 |   |
| Sales and marketing                         |       | 1,923,521                                      |       | 1,657,820                                     |       | 5,381,340 |   | 4,951,181 |   |
| General and administrative                  |       | 1,679,630                                      |       | 1,592,713                                     |       | 4,907,866 |   | 4,357,287 |   |
|                                        |       | 5,809,391                                      |       | 4,640,226                                     |       | 16,106,831 |   | 13,281,245 |   |
| Income (Loss) from Operations               |       | (80,555                                        | )          | (321,867                                      | )          | 591,315 |   | (798,059 | ) |
| Other Expenses, net:                        |       |                                           |       |                                          |       |   |   |   |   |
| Interest expense                            |       | (528,524                                       | )          | (150,806                                      | )          | (1,133,285 | ) | (412,183 | ) |
| Other income (expenses)                     |       | (8,799                                         | )          | 19,548                                        |       | 139,883 |   | 49,824 |   |
|                                        |       | (537,323                                       | )          | (131,258                                      | )          | (993,402 | ) | (362,359 | ) |
| Loss Before Income Taxes                    |       | (617,878                                       | )          | (453,125                                      | )          | (402,087 | ) | (1,160,418 | ) |
|                                        |       |                                           |       |                                          |       |   |   |   |   |
| Income Tax Benefit (Expense)                |       | —                                         |       | —                                        |       | — |   | — |   |
| Net Loss                                    |       | $                                              | (617,878   | )                                             | $          | (453,125 | ) | $ | (402,087 | ) | $ | (1,160,418 | ) |
| Loss Per Share:                             |       |                                           |       |                                          |       |   |   |   |   |
| Basic                                       |       | $                                              | (0.05      | )                                             | $          | (0.04 | ) | $ | (0.03 | ) | $ | (0.10 | ) |
|                                        |       |                                           |       |                                          |       |   |   |   |   |   |   |   |   |
| Diluted                                     |       | $                                              | (0.05      | )                                             | $          | (0.04 | ) | $ | (0.03 | ) | $ | (0.10 | ) |
|                                        |       |                                           |       |                                          |       |   |   |   |   |
| Weighted Average Common Shares Outstanding: |       |                                           |       |                                          |       |   |   |   |   |
| Basic                                       |       | 11,701,102                                     |       | 11,695,906                                    |       | 11,698,417 |   | 11,672,754 |   |
| Diluted                                     |       | 11,701,102                                     |       | 11,695,906                                    |       | 11,698,417 |   | 11,672,754 |   |

 

See notes to the consolidatedinterim financial statements.

 

4

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**IWT TESOROCORPORATION AND SUBSIDIARIES**

CONSOLIDATEDSTATEMENT OF STOCKHOLDERS’ EQUITY

(Unaudited)

 
| ** **                                                   | ** ** | **Common Stock** | ** ** | **Additional  Paid in** | ** ** | **Accumulated  Earnings** | ** ** | ** **  | ** ** |
|--------------------------------------------------------------|------------|------------------|------------|-------------------------|------------|---------------------------|------------|-------------|------------|
| ** **                                                   | ** ** | **Shares**       | ** ** | **Amount**              | ** ** | **Capital**               | ** ** | **Deficit** | ** ** | **Total** | ** ** |
|                                                         |       |             |       |                    |       |                      |       |        |       |   |   |
| Balance,  December 31, 2004                             |       | 11,697,102       |       | $                       | 11,697     |                      | $          | 4,178,800   |       | $ | (4,034,442 | ) | $ | 156,055 |   |
|                                                         |       |             |       |                    |       |                      |       |        |       |   |   |
| Issuance of shares to employees                              |       | 4,000            |       | 4                       |       | 10,596                    |       | —      |       | 10,600 |   |
|                                                         |       |             |       |                    |       |                      |       |        |       |   |   |
| Discount on convertible debt, net of loan  costs of $241,000 |       | —           |       | —                  |       | 3,827,000                 |       | —      |       | 3,827,000 |   |
|                                                         |       |             |       |                    |       |                      |       |        |       |   |   |
| Net loss, nine months ended  September 30, 2005         |       | —           |       | —                  |       | —                    |       | (402,087    | )          | (402,087 | ) |
|                                                         |       |             |       |                    |       |                      |       |        |       |   |   |
| Balance,  September 30, 2005                            |       | 11,701,102       |       | $                       | 11,701     |                      | $          | 8,016,396   |       | $ | (4,436,529 | ) | $ | 3,591,568 |   |

 

See notes to the consolidatedinterim financial statements.

 

5

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**IWT TESORO CORPORATION AND SUBSIDIARIES**

CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(Unaudited)

 
| ** **                                                                   | ** ** | **Nine Months Ended**        | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                   | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
|                                                                         |       |                         |       |   |   |
| Cash flows from operating activities:                                        |       |                         |       |   |   |
| Net loss                                                                     |       | $                            | (402,087   | ) | $ | (1,160,418 | ) |
| Adjustments to reconcile net loss to net cash  used in operating activities: |       |                         |       |   |   |
| Depreciation and amortization                                                |       | 298,758                      |       | 215,214 |   |
| Amortization of loan discount                                                |       | 113,000                      |       | — |   |
| Loss (Gain) on disposal of property and  equipment                           |       | 16,900                       |       | (21,533 | ) |
| Common stock issued for services and  compensation                           |       | 10,600                       |       | 147,050 |   |
| Provision for doubtful accounts and returns                                  |       | 53,233                       |       | 123,065 |   |
| Other                                                                        |       | —                       |       | (15,976 | ) |
| Changes in operating assets and  liabilities:                                |       |                         |       |   |   |
| (Increase) Decrease in:                                                      |       |                         |       |   |   |
| Accounts receivable                                                          |       | (1,523,893                   | )          | (2,395,867 | ) |
| Inventories                                                                  |       | (7,455,640                   | )          | (4,035,993 | ) |
| Deposit on purchase of inventories                                           |       | 82,352                       |       | — |   |
| Prepaid expenses and other assets                                            |       | (544,571                     | )          | (289,328 | ) |
| Increase in:                                                                 |       |                         |       |   |   |
| Accounts payable                                                             |       | (11,111                      | )          | 2,055,297 |   |
| Accrued expenses                                                             |       | 255,773                      |       | 329,806 |   |
| Net cash used in operating activities                                        |       | (9,106,686                   | )          | (5,048,683 | ) |
|                                                                         |       |                         |       |   |   |
| Cash flows from investing activities:                                        |       |                         |       |   |   |
| Acquisitions of property and equipment                                       |       | (247,564                     | )          | (611,097 | ) |
| Proceeds from sale of equipment                                              |       | —                       |       | 25,000 |   |
| Net cash used in investing activities                                        |       | (247,564                     | )          | (586,097 | ) |
|                                                                         |       |                         |       |   |   |
| Cash flows from financing activities:                                        |       |                         |       |   |   |
| Proceeds from revolving line of credit                                       |       | 50,813,050                   |       | 34,530,000 |   |
| Payments on revolving line of credit                                         |       | (45,399,173                  | )          | (29,799,645 | ) |
| Proceeds from convertible debt                                               |       | 4,394,338                    |       | — |   |
| Collection on notes receivable arising from  sale of stock                   |       | —                       |       | 550,000 |   |
| Proceeds from issuance of stock                                              |       | —                       |       | 147,875 |   |
| Proceeds from long-term debt                                                 |       | —                       |       | 106,360 |   |
| Payments of long-term debt                                                   |       | (102,421                     | )          | (99,628 | ) |
| Costs related to stock purchase activities                                   |       | —                       |       | (94,000 | ) |
| Loan financing costs                                                         |       | (146,260                     | )          | (10,000 | ) |
| Net cash provided by financing activities                                    |       | 9,559,534                    |       | 5,330,962 |   |
|                                                                         |       |                         |       |   |   |
| Net Increase (decrease) in Cash                                              |       | 205,284                      |       | (303,818 | ) |
| Cash, Beginning                                                              |       | 507,677                      |       | 867,361 |   |
| Cash, Ending                                                                 |       | $                            | 712,961    |   | $ | 563,543 |   |
|                                                                         |       |                         |       |   |   |
| Cash Paid During the Period for:                                             |       |                         |       |   |   |
| Interest expense                                                             |       | $                            | 1,020,285  |   | $ | 412,183 |   |
| Income tax                                                                   |       | $                            | 26,777     |   | $ | — |   |
|                                                                         |       |                         |       |   |   |
| Non-Cash Investing and Financing  Activities:                                |       |                         |       |   |   |
| Acquisition of property and equipment  financed through long-term debt       |       | $                            | 97,155     |   | $ | 95,361 |   |

 

See notes to the consolidatedinterim financial statements.

 

6

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IWT TESORO CORPORATION ANDSUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NINE MONTHS ENDED SEPTEMBER 30,2005

 

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

 

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

 

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

 

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

#### ** **

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

 

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

 

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

 

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

#### ** **

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

 

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

 

Pro forma informationregarding net income(loss) and earnings(loss) per share is required by SFAS No. 123,“*Accounting for Stock-Based Compensation*,”and has been determined as if the Company had accounted for its stock optionsunder the fair value method of that Statement. The fair value for theseoptions was estimated at the grant date using the Black-Scholes option-pricingmodel using the following weighted average assumptions for 2005 and 2004,respectively: risk-free interest rates of 3.58%, and 2.20%, dividend yields of 0% and 0%, volatilityfactors of the expected market price of the Company’s common stock of 60.79%and 21.51% and expected lives of ten years. Using these assumptions, theweighted average grant-date fair value per share of options granted in 2005 was$1.57 and in 2004 it was $1.21.

 

7

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

 

A total of 50,000 options were granted todirectors of the Company during the nine months ended September 30, 2005.During the nine months ended September 30, 2004 a total of 45,000 optionswere granted to directors of the Company and 5,000 options were granted toemployees. The effect on net income (loss) and earnings (loss) per share if theCompany had applied the fair value recognition provision of the SFAS No. 123,is presented below:

 
| ** **                                                                                                                                   | ** ** | **For the nine months ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **2005**                                         | ** ** | **2004** | ** ** |
| ** **                                                                                                                                   | ** ** | ** **                                       | ** ** | **(Restated)** | ** ** |
| Net loss as reported                                                                                                                         |       | $                                                | (402,087   | ) | $ | (1,160,418 | ) |
| Deduct: Stock-based employee compensation expense  determined under the fair value based method for all options, net of related  tax effects |       | (37,902                                          | )          | (36,012 | ) |
|                                                                                                                                         |       |                                             |       |   |   |
| Pro forma net loss                                                                                                                           |       | $                                                | (439,989   | ) | $ | (1,196,430 | ) |
|                                                                                                                                         |       |                                             |       |   |   |
| Loss per share - Basic                                                                                                                       |       |                                             |       |   |   |
| As reported                                                                                                                                  |       | $                                                | (0.03      | ) | $ | (0.10 | ) |
| Pro forma                                                                                                                                    |       | $                                                | (0.04      | ) | $ | (0.10 | ) |
| Loss per share - Diluted                                                                                                                     |       |                                             |       |   |   |
| As reported                                                                                                                                  |       | $                                                | (0.03      | ) | $ | (0.10 | ) |
| Pro forma                                                                                                                                    |       | $                                                | (0.03      | ) | $ | (0.10 | ) |

 

***Earnings per Share***

 

Basic and diluted loss per share for thethree and nine month periods ended September 30, 2005 and 2004 are equalas the effect of the common stock options and warrants were antidilutive.

 

8

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***Income Taxes***

 

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

 

***Recent AccountingPronouncements***

 

In November, 2004, the FASB issued SFAS No. 151“Inventory Costs” an amendment to Accounting Research Bulletin No. 43,“Inventory Pricing,” to clarify the accounting for abnormal amounts of idlefacility expense, freight, handling costs and wasted material.  This Statement requires that those items berecognized as current-period charges regardless of whether they meet thecriterion of “so abnormal.”  Additionallythis statement requires that allocation of fixed production overheads to thecosts of conversion be based on the normal capacity of the productionfacilities.  The provisions of SFASNo. 151 are effective for fiscal years beginning after June 15,2005.  The adoption of SFAS 151 is notexpected to have an impact on our consolidated results of operations, financialposition or cash flows.

 

In December 2004, the FASB issued SFASNo. 153, *“Exchanges of NonmonetaryAssets”* an amendment to Accounting Principles Board OpinionNo. 29, “*Accounting for NonmonetaryTransactions,”* which is based on the principle that exchanges ofnonmonetary assets should be measured based on the fair value of the assetsexchanged.  The guidance in that Opinion,however, included certain exceptions to that principle.  This Statement amends Opinion 29 to eliminatethe exception for nonmonetary exchanges of similar productive assets andreplaces it with a general exception for exchanges in which the future cashflows of the entity are not expected to change significantly as a result of theexchange.  The provisions of SFASNo. 153 are effective for nonmonetary asset exchanges in fiscal periodsbeginning after June 15, 2005.  Theadoption of SFAS 153 is not expected to have an impact on our consolidatedresults of operations, financial position or cash flows.

 

In December 2004, the FASB issued SFASNo. 123 (revised 2004), “*Share-Based Payment*,”(“SFAS No. 123(R)”).  SFASNo. 123(R) requires companies to recognize the compensation cost relatingto share-based payment transactions in the financial statements.  This Statement eliminates the ability toaccount for share-based compensation transactions using Accounting PrinciplesBoard Opinion No. 25, and requires instead that such transactions beaccounted for using a fair-value-based method. SFAS No. 123 (R) is effective for the Company’s the interim andannual periods beginning after January 1, 2006. Although we have not yetcompleted our analysis of the impact of adopting SFAS No. 123(R), webelieve the impact is likely to be material to our financial statements.

 

In March 2005, the FASBissued FIN 47 as an interpretation of FASB Statement 143, *Accounting for Asset Retirement Obligations*(FASB143). This interpretation clarifies that the term conditional asset retirementobligation as used in FASB 143 and refers to a legal obligation to perform anasset retirement activity in which the timing and/or method of settlement areconditional on a future event that may or may not be within the control of theentity. The obligation to perform the asset retirement activity isunconditional even though uncertainly exists about the timing and/or method ofsettlement.

 

Accordingly, an entity isrequired to recognize a liability for the fair value of a conditional assetretirement obligation if the fair value of the liability can be reasonablyestimated. This interpretation also clarifies when an entity would havesufficient information to reasonably estimate the fair value of an assetretirement obligation. FIN 47 is effective no later than the end of fiscalyears ending after December 15, 2005. We are currently assessing theimpact of the adoption of FIN 47.

 

On June 1, 2005, theFASB issued Statement No. 154, *AccountingChanges and Error Corrections, a replacement of APB Opinion No. 20 andFASB Statement No. 3 (SFAS 154)*. The Statement applies toall voluntary changes in accounting principle, and changes the requirements foraccounting for and reporting of a change in accounting principle. We will adoptSFAS 154 at December 31, 2005 and do not anticipate any materialchange to our operating results as a result of this adoption.

 

***Reclassifications***

 

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

 

**NOTE 2**                                                    INVENTORIES

 

Inventories consisted of the following:

 
| ** **            | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------|------------|------------------------------|------------|-----------------------------|------------|
|                  |       |                         |       |                        |       |
| Tiles                 |       | $                            | 26,944,837 |                        | $          | 17,034,540 |   |
| Inventory in  transit |       | 2,089,632                    |       | 4,544,289                   |       |
|                  |       | $                            | 29,034,469 |                        | $          | 21,578,829 |   |

 

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

 

9

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#### **NOTE 3**                                                    PROPERTYAND EQUIPMENT

 

Property and equipment consisted of thefollowing:

 
| ** **                     | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                           |       |                         |       |                        |       |
| Furniture  and fixtures        |       | $                            | 293,468    |                        | $          | 289,560 |   |
| Machinery  and equipment       |       | 858,189                      |       | 657,553                     |       |
| Vehicles                       |       | 288,064                      |       | 258,272                     |       |
| Office and  computer equipment |       | 490,239                      |       | 533,803                     |       |
| Leasehold  improvements        |       | 644,340                      |       | 719,560                     |       |
|                           |       | 2,574,300                    |       | 2,458,748                   |       |
| Less  accumulated depreciation |       | 731,946                      |       | 696,683                     |       |
|                           |       | $                            | 1,842,354  |                        | $          | 1,762,065 |   |

 

Depreciation expense for the nine months ended September 30,2005 and 2004 was approximately $247,500 and $192,000, respectively.

 

#### **NOTE 4**                                                    NOTESPAYABLE, REVOLVING LINE OF CREDIT

 

On December 31, 2004, the Company and itscommercial lender amended and restated the existing revolving line of creditagreement providing up to $25,000,000 with interest rates of either (1) LIBORplus 3.00% or (2) the base rate plus 0.50% (interest rates ranging from 6.41%to 7.25% at September 30, 2005) payable monthly.  The line of credit is limited by a borrowingbase which is comprised of a percentage of eligible accounts receivable andeligible inventories, as defined, and is collateralized by substantially allthe assets of the Company. The balance due at September 30, 2005 and December 31,2004 was $21,461,097 and $16,047,220, respectively. The line matures September 10,2006 and contains certain covenants requiring the Company to maintain a certainleverage ratio, a required minimum fixed charge coverage ratio, and certaininventory turnover ratio.

 

For the three months ended September 30,2005 and 2004, interest expense related to the credit line amounted to $365,011and $170,868, respectively. For the nine months ended September 30, 2005and 2004, interest expense related to the credit line amounted to $941,312 and$391,511 respectively.

 

#### **NOTE 5**                                                    STOCKHOLDERS’EQUITY

 

**Common Stock**

 

During the nine months ended September 30,2005, the Company issued 4,000 shares of common stock to several employeesunder the Stock Incentive Plan for services rendered, based on the tradingprice at the date of issuance, for a total of $10,600, resulting in animmediate charge to operations.

 

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#### **NOTE 6**                                                    INCOMETAXES

 

Income tax expense for the three and nine monthperiods ended September 30, 2005 and 2004 were $-0- as the benefit forincome taxes, computed by applying the Federal statutory rate to loss beforeincome taxes, was reduced by the increase in the deferred tax valuationallowance during the period, to adjust deferred taxes to the amount consideredby management more likely than not to be realized

 

**NOTE 7****                                                   ****NOTE PAYABLE – CONVERTIBLEDEBT**

 

On August 25, 2005, the Company issued asecured convertible term note in the aggregate amount of $5,000,000 resultingin net proceeds of $4,759,000.  Interestaccrues on the principal balance of the note at an annual interest rate equalto prime plus 1.5%. On September 30, 2005 the interest rate was 8.25%.  The note matures on August 25,2008.  The note is convertible intocommon stock of the Company at an initial conversion rate of $2.74 pershare.  Based upon the closing price pershare of the Company’s common stock on the date of issuance, there was anintrinsic value associated with the beneficial conversion feature of$2,072,000, which is presented as a discount on the convertible note andamortized over the term of the note*.* In connectionwith the convertible note, the Company issued to the holder of the note afive-year warrant to purchase 511,883 shares of the Company’s common stock atan exercise price of $3.15 per share and an option to purchase 1,170,110 sharesof the Company’s common stock at an exercise price of $0.001 per share.  The fair value for these options and warrantswas estimated at the grant date using the Black-Scholes option pricingmodel using the following weighted average assumptions: risk-free interest rateof 4.06, dividend yields of 0% and a volatility factor of the expected marketprice of the common stock of 60.79%.  Based upon the closing price per share of theCompany’s common stock on the date of issuance, the Company estimated the fairvalue of the warrant and option and allocated $1,996,000 of the proceeds fromthe note to the warrant and option, which is presented as a discount on theconvertible note, net of amortization to be taken over the three-year term ofthe note.  There are no financialcovenants.

 

The balance of the note as of September 30,2005, net of unamortized discounts is as follows:

 
| Principal amount of notes                                            |   | $          | 5,000,000 |   |
|----------------------------------------------------------------------|--------|------------|-----------|--------|
| Discount for  beneficial conversion features                         |   | (2,014,444 | )         |
| Discount for  fair value of warrants and options                     |   | (1,940,556 | )         |
|                                                                 |   |       |      |
| Balance as  of September 30, 2005, net of unamortized discounts |   | $          | 1,045,000 |   |

 

Interest expense related to the note amountedto $40,382 during the period of August 25, 2005 to September 30,2005.

 

Amortization of discounts for the beneficialconversion features and warrant and option resulted in charges to interestexpense totaling $113,000 during the three months ended September 30,2005.

 

The note is secured by a lien on substantially allthe assets of the Company, subject to a first priority lien of the Company’sprimary financial lender.

 

The holder of the note has agreed that it will notconvert the note, or exercise any warrant or option, into common stock inamounts that would cause the holder’s aggregate beneficial ownership of theCompany’s common stock to exceed 4.99%, without 120 days prior notice, or19.199%, without stockholder approval.

 

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**NOTE 8****                                                   ****NEW SUBSIDIARIES**

 

On June 6th,2005, the Company organized the Import Flooring Group, Inc. (IFG). IFGwill provide agency services by directly importing tile, natural stone,hardwood, laminate, and carpet and rug floor coverings from foreign factoriesto wholesale tile distributors within the United States.

 

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

 

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

 

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

 

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

 

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

 

•                  TheTile Club, Inc., formed in 2004, was organized to acquire licensing,manufacturing and distribution rights for high-end designer and artistic baseddecorative tiles and to also act as an agent for foreign manufacturers fromwhom IWT has acquired exclusive distribution rights.

 

•                  ImportFlooring Group, Inc., formed in June 2005, was organized to supportthe Company’s growth strategy with an agent- oriented business model in thefloor covering market.

 

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

 

IWT Tesoro Corporation (The Company) delivers premium floor covering productssuch as porcelain, ceramic and natural stone tiles, hardwood, laminate, carpetand rugs from around the world, to floor covering dealers, home center stores,national homebuilder buying groups, and to wholesalers. The Company’s primaryoperating subsidiary, IWTdistributes its product lines which include porcelain, ceramic and naturalstone tiles, through its network of regional distribution centers located inthe southern regions of the United States using its company-operated trucks,common carrier or commercial delivery services. The Company’s new subsidiary, IFGprovides floor covering product lines that include natural stone and tiles,hardwood, laminate, carpet and rug to large flooring distributors throughout theUnited States and Canada. IFG maintains a relatively small amount of backupinventory to support its customers’ short term product needs.

 

The Company reported a net lossof ($617,878) or diluted loss per share of $ (0.05), for the third quarter of2005 compared to a net loss of ($453,125) or loss per share of ($.04) for thethird quarter of 2004. The increased net loss resulted from the start up costsassociated with the new subsidiary, IFG. These start up costs include salaries,office and warehouse rent, travel and related expenses and marketing material.These expenses exceeded revenue by approximately $240,000 in IFG’s firstquarter of operation. IWT’s results were approximately unchanged for the threemonths ended September 30, 2005 compared to September 30, 2004. Bothquarters were hampered by hurricanes that disrupted the distribution chain. IWTcontinues to expand its business north and west to minimize the effects ofthese weather related business disruptions. Management expects

 

12

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that the IFG’s revenues willgrow in the final quarter of the year to a point where they become profitablefor the year ended December 31, 2005.

 

**Resultsof Operations**

 

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

 

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

 
| ** **               | ** ** | **Quarter ending September 30,** | ** ** |
|--------------------------|------------|---------------------------------------|------------|
| ** **               | ** ** | **September 30,  2005**          | ** ** | **September 30,  2004** | ** ** | **September 30,  2003** | ** ** |
| ** **               | ** ** | ** **                            | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
|                     |       |                                  |       |   |   |   |   |
| Revenues                 |       | $                                     | 14,006,762 |   | $ | 11,052,268 |   | $ | 8,955,693 |   |
| Cost of  Goods Sold      |       | 8,277,926                             |       | 6,733,909 |   | 5,373,248 |   |
| Gross Margin             |       | 5,728,836                             |       | 4,318,359 |   | 3,582,445 |   |
| Gross Margin  Percentage |       | 40.90                                 | %          | 39.07 | % | 40.00 | % |
| Operating  Expenses      |       | $                                     | 5,809,391  |   | $ | 4,640,226 |   | $ | 3,525,027 |   |

 

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

 

Net sales for the three monthsended September 30, 2005 increased $2,954,494 or approximately26.7% over the reported net sales for the three months ended September 30,2004. This growth follows a 23.4% increase in net sales for the three monthsended September 30, 2004 over the three months ended September 30,2003. The Company’s continued growth rate exceeds industry growth rates. Webelieve we will continue to exceed industry growth rates as a result ofcontinued expansion into national markets.

 

Gross profit for the three months ended September 30, 2005 was $5,728,836(40.9% of net sales) compared to $4,318,359 (39.1% of net sales) for the threemonths ended September 30, 2004. The third quarter 2005 gross profitincrease was a direct result of a new pricing structure implemented in March 2005.  This new pricing structure will enable us tomaintain an approximate gross margin of 38%.

 

Our operating expenses for the three months ended September 30,2005 were $5,809,391 (41.5% of net sales) compared to $4,640,226 (42.0% of netsales) for the three months ended September 30, 2004. The operatingexpense to sales ratio has remained relatively stable for the quarter ended September 30,2005 when compared to the quarter ended September 30, 2004. IWT’soperating expense structure is primarily variable with sales revenue. A largecomponent of these operating expenses include sales commissions, marketing andmerchandizing costs and delivery costs, of which each grow proportionately withsales. While management believes that there are economies of scale to be gainedrelated to warehousing and administrative costs; we estimate that the operatingexpenses of IWT will remain in the range experienced in the most recentquarter. However, the IFG’s operating expense structure is primarily fixed withregards to sales revenue. A large component of IFG’s operating expensesincludes facilities rent and administrative costs which remain constant assales grow, therefore resulting in a decreasing operating expense ratio. As IFGcontinues to grow and becomes a larger proportion of the Company’s business,management expects the overall operating ratio to decrease.

 

The Net Loss before Income Taxes for the three months ended September 30,2005 was $617,878 compared to a Net Loss before Income Taxes of $453,125 forthe three months ended September 30, 2004. The increased loss isattributable to the increased interest costs. Net interest costs for thequarter ended September 30, 2005 were approximately $528,000 as comparedto $151,000 for the quarter ended September 30, 2004. The Companyincreased its debt through the placement of a $5,000,000 subordinate debtfacility during the quarter ended September 30, 2005. The increased debt,the discount accretion, the deferred acquisition cost and the general increasein the effective interest rate have all contributed to the increase in the costof borrowed money.

 

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*Results of Operations for the Nine monthsended September 30, 2005, 2004 and 2003*

 

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

 
| ** **               | ** ** | **Nine Months Ending September 30,** | ** ** |
|--------------------------|------------|-------------------------------------------|------------|
| ** **               | ** ** | **September 30,  2005**              | ** ** | **September 30,  2004** | ** ** | **September 30,  2003** | ** ** |
| ** **               | ** ** | ** **                                | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
|                     |       |                                      |       |   |   |   |   |
| Revenues                 |       | $                                         | 42,141,461 |   | $ | 32,171,915 |   | $ | 24,147,078 |   |
| Cost of  Goods Sold      |       | 25,443,315                                |       | 19,688,729 |   | 14,464,855 |   |
| Gross Margin             |       | 16,698,146                                |       | 12,483,186 |   | 9,682,223 |   |
| Gross Margin  Percentage |       | 39.62                                     | %          | 38.80 | % | 40.10 | % |
| Operating  Expenses      |       | $                                         | 16,106,831 |   | $ | 13,281,245 |   | $ | 9,211,664 |   |

 

 *Nine months ended September 30, 2005Compared to Nine months ended September 30,, 2004 and 2003*

 

Sales for the nine months ended September 30, 2005 were $42,141,461,a 31.0% increase over sales for the nine months ended September 30, 2004.This growth follows a 33.2% increase for the same period ended in 2004 comparedwith 2003. The Company’s growth rate continues to exceed industry growthrates. We believe we will continue to exceed industry growth rates as a resultof our continued expansion into national markets.

 

The gross margin for the nine months ended September 30, 2005 was $16,698,146(39.62% of net sales) compared to $12,483,186 (38.8% of net sales) for the ninemonths ended September 30, 2004. The slightly higher gross margin for the ninemonths ended September 30, 2005 is a result of the March 2005 newpricing structure. This new price structure was implemented as a direct resultof increasing material and import costs.

 

Our operating expenses for the nine months ended September 30,2005 have increased by $2,825,586 over the same period in 2004, an increase of 21.3%.This compares with a 44.2% increase for the period ended September 30,2004 from 2003.  The decrease in thecurrent percentage of operating expenses was a result of the Company’s incrementalcosts incurred in 2003 and 2004 to building an infrastructure to support themost recent past year’s growth, current growth and plans for future growth.

 

The Net Loss before Income Taxes for the nine months ended September 30,2005 is $402,087 compared to a net loss of $1,160,418 for the nine months endedSeptember 30, 2004.  The 2.65% decreasein loss is attributed to continued growth in sales distribution channels and adecrease in incremental operating expenses.

 

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

 

Accounts receivable andinventory have increased by $1,470,660 and $7,455,640 respectively during the ninemonth period ended September 30, 2005 from the year ended December 31,2004.  The increases in these accountbalances relate primarily to our growth in sales and the expansion of ourdistribution channels. At September 30, 2005 our accounts receivablebalance represented approximately 2.0 months of sales and at December 31,2004 it represented 2.11 months of sales. This decrease is attributed to a slightimprovement in our rate of collections.  AtSeptember 31, 2005 inventory turns were 1.22 and at December 31, 2004inventory turns were 1.38.  The decreasein inventory turns is a result of expansion efforts which require a minimumstock level within these various markets.

 

We had a net increase in our investment in property and equipment of $80,289net of depreciation for the nine months ended September 30, 2005 from theyear ended December 31, 2004.  Thenet increase was primarily due to investments in leasehold furnishings for theIFG and warehouse machinery and computer equipment for the IWT.

 

Our liabilities for accounts payable decreased $11,111 and revolvingline of credit increased $5,413,877 for the nine months ended September 30,2005 from the year ended December 31, 2004.  The net increase in our long term debt relatesdirectly to the placement of a $5,000,000 subordinated debt facility to fundour sales growth throughout the United States and Canada.

 

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# **Liquidity and CapitalResources**

 

We had cash balances of approximately $713,000 at September 30,2005 and $507,700 at December 31, 2004.  We have financed our growth with new subordinated debt and increasedborrowings from our commercial lender.

 

Our senior bank credit facility is $25 million andour subordinated facility is $5 million for a total of $30 million; The Companyexpects the combination of these credit facilities to be sufficient to supportits growth in accounts receivable and inventory through 2005. Our rapid growthis expected to continue requiring the Company to seek outside capital tosupplement earnings and strengthen our balance sheet. We believe that theworking capital required to finance the necessary growth in inventory will beprovided by our existing line of credit. The current balance of our commercialline of credit is approximately $21.5 million which leaves approximately $3.5million of available working capital. We expect to raise additional capital,either debt or equity, through both the public and private markets during2005.  However, we cannot assure anyonethat we will be able to obtain outside capital, or if we do, that it will be onterms beneficial to us.

 

The balance due at September 30, 2005 for oursubordinated debt was $5 million. The balance due at September 30, 2005 toour commercial lender for the use of the revolving line of credit wasapproximately $21.5 million. The loan and security agreement contains certaincovenants, which include financial covenants that require us to maintain acertain leverage ratio, limit our unfunded capital expenditures, a requiredminimum fixed charge coverage ratio, and a certain inventory turnover ratio.

 

# **Critical AccountingPolicies**

# ** **

There were no significant changes to the Company’s critical accountingpolicies and estimates during the period. The Company’s significant accountingpolicies are described in Note 1 to the consolidated financial statementsincluded in the Company’s Annual Report on Form 10-K, for the year ended December 31,2004.

 

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**Forward-Looking Information**

 

Somestatements made in this Quarterly Report on Form 10-Q, are “forward-lookingstatements” and are not historical facts. For example, statements regarding our financial position, businessstrategy and other plans and objectives for future operations, and assumptionsand predictions about future demand for our services and products, supply, costs,marketing and pricing factors are all forward-looking statements. When we usewords like “intend,” “would”, “anticipate,” “believe,” “estimate,” “plan” or “expect”or the negative of these terms and similar expressions, we are making forward-looking statements.  You should be awarethat these forward-looking statements are subject to risks anduncertainties.  Additionally, ourforward-looking statements speak only as of the date of this report.  Other than as required by law, we undertakeno obligation to update or revise these statements, whether as a result of newinformation, future events or otherwise.  New factors emerge from time to time that may cause our business not todevelop as we expect, and it is not possible for us to predict all of them.  Factors that may cause our actual results,performance or achievements to be materially different from the results,performance or achievements expressed or implied by the forward-lookingstatements include, among other things are changes in the industry, energycosts, timing and level of capital expenditures and introduction of newproducts.

 

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

 

**Quantitativeand Qualitative Disclosures About Market Risk**

 

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

 

**ITEM 4 – CONTROLS AND PROCEDURES**

 

As of the end of theperiod covered by this Quarterly Report on Form 10-Q, Tesoro’smanagement, with participation of the Company’s principal executive officer andprincipal financial officer, have performed an evaluation of the Company’sdisclosure controls and procedures, (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (“ExchangeAct”) to ensure that information required to be disclosed by Tesoro in thereports that Tesoro files or submits under the Exchange Act is recorded,processed, summarized, and reported within the time periods specified by theSEC’s rules and forms.

 

Based onthat evaluation, Tesoro’s principal executive officer and principal financialofficer have concluded that its disclosure controls and procedures areeffective in ensuring that information required to be disclosed by the Companyin the reports that it files or submits under the Exchange Act is recorded,processed, summarized, and reported within the time periods specified by theSEC’s rules and forms. At this time, management has determined that theCompany’s current system of disclosure controls and procedures are sufficienti) to ensure that data errors, control problems, or acts of fraud aredetected and ii) to confirm that appropriate corrective action, includingprocess improvements, is undertaken in a timely manner.

 

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

 

We are in the processof implementing the requirements of Section 404 of the Sarbanes-Oxley Actof 2002 which requires our management to assess the effectiveness of ourinternal control over financial reporting and include an assertion in our

 

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2007 annual report asto the effectiveness of our internal controls over financial reporting.Subsequently, our independent registered public accounting firm, McGladrey &Pullen LLP, will be required to attest to whether our assessment of theeffectiveness of our internal controls over financial reporting is fairlystated in all material respects and separately report on whether it believes wemaintained, in all material respects, effective internal control over financialreporting as of December 31, 2007. We are in the process of performing thesystem and process documentation, evaluation and testing required formanagement to make this assessment and for the registered public accountingfirm to provide its attestation report. We have not completed this process orits assessment, and this process will require significant amounts of managementtime and resources. In the course of evaluation and testing, management mayidentify deficiencies that would need to be addressed and remediate

 

**PART II**

 

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

 

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

 

**ITEM 2.****    ****UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

On August 25, 2005, as part of theclosing of a $5.0 million private offering of debt securities with LaurusMaster Fund, Ltd., Laurus provided us with a secured revolving note with amaximum availability of $5.0 million, which is currently convertible into1,824,818 shares of common stock at a conversion price of $2.74 per share,including the amount under the secured convertible minimum borrowing note.  We also issued warrants that allow Laurus topurchase up 511,883 shares of our common stock at $3.15 per share through August 25,2010, and options to purchase 1,170,110 shares of our common stock at $.001 pershare through August 25, 2010, but which are subject to a one-year lock-upthrough August 25, 2006.  Of the$5.0 million in proceeds received, $45,000 was paid to Laurus’ counsel forlegal fees and $2,000 for escrow fees. We also paid $195,000 to Laurus Capital Management, LLC for management feesin connection with the transaction through closing and to Laurus of $25,000 fordue diligence fees.  These offeringexpenses paid on behalf of Laurus totaled $267,000 and were paid in cash.  After these expenses, we received netproceeds of approximately $4,759,000. Of the net proceeds, we extinguisheddebts totaling $338,662 to three Tesoro executive officers and directors andthe remaining proceeds were used for general corporate purposes.

 

The sale of these securitieswere deemed to be exempt from registration under the Securities act in relianceon Section 4(2) of the Securities Act, or Regulation D promulgatedthereafter, as transactions by an issuer not involving a public offering.Laurus represented its intention to acquire the securities for investment onlyand not with a view for sale in connection with any distribution thereof andappropriate legends were affixed to the share certificates and instrumentsissued in such transactions. The sales of these securities were made withoutgeneral solicitation or advertising. Laurus is an accredited investor and hadadequate access, through their relationship with the Company, to information,including financial, about the Company. None of these transactions involved any underwriters, underwritingdiscounts or commissions.

 

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

 

**(a)****         ****Exhibits**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                         |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Articles of Incorporation (filed as an Exhibit to the Company’s  Form 10-SB, filed with the Securities and Exchange Commission on  August 7, 2000)                                                                  |
| 3.1.1               |       | Articles of Amendment to Articles of Incorporation dated  September 23, 2002 (filed as an Exhibit to the Company’s Report on  Form 8-K, filed with the Securities and Exchange Commission on  October 1, 2002) |
| 3.2.2               |       | Amended and Restated Bylaws (filed as an Exhibit to the  Company’s Report on Form 8-K, filed with the Securities and Exchange  Commission on February 4, 2003)                                                      |
| 3.3.2               |       | Audit Committee Charter (filed as an Exhibit to the Company’s  Report on Form 8-K, filed with the Securities and Exchange Commission on  February 4, 2003)                                                          |
| 3.3.3               |       | Compensation Committee Charter (filed as an Exhibit to the  Company’s Report on Form 8-K, filed with the Securities and Exchange  Commission on February 4, 2003)                                                   |
| 3.3.4               |       | Nominating And Governing Committee Charter (filed as an  Exhibit to the Company’s Report on Form 8-K, filed with the  Securities and Exchange Commission on February 4, 2003)                                       |

 

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| 3.4.1 |   | Code of Ethics for Senior Financial Officers (filed as an  Exhibit to the Company’s Registration Statement, filed with the  Securities and Exchange Commission on April 11, 2003)                                                                                                                                                                                            |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.1.1 |   | Form of Warrant Agreement (filed as an Exhibit to the  Company’s Registration Statement, filed with the Securities and Exchange  Commission on April 11, 2003)                                                                                                                                                                                                          |
| 4.1.2 |   | Form of Stock Certificate (filed as an  Exhibit to the Company’s Registration Statement, filed with the  Securities and Exchange Commission on April 11, 2003)                                                                                                                                                                                                          |
| 10.3  |   | 2001 Ponca Acquisition Corporation Stock Incentive Plan. (filed as an  Exhibit to the Company’s Report on Form 8-K, filed with the  Securities and Exchange Commission on September 11, 2002)                                                                                                                                                                           |
| 10.4  |   | Employment Agreement Between Ponca Acquisition  Corporation And Henry Jr. Boucher, Jr. Dated As Of December 29,  2002 (filed as an Exhibit to the Company’s Report on Form 8-K,  filed with the Securities and Exchange Commission on September 11, 2002)                                                                                                     |
| 10.5  |   | Memorandum Of Understanding Between Ponca Acquisition Corporation And  The Stockholders Of International Wholesale Tile, Inc. (filed as an Exhibit to  the Company’s Report on Form 8-K, filed with the Securities and Exchange  Commission on September 11, 2002)                                                                                                 |
| 10.6  |   | Stock Purchase Agreement Among The Stockholders Of International  Wholesale Tile, Inc., and Ponca Acquisition Corporation effective October 1,  2002 (filed as an Exhibit on Form 8-K, filed with the Securities  and Exhibit Commission on October 15, 2002).                                                                                                |
| 10.9  |   | Form of Indemnity Agreement (filed as an Exhibit to the  Company’s Registration Statement, filed with the Securities and Exchange  Commission on April 11, 2003)                                                                                                                                                                                                        |
| 10.10 |   | Employment Agreement between International Wholesale Tile, Inc.  and Forrest Jordan (exhibits omitted) (filed as an Exhibit to the  Company’s Registration Statement, filed with the Securities and Exchange  Commission on May 21, 2003)                                                                                                                               |
| 10.11 |   | Employment Agreement between International Wholesale Tile, Inc.  and Paul F. Boucher (this document is omitted as it is substantially similar  to Forrest Jordan’s Employment Agreement with the exception of the employee’s  name and address)                                                                                                                              |
| 10.12 |   | Employment Agreement between International Wholesale Tile, Inc.  and Grey Perna (this document is omitted as it is substantially similar to  Forrest Jordan’s Employment Agreement with the exception of the employee’s  name and address)                                                                                                                                   |
| 10.13 |   | Subordination Agreement between Congress Financial Corporation  (Florida). and Forrest Jordan (filed as an Exhibit to the Company’s  Registration Statement, filed with the Securities and Exchange Commission on  May 21, 2003)                                                                                                                                             |
| 10.14 |   | Subordination Agreement between Congress Financial Corporation  (Florida). and Paul F. Boucher (this document is omitted as it is  substantially similar to Forrest Jordan’s Subordination Agreement with the  exception of the employee’s name and address)                                                                                                                      |
| 10.15 |   | Subordination Agreement between Congress Financial Corporation  (Florida). and Grey Perna (this document is omitted as it is substantially  similar to Forrest Jordan’s Subordination Agreement with the exception of the  employee’s name and address)                                                                                                                           |
| 10.16 |   | Amended and Restated Loan and Security Agreement between by and  between Fleet Capital Corporation, IWT Tesoro Corporation and International  Wholesale Tile, Inc. effective December 31, 2004 (filed as an  Exhibit to the Company Registration Statement on Form S-1 filed with  the Securities and Exchange Commission on September 21, 2005)                   |
| 10.17 |   | Form of Security Agreement dated as of August 25, 2005, by  and between IWT Tesoro Corporation and International Wholesale  Tile, Inc., on the one hand, and Laurus Master Fund Ltd., on the other  hand (without exhibits). (filed as an exhibit to the Company’s Report on  Form 8-K filed with the Securities and Exchange Commission on  August 25, 2005) |
| 10.18 |   | Form of Secured Term Note, dated as of August 25, 2005, by  Tesoro and IWT in favor of Laurus Master Fund, Ltd. (filed as an exhibit to  the Company’s Report on Form 8-K filed with the Securities and Exchange  Commission on August 25, 2005)                                                                                                                   |
| 10.19 |   | Form of Subsidiary Guaranty, dated as of August 25, 2005,  by the Tesoro’s subsidiaries in favor of Laurus Master Fund (filed as an  exhibit to the Company’s Report on Form 8-K filed with the Securities  and Exchange Commission on August 25, 2005)                                                                                                       |
| 10.20 |   | Form of Common Stock Purchase Warrant, by Tesoro in favor of  Laurus Master Fund., Ltd. dated August 25, 2005 (filed as an exhibit to  the Company’s Report on Form 8-K filed with the Securities and Exchange  Commission on August 25, 2005)                                                                                                                     |
| 10.21 |   | Form of Funds Escrow Agreement dated August 25, 2005 (filed  as an exhibit to the Company’s Report on Form 8-K filed with the Securities  and Exchange Commission on August 25, 2005)                                                                                                                                                                              |
| 10.22 |   | Form of Funds Escrow Agreement dated August 25, 2005 (filed  as an exhibit to the Company’s Report on Form 8-K filed with the  Securities and Exchange Commission on August 25, 2005).                                                                                                                                                                             |
| 10.23 |   | Minimum Borrowing Note in favor of Laurus date August 25, 2005  (filed as an Exhibit to the Company                                                                                                                                                                                                                                                                               |

 

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|   |   | Registration Statement on Form S-1 filed with the Securities and  Exchange Commission on September 21, 2005                                                                                                                                         |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.24  |   | Option Agreement to Laurus dated August 25, 2005 (filed as an  Exhibit to the Company Registration Statement on Form S-1 filed  with the Securities and Exchange Commission on September 21, 2005                                         |
| 13     |   | Annual report to security holders (filed as an exhibit to the Company Report  on Form 10-K filed with the Securities and Exchange Commission on  April 14, 2005).                                                                                   |
| 16     |   | Letter from Kantor Sewell & Oppenheimer, P.A., concurring  with statements concerning their resignation (filed as an exhibit to the  Company Report on Form 8-K filed with the Securities and Exchange  Commission on September 14, 2004). |
| 21     |   | Subsidiaries of Registrant (filed as an exhibit to the Company Report  on Form 10-K filed with the Securities and Exchange Commission on  April 14, 2005).                                                                                          |
| 31.1   |   | Certification of Henry  J. Boucher, Jr., Chief Executive Officer pursuant to Section 302 of  the Sarbanes-Oxley Act.*                                                                                                                               |
| 31.2   |   | Certification of Forrest Jordan, Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act.*                                                                                                                                            |
| 32.1   |   | Certification of Henry J.  Boucher, Jr., Chief Executive Officer pursuant to Section 906 of  the Sarbanes-Oxley Act.*                                                                                                                               |
| 32.2   |   | Certification of Forrest Jordan, Chief  Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act.*                                                                                                                                            |

 

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

 

(b)         Reports on Form 8-K

 

Form 8-K, filed on August 26, 2005, regarding the Company’s subordinated debt agreements with Laurus Master Fund, Ltd for $5.0 million.

 

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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 18, 2005 |   |   | /s/ Henry J. Boucher, Jr.             |   |
|                   |   |   | Henry J. Boucher, Jr., President      |
|                   |   |   |                                       |
| November 18, 2005 |   |   | /s/Forrest P. Jordan                       |   |
|                   |   |   | Forrest P. Jordan, Chief Financial Officer |
|                        |        |        |                                            |  |  |

 

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