**U.S. SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-KSB**

**ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For the Year Ended December 31, 2003**

**Commission File No. 000-31267**

 

**IWT TESORO CORPORATION**

(Name of Small Business Issuer in ItsCharter)

 
| **NEVADA**                                                      |   | **91-2048019**                          |
|-----------------------------------------------------------------|--------|-----------------------------------------|
| (State of Other Jurisdiction of Incorporation or  Organization) |   | (I.R.S. Employer Identification Number) |
|                                                            |   |                                    |
| **191 Post Road West, Suite 10, Westport,  Connecticut 06880**  |
| (Address of Principal Executive Offices and Zip Code)           |
|                                                            |   |                                    |
| **(203) 271-2770**                                              |
| (Issuer’s Telephone Number, Including Area  Code)          |

 

Securities registered under Section 12(b) of the Exchange Act: ** None**

 
| **Title of Each Class** |   | **Name of Each Exchange on Which Registered** |
|-------------------------|--------|-----------------------------------------------|
| NONE                    |   | NONE                                          |

 

Securities registered underSection 12(g) of the Exchange Act:

**Common Stock, $.001 par value**

(Title of Class)

 

Check whether the issuer (1) has filed all reports required to be filedby Section 13 or 15(d) of the Exchange Act during the past 12 months (orfor such shorter period that the issuer was required to file such reports, and(2) has been subject to such filing requirements for the past 90 days.

Yes  ý   No  o

 

Check if there is no disclosure of delinquent filers in response toItem 405 of Regulation S-B contained in this form, and no disclosure will becontained, to the best of issuer’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form10-KSB or any amendment to this Form 10-KSB. o

 

Check whether the registrant is an accelerated filer oYes  ýNo

 

State issuer’s revenues for its most recent fiscal year:  $ 32,659,546

 

State the aggregate market value of the voting stock held bynon-affiliates computed by reference to the price at which the stock was sold,or the average bid and asked prices of such stock, as of a date specifiedwithin the past 60 days:  $ 9,143,935.50

 

**APPLICABLE ONLY TO CORPORATE REGISTRANTS**

 

State the number of shares outstanding of each of the issuer’s classesof common equity, as of the latest practicable date.  11,660,702 shares as of March 24, 2004

 

Transitional Small Business Disclosure Format (checkone)     Yes o   No ý

 

**DOCUMENTS INCORPORATED BY REFERENCE**

None

 

 

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**PART I**

 

**ITEM1.****                        DESCRIPTIONOF BUSINESS**

 

***Background***

 

IWTTesoro Corporation (Tesoro) was organized in Nevada on May 3rd, 2000originally under the name “Ponca Acquisition Corporation” but changed its nameto IWT Tesoro Corporation on September 23, 2002.  It was originally organized to attempt to locate and negotiatewith a business entity for the combination of that target company with it.  On October 1, 2002, it acquired all ofInternational Wholesale Tile, Inc.’s (IWT) common stock from threeshareholders.  IWT is a wholesaledistributor of imported ceramic, porcelain and stone floor, wall and decorativetiles organized in 1994.  In exchangefor the IWT stock, the IWT shareholders each received 3.0 million Tesoroshares, representing 87% of Tesoro’s then outstanding common stock.

 

InJanuary 2003, Tesoro organized a Bermuda company, IWT TesoroInternational, Ltd. (International), that will own any internationalsubsidiaries.  Tesoro also organized IWTTesoro Transport, Inc. (Transport). Transport is a federally licensed freight carrier that manages bothinbound and outbound freight for IWT.

 

Tesoro’sexecutive offices are located at 191 Post Road West, Westport, CT 06880 and ourtelephone number is (203) 221-2770. Our web site can be found at *http://www.iwttesoro.com*.

 

Anytimewe refer to “we”, “our” or “us” in this Description of Business, we meanInternational Wholesale Tile, Inc.

 

***Business and Growth Strategy***

 

Webelieve that we have built our reputation by supplying quality products withoutstanding customer service at competitive prices.  We strive to stay up-to-date with the newest styles and trends inthe ceramic tile and stone industry.  Wealso aim to introduce high quality new products to the marketplace as soon aspracticable.  We further believe that wehave built confidence and loyalty among our customers by distributing ourproducts only on a wholesale level and not selling direct to the consumer.  Other keys to our success include:

 

•                  Activemerchandising programs assisting our dealer/customers to meet the consumer’sdemand with products presented in attractive easy to visualize environments;

•                  Acting as theextension of our dealer networks’ stock availability by warehousing levelsconsistent with the dealers’ delivery requirements;

•                  Selling only at the wholesale level; neverdirect to the end user or consumer.

 

Wehope to increase our business by expanding geographic penetration and byextending the lines of product we offer and support.

 

InApril 2003, we moved to our new 147,000 square foot facility that willenable us to stock more inventory for future growth.  During the third quarter of fiscal 2003, we acquired anadditional 75,000 square feet of adjacent warehouse space.

 

During2002, we created TesoroTM The Collection, a branded collection of high qualityporcelain floor and wall tiles complemented by coordinated decorative bordersand listellos.  We plan to expand theTesoroTM line of products by building our proprietary TesoroTM brandawareness.  We prominently display theTesoro line at all of the national and regional flooring exhibitions in whichwe participate.  We have also placedinstitutional print media and television advertising to educate consumers andto support our dealer network.

 

Tesorofurther intends to grow by acquiring or merging with existing regionaldistributors.

 

Tesoro’sshort-term objectives are to:

 

•                  Raise equity capital for our internal growth,to

 

•                  Augment our client base and marketpenetration by expanding nationally in three to five additional markets, mostlikely in the West, Southwest, and Midwest, by duplicating our Palm City,Florida model.  Southern California isour highest priority.

 

•                  Expand our position as a preferred vendor fornational buying groups who work directly with some of the nation’s largest homebuilders and provide purchasing contracts for independently owned, brandedfloor covering stores such as Carpet One and Abby Carpet,

 

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•                  Expand further into the home center business,

 

•                  Increase our product lines,

 

•                  Increase investment in merchandise samplingand displays within our customer base.

 

•                  Strengthen our consolidated balance sheet byreducing our debt to equity ratio.  Wehope to accomplish this by using new equity to fund growth and eventuallyreduce debt, and

 

•                  Provide capital for expansion throughcompatible business combinations.

 

Ona short-term basis, Tesoro intends to look to acquire assets of businesses withproducts and services that complement our business.  Tesoro also intends to establish subsidiaries based in Spain andItaly to handle our relationships with manufacturers located in thosecountries.

 

***The Ceramic, Porcelain and Natural StoneFlooring and Wall Covering Market***

 

Weoperate in the floor covering industry which has grown from $12.4 billionin sales (in wholesale dollars) in 1992 to $20.3 billion in 2002,according to the July 21, 2003 Floor Covering Weekly.  Additionally, according to that same issue,the United States floor covering industries’ primary categories were carpet andrugs (65%), ceramic tile (12%), vinyl and rubber (10%), hardwood (9%), andlaminate (4%).

 

Accordingto Market Studies, Inc., a recognized industry market research firm, the estimated2003 market for ceramic tile in the United States was approximately$2.53 billion, up 7.4% from year-earlier levels.  Additionally, according to The Ceramic Tile Market, 2004 editionpublished by Market Studies, Inc., during the five-year period from 1997 to2002, the U.S. ceramic tile market advanced at a 10.6% annual rate on a squarefootage basis.  Imported productsatisfied most of this demand, climbing at an annual rate of 14.7%, expandingits market share to 77% in 2002 from 64% in 1996.  This trend continued in 2003 as imports posted a 9.6% gain involume and garnered an additional 1% share of the market despite a 2.6% priceincrease.

 

TheU.S. Ceramic market has been positively impacted by:

 

1.               U.S. population growth, requiring new andrenovated housing and commercial space

 

a.               Housing starts reached 1.85 million units in2003, surging by 8.4%, which was the best performance in twenty-six years;

 

b.              In 2003, the new construction market reboundwas driven by a 10.3% surge in the residential sector which included

 

i.                  2003 issuance of building permits was up6.6%  and

 

ii.               new,one-family home sales rose 13.8% in the south, our primary market;

 

2.               Mortgagerates at a forty-year low made homes affordable for an expanding number ofhouseholds while the refinancing of existing mortgages improved consumers’financial positions and provided increased funds for spending for remodeling;

 

3.               Increasingaverage house size (up approximately 30% since 1980); and

 

4.               Growthin vacation (second) home ownership.

 

Ceramictile usage in the United States doubled in the past seven years, from 1.42billion square feet in 1996 to 2.86 billion square feet in 2003.  The compound average growth rates for unitssold (measured by square yards) for each of the floor covering categories abovefor the period from 1998 through 2002 have exceeded the growth rate of theUnited States’ gross domestic product over the same period.  During this time, based on square footage,as cited by July 21, 2003 Floor Covering Weekly, the compound averagegrowth rate was 8.7% for ceramic tile.

 

Forty-ninepercent of imported ceramic tile comes from Italy, 17% from Spain and 10% fromMexico.  The balance originates from alarge number of countries including Brazil, Turkey, China and Portugal.  The United States’ market is the fourthlargest consumer of tile in the global market representing about 20% of globalconsumption.  Our products are primarilyimported and our purchases distribution among international suppliersapproximates these national statistics.

 

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 Theaverage wholesale price of ceramic tile edged lower in 2003, falling to $.88per square foot.  This decline was dueprimarily to a 4.7% reduction in the prices for domestic product.  Imported ceramic tile prices rose two centsa square foot to $.79 in 2003, largely on price increases for Italiantile.  The rising Euro coupled withenergy cost inflation is expected to boost overall ceramic tile prices in2004.  This will be the first increaseafter ten years of deflation.  Thestrong demand for new and remodeled housing in the United States, coupled withthe continuing shift by the consumer away from carpet and toward hard surfaces,has resulted in a forecast by Market Studies that the demand will remain robustand that prices will stabilize.

 

MarketStudies, Inc. projects “that the U.S. ceramic tile market will reach 3.76billion square feet by 2008, posting and annual growth rate of 5.6%.  Imports will continue to outpace domesticproduction, garnering an additional 4% market share.  The value of this market is expected to reach $3.4 billionby 2008, expanding at a 6% annual pace as prices for ceramic tile firm”.

 

Longacknowledged for its durability and functionality, ceramic tile now meansfashion.  Consumers can chose from softhues or primary colors, finishes that resemble stone or fabric, and canincorporate metal and glass accents for flexible design.  The high growth rate of ceramic tilerelative to other flooring options has led to more full servicedistributorships, manufacturers, and retailers adding ceramic tile to theirlines.  With more floor space beingdevoted to ceramic tile at retail, efforts at product differentiation haveintensified.  Licensing, a relativelynew strategy in the ceramic tile marketplace, is heating up, including thefollowing partnerships: Shaw Industries with Martha Stewart and Kathy Ireland;Witex with Laura Ashley, Armstrong’s Liz Claiborne line in partnership withCarpet One, and Marrazzi Group with Benetton.

 

Salesin the ceramic tile industry are influenced by economic and market factorsincluding:

 

•                  consumer confidence;

•                  spending for durable goods;

•                  interest rates;

•                  turnover in housing, the condition of theresidential and commercial construction industries; and

•                  the overall strength of the economy.

 

“USCeramic Tile Market- 2004 Edition”, published by Market Studies, pointed to amarket growth rate for ceramic tile of approximately 5% to 7% per year.  This growth rate is higher in the Sun Beltareas, including the Southeastern part of the United States, where we currentlyoperate.

 

Glazedfloor and wall tile represented 86% of the total industry dollars shipped in2002.  Unglazed mosaic and porcelain,11% of the total, and quarry title, 3% of the total, represent the balance ofthe industry’s 2002 dollars shipped. The ceramic title industry’s two primary markets, residentialapplications and commercial applications, represents 72.3% and 27.7% of theindustry total, respectively.  Of thetotal residential market, 67% of the dollar shipments are for new construction.

 

***IWT’s Products***

 

Wepurchase our products on the world market. Approximately 50% of our products are imported from Italy, 35% fromSpain and 5% each from Brazil, Turkey and China.  Each foreign manufacturer has registered agents in the UnitedStates that work with us, as well as with other distributors.  We believe that we maintain close personalcontact with our suppliers, visiting the plants regularly and working withsuppliers to influence design, quality and reliability.  We do not purchase any raw materials, butonly finished goods.  Our principalsuppliers and the countries in which each is located include

 

•                  Gruppo CBS, division of Kis Ceramiche, Italy;

•                  Imolagres, Italy;

•                  Ceramica Gomez, Spain;

•                  Ceramica Colli, Italy;

•                  Ceramica Fondavalle, Italy; and

•                  Ceramica Gaya, S.A., Spain.

 

Ourproduct types include ceramic tile, porcelain tile, tumbled marble, mosaiclistellos and medallions, honed and filled marble, unfilled marble, resintravertine listellos, and polished medallions. Each year, new products are added to our product line.  For example, we have recently added granitecounter and backsplash tiles to our product mix.  Items are removed when they become obsolete, which we define ashaving minimal sales in any consecutive 12-month period.

 

Wemaintain a wide distribution of price points for our product.  Our lowest priced products include red bodyceramic tiles to mid priced solid body porcelain to higher priced natural stonetiles.  Pricing strategies are alsodesigned to provide incentives to customers for purchasing product in largerquantities.  We ship product to ourcustomers in quantities

 

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rangingfrom “cut order” specific to a consumer’s project to full pallets of a singleproduct to full container and truckload packages.  These larger quantities allow our customers to stock their ownproduct to service cash and carry consumers.

 

Themarket for ceramic tiles, once characterized by little or no brand recognition,is beginning to enter into branding agreements with well-known designer namessuch as Martha Stewart and Laura Ashley. In May 2002, we introduced our proprietary brand TesoroTM.  Tesoro is a collection of porcelain tilesand decorative inserts, borders, and accents that will be marketed throughoutthe United States.  We have invested inspecifically designed display racks that communicate the quality and value ofour new brand.

 

Weimport our products into the Port of Miami. All our customers are approved by sales territory managers and mustqualify as IWT customers.  Material isshipped to the customer base via our trucks or by common carrier.  We generally ship same day on orders placedbefore 2:00 p.m.  Most deliverypoints are one to two day services for the southeastern United States.  Local trucks deliver between Daytona Beach,Florida and Miami, Florida.  Each day,common carriers pick up materials near the end of the business day to deliverto other parts of the country.

 

***Inventory***

 

Weare committed to maintaining inventory levels that support the sales of ourdealer network.  Our new 147,000 squarefoot warehouse contains over nine million square feet of product, representingover 2500 SKU’s (individually numbered product items).  We target an inventory turn over rate of 2.5to 3.0.  This turn over rate isestablished to minimize out of stock situations and to attain our goal of sameday shipping for qualified orders received by 2 PM.

 

Industrytrends toward product packages, i.e. floor and wall tile combinations and thepre-organized tile, borders, decorative listellos, bull nose and end caps,increases the number of parts we must carry in stock to ensure that our dealerscan meet the demand of their consumer.

 

***Freight and Transportation Costs***

 

Webase our distribution costs on a number of factors including, among others,

 

•                                          factory cost,

•                                          freight (international and domestic), and

•                                          duties, tariffs, taxes and other regulatorycosts.

 

Becauseocean freight charges differ from country to country, our selling price isbased on factors specific to each international manufacturer.  We pay all our international manufacturersin U.S. dollars.  The strength of theU.S. dollar relative to a specific country’s currency will have an impact onthe price we pay for product.  There isnow a new security port charge of $150.00 per shipment that we must pay.  Additionally, we also take into account thattitle to our products transfers at the port of the originating country.  We generally ship between ten and twentycontainers at any one time.  Wecurrently estimate that our maximum exposure for loss would be approximately$150,000.  Based on maritime losshistory, cost of ocean marine insurance and our ultimate ability to subrogateagainst the freight carrier, we self-insure in the event of loss after title istaken.

 

However,we often place special orders on behalf of our customers.  If any shipments were lost or damaged, ourclients would not be able to receive their product in a timely fashion, which,in turn, could adversely affect our relationship with those customers.  To date, we have only incurred minimallosses with respect to products that have been lost after it acquired title.  Likewise, the outbound transportation costsdiffer depending on how far our products are to be shipped.

 

Becauseof the increase in gasoline and fuel prices and other surcharges, our shippingcosts have increased.  However, we havenot yet passed any surcharges to all customers.  As such, our gross margins may be lower because we are currentlyabsorbing these increased costs.

 

Asa result of these increased shipping costs, Tesoro recently organized IWTTesoro Transportation, Inc., a federally licensed freight carrier.  By working with this affiliate company tosupply a portion of our shipping needs, we hope to decrease these costs.

 

***IWT’s Customer Base and DistributionChannels***

 

Wedistribute our products through three separate distribution channels.

 

•                  The retail floor-covering dealer market isour largest channel.  This channelcurrently accounts for about 75% of the sales revenue.  These customers, who sell direct to thepublic, can be either “cut to order” or “stocking” dealers/regionaldistributors.  We currently serveapproximately 2,000 customers in this channel through our sales personnel.  In addition, we have sub-distributors thathandle specific market territories for

 

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limitednumbers of our Tesoro product packages.

 

•                  The home center“buy-it-yourself/do-it-yourself” store market makes up our second distributionchannel.  These customers typicallyoperate under blanket purchase orders. The home center market offers us the opportunity to ship truck andcontainer load volumes to central distribution hubs for final distribution bythe customer.  There are two basicprograms for home center stores.  Thefirst is a special order program. Consumers place orders from sample boards provided by us to thestore.  The store representatives forwardthese orders to us and we ship the product either directly to the consumer orto the store for pick-up by the consumer. The second program is a stocking program, which provides for a homecenter store to maintain specific product inventories for their cash and carrytrade.  The home center store channelcurrently accounts for about 5% of our revenue.

 

•                  Our third channel, accounting for 5% of ourrevenues, is made up of national buying groups.  These groups support independently owned, branded floor coveringoutlets with coordinated buying agreements that require us to market directlyto each individual retail outlet.  Thischannel also includes large builders who staff and maintain captive designcenters specifically for their own customers.

 

•                  Our forth channel is the bulk salechannel.  In this channel weservice larger buyers that purchase full truckloads or containers of specificproduct that is manufactured for us specifically for this program.  These products can be drop-shipped from ourmanufacturer directly to the customer. The customer base for this channel is the United States and Canada.  This channel makes up the remaining 15% ofour sales.

 

Wemaintain separate and coordinated sales forces for each of the channels ofdistribution.  We also sell differentproduct series to each channel to avoid market saturation or channelconflict.  Currently, we do not dependon any single customer for more than 2% of our sales.

 

***Merchandising***

 

Webelieve that a strong and focused merchandising program is a key component toour success.  A mainstay of this programis our branding of our TesoroTM collection of coordinated and high endproducts.  We have created a series ofproduct display units that assist our dealers with the communication of productcombinations to their consumer.  We arecontinually updating these displays with new products.  We have a fifteen-year warranty program forTesoroTM products that we believe elevate the quality position of our products.

 

Inaddition to the display units, we provide our customers with display boardsthat are smaller and show a single line of product with its accent pieces.  These boards are portable so as to allow thedealer to easily show our product or take it to the installation site.  Our sales force distributes lose samplepacks, usually an assortment of colors for a single product line, whenever aline or dealer needs restocking.  Wecarry the display units and sample boards as assets on our books and depreciateover their useful lives.  The samplepacks are charged as marketing expenses when they are distributed.

 

***Credit and Collection Procedures***

 

Wemaintain strict criteria for credit approval:

 

•                                          Potential customers must complete our creditapplication;

•                                          Credit must be approved by our creditdepartment; and

•                                          We may require a personal guaranty.

 

Onceapproved, typically our customers receive 30-day terms.  Our bulk truckload customers may be offeredextended terms of payment.  We havepurchased credit insurance for these extended term customers to offset some ofthe risk inherent in the extending of longer credit terms.

 

Additionally,to be an IWT customer, a business must, at the least:

 

•                                          Have a storefront,

•                                          Sell retail, and

•                                          Have a forklift.

 

Whensales orders are entered, our computer system notes if a customer is on credithold.  If so, those orders are given toour credit department to determine whether the products can be shipped.  Customers are generally given a 15 day graceperiod and orders are held and not shipped once an invoice is 60 days orolder.

 

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***Marketing, Promotion and Sales***

 

Ourpublic relations and marketing activities focus on creating demand for ourproducts.  We have an in-houseadvertising and marketing staff that develops and coordinates our salesmaterials.  We use trade magazinesarticles, specifically designed mailer programs and trade shows as our primarycommunication devices.

 

Ourcommission based sales force work with dealers to place the products in showrooms, educate the dealers regarding the quality and variety of productavailable to them and work with our internal customer service staff tofacilitate delivery.  We employ atwenty-person full time sales force most of whom have been with us for fiveyears after spending many years in various facets of the tile business.

 

***Competition***

 

Wecompete in the flooring industry with both large national companies that supplyboth soft and hard materials and with smaller regional distributors that focusspecifically on ceramic, porcelain and stone. Vertically integrated companies such as Shaw Industries and Mohawk,while maintaining their dominant positions in the carpet market, are movingaggressively into the hard flooring sector. Dal-tile, a subsidiary of Mohawk, manufactures, wholesales and retailstile on a national basis.

 

Regionalcompetitors such as Master Tile, Florida Tile and Arizona Tile act as bothwholesalers and retailers.  In theirmarkets, each supplies smaller dealers and distributors and also operatesbranded retail outlets.  We currentlyonly distribute on a regional basis at a wholesale level.

 

Webelieve that our competitive strengths include:

 

•                  *Focusing solely on thewholesale segment of the distribution process.* We donot own or operate direct to consumer locations.  We work exclusively through dealers and stocking distributors whoservice the buying public.  As a result,we do not compete with our customers. Our customers can buy from us specific materials to meet a consumer’sneed, i.e. “cut orders” or can stock limited amounts of product for cash andcarry business by purchasing larger quantities.

 

•                  *Getting involved indesigning products.* We actively participate in designing andselecting new color, texture and formats for emerging style tends.  Our field sales force is constantly workingwith our customers to identify trends in the market.  Feedback from these sources is continuously shared with themanufacturers.  Manufacturer’s representativesfrequently meet with us and our management travels to the manufacturing sitesto communicate the markets needs.

 

•                  *Building our TesoroTM BrandEquity.* We are branding all our designs and many ofour products with our Tesoro Brand.  Weincorporate products from different manufacturers and different countries intoprograms that leverage the best of each source to create Tesorocollections.  Unlike most other tile andceramic products, Tesoro products include a 15-year warranty against wear.

 

•                  *Providing superiormerchandising and customer support programs.* We maintain an active samplingprogram to ensure that customers have the latest materials in theirshowrooms.  Our field sales forcecontinually updates, refreshes and replaces sales materials.  We distribute literature to consumersreferencing our dealer network participants. Our field personnel work with the customer and train them on theappropriate use and care of the product. Our goal is to make the dealers’ job as easy as possible.

 

•                  *Implementing ourDistribution Philosophy.* We see ourselves as an extension of thedealer warehouse.  We aim to beresponsive to our customers’ needs by shipping most orders the same day theyare received.  We also carry stock toback-up our customers in the cash and carry market.

 

Bymaintaining these competitive strengths, we believe that we can profitablychallenge our competitors for a greater share of our targeted market.

 

***Government Regulations***

 

TheFederal trade commission regulates IWT’s wholesale operations.  The Federal Motor Carriers Administrationregulates Transport’s freight brokerage. International is an exempt company subject to Bermudian commerciallaw.  We do not expect to import productinto Bermuda and will therefore maintain our exempt status.  Both federal and state authorities regulatethe distribution and sale of imported products.  We have obtained all required federal and state permits, licensesand bonds to operate our businesses.  Wemake no assurances that our operations and profitability will not be subject tomore restrictive regulations, oversight or increased taxation by foreign,federal, state or local agencies.

 

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Wecurrently purchase our products from foreign manufacturers in U.S.dollars.  Our fund transfers arerelatively large.  The Office of the Comptrollerof the Currency (USOCC) monitors these activities.  Should the EURO continue to strengthen against the US dollar, wecould see an increase in our cost of product that could, in time, to pass on toour customers and therefore have a detrimental impact on ourprofitability.  Our competitors rely asheavily on imported product as we do. Therefore, we do not see any change in the competitive landscape forceramic tile as a result of the strength of the EURO.

 

***Acquisitions and other Interests***

 

Tesorointends to expand its operating activities globally.  We have had preliminary discussions with manufacturers, productaggregators and agencies in Spain, Italy and Brazil.  We expect to take an interest position in several operationsduring 2004.  In the United States, wehope to expand our geographical position by acquiring the assets of similar,but smaller, distributors and are in preliminary discussions with a distributorin the southwest.  We cannot assureanyone, however, that any of these discussions will result in the intendedacquisitions or that any acquisitions, if made, will generate the plannedrevenue or profits.

 

***Intellectual Property***

 

Weincorporate our proprietary brand TesoroTM in connection with a collection ofporcelain tiles and decorative inserts, borders, and accents.  We are in the process of applying forfederal trademark protection for our trademark, but unless and until ourregistration is granted, we must rely on common law to protect our brand.  We make no assurances that this protectionwill be meaningful.  We are not aware ofany claims of infringement against us and we have not been involved in anyrelated court proceedings.

 

***Employees***

 

IWTcurrently employs 80 non-union warehouse and administrative staff and 20salespeople.  IWT believes that itsrelationships with its employees are good. Tesoro currently has two employees. Neither Transport nor International currently has any employees.

 

**IMPORTANT RISK FACTORS**

 

Investing in our common stock involves high risk.  You should carefully consider the followingimportant risk factors and the other information contained in this prospectusbefore investing in our common stock. The price of our common stock could decline because of any of these risks,and you could lose all or part of your investment.  You also should read and consider the other information includedin this prospectus, including the financial statements and related notes.  If any of the events described here occur,our business prospects, financial condition and operating results could bematerially affected in a negative manner.

 

Company Risks

 

*As to Tesoro:*

 

WE WILL LIKELY NEED TO RAISE ADDITIONAL FUNDS IN THE FUTURE FORACQUISITIONS AND GROWTH.  IF WE CANNOTSECURE ADDITIONAL FUNDS, WE MAY NOT BE ABLE TO EXPAND OUR BUSINESS.

 

Future events, including the problems, delays, expenses anddifficulties frequently encountered by wholesale tile and ceramics distributorslike us, may lead to increased costs that could make it difficult for us tosucceed with our business plan.  Toraise additional capital, we may sell additional equity securities, accept debtfinancing, or obtaining financing through a bank or other entity.  There is no limit as to the amount of debtwe may incur nor have we adopted a ratio of our equity to debt.  If we need to obtain additional financing, itmay not be available or it may not be available on terms acceptable to us.  Likewise, an offering of our securities maynot be successful.  If additional fundsare raised through issuing additional stock, the value of our outstanding stockmay be significantly diluted.

 

Our future capital requirements will depend upon many factors,including the following:

 

•                                          Themagnitude of the inventory we must carry to adequately support our customers;

•                                          Thevolume of sample material and product we must have in place with our customersto help merchandise our products;

•                                          Thenumber of different product variations demanded by our customers

 

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•                                          Currencyfluctuations, particularly with respect to the Euro Dollar against the U.S.Dollar;

•                                          Therate at which we expand our operations; and

•                                          Theoccurrence, timing, size and success of acquisitions.

 

OUR QUARTERLY OPERATING RESULTS FLUCTUATE, WHICH COULD RESULT IN ALOWER PRICE FOR OUR COMMON STOCK.

 

Our quarterly results may be affected by a variety of factors, some ofwhich are beyond our control, including, for example, the following:

 

•                                          Introducingnew products or pricing programs by our competitors;

•                                          Increasedtransportation costs;

•                                          Increasesin selling and marketing expenses, as well as other operating expenses;

•                                          Economicconditions specific to building materials industry; and

•                                          Costsand risks associated with potential acquisitions.

 

Of these conditions, the 1st, 2nd and 4th factors are largely beyondour control.

 

GENERALLY, WE MUST PAY ALL COSTS AND EXPENSES INCURRED WITH DEFENDINGANY ACTIONS ALLEGED AGAINST ANY OF OUR DIRECTORS.

 

Our articles of incorporation and bylaws provide that we may indemnifyour officers and directors against losses sustained or liabilities incurredarising from any transaction in that officer’s or director’s respectivemanagerial capacity unless that officer or director:

 

•                                          violatesa duty of loyalty,

•                                          didnot act in good faith,

•                                          engagesin intentional misconduct or knowingly violated the law, or

•                                          derivesan improper benefit from the transaction.

 

Additionally, we have also entered into separate indemnity agreementswith each of our executive officers and directors to provide added protectionunless that person committed any of the prohibited acts described above.  We carry standard directors and officersliability insurance and employment practices liability insurance.  Any obligations we incur defending any suchactions could adversely affect our cash flow and profitability.

 

OUR ARTICLES OF INCORPORATION AND BYLAWS CONTAIN CERTAIN PROVISIONSTHAT COULD HINDER A CHANGE IN OUR CORPORATE CONTROL.

 

Certain provisions of our certificate of incorporation and bylaws maydiscourage, delay or prevent a merger or acquisition that a stockholder mayconsider favorable.  Only our directorsmay call annual stockholder meetings and only our directors, officers orstockholders holding not less than a majority of all shares entitled to votemay call a special stockholder meeting, Likewise, our bylaws require noticeprocedures with regard to stockholder proposals and nominations of candidatesfor electing directors are required. Furthermore, vacancies on our Board, including newly createddirectorships, may be filled by a majority of our directors then in office andnot by our stockholders.

 

FAILING TO IDENTIFY SUITABLE ACQUISITION CANDIDATES, TO COMPLETEACQUISITIONS AND TO INTEGRATE THE ACQUIRED OPERATIONS SUCCESSFULLY COULDADVERSELY AFFECT OUR BUSINESS STRATEGY AND OPERATIONS.

 

As part of our business strategy, we intend to acquire complementarybusinesses.  Although we regularlyevaluate acquisition opportunities, we may not be able to:

 

•                                          Successfullyidentify suitable acquisition candidates;

•                                          Obtainsufficient financing on acceptable terms to fund acquisitions;

•                                          Completeacquisitions; or

•                                          Profitablymanage acquired businesses.

 

Additionally, acquired operations may not achieve levels of sales,operating income or productivity comparable to those of our existingoperations, or perform as expected. Acquisitions may also involve a number of special risks, some or all of

 

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which could have a material and adverse effect on our business,operating results and financial condition. Among these risks are:

 

•                                          Ourinability to integrate operations, systems and procedures and to eliminateredundancies and excess costs effectively;

•                                          Divertingmanagement’s attention and resources; and

•                                          Difficultyretaining and training acquired key personnel.

 

WE MAY BE UNABLE TO OBTAIN PRODUCTS ON A TIMELY BASIS, WHICH COULDMATERIALLY HAVE AN ADVERSE EFFECT ON OUR BUSINESS.

 

We do not manufacture any of the products we distribute.  Our business depends upon a continuoussupply of material from third party suppliers. We currently import a majority of our products from 40 foreignmanufacturers.  While we believe thislarge group of suppliers insulates us from the effect of any one supplier,international supply relationships are sensitive to geo-political situationsbeyond our control.  In particular, wedepend heavily on Italy and Spain and any disruption in this supply chain couldput us in a difficult position. However, any extended interruption in product supply would disrupt ouroperations, which could adversely affect our business, financial condition andoperating results.

 

BECAUSE WE DO NOT CARRY ANY INSURANCE ON OUR PRODUCTS THAT ARE INTRANSIT, WE RISK LOSING ENTIRE SHIPMENTS.

 

Title to our products transfers at the port of the originatingcountry.  We self-insure in the event ofloss after title is taken.  We only shipbetween ten and twenty containers at any one time.  We currently estimate that our current maximum exposure for losswould be approximately $150,000. Because we often place special orders on behalf of our customers, if anyshipments were lost or damaged, our clients would not be able to receive theirproduct in a timely fashion, which, in turn, could adversely affect ourrelationship with those customers.  Todate, we have only incurred minimal losses with respect to products that havebeen lost after it acquired title.

 

IF THE CONFLICT IN THE MIDDLE EAST ESCALATES, WE MAY HAVE DIFFICULTYOBTAINING PRODUCTS FROM CERTAIN FOREIGN MANUFACTURERS.

 

To date, we have not been adversely affected in any material way byconflicts in the Middle East.  We havenot had problems obtaining product from Turkey, although minor problems withproduct from Dubai have occurred. However, we purchase only limited product from Dubai manufacturers andcan obtain substitute products, if necessary. Protest strikes in the European Union countries such as Spain and Italymay slightly delay shipping of products, but to date, these delays have beenvery minor.

 

WE MAY BE UNABLE TO PASS ON TO OUR CUSTOMERS INCREASES INTRANSPORTATION COSTS, WHICH COULD HAVE A MATERIAL EFFECT ON OUR PROFITABILITY.

 

Significant increases in transportation costs could adversely effect onour operating margins and our business, financial condition and operating results.  Although we generally attempt to pass onincreases in the costs to our customers, our ability to do so is, to a largeextent, depends on the rate and magnitude of any increase, as well ascompetitive pressures and market conditions for our products.  There have been, in the past and may be inthe future, periods of time during which increases in this cost cannot berecovered.  During these periods, ourprofitability could be adversely affected.

 

IF WE GROW TOO QUICKLY, WE COULD ENCOUNTER PROBLEMS RELATED TOINCREASED CUSTOMER DEMANDS ON OUR LIMITED RESOURCES.

 

Rapid growth would place a significant strain on our managerial,operational, financial and other resources. Our systems, procedures, controls and management resources may not beadequate to support our future operations. Future growth will require us to

 

•                                          implementadditional management information systems,

•                                          developfurther our operating, administrative, financial and accounting systems, and

•                                          maintainclose coordination between departments.

 

If we cannot manage our growth, we could limit our ability tocapitalize on new business opportunities that may arise or to implement ourbusiness strategy.  Additionally, wecannot assure anyone that our personnel, systems and controls will be

 

10

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adequate to support future growth. Our inability to manage growth or to maintain the quality of ourproducts and services could cause us to lose customers and could significantlyincrease our operating expenses.

 

WE DEPEND ON OUTSIDE DISTRIBUTORS FOR PRODUCT SALES.

 

We sell our products primarily through a network of dealers andsub-distributors.  These distributors donot have a minimum sales requirement. Our distributors are independent contractors.  If we do not competitively price our products or if the qualityof the products is low our distributors may fail to aggressively market ourproducts for us.  If our distributors donot successfully sell our products, then our revenue and profits may notmaterialize.

 

IF WE ARE UNABLE TO RETAIN OUR MANAGEMENT TEAM, OUR BUSINESS OPERATIONSAND OUR GROWTH OBJECTIVES MAY BE ADVERSELY AFFECTED.

 

Our success in achieving our growth objectives depends upon the effortsof our top management team including the efforts of Henry J. Boucher, Jr., ourChief Executive Officer, Forrest Jordan, our Chief Financial Officer and SeniorVice President, and Paul F. Boucher and Grey Perna who also are Senior VicePresidents, as well as other of our management members.  While we do have written employmentagreements with each of these individuals, we currently do not have employmentagreements with all our employees.  Theloss of the services of any of these individuals may have a material adverseeffect on our business, financial condition and operating results.  We may not be able to maintain and achieveour growth objectives should we lose any or all of these individuals’ services.

 

FUTURE EXCHANGE RATE FLUCTUATIONS OR INFLATION COULD HAVE A MATERIALADVERSE EFFECT ON OUR OPERATING RESULTS.

 

We import most of the product we sell from countries whose currency isthe Euro Dollar.  We currently writepurchase contracts and pay for materials in U.S. dollars.  However, the manufacturing facilities payall their expenses in their country’s currency.  This means that IWT realizes a benefit when a country’s currencydevalues against the U.S. dollar, although that country’s inflation rate orinternal expenses may offset this benefit. Any future increases in a country’s inflation rate, which are not offsetby devaluation of their currency, may negatively impact our operatingresults.  To the extent that a foreigncountry’s currency appreciates against the U.S. dollar, there could be amaterial adverse effect on our business, financial condition and operatingresults.

 

Industry Risks

 

OUR INDUSTRY IS CYCLICAL AND PROLONGED DECLINES IN RESIDENTIAL ORCOMMERCIAL CONSTRUCTION ACTIVITY COULD ADVERSELY AFFECT OUR BUSINESS.

 

The ceramic and tile floor covering industry depends on residential andcommercial construction activity, including both new construction, as well asremodeling.  New construction activity,and remodeling to a lesser degree, is cyclical in nature and a prolongeddecline in residential or commercial construction activity could have a materialadverse effect on our business, financial condition and operating results.  Construction activity is significantlyaffected by numerous factors, all of which are beyond our control, including:,among others,

 

•                                          Nationaland local economic conditions;

•                                          Interestrates;

•                                          Housingdemands;

•                                          Employmentlevels;

•                                          Changesin disposable income;

•                                          Financingavailability;

•                                          Commercialrental vacancy rates;

•                                          Federaland state income tax policies; and

•                                          Consumerconfidence.

 

The U.S. construction industry has experienced significant downturns inthe past, which have adversely affected suppliers to the industry, includingsuppliers of ceramic and tile floor coverings. The industry could experience similar downturns in the future, whichcould have a negative impact on our business, financial condition and operatingresults.

 

WE FACE INTENSE COMPETITION IN THE FLOORCOVERING INDUSTRY, WHICH COULDDECREASE DEMAND FOR OUR PRODUCTS AND COULD HAVE A MATERIAL ADVERSE EFFECT ONOUR PROFITABILITY.

 

11

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The industry is highly competitive. We face competition from a large number of domestic and foreignimporters and independent distributors of floor covering products.  Some of our existing and potentialcompetitors may be larger and have greater resources and access to capital thanwe do.  Maintaining our competitiveposition may require us to make substantial investments in our product designefforts, distribution network and sales and marketing activities.  Competitive pressures may also result indecreased demand for our products and in the loss of market share.  In addition, we face, and will continue toface, pressure on sales prices of our products from competitors, as well asfrom large customers.  As a result ofany of these factors, there could be a material adverse effect on our sales andprofitability.  Hard flooring productsalso face competition from alternative products such as carpet, hardwood andvinyl.  Changes in customer attitudestoward hard flooring and wall covering materials could also adversely affectour ability to market and sell our products profitably.

 

Investment Risks

 

IN ADDITION TO THE SHARES ELIBIBLE FOR SALE IN THE FUTURE, WE MAY ISSUEMORE SHARES OF OUR COMMON STOCK IN THE FUTURE. THIS WOULD REDUCE INVESTORS PERCENTAGE OF OWNERSHIP AND MAY REDUCE OURSHARE VALUE.

 

Sales of substantial amounts of this common stock in the public marketcould adversely affect the market price of the common stock.  Furthermore, all of the remaining shares ofcommon stock presently outstanding are restricted or affiliate securities thatare not presently, but may in the future be sold, pursuant to Rule 144, intoany public market that may exist for the common stock.  Future sales by current shareholders coulddepress the market prices of the common stock in any such market.

 

Our Articles of Incorporation authorizes our issuing up to100.0 million shares of common stock and 25 million shares ofpreferred stock.  If we issue all orpart of our remaining authorized common stock or preferred stock, depending onits terms, the percentage of common stock held by existing stockholders wouldbe diluted. We may value any stock issued in the future on an arbitrary basis.Issuing common or preferred stock for future services or acquisitions or othercorporate actions may have the effect of diluting the value of the shares heldby our investors, and might have an adverse effect on the value of our shares.

 

SINCE WE HAVE NOT PAID ANY DIVIDENDS ON OUR STOCK AND DO NOT INTEND TOIN THE NEAR FUTURE, A PURCHASER OF OUR STOCK WILL ONLY REALIZE A GAIN ON HIS ORHER INVESTMENT IF THE MARKET PRICE OF OUR COMMON STOCK INCREASES.

 

We have never paid, and do not intend to pay, any cash dividends on ourcommon stock in the current year. Therefore, an investor in this offering, inall likelihood, will only realize a profit on his investment, in the shortterm, if the market price of our common stock increases in value.

 

WE CANNOT ASSURE ANYONE THAT THERE WILL EVER BE A LIQUID PUBLIC MARKETFOR OUR SECURITIES.

 

Although our common stock are eligible for quotation on the OTCBBmaintained by the NASD, there has been only limited and sporadic trading in thestock since it commenced trading on December 17, 2003.  No regular or established public trading marketfor our common stock has been established prior to this offering, and we cannotassure anyone that a regular and established market will develop or ifdeveloped, that it will continue. Additionally, we make no assurances as to the depth or liquidity of anymarket for our stock or the prices as which our stockholders may be able tosell their securities.  As a result, aninvestment in our common stock may be illiquid and investors may not be able toreadily liquidate their investment or at all when they need or desire to sell.

 

OUR COMMON STOCK’S CURRENT TRADING MAY NOT ACCURATELY REFLECT ITSFUTURE MARKET PERFORMANCE.

 

The trading price of our common stock may be highly volatile and couldbe subject to wide fluctuations in response to factors such as the active floatof our securities could be small, meaning that relatively small trades of oursecurities could materially effect the share price and other general economicor stock market conditions, many of which are beyond our control.

 

In addition, the stock market in general, and the market for shares intile and ceramic floor covering companies in particular, have experiencedextreme price and volume fluctuations that have often been unrelated ordisproportionate to the operating

 

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performance of such companies. We make no assurance that these tradingprices and price earnings predictions will be sustained.

 

In addition, a substantial portion of our future expenses, includingmost product design and selling and marketing expenses, must be incurred inadvance of revenue generation. If our actual revenue does not meet ourexpectations, then our operating profit, if any, may fall short of ourexpectations, or our operating loss may be greater than our expectations. Wemay need to change our pricing strategy for and these changes may affect ourquarterly results. Any one or more of these factors could affect our business,financial condition and operating results, and this makes the prediction ofoperating results on a quarterly basis unreliable. As a result,period-to-period comparisons of our historical operating results may not bemeaningful and you should not rely on them as an indication of our futureperformance. This could adversely affect the price of our common stock.

 

OUR SHARES CURRENTLY DO NOT QUALIFY FOR LISTING ON NASDAQ. OUR COMMONSTOCK MAY ONLY TRADE ON THE OVER-THE-COUNTER BULLETIN BOARD.

 

Under the current rules relating to the listing of shares on NASDAQSmallCap, we must have:

 

•                                          Threeregistered and active market makers;

•                                          Stockholders’equity of at least $5 million, or market capitalization of at least$50 million, or net income of at least $750,000 in the most recentlycompleted fiscal year or in two of the last three most recently completedfiscal years;

•                                          Operatinghistory of at least one year or market capitalization of $50 million;

•                                          Publicfloat of at least 1,000,000 shares;

•                                          Marketvalue of public float of at least $5 million;

•                                          Aminimum bid price of $4.00 per share; and

•                                          Atleast 300 stockholders who own at least 100 share each, among otherrequirements.

 

For a continued listing, a company must maintain:

 

•                                          Tworegistered and active market makers, one of which can be a market makerentering a stabilizing bid;

•                                          Stockholders’equity of at least $2.5 million, market capitalization of at least$35 million, or net income of at least $500,000 in the most recentlycompleted fiscal year or in two of the last three most recently completedfiscal years;

•                                          Apublic float of at least 500,000 shares;

•                                          Marketvalue of public float of at least $1 million; and

•                                          Aminimum bid price of $1.00 per share, among other requirements.

 

Our common stock will not initially be eligible for listing on theNASDAQ SmallCap. Accordingly, trading is currently being conducted on theOTCBB, which ordinarily has a much lower trading volume than on NASDAQ. Veryfew market makers take interest in shares traded OTCBB and, accordingly, themarkets for such shares are less orderly than is usual for NASDAQ stocks. As a resultof the low trading volumes ordinarily obtained in over-the-counter markets,sales of common stock in any significant amount can generally not be absorbedwithout a dramatic reduction in price. Moreover, thinly traded shares in theover-the-counter markets are more susceptible to trading manipulations than isordinarily the case for more actively traded shares.

 

THE APPLICATION OF THE “PENNY STOCK RULES”COULD ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK.

 

While our common stock is currently not considered to be a “pennystock”, it may in the future.  Pennystocks generally are equity securities with a price of less than $5.00 pershare other than securities registered on certain national securities exchangesor quoted on the NASDAQ Stock Market, provided that current price and volumeinformation with respect to transactions in such securities is provided by theexchange or system.  Our common stockmay be subject to “penny stock rules” that impose additional sales practicerequirements on broker-dealers who sell such securities to persons other thanestablished customers and accredited investors (generally those with assets inexcess of $1,000,000 or annual income exceeding $200,000 or $300,000 togetherwith their spouse).  For transactionscovered by these rules, the broker-dealer must make a special suitabilitydetermination for the purchase of such securities and have received thepurchaser’s written consent to the transaction prior to the purchase.  Additionally, for any transaction involving apenny stock, unless exempt, the “penny stock rules” require the delivery, priorto the transaction, of a disclosure schedule prescribed by the Commissionrelating to the penny stock market.  Thebroker-dealer also must disclose the commissions payable to both

 

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the broker-dealer and the registered representative and currentquotations for the securities.  Finally,monthly statements must be sent disclosing recent price information on thelimited market in penny stocks. Consequently, the “penny stock rules” may restrict the ability ofbroker-dealers to sell our common stock and may have the effect of reducing thelevel of trading activity of our common stock in the secondary market.  These required penny stock restrictions willnot apply to our securities if such securities maintain a market price of $5.00or greater.  There can be no assurancethat the price of our common stock will reach or maintain such a level.

 

A SMALL NUMBER OF STOCKHOLDERS OWN MOST OF OUR COMMON STOCK.

 

Those persons who are officers, directors or who own more than 5% ofour common stock will hold approximately 85% of our stock. Our management willcontinue to control most matters requiring approval by our stockholders. As aresult, management acting together have the ability to control substantiallyall matters submitted to our stockholders for approval, including electing andremoving directors and any merger, consolidation, takeover or other businesscombination involving us, and to control our management and affairs. This maydiscourage a potential acquirer from making a tender offer or otherwiseattempting to obtain control in an acquisition or takeover.

 

**ITEM2.****                        DESCRIPTIONOF PROPERTY**

 

Tesorocurrently subleases office space in Westport, Connecticut. We pay a monthlybase services fee of  $3,100 per monthand our lease expires June 2004. Tesoro anticipates that it will be obtaining more permanent space in thenear future.

 

IWTcurrently leases approximately 147,000 square feet in Palm City, Florida, ofwhich 5,000 square feet is for office space and the remaining 142,000 squarefeet is for warehouse space. The term of the lease is for 10 years asfollows: 

 

| 2004                |   | $ 908,639                                 |       |
|---------------------|--------|-------------------------------------------|------------|
| 2005                |   | $ 851,887                                 |       |
| 2006                |   | $ 872,437                                 |       |
| 2007                |   | $ 893,800                                 |       |
| 2008                |   | $ 915,6500                                |       |
| 2009 and thereafter |   | An aggregate of $3,866,100 |       |
| **TOTAL**           |   | **$** 8,893,786                           | ** ** |

 

**ITEM3.****                        LEGALPROCEEDINGS**

 

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

 

**ITEM4.****                        SUBMISSIONSOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

NONE

 

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**PART II**

 

**ITEM 5.****                         MARKETPRICE OF AND DIVIDENDS ON OUR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

 

*Market Information*.  On December 17, 2003, our common stockcommenced trading on the Over The Counter (OTC) Bulletin Board.  Trading of our common stock is limited andvery sporadic and we make no assurances that an established public tradingmarket will ever occur.

 

The high and low bid and ask price for the stock is as follows:

 
|                     |   | **High  Bid Price** |   | **Low  Bid Price** |   | **High  Ask Price** |   | **Low  Ask Price** |   |
|--------------------------|--------|---------------------|--------|--------------------|--------|---------------------|--------|--------------------|--------|
| 12/17/03 – 12/31/03 |   | $                   | 5.25   |               | $      | 5.00                |   | $                  | 6.50   |   | $ | 6.00 |   |
| 1/1/04 – 3/23.04    |   | $                   | 6.00   |               | $      | 4.50                |   | $                  | 6.50   |   | $ | 5.25 |   |

 

The Securities and Exchange Commission has adopted Rule 15g-9 whichestablishes the definition of a “penny stock”, for purposes relevant to Tesoro,as any equity security that has a market price of less than $5.00 per share orwith an exercise price of less than $5.00 per share, subject to certainexceptions.  For any transactioninvolving a penny stock, unless exempt, the rules require:

 

(i)                  that a broker ordealer approve a person’s account for transactions in penny stocks and

 

(ii)               the broker or dealerreceive from the investor a written agreement to the transaction, setting forththe identity and quantity of the penny stock to be purchased.

 

In order to approve a person’s account for transactions in pennystocks, they must

 

(i)                                     obtainfinancial information and investment experience and objectives of the person;and

 

(ii)                                  makea reasonable determination that the transactions in penny stocks are suitablefor that person and that person has sufficient knowledge and experience infinancial matters to be capable of evaluating the risks of transactions inpenny stocks.

 

The broker or dealer must also deliver, prior to any transaction in apenny stock a disclosure schedule prepared by the Commission relating tothe penny stock market, which, in highlight form,

 

(i)                                     setsforth the basis on which the broker or dealer made the suitabilitydetermination and

 

(ii)                                  thatthe broker or dealer received a signed, written agreement from the investorprior to the transaction.  Disclosurealso has to be made about the risks of investing in penny stocks in both publicofferings and in secondary trading, and about commissions payable to both thebroker-dealer and the registered representative, current quotations for thesecurities and the rights and remedies available to an investor in cases offraud in penny stock transactions.

 

Finally, monthly statements have to be sent disclosing recent priceinformation for the penny stock held in the account and information on thelimited market in penny stocks.

 

(b)                                 *Holders*. As of March 24, 2004, there were approximately 232 holders ofTesoro’s Common Stock.  The issued andoutstanding shares of Tesoro’s Common Stock were issued in accordance with theexemptions from registration afforded by Section 4(2) of the SecuritiesAct of 1933 and Rule 506 promulgated thereunder.

 

(c )*                               Dividends. *Dividends, if any, will be contingentupon Tesoro’s revenues and earnings, if any, capital requirements and financialconditions.  The payment of dividends,if any, will be within the discretion of Tesoro’s Board of Directors.  Tesoro presently intends to retain allearnings, if any, for use in its business operations and accordingly, the Boardof Directors does not anticipate declaring any dividends prior to a businesscombination.

 

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(d)                                 *Securities Authorized**to be Issued upon ourEquity Compensation Plans*

 

 

**Equity Compensation Plan Information**

 
|                                                    |   | **Number of  Securities  to be issued upon  Exercise of  Outstanding  options,  warrants  and rights** |       | **Weighted-  average  Exercise price of  outstanding  options,  warrants and  rights** |   | **Number of  securities remaining  available for future  issuance under  equity compensation  plans (excluding  securities in column)** |          |
|---------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------|---------------|
| Equity compensation plans approved by stockholders      |   | 306,668                                                                                                |       | $                                                                                      |   |                                                                                                                                    | 3,568,832     |   |
| Equity compensation plans not approved by  stockholders |   | -0-                                                                                                    |       | -0-                                                                                    |   | -0-                                                                                                                                     |          |
|                                                    |   |                                                                                                   |       |                                                                                   |   |                                                                                                                                    |          |
| **Total**                                               |   | **306,668**                                                                                            | ** ** | **$**                                                                                  |   |                                                                                                                                    | **3,568,832** | **(1)** |

 

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(1)                                  Tesoro’s Stock Incentive Plan includes theright to grant options and to issue restricted stock and the Plan was approvedby Tesoro’s then sole stockholder in December 2001. This number reflects124,500 restricted shares that have been issued all pursuant to the Planthrough December 31, 2003.

 

*Sales of Securitiesin connection with Our June 17, 2003 Offering.*

 

OnJune 17, 2003, the Securities and Exchange Commission declared ourregistration statement on Form SB-2 effective.

 

 Inconnection with the Registration Statement, two offerings are occurring. The first is the offer and sale of 250,000 units at $5.50 per unit.  Eachunit consists of one share of Tesoro common stock and a warrant to purchase oneshare at $7.00 per share through June 17, 2006.  The second is anoffer by certain Tesoro’s stockholders to sell an aggregate of 1,243,502 sharesregistered for resale.

 

Asrequired by Rule 463, as of December 31, 2003, all 250,000 units weresold, for which Tesoro received gross proceeds of $1,375,000.  Of the proceeds, $82,500 was paid inconnection with financial advisory fees and commissions, $125,000 was paid foroffering expenses and b. the remainder for inventory to support growth.

 

**ITEM6.****                        MANAGEMENT’SDISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS.**

 

Thefollowing discussion should be read along with our financial statements, whichare included in another section of this prospectus. This discussioncontains forward-looking statements about our expectations for our business andfinancial needs. These expectations are subject to a variety of uncertaintiesand risks that may cause actual results to vary significantly from ourexpectations. The cautionary statements made in this prospectus should be readas applying to all forward-looking statements in any part of this prospectus.

 

Wewere incorporated on May 5, 2000 as a Nevada corporation. Our principaloffice is located at 191 Post Road West, Suite 10, Westport, CT 06880. Anyreference in this “Management’s Discussion and Analysis or Plan of Operations”discussion to “the company,” “our,” “we” or “us” refers to Tesoro.

 

EffectiveOctober 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 ofthe IWT shares. As part of the transaction, Tesoro and each of the three IWTstockholders entered into a repurchase agreement by which the threestockholders may each sell a total of 150,000 shares of Tesoro’s common stockover a three-year period back to us for a price based on an amount equal to 88%of its then weighted average trading price. This agreement was terminated on June 26, 2003.  At that time, the common stock was nottrading on any exchange or quotation system.

 

Through IWT, we provide hard floor and wall covering materials,primarily ceramic, porcelain and granite tiles to the

 

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new construction and remodeling industries for the commercial andresidential marketplaces. We distribute our products through a network ofindependently owned dealers and distributors, buying groups and home centerretailers. We currently purchase our products predominately from foreignmanufacturers.

 

Ourprimary source of revenue is the sale of hard flooring and wall coveringmaterials and our primary costs relate to the acquisition, warehousing anddelivery of those products. While sales are made throughout the United States,the majority of our sales are in the southeastern quadrant of the country. Theprimary sources of working capital are a $17 million (US) revolving lineof credit from a division of a large US commercial bank, stockholders’ equityand our suppliers who have extended us terms. During 2003, we began trading our stock on the OTC-BB and raised equitythrough the public market. The new equity was used to strengthen our balancesheet and to provide capital for continued growth.

 

Inthe first quarter of 2003, we have created two new wholly owned subsidiarycompanies. The first is IWT Tesoro International Ltd, a Bermuda basedexempt company. A Bermuda exempt company is a company domiciled in Bermuda thatis not actively involved in trade or business on the island and is thereforeexempt from certain licensing requirements. International will serve as theholding company for any international based ventures we need to supportexpanding our sales effort. The other subsidiary is IWT TesoroTransport, Inc., a Florida corporation, and a licensed freight carrierthat will handle our freight operations.

 

Resultsof Operations for the year ending December 31, 2003

 

Thefollowing discussion and analysis should be read in conjunction with thefinancial statements and notes thereto that appear elsewhere in this document.The table below sets forth certain operating data as a percentage of totalrevenue for the periods indicated.

 
|               |   | **Fiscal  Year Ending  December 31** |   |
|--------------------|--------|-------------------------------------------|--------|
|               |   | **2001**                                  |   | **2002** |   | **2003** |   |
| Revenues           |   | 100                                       | %      | 100 | % | 100 | % |
| Cost of Goods Sold |   | 64                                        | %      | 60 | % | 61 | % |
| Gross Margin       |   | 36                                        | %      | 40 | % | 39 | % |
| Operating Expenses |   | 29                                        | %      | 31 | % | 36 | % |

 

*December 31, 2002 compared to December 31, 2001*

 

Salesfor the year ended December 31, 2003 were $32,659,546 a 29% increase oversales for the year ended December 31, 2001. This growth follows a 31%growth from 2000 to 2001 and a 29% growth from 2001 to 2002. We are arelatively small player in a growing market. We are entering new markets andadding new products; and we expect to be able to grow faster than the market asa whole for the next several years. Our share of this market is approximately1.5%. The tile market in the United States is approximately $2.34 billionand is growing at a five to seven percent rate.

 

Aswe grow, we have been able to purchase product at lower prices and haveconsequently lowered our cost of goods to 60% in 2002 from 64% in 2001. In2003, we added a bulk sales unit.  Inthis unit we sell full truckload quantities to other wholesalers across theUnited States and Canada.  The salesprice of these bulk products is somewhat lower than our dealer unit and willhave a moderating impact on our ability to reduce our cost of goods sold.  Consequently our cost of goods soldincreased to 61% for the year ended December 31, 2003.  Our cost of goods will be a function of themix of the sales from our different units, but should stay in the range we haveestablished over the past few years.

 

Ourearnings before interest, taxes, depreciation and amortization (EBITDA) fellfrom $2.65 million in 2002 to $1.59 million in 2003.

 

We have included reconciliation from our net income to EBITDA

 
|                    |   | **2003** |      | **2002** |   |
|-------------------------|--------|----------|-----------|----------|--------|
|                    |   |     |      |     |   |
| Net income              |   | $        | 436,305   |     | $      | 1,934,027 |   |
| Interest expense        |   | 480,139  |      | 328,920  |   |
| Income taxes (deferred) |   | 36,750   |      | (34,384  | )      |
| Depreciation            |   | 634,984  |      | 422,435  |   |
| Amortization            |   | 0        |      | 0        |   |
| EBIDTA                  |   | $        | 1,588,178 |     | $      | 2,650,998 |   |

 

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•                                          Themajor causes of the decreased EBITDA were (a) an decrease in net incomecaused by increased operating expenses for expanded warehouse facilities,shipping and sales personnel to open new business units and the costsassociated with being a public company, including one time costs for our initialpublic offering and ongoing legal, accounting and administrative costs, and(b) an decrease of 1% on the gross margin.

 

•                                          EBIDTAis not a GAAP concept and should not be used as the only measure of a company’sfinancial performance. Investors should refer to our financial statementsbefore making any investment decisions.

 

•                                          EBITDAis a concept used by financial managers to compare businesses that operate indifferent industries with different capital needs, tax circumstances and debtstructure.

 

Inearly April 2003, we moved into a new warehouse facility of nearly 147,000square feet, an increase of nearly 50% over the previous facility. 5,000 squarefeet of the new facility is for office space. In the third quarter of fiscal 2003, we acquired 68,000 square feet ofadditional adjacent warehouse space to accommodate our new bulk sale unit.These new facilities will allow us to increase our inventory and better serveour customers who rely upon us to meet the short lead times and limitedinventory capacity that exist in their markets. We hope to improve theefficiency of our warehouse operations by simplifying the receiving andshipping functions. We currently maintain between nine and eleven millionsquare feet of product in our facility. Our inventory turns, in 2003, were approximately 1.64 times.Availability of product is a key success factor for us and is a good use of ourcapital.

 

Makingit easy for our customers to sell product is a key success factor for us. Wehave an extensive sampling and display program that augments the training andmarketing support we provide our customers. As of December 31, 2003, ourinventory of samples in the field with our customers represents a significantinvestment ($4,226,949 before accumulated depreciation) that is capitalized onour balance sheet.

 

*Liquidity and Capital Resources*

 

Wehad cash balances of $867,361 and $574,046 at the end of December 31, 2003and December 31, 2002, respectively.

 

InDecember 2003, we completed a private offering of unregistered securitiesand signed a subscription agreement with an accredited investor to purchase100,000 shares of common stock and warrants to purchase 100,000 shares at $7.00per share at $5.50 per unit.  Inaddition, the investor signed a stock pledge agreement and a promissory notefor the $550,000, plus $3.0 interest per year that matures on June 30,2004.  Subsequent to the end of fiscal2003, the note was paid in full. The proceeds were used for inventory andworking capital purposes.  All of thewarrants were outstanding at December 31, 2003.

 

During2003, Tesoro completed a public offering of units substantially similar tothose described above at $5.50 per unit. We received net proceeds of $1,292,250after offering costs of $82,500.  Theproceeds were used for inventory and working capital purposes.  All of the warrants were outstanding atDecember 31, 2003.

 

InOctober 2002, we commenced a private offering of our common stock toaccredited investors for up to one million units at $3.00 per unit. Eachunit consists of one share of common stock and warrants to purchase 1-1/2shares initially at $3.00 per share for five years from the date the warrantwas issued. The price of the warrants will increase by $.25 per share at thebeginning of each calendar quarter following the first public sale of Tesoro’scommon stock and continue until the warrant expires.  Through closing at March 31, 2003, we raised $530,000 fromunit sales. We also raised an additional $255,000 from 85,000 warrants thatwere exercised by year-end December 31, 2003. The proceeds from theoffering and the warrant exercises were used for general corporate purposes,including paying fees to outside professionals and working capital.

 

OnNovember 21, 2000, our subsidiary, IWT, entered into a new loan andsecurity agreement with a financial institution totaling $5 million as arevolving loan, for a period of three years, with an option to renew for oneadditional year. This was amended and restated effective November 13, 2002and the amount of the maximum credit was increased from $5 million to$7.5 million.  OnSeptember 10, 2003, we entered into a new loan and security agreement withFleet Capital, a division of Fleet Bank, N.A. The new facility, a revolving line of credit, has a maximum limit of$17,000,000. The interest rate on this loan is calculated with reference to theBase rate and or LIBOR (London Interbank Offered Rate).  The balance due at December 31,2003 was$9,599,340

 

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**ITEM7.****                        FINANCIALSTATEMENTS**

 

The financial statements and supplemental data required by this Item 7follow the index of financial statements that appears at the end of Part I ofthis Form 10-KSB.

 

**ITEM8.****                       CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

EffectiveDecember 1, 2003, Tesoro independent accountants, Sewell and Company,PA, of Hollywood, Florida was replaced by the accounting firm of Kantor, Sewell& Oppenheimer, PA (KSO), the successor firm to Sewell and Company.  KSO maintains the same facilities as Sewell andCompany and is a Florida SEC qualified accounting firm.  Sewell reportedon and audited the financial statements prepared by the Registrant for theperiod commencing September 20, 2000 through September 30, 2003.

 

Therecommendation by Tesoro’s Audit Committee was based upon KSO becoming thesuccessor firm pursuant to the merger of Sewell with Kantor and Oppenheimer.

 

Noneof Sewell’s reports on the financial statements for either the past two yearscontained an adverse opinion or a disclaimer of opinion, nor were qualified ormodified as to uncertainty, audit scope, or accounting principles. Additionally, during the Registrant’s two most recent fiscal years and anysubsequent interim period preceding Sewell’s dismissal, there were nodisagreements with the Registrant’s former accountant on any matter ofaccounting principles or practices, financial statement disclosure, or auditingscope or procedures.

 

OnSeptember 13, 2002, Tesoro notified the accounting firm of Magee,Rausch & Shelton, LLP of Tulsa, OK (“MRS”) that MRS had been replacedas Tesoro’s principal accountant. MRS reported on and audited the financialstatements prepared by Tesoro since our inception on May 3, 2000 andending July 15, 2000. It has not prepared any financial statementssubsequent to the July 15, 2000, reports.

 

OnAugust 23, 2002, Tesoro engaged the accounting firm of Sewell and Company,PA of Hollywood, Florida, as its principal accountant to audit the financialstatements prepared by Tesoro for the fiscal year ended December 31, 2002and for its past financial filings. The decision to change accountants wasapproved by Tesoro’s Board of Directors and was based on its belief thatTesoro’s operations would be more accessible and economically undertaken by aFlorida SEC qualified accounting firm since its wholly-owned subsidiary,International Wholesale Tile, Inc. is a Florida corporation located inPalm City, Florida.

 

MRSdid not prepare the audited financial statements for the last two fiscal years.However, for the previously prepared audited report prepared by MRS, the MRSreport on Tesoro’s financial statements and audits contained no adverse opinionor disclaimer of opinion and were not qualified as to uncertainty audit scopeor accounting principle. For those reports and documents prepared by MRS, therehave been no disagreements with MRS on any matter of accounting principles orpractices, financial statement disclosures, or auditing scope or procedures.

 

**ITEM8A.****               CONTROLSAND PROCEDURES.**

 

*Disclosure Controls and Procedures*

 

(a)                                  Withinthe 90 days prior to the date of this report, we carried out an evaluation,under the supervision and with the participation of management, including ourprincipal executive officer and principal financial officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures pursuant to Exchange Act Rule 13a-14.  Based upon this evaluation, our principal executive officer andprincipal financial officer concluded that our disclosure controls andprocedures are effective in timely alerting them to material informationrelating to us (including our consolidated subsidiaries) that is required to beincluded in our periodic SEC reports.

 

(b)                                 Therehave been no significant changes in our internal controls or in other factorsthat could significantly affect these controls subsequent to the date of theevaluation described in the preceding paragraph.

 

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**ITEM9.****                        DIRECTORS,EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH 16(a).**

 

**Directors and Executive Officers**

 

Thefollowing table includes the names, positions with Tesoro and ages of ourExecutive Officers and Directors.

 
| **Name**               |   | **Age** |   | **Position**                                                                                                                                                                                                                                                                                                                   |   |
|------------------------|--------|---------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Henry  J. Boucher, Jr. |   | 56      |   | •    Tesoro: Chairman,  President, Chief Executive Officer, Director•    IWT Tesoro  International Ltd.: Director•    IWT Tesoro  Transport, Inc.: President and Director                                                                           |   |
|                   |   |    |   |                                                                                                                                                                                                                                                                                                                           |   |
| Forrest  Jordan        |   | 56      |   | •    Tesoro: Chief  Financial Officer, Senior Vice President; Director •    IWT: Senior Vice  President, Treasurer, Secretary, Director •    IWT Tesoro  International Ltd.: Director •    IWT Tesoro  Transport: Director |   |
|                   |   |    |   |                                                                                                                                                                                                                                                                                                                           |   |
| Paul  F. Boucher       |   | 45      |   | •    Tesoro: Director,  Senior Vice President •    IWT: President, Director  •    IWT Tesoro  International Ltd.: Director                                                                                                                          |   |
|                   |   |    |   |                                                                                                                                                                                                                                                                                                                           |   |
| Grey  Perna            |   | 47      |   | •    Tesoro: Director,  Senior Vice President •    IWT: Senior Vice  President, Director •    IWT Tesoro  International Ltd.: President, Director                                                                                                   |   |
|                   |   |    |   |                                                                                                                                                                                                                                                                                                                           |   |
| James  R. Edwards      |   | 52      |   | •    Tesoro: Secretary,  Director                                                                                                                                                                                                                                                                     |   |
|                   |   |    |   |                                                                                                                                                                                                                                                                                                                           |   |
| Carl  G. Anderson, Jr. |   | 59      |   | •    Tesoro: Director                                                                                                                                                                                                                                                                                 |   |
|                   |   |    |   |                                                                                                                                                                                                                                                                                                                           |   |
| James  Lafond          |   | 61      |   | •    Tesoro: Director                                                                                                                                                                                                                                                                                 |   |
|                   |   |    |   |                                                                                                                                                                                                                                                                                                                           |   |
| Robert  B. Rogers      |   | 68      |   | •    Tesoro: Director                                                                                                                                                                                                                                                                                 |   |
|                   |   |    |   |                                                                                                                                                                                                                                                                                                                           |   |
| Allen  G. Rosenberg    |   | 56      |   | •    Tesoro: Director                                                                                                                                                                                                                                                                                 |   |

 

**Henry J. Boucher, Jr.**    Henry has served asour President and a Director since December 29, 2001 and as our Chairmanand Chief Executive Officer since November 2002. He is also a Director ofInternational and President and a Director of Transport. Henry is the Presidentand a Director of Borough Corporation, an inactive company. He received hisM.S. in economics from South Dakota State University in 1972. From 1992 toJune 1999, Henry was a Vice President of Mercer Management Consulting, asubsidiary of Marsh McLennan, an insurance brokerage firm. Prior to joiningMercer, he was a partner with the accounting firm of Coopers and Lybrand (nowPriceWaterhouse Coopers). From June 1999 to July 2000, Henry was apartner with Arthur Andersen. He joined Business Edge Solutions, a technologyconsulting firm serving the financial services industry with e-commercepackaged solutions, where he was a Vice President until December 2000.Since January 2001, Henry has been a principal of Mentus Consulting LLC, aconsulting firm providing process improvement support services to a wide rangeof companies and industries.

 

**Forrest Jordan.**    Forrest has served as a Senior Vice Presidentof Tesoro since November 2002, a Director since October 1, 2002, andas our Chief Financial Officer since March 28, 2003. Forrest has served asa Vice President, Secretary and Treasurer of IWT since April of 1994. Healso serves as IWT’s sales manager. Forrest is also a Director of IWT, ofInternational and of Transport. He received his M.B.A. from Anna Maria Collegein Paxton, MA.

 

**Paul F. Boucher.**    Paul has served as a Senior Vice President ofTesoro since November 2002 and as one of our Directors sinceOctober 1, 2002. Paul has been the President of IWT since April 1994and in particular, focuses on IWT’s operations. He is also a Director of IWTand International.

 

**Grey Perna.**    Grey has served as a Senior Vice President ofTesoro since November 2002 and as one of our Directors sinceOctober 1, 2002. He has served as a Vice President of IWT since January 1997.He also serves as IWT’s marketing manager. He is also the President and aDirector of International.

 

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**James R. Edwards.**    Jim has served as one of our Secretaries sinceNovember 2002 and as a Tesoro Director since April 20, 2002. He hasbeen the Vice President, General Counsel and Secretary of WirelessKnowledge, Inc., a telecommunications company since March 2002, whichit absorbed into Qualcomm, its parent company. From April 2000 to March 2002, Jim served as the VicePresident, General Counsel and Secretary and Vice President ofFinance & Administrative for Vapotronics, Inc., a medical devicecompany. From March 1987 to April 2000, he was the Vice President, GeneralCounsel and Secretary of General Atomics, a high-technology research anddevelopment company.

 

**Carl G. Anderson, Jr.**    Carl has served as aDirector of Tesoro since October 28, 2002. He is Vice Chairman of theBoard and General Manager of Arrow International Inc., a $300 millioncritical care medical device business located in Reading, Pennsylvania since2002. Between May 1997 and 2002, Carl was the President and ChiefExecutive Officer of ABC School Supply, a $50 million supplier ofmaterials and equipment for public and private schools. Prior to joining ABCSchool Supply, he served as Vice President and General Manager of the RetailConsumer Products Division of James River Corporation since August 1994.He also served as Vice President of Marketing for James River Corporation fromMay 1992 to August 1994. He was a marketing executive atProcter & Gamble from 1972 to 1984 and Vice President and GeneralManager at Nestle Foods Corporation in Purchase, New York from 1984 to 1992.Carl also served as a Director of the J.B. Williams Company, Inc., amanufacturer of consumer products, until the company was sold inOctober 2002, and as a Director of ABC School Supply until the company wassold in August 2002. He also serves as a trustee of Lafayette College.Carl graduated from Lehigh University Graduate School of BusinessAdministration in 1972 and Lafayette College in 1967.

 

**James Lafond.**    Jim has served as a Director of Tesoro sinceOctober 24, 2002. Through September 30, 2002, he served asPricewaterhouseCooper’s Area Managing Partner for the Greater Washington Area,which encompasses client service offices in Washington, D.C., Maryland andVirginia. In this role, Jim had oversight responsibility for all of the Firm’slines of service, marketing and operations in metropolitan Washington, D.C.Over the course of his career, Jim has led PWC’s National Business Developmentand Industry Specialization functions, served as U.S. leader of the Marketingand Sales functions, and as Director of National Emerging Business Services,providing financial and tax advice to entrepreneurs and growing companies. Jimwas admitted as a General Practice Partner in 1974 in Massachusetts, moved toNew York in 1984, Florida in 1992 and to the Greater Washington area in late1994. Jim is resigning as a board member effective at the end of business onMarch 31, 2004.

 

**Robert B. Rogers.**    Bob has served as a Director of Tesoro sinceJanuary 2003, Since March 1999, he has served as the ChairmanEmeritus of the Ewing Marion Kauffman Foundation. Bob became president of theFoundation in April 1990 and in September 1993 was named chairman ofthe Board of its Directors. He remained as president of the Foundation untilJuly 1997, when he assumed chairman duties full time. Between 1967 and1971, Bob served in a variety of middle management positions for Trans WorldAirlines (TWA) in New York and in Kansas City. After leaving TWA, he joined theKansas City financial services firm of Waddell and Reed, where he was corporatecontroller until 1974. From there, Bob became chief financial officer ofGateway Sporting Goods until he joined Marion Laboratories in 1975 as corporatecontroller. A wide range of positions, including vice president of informationsystems and controls, vice president of financial controls, vice president ofcommunity affairs and finally president of the Marion Foundation, markedRoger’s tenure at Marion. Bob is also a Certified Public Accountant.

 

**Allen G. Rosenberg.**    Allen has served as a Director of Tesoro sinceNovember 7, 2002. Since February 2, 2004, Allen serves as the VicePresident of Marketing for Panolanm Industries International, Inc., a laminatemanufacturing company. He also co-founded Marke Communications Inc. in1979, for which he worked until January 2004, a direct response agency specializingin marketing and graphic arts productions.

 

Pauland Henry Boucher are brothers.

 

**Directors**

 

Amajority of the members of Tesoro’s Board of Directors are independent.

 

Directorsare elected at our annual meeting of stockholders and serve for one year oruntil their successors are elected. Our bylaws permit the Board of Directors tofill any vacancy and such Director may serve until our next Annual Meeting ofStockholders or until his successor is elected and qualified. Officers areelected by the Board of Directors and their terms of office are, except to theextent governed by employment contracts, at the discretion of the Board. Theofficers of the Company devote full time to our business.

 

Duringfiscal year 2003, the Board of Directors held four meetings and all directorsattended at least 75% of all meetings.

 

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**Board of Directors Committees**

 

OnNovember 22, 2002 our Board of Directors formed an Audit Committee, aCompensation Committee and a Nominating and Governance Committee. OnJanuary 23, 2003, upon the recommendation of each of the committees, ourBoard adopted charters for each of these committees.

 

AuditCommittee

 

Themembers of our Audit Committee include Jim Lafond, Chairman, Carl Anderson andBob Rogers. Each member possesses the required level of financial literacy andat least one member, Jim Lafond, meets the current standards of the “auditcommittee financial expert” required by applicable rules and regulations. Nomember of the Audit Committee has any relationship to Tesoro or to any of itssubsidiaries or affiliates that may interfere with the exercise of theirindependence from management and Tesoro.

 

OurAudit Committee

 

•                  reviews the planned scope and results ofaudits,

•                  considers any recommendations the auditorsmay make with respect to Tesoro’s internal controls and procedures,

•                  oversees any responses made to suchrecommendations, and

•                  reviews certain reports, including ourquarterly and annual reports that are filed with the SEC.

 

Ourauditors report directly to the Audit Committee.

 

OurAudit Committee meets with management and our auditors to receive informationconcerning, among other things, significant deficiencies in the design oroperation of internal controls. This information is received and reviewed priorto the filing of the required officers’ certification with our quarterly andannual reports filed with the SEC.

 

TheAudit Committee’s formal written charter specifies:

 

•                  Its membership requirements;

•                  Its rules and procedures;

•                  Its authority and responsibilities;

•                  The outside auditor’s accountability to theBoard and Audit Committee, and

•                  Its responsibility to oversee theindependence of the outside auditor.

 

During2003, the Audit Committee held eight meetings.

 

CompensationCommittee

 

Themembers of the Compensation Committee include Jim Edwards, Chairman and AllenRosenberg. Each of the members of this Committee meets the appropriate testsfor independence and no member has any relationship to Tesoro or any of itssubsidiaries or affiliates that may interfere with the exercise of theirindependence from management and Tesoro.

 

Thepurpose of this Committee is to discharge the Board’s responsibilities relatingto

 

•                  our Executive Officers’ compensation;

•                  our equity-based compensation plans,including, without limitation, stock option and restricted stock plans, inwhich officers or employees may participate, and

•                  arrangements with executive officers relatingto their employment relationships with Tesoro, including employment agreements,severance agreements, supplemental pension or savings arrangements, change incontrol agreements and restrictive covenants.

 

ThisCommittee has overall responsibility for approving and evaluating our executiveofficer compensation plans, policies and programs. It is also responsible forproducing an annual report on executive compensation to be included in ourproxy statement and assisting in preparing certain information to be includedin other periodic reports filed with the SEC.

 

TheCompensation Committee’s formal written charter specifies its

 

•                  Membership requirements;

•                  Rules and procedures; and

•                  Authority and responsibilities.

 

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During2003, the Compensation Committee held four meetings.

 

Nominatingand Governance Committee

 

Themembers of our Nominating and Governance Committee are Carl Anderson, Chairman,and Jim Edwards. Each member meets the appropriate tests for independence. Nomember of this Committee has any relationship to Tesoro or any of itssubsidiaries or affiliates that may interfere with the exercise of theirindependence from management and Tesoro.

 

TheNominating and Governance Committee is responsible for selecting thoseindividuals who stand for election to our Board of Directors and to considerall reasonable comments from Stockholders regarding proposed nominees forDirectors, as well as nominations for Board members recommended byStockholders.

 

TheCommittee also oversees the evaluation of the Board and management and developsand recommends to the Board a set of Corporate Governance guidelines. Inaddition, the Compensation Committee oversees, reviews and approves all ofTesoro’s ERISA and other employee benefit plans.

 

Likethe Compensation Committee, the Nominating and Governance’s formal writtencharter specifies its:

 

•                  Membership requirements;

•                  Rules and procedures; and

•                  Authority andresponsibilities.

 

During2003, the Nominating and Governance Committee held four meetings.

 

**Audit Committee Report**

 

The purpose of the Audit Committee is to monitor (i) the integrity ofthe financial statements, (ii) the compliance with legal and regulatoryrequirements, (iii) the independent auditor’s qualifications and independence,and (iv) the performance of the Company’s internal audit function andindependent auditors.  The Boardof Directors, in its business judgment, has determined that each current memberof the Committee is “independent”, as required by applicable listing standardsof the Sarbanes-Oxley Act of 2002 and applicable SEC rules. Management of theCompany is responsible for the preparation, presentation and integrity of theCompany’s financial statements. Management is also responsible for theCompany’s accounting and financial reporting principles and internal controlsand procedures designed to assure compliance with accounting standards andapplicable laws and regulations. The independent auditors are responsible forauditing the Company’s financial statements and expressing an opinion as to theirconformity with accounting principles generally accepted in the United Statesof America. The Audit Committee acts in accordance with a written charteradopted by the Board of Directors. The Committee reviews this charter annually.

 

Inthe performance of its oversight function, the Audit Committee has consideredand discussed the audited financial statements and unaudited quarterlyfinancial statements with management and the independent auditors including adiscussion of the quality, not just the acceptability, of accountingprinciples, the reasonableness of significant judgments and the clarity ofdisclosures in the financial statements. The Audit Committee has also discussedwith the independent auditors the matters required to be discussed by Statementon Auditing Standards No. 61, Communication with Audit Committees as currentlyin effect. Finally, the Committee has received the written disclosures and theletter from the independent auditors required by Independence Standard No. 1, *Independence Discussions with Audit Committees*,currently in effect, and has discussed with the auditors the auditors’independence from the Company and its management, and reviewed and approved thecompatibility of non-audit services provided by Sewell and Company and approvedthe fees paid to them for the 2003 fiscal year.

 

TheAudit Committee meets with the independent auditors, with and withoutmanagement present, to discuss the results of their examinations, theirevaluations of the Company’s systems of internal control, and the overallquality of the Company’s financial reporting**.**The Audit Committee reviewed the Company’s internal controls withthe Company’s independent auditors and, consistent with Section 302 of theSarbanes-Oxley Act of 2002 and the rules adopted thereunder, met withmanagement and the auditors prior to the filing of officers’ certificationsrequired by that statute to receive any information concerning (a) significantdeficiencies in the design or operation of internal controls which could adverselyaffect the Company’s ability to record, process, summarize and report financialdata and (b) any fraud, whether or not material, that involves management orother employees who have a significant role in the Company’s internal controls.

 

Itis not the Audit Committee’s duty or responsibility to conduct auditing oraccounting reviews or procedures. Audit Committee members are not employees ofthe Company and may not be, and may not represent themselves to be, or to

 

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serveas, accountants or auditors by profession. Members of the Audit Committee rely,without independent verification, on the information provided to them and onthe representations made by management and the independent accountants.

 

Basedupon the reports and discussions described in this report, and subject to thelimitations on the role and responsibilities of the Audit Committee referred toabove, the Audit Committee recommended to the Board that the audited financialstatements be included in the Company’s Annual Report on Form 10-KSB for theyear ended December 31, 2003 to be filed with the Securities and ExchangeCommission. The Committee has also recommended to the Company’s shareholdersthe appointment of Kantor, Sewell and Oppenheimer as Tesoro’s independentauditors for the 2004 fiscal year.

 

**James Lafond, Chairman**

**Carl G. Anderson Jr.**

**Robert Rogers**

 

## **Corporate Governance.**

##  

Our Board has also adopted “Principles of Corporate Governance/” Theseprinciples include the standards for our Board and management, which, includeother things,

 

•                  requires anethical Board, Chief Executive Officer and management;

•                  sets forth ourDirectors’ and committee members’ qualification standards and responsibilities;

•                  describes ourmanagement’s responsibilities to new Board members;

•                  enumerates theguidelines for our Board’s compensation;

•                  provide foraccess to our management and independent advisors; and

•                  addresssuccession planning for senior management.

 

**Code of Ethics**

 

On November 22, 2002, Tesoro’s Board of Directors adopted a Codeof Ethics for its executive officers, including its CEO and CFO.  **A COPY OFTHE CODE OF ETHICS IS AVAILABLE ON TESORO’S WEBSITE AT**www.iwttesoro.com.  The Company will also provide, at no charge,a copy of its Code of Ethics.

 

**Section 16(a)Beneficial Ownership Reporting Compliance**

** **

Section 16(a) of the Securities Exchange Act of1934, as amended, requires our Executive Officers, Directors and 10%Shareholders to file reports regarding initial ownership and changes in ownershipwith the SEC. Executive Officers, Directors, and 10% shareholders are requiredby SEC regulations to furnish us with copies of all Section 16(a) formsthey file. Our information regarding compliance with Section 16 is basedsolely on a review of the copies of such reports furnished to us by ourExecutive Officers, Directors and 10% shareholders. These forms include (i)Form 3, which is the Initial Statement of Beneficial Ownership of Securities,(ii) Form 4, which is a Statement of Changes in Beneficial Ownership, and (iii)Form 5, which is an Annual Statement of Changes in Beneficial Ownership.

 

Based on information provided to the Company, through February 29,2004, all required filings have been made with the following exceptions (a)James Edwards filed a delinquent Form 4 on February 4, 2003 that was dueon January 10, 2003; (b) Henry J. Boucher, Jr. filed a delinquent Form 4on September 24, 2003 that was due on September 14, 2003; (c) HenryJ. Boucher, Jr. filed a delinquent Form 4 on December 18, 2003 that wasdue on December 15, 2003; and (d) Robert Rogers filed a delinquent Form 4 on December 19, 2003 thatwas due on December 4, 2003.

 

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**ITEM10.****                 EXECUTIVECOMPENSATION**

 

Theinformation described in our discussion concerning “Executive Officers”includes Henry J. Boucher, Jr., Paul Boucher, Forrest Jordan and Grey Perna.Prior to November 2002, no individual held the title of Chief ExecutiveOfficer, however Henry J. Boucher, Jr. has acted in that capacity sinceDecember 2001.

 

**Summary Compensation Table**

 
|                                          |   |         |   |                    |    |           |   |                                 |   |                               |   | **Long-Term Compensation** |   |                  |
|-----------------------------------------------|--------|--------------|--------|-------------------------|---------|----------------|--------|--------------------------------------|--------|------------------------------------|--------|----------------------------|--------|-----------------------|
|                                          |   |         |   | **Annual Compensation** |    | **Awards**     |   | **Payouts**                          |   |                               |
| **Name and Principal Position**               |   | **Year**     |   | **Salary**              |    | **Bonus  ($)** |   | **Other  Annual  Compensation  ($)** |   | **Restricted  Stock  Awards  ($)** |   | **Options/  SARs**         |   | **LTP  Payouts  ($)** |   | **All Other  Compensation** |   |   |
|                                          |   |         |   |                    |    |           |   |                                 |   |                               |   |                       |   |                  |   |   |   |   |   |   |   |
| Henry J. Boucher, Jr.,                   |   | 2003         |   | $                       | 240,000 |           | $      | 25,000                               |   | $                                  | 18,000 | (2)                        | — |                  | — |   | — |   | — |   |   |
| Chairman, Director, President,                |   | 2002         |   | 120,000                 |    | -0-            |   | -0-                                  |   | —                             |   | 100,000                    | (3)    | -0-                   |   | -0- |   |   |
| Chief Executive Officer(1)                    |   |         |   | —                  |    | —         |   | —                               |   | —                             |   | —                     |   | —                |   | — |   |   |
|                                          |   |    |   |                    |    |           |   |                                 |   |                               |   |                       |   |                  |   |   |   |   |
| Paul F. Boucher, Director,               |   | 2003         |   | $                       | 263,066 |           | $      | 25,000                               |   | $                                  | 40,150 | (5)                        | — |                  |   |   | -0- |   | $ | — |   |   |
| Senior Vice President,                        |   | 2002         |   | 237,067                 | (4)     | -0-            |   | 57,6539                              | (6)    | —                             |   | 100,000                    | (3)    | -0-                   |   | 621,340 | (8) |   |
| President, International Wholesale Tile, Inc. |   | 2001         |   | 193,  783               |    | —         |   | 23,090                               | (7)    | —                             |   | —                     |   | —                |   | 173,819 | (8) |   |
| Forrest Jordan, Director, Senior              |   | 2003         |   | $                       | 253,067 |           | $      | 25,000                               |   | $                                  | 42,374 | (9)                        | — |                  |   |   | -0- |   | $ | — |   |   |
| Vice President, Vice President,               |   | 2002         |   | 237,067                 | (4)     | -0-            |   | 49,000                               | (10)   | —                             |   | 100,000                    | (3)    | -0-                   |   | 621,340 | (8) |   |
| Treasurer and Secretary,                      |   | 2001         |   | 193,783                 |    | —         |   | 19,871                               | (11)   | —                             |   | —                     |   | —                |   | 173,819 | (8) |   |
| International Wholesale Tile, Inc.            |   |         |   |                    |    |           |   |                                 |   |                          |   |                       |   |                  |   |   |   |   |
| Grey Perna, Director, Senior                  |   | 2003         |   | $                       | 253,067 |           | $      | 25,000                               |   | $                                  | 49,558 | (12)                       | — |                  |   |   | -0- |   | $ | — |   |   |
| Vice President, Vice President,               |   | 2002         |   | 237,067                 | (4)     | -0-            |   | 51,883                               | (13)   | —                             |   | 100,000                    | (3)    | -0-                   |   | 621,3409 | (8) |   |
| International Wholesale Tile, Inc.            |   | 2001         |   | 193,783                 |    | —         |   | 22,688                               | (14)   |                               |   | —                     |   | —                |   | 173,819 |   |   |

 

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| (1)    |   | Henry signed a Salary  Deferral Agreement with Tesoro, which was terminated by our Board, with Henry  abstaining from the vote.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| (2)    |   | This amount represents an  automobile fringe benefit.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| (3)    |   | These represent incentive  stock options granted as of November 23, 2002 pursuant to our Stock  Incentive Plan. The options are for ten years and have an exercise price of  $3.00 per share. The options vest as follows: (a) 33% at such time as  our Common Stock begins trading on the OTCBB (or equivalent), (b) 33% at  such time as Tesoro attains no less than a $50.0 million market cap for  ten consecutive trading days, and (c) 34% when Tesoro achieves its 2003  revenue and profit targets, as approved by Tesoro’s Board of Directors. To  date, none of these options have vested.   During 2003, of the options granted, 66,667 were vested and the  remaining 33,333 have been cancelled. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| (4)    |   | Of the annual salary,  $63,250 represents salary for the last quarter of 2002 following our  acquisition of IWT effective October 1, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| (5)    |   | Includes an automobile  allowance of $12,914, an automobile fringe benefit of $1,919 and payment of  $25,317 for an Executive Life Insurance policy with his spouse as  beneficiary.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| (6)    |   | Includes an automobile  allowance of $10,500 (of which $4,500 was paid in last quarter of 2002  following the IWT acquisition), $2,055 for automobile fringe benefits (paid  prior to the IWT acquisition), $2,885 for additional health benefits (paid  prior to the IWT acquisition), and payment of $42,213 for an Executive Life  Insurance policy with his spouse as beneficiary (of which $6,329 was paid  following the IWT acquisition).                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |

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| (7)    |   | Includes automobile fringe  benefit of $2,137, health fringe benefits of $6,185 and payment of $14,768  for an Executive Life Insurance policy with his spouse as beneficiary.                                                                                                                                               |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                         |
| (8)    |   | Includes “S” distributions  and allowance for taxes.                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| (9)    |   | Includes an automobile  allowance of $7,413, automobile fringe benefits of $1,351 and payment of  $33,610 for an Executive Life Insurance policy with his spouse as  beneficiary.                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| (10)   |   | Includes an automobile  allowance of $6,785 (of which $4,500 was paid in last quarter of 2002  following the IWT acquisition) and payment of $42,215 for an Executive Life  Insurance policy with his spouse as beneficiary (of which $8,402 was paid  following the IWT acquisition).                                       |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| (11)   |   | Includes automobile fringe  benefit of $265 and payment of $19,606 for an Executive Life Insurance policy  with his spouse as beneficiary.                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| (12)   |   | Includes an automobile  allowance of $9,551, an automobile fringe benefit of $9,949 and payment of  $30,058 with his spouse as beneficiary.                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| (13)   |   | Includes an automobile  allowance of $7,739 (of which $4,500 was paid in last quarter of 2002  following the IWT acquisition), $1,936 for additional health benefits and  payment of $42,208 of an Executive Life Insurance policy with his spouse as  beneficiary (of which $7,514 was paid following the IWT acquisition). |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| (14)   |   | Includes automobile fringe  benefit of $1,113, health fringe benefits of $4,042 and payment of $17,533  for an Executive Life Insurance policy with his spouse as beneficiary.                                                                                                                                               |

 

**Our 2001 Tesoro Stock Incentive Plan.**

 

OnDecember 27, 2001, our then sole Director recommended approving the 2001Tesoro Stock Incentive Plan (the “Plan”) to our then sole stockholder, who, onDecember 27, 2001, approved the Plan. Below is a summary of the Plan:

 

Webelieve that our Plan satisfies our objective of enhancing our profitabilityand value for the benefit of our stockholders by enabling us to offer oureligible employees, consultants and our affiliates, stock-based incentives. Webelieve that this will help to create a means to raise the level of stockownership by these individuals in order to attract, retain and reward suchindividuals and strengthen the mutuality of interests between such individualsand our stockholders.

 

Underthe Plan, we may grant “non-qualified” and incentive stock options to purchase,and restricted stock (Awards). The aggregate maximum number of shares for whichAwards may be issued under the Plan will be 4 million shares of our commonstock. The Plan does provide for equitable adjustment of the number of sharesand the number of shares of each subsequent Award and of the unexercisedportion of the stock option award described below in the event of a change inour capitalization due to a stock split, stock dividend recapitalization,merger, or similar event. Other than with regard to incentive stock options,the number of shares that may be delivered under the Plan will be determinedafter giving effect to the use by a participant of the right, if granted, tocause Tesoro to withhold from the shares of common stock otherwise deliverableto a recipient upon exercising an Award in payment of all or a portion of hisor her withholding obligation arising from such exercise.

 

OurCompensation Committee currently controls and manages the Plan’s operation andadministration. The Committee has discretion to:

 

•                  Determine the types, terms and conditions ofall Awards, including exercise price or purchase price (if any), performancegoals, and other earn-out and/or vesting contingencies and accelerationprovisions,

•                  Adopt, alter or repeal administrative rules,guidelines and practices (including special guidelines for non-U.S. employees),

•                  Delegate administrative responsibilities,

•                  Construe and interpret the Plan’s terms andany agreements evidencing Awards granted.

 

TheCommittee, in its sole discretion, may grant stock options and restricted stockto our employees and consultants, our subsidiary corporations, or parentcorporation. Participants will be selected on the basis of demonstrated abilityto contribute substantially to us. Our Board has authority to grant stockoptions to Non-Employee Directors according to the Plan. All awards are subjectto the terms of a written agreement between the participant and us.

 

Theawards granted under the Plan may be either incentive stock options ornon-qualified stock options or restricted stock awards. The maximum number ofshares subject to any award of stock options or shares of Restricted Stock is100,000.

 

Thevesting schedule for any option granted under the Plan will be determinedby the Committee and will be set forth in a specific option agreement. To theextent not exercised, installments will accumulate and be exercisable, in wholeor in

 

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part,at any time after becoming exercisable, but not later than the date the optionexpires. The Committee has the right to accelerate the exercisability of anyoption.

 

IncentiveStock Options

 

Stockoptions qualify as “incentive stock options” (ISOs) if they meet therequirements of Section 422 of the Internal Revenue Code (Code). ISOs mayonly be granted to our employees and our affiliates and any person holding ourcapital stock or any affiliate possessing more than 10% of the total combinedvoting power of all classes of our capital stock. Affiliates will not beeligible to receive ISOs unless the exercise price per share is at least 110% ofthe fair market value of the stock on the date the option is granted. Each ISOgranted pursuant to the Plan is exercisable, during the optionee’s lifetime,only by the optionee or the optionee’s guardian or legal representative.

 

Non-QualifiedStock Options

 

Non-qualifiedstock options may be granted to employees or to Directors who are not ourofficers nor employees, as well as to consultants and other persons who provideservices to our affiliates and us. Stock options are non-qualified stockoptions if they do not meet the requirements for ISOs.

 

RestrictedStock

 

TheCommittee may grant shares of restricted stock, which is an award of shares ofcommon stock that is subject to the attainment of pre-established performancegoals and other conditions, restrictions and contingencies as the Committeedetermines. Awards of restricted stock may be granted solely to participantswho are our employees or consultants, or of any of its subsidiaries or parentcorporation. Unless otherwise determined by the Committee at the time of thegrant, each award of restricted Stock will provide that if the participantengages in detrimental activities (as defined in the Plan) prior to, or duringthe one year period after, any vesting of restricted Stock, the Committee may direct(at any time within two years thereafter) that all unvested Restricted Stock beimmediately forfeited to us and that the participant will pay us an amountequal to the fair market value at the time of vesting of any restricted stockthat has vested in the period referred to above. (This does not apply upon aChange of Control). The Committee will fix the purchase price of the RestrictedStock.

 

Awardsof restricted stock must be accepted within 90 days (or such shorterperiod as the Committee may specify at grant) after the award date by executinga Restricted Stock Award agreement and paying whatever price (if any) theCommittee designates. Additionally, recipients of restricted stock are requiredto enter into a restricted stock agreement, which states the restrictions towhich the shares are subject and the criteria or date or dates on which suchrestrictions will lapse. Within these limits, based on service, attainment ofobjective performance goals, and such other factors as the Committee may determinein its sole discretion, the Committee may provide for the lapse of suchrestrictions or may accelerate or waive such restrictions at any time. Aparticipant who receives an Award of restricted stock shall not have any rightswith respect to such award of restricted stock, unless and until suchparticipant has delivered a fully executed copy of a restricted stock awardagreement and has otherwise complied with the applicable terms and conditionsof such award.

 

Awardsof restricted stock may be intended to satisfy Section 162(m) of the Code.Under the Plan, an award of restricted stock may be conditioned upon or subjectto the attainment of performance goals. These performance goals will be basedon one or more of the objective criteria with regard to us (or any subsidiarycorporation, parent corporation, division, or other operational unit of ours)as described in the Plan.

 

Alloptions will lapse on the expiration of the option terms specified by theCommittee in a certificate evidencing such option, but in no event willnon-qualified or incentive stock options be exercisable after the expiration of10 years from the date such option is granted (five years for participantswho own more than 10% of the total combined voting power of all classes of thestock of ours, our corporations or our parent corporation).

 

Theexercise price per share of Common Stock subject to an Incentive Stock Optionor a Stock Option intended to be “performance-based” for purposes ofSection 162(m) of the Code shall be determined by the Committee at thetime of grant but shall not be less than 100% of the fair market value of theshares of Common Stock at the time of grant. However, if an Incentive StockOption is granted to a 10% Stockholder, the exercise price shall be no less than110% of the fair market value of the Common Stock. The Committee will determinethe exercise price per share of Common Stock subject to a non-qualified stockoption.

 

Tothe extent that the aggregate fair market value (determined as of the time ofgrant) of the Common Stock with respect to which Incentive Stock Options areexercisable for the first time by an employee during any calendar year underthis Plan and/or any other stock option plan of ours or any of our subsidiariesor parent corporation exceeds $100,000, such

 

27

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optionsshall be treated as non-qualified stock options. In addition, if an employeedoes not remain employed by us or any of our subsidiaries or parent corporationat all times from the time an ISO is granted until three months prior to thedate of exercise (or such other period as required by applicable law), suchoption shall be treated as a non-qualified stock option. Should any provisionof this Plan not be necessary in order for the Stock Options to qualify asIncentive Stock Options, or should any additional provisions be required, theCommittee may amend this Plan accordingly, without the necessity of obtainingthe approval of our stockholders.

 

Paymentof the purchase price is by (i) cash, (ii) check, or (iii) suchother consideration as the Plan Administrators, in their sole discretion,determine and is consistent with the Plan’s purpose and applicable law, or(iv) any combination of the foregoing.

 

Uponthe award of Restricted Stock, the recipient has all rights of a stockholderwith respect to the shares, including, without limitation, the right to receivedividends, the right to vote those shares and, subject to and conditioned uponthe full vesting of the shares of restricted stock, the right to tender thoseshares.

 

Optioneesdo not have stockholder rights (e.g., right to vote and receive dividends)until they exercise their option and receive shares of Common Stock.

 

Eachstock option expires and is no longer exercisable on the dates that the Planadministrators determine at the time when the options are granted. Stockoptions can also be terminated under certain circumstances following a “Changeof Control.”

 

Accordingto our Plan, a “Change of Control” occurs if we

 

•                  are dissolved or liquidated,

•                  are reorganized, merged or consolidated withone or more corporations where we are not the surviving entity, or

•                  transfer substantially all of our property ormore than 80% of our then outstanding shares to another corporation not controlledby our stockholders.

 

Upona Change of Control, the Plan and any outstanding options will terminate unlesswe provide for the Plan to be assumed and continued with our options eitherassumed or replaced with substitute options covering the shares of a successorcorporation. If no provision is made for Plan continuation, we will give alloption holders advance written notice of the Change of Control, all optionswill become fully exercisable and the option holders will then have30 days to exercise their options.

 

Ifour corporate structure changes or if our shares change (i.e. if werecapitalize, our stock splits, we consolidate, we undertake a rights offering,or we issue a stock dividend), the Plan administrators will make appropriateadjustments to the number or class of shares which may be distributed under thePlan and the option price or other price of shares subject to the outstandingawards under the Plan in order to maintain the purpose of the original grant.

 

Thefollowing discussion of the federal income tax consequences of granting andexercise of stock options and restricted stock awards under the Plan and thesale of common stock acquired as a result of any exercises of options is basedon an analysis of the Code, existing laws, judicial decisions, andadministrative rulings and regulations, all of which are subject to change. Inaddition to being subject to the federal income tax consequences describedbelow, a participant may also be subject to state, local, estate and gift taxconsequences, none of which is described below. This discussion is limited tothe U.S. federal income tax consequences to individuals, who are citizens orresidents of the United States, other than those individuals who are taxed on aresidence basis in a foreign country.

 

*Incentive Stock Options.*

 

Neitherthe grant nor (provided the holding periods described below are satisfied) theexercise of an incentive stock option will result in taxable income to aparticipant or a tax deduction for us. However, for purposes of the alternativeminimum tax, the excess of the fair market value of the shares acquired uponexercise of an incentive stock option (determined at the time the option isexercised) and the exercise price for such shares will be considered part of theparticipant’s income.

 

Ifthe applicable holding periods described below are satisfied, the sale ofshares of common stock purchased upon the exercise of an incentive stock optionwill result in capital gain or loss to the participant and will not result in atax deduction to us. To receive the foregoing incentive stock option taxtreatment as to the shares acquired upon exercise of an incentive stock option,a participant must hold such shares for at least two years following the datethe incentive stock option is granted and for one year following the date ofthe exercise of the incentive stock option. In addition, a

 

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participantgenerally must be an employee of ours (or a subsidiary corporation or parentcorporation of ours) at all times between the date of grant and the date threemonths before exercise of the option.

 

Ifthe holding period rules are not satisfied, the portion of any gain recognizedon the disposition of the shares acquired upon the exercise of an incentivestock option that is equal to the lesser of the fair market value of the shareson the date of exercise minus the exercise price, or the amount realized on thedisposition minus the exercise price, will be treated as ordinary compensationincome in the taxable year of the disposition of the shares, with any remaininggain being treated as capital gain. If the holding periods are not satisfied,we will generally be entitled to a tax deduction equal to the amount of suchordinary income included in the participant’s taxable income, subject toSection 162(m) of the Code.

 

*Non-Qualified Stock Options.*

 

Aparticipant will recognize no taxable income at the time a non-qualified stockoption is granted to a recipient.

 

Aparticipant will recognize ordinary compensation income at the time anon-qualified stock option is exercised, and the amount of such income will beequal to the excess of the fair market value on the exercise date of the sharespurchased by the optionee over the exercise price for such shares. Other thanwith regard to Non-Employee Directors, this ordinary compensation income willalso constitute wages subject to income tax withholding under the Code and wewill require the participant to make suitable arrangements to ensure that theparticipant remits to us an amount sufficient to satisfy all tax withholdingrequirements.

 

Wewill generally be entitled to a deduction for federal income tax purposes atsuch time and in the same amount as the amount includable in the participant’sordinary income in connection with his or her exercise of a non-qualified stockoption, subject to Section 162(m) described herein.

 

Upona participant’s subsequent sale or other disposition of shares purchased onexercise of a non-qualified stock option, the participant will recognizecapital gain or loss (which may be short-term or long-term depending upon theparticipant’s holding period) on the difference between the amount realized onsuch sale or other disposition and the participant’s tax basis in the sharessold. The tax basis of the shares acquired upon the exercise of the option willbe equal to the sum of the exercise price for such shares and the amountincludable in the participant’s income with respect to such exercise andacquisition of the shares.

 

*All Stock Options.*

 

Thefollowing considerations may also apply to grants of non-qualified stockoptions and/or incentive stock options:

 

•                  Any of our officers and directors subject toSection 16(b) of the Exchange Act may be subject to special tax rulesregarding the income tax consequences concerning their stock options,

•                  Any entitlement to a tax deduction on thepart of us is subject to the applicable tax rules (including, withoutlimitation, Section 162(m) of the Code regarding a $1,000,000 limitationon deductible compensation), and

•                  In the event that the exercisability orvesting of any stock option is accelerated because of a change in control,payments relating to the stock option (or a portion thereof), either alone ortogether with certain other payments, may constitute parachute payments underSection 280G of the Code, which excess amounts may be subject to excisetaxes.

 

Ingeneral, Section 162(m) of the Code does not allow a publicly heldcorporation, for federal income tax purposes, to deduct compensation in excessof $1 million per year per person to its chief executive officer and thefour other officers whose compensation is disclosed in its proxy statement,subject to specific exceptions. Our Plan does not currently qualify for theexceptions and is therefore subject to the limitations of Section 162(m).

 

Optionsmay not be sold, assigned, transferred, pledged or encumbered, except by willor by the laws of descent and distribution. The optionee may only exercise anoption during his or her lifetime or his or her estate, for a period of timeafter the optionee’s death.

 

Generally,our Board of Directors or the Committee have the power to amend, terminate orsuspend all or any portion of the Plan without stockholder approval. However,no amendment may impair an existing award or alter the rights of a recipient ofoptions already granted under the Plan without the recipient’s consent.Additionally, the Board of Directors may not, without further approval of ourstockholders and according to Nevada law, solely to the extent required by theapplicable provisions of Rule 16b-3, Section 162(m) or 422 of theCode, or the rules of any applicable exchange:

 

•                  Increase the aggregate number of shares ofCommon Stock that may be issued under this Plan,

•                  Increase the maximum individual Participantlimitations for a fiscal year,

•                  Change the classification of employees,Consultants or Non-Employee Directors eligible to receive Awards 

 

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under this Plan,

•                  Decrease the minimum option price of anyStock Option,

•                  Extend the maximum Stock Option period,

•                  Materially alter the Performance Criteria forthe Award of Restricted Stock, or

•                  Make any other amendment that would requirestockholder approval under the rules of any exchange or system on which oursecurities are listed or traded.

 

Unlesspreviously terminated by the Board of Directors, the Plan shall terminate onthe earlier of December 31, 2012 or ten years after the date the Plan iseffective. Through December 31, 2003, 440,000 options were granted, ofwhich 306,668 have vested and the remaining 133,332 were cancelled.  Additionally, 124,500 restricted shares wereissued under the Plan.

 

Subsequentto the end of fiscal 2003, all the share underlying the Plan were registeredand those shares already issued were registered for resale, pursuant to a FormS-8.

 

**Stock Option Grants in Last Fiscal Year**

 

Duringthe fiscal year ended December 31, 2003, no options were granted.

 

**Option Exercises and Year End Values**

 

Nooptions were exercised during fiscal year ended December 31, 2003 by thepersons named in the “Summary Compensation Table” above.

 

**Pension Plan**

 

The Company sponsors a 401(k) plan known asthe International Wholesale Tile 401(k) Profit Sharing Plan & Trust.  The Pension Plan provides tax deferredsalary deductions for eligible employees. Employees may contribute from 1% to 12% of their annual compensation tothe Pension Plan, limited to an annual maximum amount as set periodically bythe Internal Revenue Service.  TheCompany provides matching contributions equal to 100% of the employee’scontributions up to a maximum of 3% of eligible pay.  The contribution expense related to the Pension Plan amounted to$76,249 and $59,352 for the years ended December 31, 2003 and 2002,respectively.

 

**Directors’ Compensation**

 

Underthe Plan, the Board of Directors has the authority to grant to Non-EmployeeDirectors, subject to the terms of the Plan, options to purchase

 

•                  up to a maximum of 150,000 shares of CommonStock as of the date the non-employee Director begins service as a non-employeeDirector and

•                  up to a maximum of 75,000 shares of CommonStock in any calendar year, provided the non-employee Director has not ceasedto be a Director or if he ceased to be a Director he has not become an employeeor consultant of Tesoro or its affiliates.

 

Theper share exercise price will be determined by the Board of Directors but willnot be less than 100% of the fair market value of the share of Common Stock atthe time of grant and may be subject to stockholder approval. The term of eachoption granted to a Director pursuant to the Plan shall be 10 years, andsuch option shall be 50% vested and exercisable on the date such option isgranted, and 50% vested and exercisable on the first anniversary of the grantdate.

 

OnNovember 22, 2002, our Board approved the compensation of the outsideDirectors as follows:

 

•                  Issuing 10,000 shares upon accepting theBoard appointment;

•                  A stipend of $500 per Director per meetingattended;

•                  A stipend of $500 per Director per committeemeeting attended (with the exception of the Chair of the Audit Committee, whowill receive a stipend of $1,000 per meeting);

•                  Reimbursement of out of pocket expensesincurred by each Director in order to attend a meeting (spouse costs includedfor annual stockholder/ Board meeting only); and

•                  10,000 options to acquire shares of commonstock at the fair market value per each full calendar year of service.

 

**Compensation Committee Interlocks and Insider Participation**

 

Nomember of our compensation committee has ever been an executive officer oremployee of ours. None of our executive officers currently serve, or has servedduring the last completed fiscal year, on the compensation committee or boardof directors or any other entity that has one or more executive officersserving as a member of our board of directors or compensation committee.

 

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**Board Compensation Committee Report on Executive Compensation**

 

General Compensation Policy. The Compensation Committee administers the Corporation’s executivecompensation program, which is intended to provide incentives to executiveofficers to achieve both current and long-term strategic management goals of theCorporation, with the ultimate objective of achieving a superior return on theshareholders’ investment.  To this end,the program is comprised of cash and equity-based components, which recognizeperformance as measured against the Corporation’s annual and long-term goals aswell as performance evaluated in comparison to industry peers.

 

Equity-based compensation, including the Stock Incentive Plan,encourages ownership and retention of the Corporation’s common stock by keyemployees, assuring that they have a meaningful stake in the Corporation’scontinued success and thereby aligning the interests of these employees andshareholders.

 

The executive compensation program is designed to assist theCorporation in achieving its business objectives by: maintaining a competitivecompensation program to attract and retain qualified executives;  providing performance-based incentivecompensation that is directly related to the Corporation’s financialperformance and individual contributions to that performance; and linkingcompensation to factors which affect short-term and long-term stockperformance.

 

The manner in which the Committee establishes the compensation andincentives of each of Tesoro’s executive officers listed in the SummaryCompensation Table is described below.

 

Cash Compensation.  TheCompensation Committee determined the annual cash compensation paid to theCorporation’s executive officers for 2003, consisting of salary and incentivecompensation.  The salaries paid to theexecutive officers named in the Summary Compensation Table for 2003 are shownin the “Salary” column of that Table. These salaries were subjectivelydetermined after consideration of the executive officer’s individualresponsibilities, performance, experience, the chief executive officer’sevaluation of the other executive officers, a review of several measurements ofthe Corporation’s short-term and long-term financial results compared withindustry peers, and other factors such as budgetary considerations andinflation rates.

 

The incentive compensation in the form of stock option were granted andvested pursuant to the Stock Incentive Plan, which incorporates modernincentive plan techniques and executive retention features for the purpose ofclosely aligning the interests of executives with those of shareholders.  Typically, the Committee may assign tocertain or all executive officers a target bonus.  The participant’s incentive compensation is based onaccomplishment of specific performance levels set forth in stock option orincentive agreements.

 

On November 23, 2002, the Committee granted incentive stockoptions pursuant to the Plan to purchase up to 100,000 shares to each of thefour executive officers, The options are for ten years and have an exerciseprice is $3.00 per share. The options vest as follows: (a) 33% at suchtime as our Common Stock begins trading on the OTCBB (or equivalent),(b) 33% at such time as Tesoro attains no less than a $50.0 millionmarket cap for ten consecutive trading days, and (c) 34% when Tesoroachieves its 2003 revenue and profit targets, as approved by Tesoro’s Board ofDirectors. Of the criteria, each achieved (a) and (b), but not (c).  As such, options to purchase up to 66,667shares were vested in each of the executive officers.

 

Other Compensation.  Theexecutive officers are also covered by medical plans that are generallyapplicable to full-time employees of the Corporation and its subsidiaries.  They also receive automobile allowances andpayment of life insurance policies.

 

The above report is submitted by:

 

**James Edwards, Chairman**

**Allen Rosenberg**

 

**Employment and Consulting Agreements**

 

**Henry J. Boucher, Jr.**    On December 29,2001, Tesoro entered into an employment agreement with Henry to serve asTesoro’s President. In consideration for his services, and under the terms ofhis employment agreement, Henry receives an annual salary of $120,000. He hadsigned a Salary Deferral Agreement that was later terminated by Tesoro’s Board,with Henry abstaining. All his deferred salary was paid to Henry Boucher inDecember 2002. He also receives a monthly car allowance of $1,500. HenryBoucher’s employment may be terminated for cause at any time and within30 days without cause. He is subject to non-disclosure and non-competeprovisions.

 

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OnMarch 27, 2003, the Board of Directors voted to increase the term of HenryBoucher’s employment agreement from one year to three years and to increase hissalary to $240,000 per year at such time as the registration statement of whichthis prospectus is a part is effective. At that time, the salary will beretroactive as of January 1, 2003. At the same time, the Board also votedto issue Mr. Boucher a $25,000 bonus for 2002.

 

**Forrest Jordan.**    Effective October 2, 2002, IWT enteredinto an employment agreement with Forrest for one year, renewed automaticallyunless terminated by IWT not less than ninety days prior to the expiration ofthe term. In consideration for his services, Forrest Jordan receives a salaryof $253,000 per year. He also receives a monthly car allowance of $1,500.Forrest Jordan also receives a life insurance policy whose beneficiary is hisfamily and such other compensation as determined by the Compensation Committee.He is subject to non-disclosure and non-compete provisions. On March 27,2003, the Board of Directors voted to increase the term of his employmentagreement from one year to three years and to issue Forrest Jordan a $25,000bonus for 2002.

 

**Paul F. Boucher.**    Paul Boucher’s employment agreement issubstantially the same as that of Forrest Jordan’s, with the exception that hereceives an annual salary of $263,000. On March 27, 2003, the Board ofDirectors voted to increase the term of his employment agreement from one yearto three years and to issue Paul Boucher a $25,000 bonus for 2002.

 

**Grey Perna.**    Grey Perna’s employment agreement issubstantially the same as that of Forrest Jordan’s. On March 27, 2003, theBoard of Directors voted to increase the term of his employment agreement fromone year to three years and to issue Grey Perna a $25,000 bonus for 2002.

 

**ITEM11.****                 SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

 

Thefollowing table sets forth, as of March 24, 2004, the shares of CommonStock owned beneficially by (i) each of our Executive Officers,(ii) each of our current Directors, (iii) all Executive Officers andDirectors as a group, (iv) each person known by us to be the beneficialowner of more than five percent of our Common Stock. “Beneficial Ownership” isa technical term broadly defined by the Securities and Exchange Commission tomean more than ownership in the usual sense. For example, Common Stock is“beneficially” owned not only if it is held directly, but also if it is heldindirectly (though a relationship, a position as a director or trustee, or acontract or understanding), or has (or share the power to vote the stock orsell it) the right to acquire it within 60 days. Except as disclosed inthe footnotes below, each of the Executive Officers and Directors listed havesole voting and investment power over his or its shares.  As of March 24, 2004, 11,660,702 sharesof our common stock were issued and outstanding, held by approximately 232holders of record. 
| **Name(1) **                                                                     |   | **Current  Title**                                                                                                                                                                                                                                     |   | **Shares  Beneficially  Owned** |        | **Percent  of  Class** |   |
|---------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------|-------------|------------------------|--------|
| Henry J. Boucher, Jr.                                                                 |   | •  Tesoro: Chairman, President, Chief  Executive Officer, Interim Chief Financial Officer, Director 

•  IWT Tesoro International Ltd.: Director 

•  IWT Tesoro Transport, Inc.: President and  Director |   | 850,167                         | (2)         | 7.2                    | %      |
|                                                                                  |   |                                                                                                                                                                                                                                                   |   |                            |        |                   |   |
| James R. Edwards(3)(4)                                                                |   | Tesoro:  Director                                                                                                                                                                                                                                      |   | 50,000                          | (5)         | *                      |   |
|                                                                                  |   |                                                                                                                                                                                                                                                   |   |                            |        |                   |   |
| James Lafond(6)                                                                       |   | Tesoro:  Director                                                                                                                                                                                                                                      |   | 25,000                          | (7)         | *                      |   |
|                                                                                  |   |                                                                                                                                                                                                                                                   |   |                            |        |                   |   |
| Carl G. Anderson, Jr.(4)(6)                                                           |   | Tesoro:  Director                                                                                                                                                                                                                                      |   | 75,000                          | (8)         | *                      |   |
|                                                                                  |   |                                                                                                                                                                                                                                                   |   |                            |        |                   |   |
| Robert B. Rogers(6)                                                                   |   | Tesoro:  Director                                                                                                                                                                                                                                      |   | 22,500                          | (9)         | *                      |   |
|                                                                                  |   |                                                                                                                                                                                                                                                   |   |                            |        |                   |   |
| Allen G. Rosenberg(3)                                                                 |   | Tesoro:  Director                                                                                                                                                                                                                                      |   | 25,000                          | (7)         | *                      |   |
|                                                                                  |   |                                                                                                                                                                                                                                                   |   |                            |        |                   |   |
| Paul F. Boucher                                                                       |   | •  Tesoro: Director, Senior Vice President 

•  IWT: President, Director 

•  IWT Tesoro International Ltd.: Director                                                                                     |   | 3,096,667                       | (2)(10)(11) | 26.4                   | %      |
|                                                                                  |   |                                                                                                                                                                                                                                                   |   |                            |        |                   |   |
| Forrest Jordan                                                                        |   | •  Tesoro: Senior Vice President, Director 

•  IWT: Senior Vice President, Treasurer,  Secretary, Director 

•  IWT Tesoro International Ltd.: Director                                                  |   | 3,066,667                       | (2)(10)     | 26.1                   | %      |
|                                                                                  |   |                                                                                                                                                                                                                                                   |   |                            |        |                   |   |
| Grey Perna                                                                            |   | •  Tesoro: Director, Senior Vice President 

•  IWT: Senior Vice President, Director 

•  IWT Tesoro International Ltd.: Director                                                                         |   | 3,068,667                       | (2)(10)(12) | 26.2                   | %      |
|                                                                                  |   |                                                                                                                                                                                                                                                   |   |                            |        |                   |   |
| All Current Officers, Directors and Nominees for  Director; as a Group (nine persons) |   |                                                                                                                                                                                                                                                   |   | 10,279,168                      |        | 85.5                   | %      |

 

32

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----

*Lessthan 1%.

 

(1)                                  The address for each of Tesoro’s Directors,Nominees for Directors and Executive Officers is 191 Post Road West, Suite 10,Westport, CT 06880.

 

(2)                                  Includes options to purchase up to 66,667shares at $3.00 per share.

 

(3)                                  Member of the Compensation Committee.

 

(4)                                  Member of the Nominating and GoverningCommittee.

 

(5)                                  Includes 15,000 incentive stock options, ofwhich (a) 10,000 are vested and which are exercisable at $3.00 per share; and(b) 5,000 options are vested and exercisable at $6.00 per share.  Also includes warrants to purchase up to15,000 shares at $3.00 per share through January 7, 2008.

 

(6)                                  Member of the Audit Committee.

 

(7)                                  Includes 15,000 incentive stock options, ofwhich (a) 10,000 are vested and which are exercisable at $3.00 per share; and(b) 5,000 options are vested and exercisable at $6.00 per share.

 

(8)                                  Includes 15,000 incentive stock options, ofwhich (a) 10,000 are vested and which are exercisable at $3.00 per share; and(b) 5,000 options are vested and exercisable at $6.00 per share.  Also includes warrants to purchase up to10,000 shares at $3.00 per share through March 10, 2008.

 

(9)                                  Includes 5,000 incentive stock options thatare currently vested at $6.00 and warrants to purchase 3,500 shares at $7.00per share.

 

(10)                            IWT’s institutional lender requires that during the term of its loan,Paul Boucher, Grey Perna and Forrest Jordan will not allow their aggregatebeneficially ownership interest in Tesoro to be less than 51%.

 

(11)                            Includes 30,000 shares held by Mr. Boucher’s minor children.

 

(12)                            Includes 12,000 shares held by Mr. Perna’s wife.

 

**ITEM12.****                 CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

Thefollowing are brief descriptions of transactions between us (or any of ouraffiliates) and any of our Directors, Executive Officers or Stockholdersbeneficially owning more than 5% of our shares, or any member of the immediatefamily of any of those persons, or other entities in which such personsbeneficially own more than 5%.

 

InMay 2002, Tesoro sold 100,000 shares of our common stock for an aggregateof $20,000 to Mentus Consulting LLC, a limited liability company, controlled byHenry J. Boucher, our President and Chief Executive Officer.

 

ForrestJordan, Grey Perna and Paul F. Boucher as payees, hold promissory notes fromIWT in the principal amounts of $88,711.93, $120,000 and $240,000,respectively. The notes bear interest at 10% per year and are due on or beforeDecember 31, 2025. In connection with our credit facility for$17.0 million, Forrest, Grey and Paul have each entered

 

33

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intoa subordination agreement with the lender that provides that each of theseobligations are subordinated to that of the lender and these obligations havealso been assigned to the lender as security for our obligations to the lender.

 

Aspart of our acquiring IWT, we issued nine million shares to Forrest Jordan,Grey Perna and Paul F. Boucher. Each of these stockholders entered into arepurchase agreement by which each may sell a total of 150,000 shares of Tesorocommon stock over a three-year period back to us for a price per share based on88% of Tesoro’s then weighted average price. On June 26, 2003, each of these repurchase agreements wasterminated and is no longer of any force or effect.

 

**ITEM13.****                 EXHIBITS,LIST AND REPORTS ON FORM 10-KSB**

 

a.                                       Exhibits

 
| **EXHIBIT  NUMBER** |   | **DESCRIPTION**                                                                                                                                                                                                                                                               |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 1.1                 |   | Form  of Selected Dealers Agreement (filed as an Exhibit to the Company’s  Registration Statement, filed with the Securities and Exchange Commission on  June 4, 2003)                                                                                              |
| 1.2                 |   | Selected  Exclusive Dealers Agreement dated November 22, 2003 (filed as an Exhibit  to the Company’s Report on Form 8-K, filed with the Securities and Exchange  Commission on September 24, 2003)                                                             |
| 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                                                                                                                                                                                  |

 

34

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|   |   | 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 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  |   | Termination  of Repurchase Agreement dated June 26, 2003 between IWT Tesoro  Corporation and Forrest 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 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 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 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.*                                                                                                                                                                                                                                                                                                         |
| 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)                                                                                                                                                                                                                         |

 

----

| *      |   | Included in this filing. |
|--------|--------|--------------------------|
|   |   |                     |
| (b)    |   | Reports on  Form 8-K.    |

 

 

**—**Reporton Form 8-K filed October 31, 2003 discussing Tesoro’s entering into anExclusive Dealer Agreement in connection with its Public Offering.

 

—Report onForm 8-K filed December 9, 2003 in connection with the Merger of Tesoro’sIndependent Accountants and the completion of the sale of its units in Tesoro’spublic Offering.

 

—Report onForm 8-K filed December 17, 2003 announcing the commencing of trading ofTesoro’s common stock on the Over the Counter Bulletin Board under the symbol“IWTT”.

 

35

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**ITEM14.      PRINCIPAL ACCOUNTANT FEES ANDSERVICES.**

 

*Merger of Independent Auditors*

 

EffectiveDecember 1, 2003, IWT Tesoro Corporation’s independentaccountants, Sewell and Company, PA, of Hollywood, Florida (Sewell) wasreplaced by the accounting firm of Kantor, Sewell & Oppenheimer, PA (KSO),the successor firm to Sewell.  KSO maintains the same facilities as Sewelland is a Florida SEC qualified accounting firm.  Sewell reported on andaudited the financial statements prepared by Tesoro for the period commencing September 20,2000 through September 30, 2003.

 

Therecommendation by Tesoro’s Audit Committee was based upon KSO becoming thesuccessor firm pursuant to the merger of Sewell with Kantor and Oppenheimer.

 

*Audit Fees*

 

Sewellwas the company’s principal accountant and reported on and audited thefinancial statements prepared by Tesoro for the period commencingSeptember 20, 2000 through September 30, 2003.  Total fees paid to Sewell for audit servicesrendered during 2003 and 2002 were $100,495 and $97,250, respectively.

 

KSOhas been Tesoro’s principal accountant since October 1, 2003.  Total fees paid to KSO for audit servicesrendered during the fourth quarter of 2003 was $74,830.

 

Totalfees incurred by the company for audit services rendered by Sewell and KSOduring 2003 and 2002 were $175,325 and $97,250, respectively.

 

*Audit-*Related*Fees.*

 

Feespaid to Sewell for audit-related services rendered through September 30,2003 and during 2002 were $0 and $0, respectively.

 

Feespaid to KSO for audit-related services rendered for the fourth quarter of 2003was $0.

 

Nofees for audit-related services rendered by Sewell and KSO were paid during2003 and 2002, respectively.

 

*Tax Fees.*

 

Feespaid to Sewell for tax services rendered through September 30, 2003 andduring 2002 were $6,550 and $0, respectively, related primarily to preparingfederal and state tax returns and other consulting services.

 

Feespaid to KSO for tax services rendered for the fourth quarter of 2003 was $0.

 

Totalfees incurred by the company for tax services rendered by Sewell and KSO during2003 and 2002 were $6,550 and $0, respectively.

 

*All Other Fees.*

 

Totalfees paid to Sewell for all other services rendered through September 30,2003 and during 2002 were $3,490 and $0, respectively, primarily related tobusiness review of controls surrounding systems implementation, and otherprofessional services.

 

Totalfees paid to KSO for all other services rendered for the fourth quarter of 2003was $2,897, primarily related to audit committee meetings.

 

Totalfees incurred by the company for all other services rendered by Sewell and KSOduring 2003 and 2002 were $6,387 and $0, respectively.

 

36

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SIGNATURES

 

In accordance with Section 13 or 15(d) of the Exchange Act of1934, the Company caused this Registration Statement to be signed on its behalfby the undersigned thereunto duly authorized.

 

IWT TESORO CORPORATION

 
| By:                                                                                                                                                                          | /s/ Henry J. Boucher, Jr.                        |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------|--------|
|                                                                                                                                                                         | Henry J.  Boucher, Jr.,  President          |
|                                                                                                                                                                         |                                             |
| Date: March 30, 2004                                                                                                                                                    |
|                                                                                                                                                                         |                                             |
| In accordance with the Exchange Act, this report has been signed  below by the following persons on behalf of the Company and in the capacities  and on the dates indicated. |
|                                                                                                                                                                         |                                             |
| /s/ Henry J. Boucher, Jr.                                                                                                                                                    | March 30, 2004                              |
| Henry J.  Boucher, Jr.,  Principal Executive Officer                                                                                                                    |
|                                                                                                                                                                         |                                             |
| /s/ Forrest Jordan                                                                                                                                                           | March 30, 2004                              |
| Forrest Jordan, Principal Financial Officer                                                                                                                                  |
|                                                                                                                                                                         |                                             |
| /s/ Henry J. Boucher, Jr.                                                                                                                                                    | March 30, 2004                              |
| Henry J.  Boucher, Jr.,  Director                                                                                                                                       |
|                                                                                                                                                                         |                                             |
| /s/ James R. Edwards, Director                                                                                                                                               | March 30, 2004                              |
| James Edwards, Director                                                                                                                                                      |
|                                                                                                                                                                         |                                             |
| /s/ Paul F. Boucher                                                                                                                                                          | March 30, 2004                              |
| Paul F.  Boucher, Director                                                                                                                                              |
|                                                                                                                                                                         |                                             |
| /s/ Forrest Jordan                                                                                                                                                           | March 30, 2004                              |
| Forrest Jordan, Director                                                                                                                                                     |
|                                                                                                                                                                         |                                             |
| /s/ Grey Perna                                                                                                                                                               | March 30, 2004                              |
| Grey Perna, Director                                                                                                                                                         |
|                                                                                                                                                                         |                                             |
| /s/ James Lafond                                                                                                                                                             | March 30, 2004                              |
| James Lafond, Director                                                                                                                                                       |
|                                                                                                                                                                         |                                             |
| /s/ Allen Rosenberg                                                                                                                                                          | March 30, 2004                              |
| Allen Rosenberg, Director                                                                                                                                                    |
|                                                                                                                                                                         |                                             |
| /s/ Carl G. Anderson, Jr.                                                                                                                                                    | March 30, 2004                              |
| Carl G.  Anderson, Jr.,  Director                                                                                                                                       |
|                                                                                                                                                                         |                                             |
|                                                                                                                                                                         | March      ,  2004 |
| Robert Rogers, Director                                                                                                                                                      |
|                                                                                                                                                                              |                                                  |        |  |

 

37

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**IWT TESORO CORPORATIONAND SUBSIDIARIES**

 

CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED

 

DECEMBER 31, 2003 AND 2002

 

----

 

**IWT TESORO CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATED FINANCIAL STATEMENTS**

**FOR THE YEARS ENDED DECEMBER 31,2003 AND 2002**

 

 

# **TABLEOF CONTENTS**

 
| Independent Auditors’  Report                               |   |
|------------------------------------------------------------------|--------|
|                                                             |   |
| Consolidated Balance Sheets                                      |   |
|                                                             |   |
| Consolidated Statements  of Operations                           |   |
|                                                             |   |
| Consolidated  Statements of Changes in Stockholders’ Equity |   |
|                                                             |   |
| Consolidated  Statements of Cash Flows                           |   |
|                                                             |   |
| Notes to  Consolidated Financial Statements                      |   |

 

F-1

----

 

**INDEPENDENTAUDITORS’ REPORT**

 

To the Board of DirectorsIWT Tesoro Corporation and SubsidiariesWestport, CT

 

We have audited theaccompanying consolidated balance sheets of IWT Tesoro Corporation andSubsidiaries as of December 31, 2003 and 2002, and the related consolidatedstatements of operations, changes in stockholders’ equity, and cash flows forthe years ended December 31, 2003 and 2002.  These consolidated financial statements are the responsibility ofthe Company’s management.  Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

 

We conducted our auditsin accordance with auditing standards generally accepted in the United Statesof America.  Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe consolidated financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the consolidatedfinancial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall consolidated financialstatement presentation.  We believe thatour audits provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of IWT Tesoro Corporation andSubsidiaries as of December 31, 2003 and 2002, and the results of itsoperations, and its cash flows for the years ended December 31, 2003 and2002, in conformity with accounting principles generally accepted in the UnitedStates of America.

 

 

KANTOR, SEWELL &OPPENHEIMER, PA

 

 

Hollywood, Florida

January 23, 2004

 

F-2

----

 

**IWT TESORO CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

**DECEMBER 31, 2003 AND 2002**

 

**Assets**

 
|                                                                                                              |   | **2003**   |       | **2002**  |   |
|-------------------------------------------------------------------------------------------------------------------|--------|------------|------------|-----------|--------|
|                                                                                                              |   |       |       |      |   |
| Current  assets                                                                                                   |   |       |       |      |   |
| Cash                                                                                                              |   | $          | 867,361    |      | $      | 574,046 |   |
| Accounts  receivable, net of allowance for doubtful accounts of approximately $120,000  and $83,000, respectively |   | 4,907,705  |       | 2,875,532 |   |
| Inventories                                                                                                       |   | 13,058,839 |       | 6,047,876 |   |
| Note  receivable                                                                                                  |   | 550,000    |       | —    |   |
| Prepaid  expenses                                                                                                 |   | 754,289    |       | 286,820   |   |
| Deferred  tax asset                                                                                               |   | 146,192    |       | 34,348    |   |
| Total  current assets                                                                                             |   | 20,284,386 |       | 9,818,622 |   |
|                                                                                                              |   |       |       |      |   |
| Property  and equipment, net                                                                                      |   | 4,283,518  |       | 2,712,422 |   |
|                                                                                                              |   |       |       |      |   |
| Other  assets                                                                                                     |   |       |       |      |   |
| Deposits                                                                                                          |   | 59,609     |       | 9,173     |   |
| Other  receivables                                                                                                |   | 69,370     |       | 69,705    |   |
| Other  assets                                                                                                     |   | 253,120    |       | 112,835   |   |
|                                                                                                              |   | 382,099    |       | 191,713   |   |
|                                                                                                              |   |       |       |      |   |
|                                                                                                              |   | $          | 24,950,003 |      | $      | 12,722,757 |   |

 

The notes toconsolidated financial statements are an integral part of the above statement.

 

F-3

----

 

**IWTTESORO CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

**DECEMBER31, 2003 AND 2002**

 

**Liabilitiesand Stockholders’ Equity**

 
|                                                                                                             |   | **2003**   |       | **2002**  | ** ** |
|------------------------------------------------------------------------------------------------------------------|--------|------------|------------|-----------|------------|
|                                                                                                             |   |       |       |      |       |
| Current  liabilities                                                                                             |   |       |       |      |       |
| Accounts  payable                                                                                                |   | $          | 9,859,161  |      | $          | 5,403,816 |   |
| Accrued  expenses and other liabilities                                                                          |   | 137,292    |       | 151,064   |       |
| Current  portion of leases payable                                                                               |   | 63,151     |       | 47,222    |       |
| Current  portion of notes payable - unrelated parties                                                            |   | 42,719     |       | 48,779    |       |
| Total  current liabilities                                                                                       |   | 10,102,323 |       | 5,650,881 |       |
|                                                                                                             |   |       |       |      |       |
| Deferred  tax liability - non current                                                                            |   | 148,594    |       | —    |       |
| Long  term leases payable                                                                                        |   | 149,183    |       | 108,438   |       |
| Long  term notes payable - related parties                                                                       |   | 338,662    |       | 448,712   |       |
| Long  term notes payable - unrelated parties                                                                     |   | 42,560     |       | 64,872    |       |
| Long  term loan payable                                                                                          |   | 9,599,340  |       | 4,864,778 |       |
|                                                                                                             |   | 10,278,339 |       | 5,486,800 |       |
|                                                                                                             |   |       |       |      |       |
| Redeemable  common stock (450,000 shares issued and outstanding)                                                 |   | —     |       | 1,073,160 |       |
|                                                                                                             |   |       |       |      |       |
| Stockholders’  equity                                                                                       |   |       |       |      |       |
| Preferred  stock, $0.001 par value, 25,000,000 authorized; none issued                                           |   | —     |       | —    |       |
| Common  stock, $0.001 par value, 100 million shares authorized, 11,622,702 and  10,587,834 issued and oustanding |   | 11,623     |       | 10,588    |       |
| Additional  paid in capital                                                                                      |   | 4,306,153  |       | 686,068   |       |
| Retained  earnings (deficit)                                                                                     |   | 251,565    |       | (184,740  | )          |
|                                                                                                             |   | 4,569,341  |       | 511,916   |       |
|                                                                                                             |   |       |       |      |       |
|                                                                                                             |   | $          | 24,950,003 |      | $          | 12,722,757 |   |

 

The notes toconsolidated financial statements are an integral part of the above statement.

 

F-4

----

 

**IWT TESORO CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFOPERATIONSYEARS ENDED DECEMBER 31, 2003 AND 2002**

 
|                                                               |   | **2003**   |       | **2002**   |   |
|--------------------------------------------------------------------|--------|------------|------------|------------|--------|
| Revenue                                                            |   |       |       |       |   |
|                                                               |   |       |       |       |   |
| Sales,  net of discounts and returns                               |   | $          | 32,659,546 |       | $      | 25,387,708 |   |
| Cost  of goods sold                                                |   | 19,814,514 |       | 15,268,535 |   |
| Gross  profit                                                      |   | 12,845,032 |       | 10,119,173 |   |
|                                                               |   |       |       |       |   |
| Expenses                                                           |   |       |       |       |   |
| Payroll                                                            |   | 5,460,251  |       | 3,841,761  |   |
| Delivery                                                           |   | 1,576,816  |       | 1,245,174  |   |
| Leases                                                             |   | 1,031,559  |       | 479,905    |   |
| General  and administrative                                        |   | 749,054    |       | 637,202    |   |
| Sales                                                              |   | 660,937    |       | 211,396    |   |
| Depreciation                                                       |   | 634,984    |       | 422,435    |   |
| Professional  fees                                                 |   | 388,342    |       | 150,085    |   |
| Repairs  and maintenance                                           |   | 386,190    |       | 250,378    |   |
| Insurance                                                          |   | 353,752    |       | 324,699    |   |
| Travel  and entertainment                                          |   | 309,009    |       | 104,831    |   |
| Bad  debts                                                         |   | 204,581    |       | 3,082      |   |
| Advertising                                                        |   | 120,939    |       | 203,838    |   |
|                                                               |   | 11,876,414 |       | 7,874,786  |   |
| Income  from operations                                            |   | 968,618    |       | 2,244,387  |   |
|                                                               |   |       |       |       |   |
| Other  income/(expenses)                                           |   |       |       |       |   |
| Interest  expense                                                  |   | (480,139   | )          | (328,920   | )      |
| Other  expense, net                                                |   | (15,424    | )          | (15,788    | )      |
|                                                               |   | (495,563   | )          | (344,708   | )      |
|                                                               |   |       |       |       |   |
| Income  before taxes                                               |   | 473,055    |       | 1,899,679  |   |
|                                                               |   |       |       |       |   |
| Income  taxes - current                                            |   | —     |       | —     |   |
| Income  tax (expense) benefit - deferred                           |   | (36,750    | )          | 34,348     |   |
| Net  income                                                        |   | $          | 436,305    |       | $      | 1,934,027 |   |
|                                                               |   |       |       |       |   |
| Earnings  per share                                                |   |       |       |       |   |
| Basic                                                              |   | $          | 0.04       |       | $      | 0.18 |   |
| Diluted                                                            |   | $          | 0.04       |       | $      | 0.18 |   |
|                                                               |   |       |       |       |   |
| Average  number of common and common equivalent shares outstanding |   |       |       |       |   |
| Basic                                                              |   | 11,197,665 |       | 10,845,775 |   |
| Diluted                                                            |   | 11,509,028 |       | 10,845,775 |   |

 

The notes toconsolidated financial statements are an integral part of the above statement.

 

F-5

----

 

**IWT TESORO CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGESIN STOCKHOLDERS’ EQUITYYEARS ENDED DECEMBER 31, 2003 AND 2002**

 
|                                                              |   | **Common  Stock** |   | **Additional  Paid in** |   | **Subscription** |   | **Retained  Earnings** |   |          |    |
|-------------------------------------------------------------------|--------|-------------------|--------|-------------------------|--------|------------------|--------|------------------------|--------|---------------|---------|
|                                                              |   | **Shares**        |   | **Amount**              |   | **Capital**      |   | **Receivable**         |   | **(Deficit)** |    | **TOTAL** |   |
| Balances,  January 1, 2002                                   |   | 9,000,000         |   | $                       | 9,000  |             | $      | 116,400                |   | $             | (84,000 | ) | $ | 830,582 |   | $ | 871,982 |   |
|                                                              |   |              |   |                    |   |             |   |                   |   |          |    |   |   |
| Distributions,  September 30, 2002                           |   | —            |   | —                  |   | —           |   | —                 |   | (1,864,020    | )       | (1,864,020 | ) |
|                                                              |   |              |   |                    |   |             |   |                   |   |          |    |   |   |
| Payment  of subscription receivable                               |   | —            |   | —                  |   | —           |   | 84,000                 |   | —        |    | 84,000 |   |
|                                                              |   |              |   |                    |   |             |   |                   |   |          |    |   |   |
| Net  income, nine months ended September 30, 2002            |   | —            |   | —                  |   | —           |   | —                 |   | 2,118,767     |    | 2,118,767 |   |
|                                                              |   |              |   |                    |   |             |   |                   |   |          |    |   |   |
| Balance  September 30, 2002 - before recapitalization        |   | 9,000,000         |   | 9,000                   |   | 116,400          |   | —                 |   | 1,085,329     |    | 1,210,729 |   |
|                                                              |   |              |   |                    |   |             |   |                   |   |          |    |   |   |
| Recapitalization  on October 1, 2002                         |   | 1,800,000         |   | 1,800                   |   | 972,471          |   | —                 |   | (1,085,329    | )       | (111,058 | ) |
|                                                              |   |              |   |                    |   |             |   |                   |   |          |    |   |   |
| Balance  after recapitalization on October 1, 2002           |   | 10,800,000        |   | 10,800                  |   | 1,088,871        |   | —                 |   | —        |    | 1,099,672 |   |
|                                                              |   |              |   |                    |   |             |   |                   |   |          |    |   |   |
| Reclassification  of redeemable stock                             |   | (450,000          | )      | (450                    | )      | (60,086          | )      | —                 |   | —        |    | (60,536 | ) |
|                                                              |   |              |   |                    |   |             |   |                   |   |          |    |   |   |
| Issuance  of shares in exchange for legal services                |   | 15,000            |   | 15                      |   | 40,635           |   | —                 |   | —        |    | 40,650 |   |
|                                                              |   |              |   |                    |   |             |   |                   |   |          |    |   |   |
| Issuance  of shares to employees, directors and consultants (SIP) |   | 134,500           |   | 135                     |   | 364,360          |   | —                 |   | —        |    | 364,495 |   |
|                                                              |   |              |   |                    |   |             |   |                   |   |          |    |   |   |
| Issuance  of shares - private offering (See Note 10)              |   | 83,334            |   | 83                      |   | 249,917          |   | —                 |   | —        |    | 250,000 |   |
|                                                              |   |              |   |                    |   |             |   |                   |   |          |    |   |   |
| Exercise  of warrants                                             |   | 5,000             |   | 5                       |   | 14,995           |   | —                 |   | —        |    | 15,000 |   |
|                                                              |   |              |   |                    |   |             |   |                   |   |          |    |   |   |
| Sub-total                                                         |   | 10,587,834        |   | $                       | 10,588 |             | $      | 1,698,692              |   | $             | —  |   | $ | — |   | $ | 1,709,280 |   |

 

The notes toconsolidated financial statements are an integral part of the above statement.

 

F-6

----

 
|                                                 |   | **Common  Stock** |   | **Additional  Paid in** |   | **Subscription** |   | **Retained  Earnings** |   |          |   |
|------------------------------------------------------|--------|-------------------|--------|-------------------------|--------|------------------|--------|------------------------|--------|---------------|--------|
|                                                 |   | **Shares**        |   | **Amount**              |   | **Capital**      |   | **Receivable**         |   | **(Deficit)** |   | **TOTAL** |   |
|                                                 |   | 10,587,834        |   | $                       | 10,588 |             | $      | 1,698,692              |   | $             | — |   | $ | — |   | $ | 1,709,280 |   |
|                                                 |   |              |   |                    |   |             |   |                   |   |          |   |   |   |
| Accretion  of redeemable stock                       |   | —            |   | —                  |   | (1,012,624       | )      | —                 |   | —        |   | (1,012,624 | ) |
|                                                 |   |              |   |                    |   |             |   |                   |   |          |   |   |   |
| Net  loss, three months ended December 31, 2002 |   | —            |   | —                  |   | —           |   | —                 |   | (184,740      | )      | (184,740 | ) |
|                                                 |   |              |   |                    |   |             |   |                   |   |          |   |   |   |
| Balance,  December 31, 2002                     |   | 10,587,834        |   | $                       | 10,588 |             | $      | 686,068                |   | $             | — |   | $ | (184,740 | ) | $ | 511,916 |   |

 

The notes toconsolidated financial statements are an integral part of the above statement.

 

F-7

----

 
|                                                                          |   | **Common  Stock** |   | **Additional  Paid in** |   | **Subscription** |   | **Retained  Earnings** |   |          |   |
|-------------------------------------------------------------------------------|--------|-------------------|--------|-------------------------|--------|------------------|--------|------------------------|--------|---------------|--------|
|                                                                          |   | **Shares**        |   | **Amount**              |   | **Capital**      |   | **Receivable**         |   | **(Deficit)** |   | **TOTAL** |   |
| Balances,  January 1, 2003                                               |   | 10,587,834        |   | $                       | 10,588 |             | $      | 686,068                |   | $             | — |   | $ | (184,740 | ) | $ | 511,916 |   |
|                                                                          |   |              |   |                    |   |             |   |                   |   |          |   |   |   |
| Cancellation  of stock repurchase agreement                                   |   | 450,000           |   | 450                     |   | 1,072,710        |   | —                 |   | —        |   | 1,073,160 |   |
|                                                                          |   |              |   |                    |   |             |   |                   |   |          |   |   |   |
| Issuance  of shares - private offering (See Note 10)                          |   | 136,668           |   | 137                     |   | 409,863          |   | —                 |   | —        |   | 410,000 |   |
|                                                                          |   |              |   |                    |   |             |   |                   |   |          |   |   |   |
| Exercise  of warrants                                                         |   | 80,000            |   | 80                      |   | 239,920          |   | —                 |   | —        |   | 240,000 |   |
|                                                                          |   |              |   |                    |   |             |   |                   |   |          |   |   |   |
| Issuance  of shares to employees,  and directors  (SIP)                  |   | 16,000            |   | 16                      |   | 43,344           |   | —                 |   | —        |   | 43,360 |   |
|                                                                          |   |              |   |                    |   |             |   |                   |   |          |   |   |   |
| Issuance  of shares - public offering, net of offering expenses (See Note 10) |   | 250,000           |   | 250                     |   | 1,292,250        |   | —                 |   | —        |   | 1,292,500 |   |
|                                                                          |   |              |   |                    |   |             |   |                   |   |          |   |   |   |
| Issuance  of shares - private offering (See Note 10)                          |   | 100,000           |   | 100                     |   | 549,900          |   | —                 |   | —        |   | 550,000 |   |
|                                                                          |   |              |   |                    |   |             |   |                   |   |          |   |   |   |
| Issuance  of shares to employees (SIP)                                        |   | 2,200             |   | 2                       |   | 12,098           |   | —                 |   | —        |   | 12,100 |   |
|                                                                          |   |              |   |                    |   |             |   |                   |   |          |   |   |   |
| Net  income, for the year                                                     |   | —            |   | —                  |   | —           |   | —                 |   | 436,305       |   | 436,305 |   |
|                                                                          |   |              |   |                    |   |             |   |                   |   |          |   |   |   |
| Balance,  December 31, 2003                                              |   | 11,622,702        |   | $                       | 11,623 |             | $      | 4,306,153              |   | $             | — |   | $ | 251,565 |   | $ | 4,569,341 |   |

 

The notes toconsolidated financial statements are an integral part of the above statement.

 

F-8

----

 

**IWT TESORO CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YEARS ENDED DECEMBER 31, 2003 AND 2002**

 
|                                                                                               |   | **2003**    |    | **2002**    |   |
|----------------------------------------------------------------------------------------------------|--------|-------------|---------|-------------|--------|
| Cash  flows from operating activities:                                                             |   |        |    |        |   |
| Net  Income                                                                                        |   | $           | 436,305 |        | $      | 1,934,027 |   |
| Adjustments  to reconcile net income to net cash provided by (used in)  operating activities: |   |        |    |        |   |
| Depreciation                                                                                       |   | 634,984     |    | 422,435     |   |
| Loan  amortization cost                                                                            |   | 7,083       |    | 26,575      |   |
| Loss  (gain) on sales of assets                                                                    |   | 18,757      |    | (5,979      | )      |
| Bad  debts                                                                                         |   | 204,581     |    | 3,085       |   |
| Deferred  taxes                                                                                    |   | 36,750      |    | (34,348     | )      |
| Compensation  in exchange for stock and options                                                    |   | 55,460      |    | 405,145     |   |
| (Increase)  decrease in operating assets                                                           |   |        |    |        |   |
| Accounts  receivable                                                                               |   | (2,236,752  | )       | (786,221    | )      |
| Inventories                                                                                        |   | (7,010,963  | )       | (1,062,449  | )      |
| Prepaid  expenses                                                                                  |   | (467,469    | )       | (263,798    | )      |
| Other  assets                                                                                      |   | (131,079    | )       | (16,640     | )      |
| Increase  (decrease) in operating liabilities                                                      |   |        |    |        |   |
| Accounts  payable and accrued expenses                                                             |   | 4,441,574   |    | 1,242,495   |   |
| Total  adjustments                                                                                 |   | (4,447,074  | )       | (69,700     | )      |
| Net  cash provided by (used in) operating activities                                               |   | (4,010,769  | )       | 1,864,327   |   |
|                                                                                               |   |        |    |        |   |
| Cash  flows from investing activities:                                                             |   |        |    |        |   |
| Proceeds  from sale of property                                                                    |   | 20,000      |    | 11,000      |   |
| Acquisition  of property and equipment                                                             |   |        |    |        |   |
| Displays  and sample boards                                                                        |   | (1,239,449  | )       | (908,238    | )      |
| Other  property and equipment                                                                      |   | (914,485    | )       | (58,049     | )      |
| Net  cash used in investing activities                                                             |   | (2,133,934  | )       | (955,287    | )      |
|                                                                                               |   |        |    |        |   |
| Cash  flows from financing activities:                                                             |   |        |    |        |   |
| Proceeds  from issuance of stocks, net                                                             |   | 1,942,500   |    | 349,000     |   |
| Proceeds  from new borrowings                                                                      |   | 42,396,903  |    | 26,010,639  |   |
| Proceeds  from loans from related party                                                            |   | —      |    | 10,640      |   |
| Distributions  to stockholders                                                                     |   | —      |    | (1,864,020  | )      |
| Payments  on stockholder loan                                                                      |   | (110,050    | )       | (25,000     | )      |
| Payments  on new borrowings                                                                        |   | (37,662,341 | )       | (25,105,628 | )      |
| Principal  payments on notes payable and capital leases                                            |   | (128,994    | )       | (113,125    | )      |
| Net  cash provided by (used in) financing activities                                               |   | 6,438,018   |    | (737,494    | )      |
|                                                                                               |   |        |    |        |   |
| Net  increase in cash and cash equivalents                                                         |   | 293,315     |    | 171,546     |   |
|                                                                                               |   |        |    |        |   |
| Cash  and cash equivalents, beginning of period                                                    |   | 574,046     |    | 402,500     |   |
| Cash  and cash equivalents, end of period                                                          |   | $           | 867,361 |        | $      | 574,046 |   |

 

The notes toconsolidated financial statements are an integral part of the above statement.

 

F-9

----

 
|                                                |   | **2003** |    | **2002** |   |
|-----------------------------------------------------|--------|----------|---------|----------|--------|
|                                                |   |     |    |     |   |
| Supplemental  disclosures of cash flow information: |   |     |    |     |   |
|                                                |   |     |    |     |   |
| Cash  paid during the period for:                   |   |     |    |     |   |
|                                                |   |     |    |     |   |
| Interest  expense                                   |   | $        | 473,056 |     | $      | 302,345 |   |
|                                                     |        |          |         |          |        |  |  |

 

The notes toconsolidated financial statements are an integral part of the above statement.

 

F-10

----

 

**IWT TESORO CORPORATION ANDSUBSIDIARIES****NOTES TO CONSOLIDATED FINANCIAL STATEMEN****TS****FOR THEYEARS ENDED DECEMBER 31, 2003 AND 2002**

 

**NOTE 1****                                                    SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

Nature of Operations

 

IWT Tesoro Corporationwas incorporated in the state of Nevada on May 3, 2000 as Ponca AcquisitionCorporation.  On September 23,2002, the Company changed the name of Ponca Acquisition Corporation to IWTTesoro Corporation.

 

On October 1, 2002,IWT Tesoro Corporation (an inactive publicly held company) acquired 100% of theoutstanding stock of International Wholesale Tile, Inc. (IWT) in exchange for83% of its outstanding common stock in a transaction accounted for as arecapitalization of IWT.

 

International WholesaleTile, Inc. (IWT) is a wholesale distributor of imported ceramic, porcelain, andstone tile, dealing mainly in imported floor & wall tiles.  IWTTesoro International, Ltd. (ITIL) was set up as a foreign subsidiary, to bebased in Bermuda to handle future operations of foreign subsidiaries.  IWT Tesoro Transport, Inc. (ITTI) was initiallyformed to be a transport broker.  ITTIhas been relicensed as a common carrier for the overland transport of tile fromFlorida to destinations within the United States and return shipments of otherfreight back to Florida.

 

The consolidatedfinancial statements include the accounts of IWT Tesoro Corporation, the parentcompany, and its wholly-owned subsidiaries, International Wholesale Tile, Inc.,IWT Tesoro Transport, Inc. and IWT Tesoro International, Inc.  Significant intercompany accounts and transactionshave been eliminated.  IWT TesoroCorporation and Subsidiaries are hereinafter referred to as “the Company.”

 

Accounting Estimates

 

The preparation offinancial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

Cash and Cash Equivalents

 

The Company considers allhighly liquid debt instruments purchased with an original maturity of threemonths or less to be cash equivalents.

 

Accounts Receivable

 

Accounts receivable arestated at the face amount net of allowance for doubtful accounts.  Generally accepted accounting principlesrequire that the allowance method be used to reflect bad debts.  A provision for doubtful accounts has beenestablished to reflect an allowance for uncollectible amounts.

 

Inventories

 

Inventories consisting oftiles are valued at the lower of cost or market.  Cost is determined by the first-in, first-out method (FIFO).  The Company includes inventory in transit asan asset of the company because merchandise overseas is purchased FOB shippingpoint.  Title passes to the Company whenmerchandise leaves the factory.

 

F-11

----

 

Property, Plant andEquipment

 

Property, plant andequipment are stated at cost. Depreciation is computed principally by thestraight-line method over the estimated useful lives.  Expenditures for maintenance, repairs, and minor replacements arecharged to expense as incurred. Renewals and betterments are capitalized.

 

Income Taxes

 

The Company accounts forincome taxes under Financial Accounting Standards Board (FASB) Statement No.109, *Accounting for Income Taxes*.  SFAS No. 109 is an asset and liabilityapproach that requires the recognition of deferred tax assets and liabilitiesfor the expected future tax consequences of events that have been recognized inthe financial statements or tax returns. (See Note 9)

 

Revenue Recognition

 

Revenues are recognizedwhen products are shipped through common carrier (FOB shipping point withfreight allowed in most orders), or when products are received and accepted bycustomer if delivered by company (FOB destination).  Title passes to the customer at the FOB point (shipping ordestination).  Customers have the rightto return merchandise within 30 days of the date of shipment.  The Company did not establish an allowancefor return because they are infrequent, represent a small dollar amount andoccur over a fairly short time period following the sale.

 

Long Lived Assets

 

The Company continuallyevaluates the carrying value of property and equipment to determine whetherthere are any impairment losses.  Ifindicators of impairment are present, and future undiscounted cash flows arenot expected to be sufficient to recover the assets’ carrying amount, animpairment loss would be charged to operations in the period identified basedon the difference between the carrying value and the fair value of the asset.

 

No reduction forimpairment of long-lived assets was necessary at December 31, 2003 or2002.

 

Stock Options

 

The Company elected toaccount for stock options issued to employees in accordance with AccountingPrinciples Board Opinion No. 25**(APBOpinion No. 25) *Accounting For Stock Issuedto Employees* and related interpretations, which establishedfinancial accounting and reporting for compensation cost of stock issued toemployees through non-variable plans, variable plans, and non-compensatoryplans, and accounts for stock options and warrants issued to non-employees inaccordance with SFAS 123, *Accounting forStock-Based Compensation*, which established a fair value method ofaccounting for stock compensation plans with employees and others.

 

Inaccordance with SFAS No. 123, for options issued to employees, the Company haselected to account for these stock options under APB No. 25 and relatedinterpretations in accounting for its plan. Accordingly, no compensation costs have been recognized for optionsissued under the plan as of December 31, 2003 and 2002.

 

F-12

----

 

Inaccordance with SFAS No. 123, for options issued to employees, the Company haselected to account for these stock options under APB No. 25 and relatedinterpretations in accounting for its plan. Accordingly, no compensation costs have been recognized for optionsissued under the plan as of December 31, 2003 and 2002.

 

Hadcompensation costs for the Company’s stock option been determined on the fairmarket value at the grant dates for the options, consistent with Statement ofAccounting Standards No. 123, *Accounting forStock Based Compensation* (Statement No. 123), the Company’s resultsof operations for the years ended December 31, 2003 and 2002 would havechanged to the pro-forma amounts indicated.

 
|                                                                                                                                 |   | **2003** |    | **2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| Net income as reported                                                                                                               |   | $        | 436,306 |     | $      | 1,934,027 |   |
| Add: Stock based employee compensation cost, net  of  related tax effects, included in the determination of  net income as reported  |   | 55,460   |    | 234,355  |   |
|                                                                                                                                 |   |     |    |     |   |
| Less: Stock based employee compensation cost, net  of  related tax effects, determined under fair value based  method for all awards |   | (55,460  | )       | (295,656 | )      |
|                                                                                                                                 |   |     |    |     |   |
| Pro-forma  net income                                                                                                                |   | $        | 436,306 |     | $      | 1,872,726 |   |
|                                                                                                                                 |   |     |    |     |   |
| Net  income per share - basic                                                                                                        |   |     |    |     |   |
| As  reported                                                                                                                         |   | $        | 0.04    |     | $      | 0.18 |   |
| Pro-forma                                                                                                                            |   | $        | 0.04    |     | $      | 0.18 |   |
|                                                                                                                                 |   |     |    |     |   |
| Net  income per share - diluted                                                                                                      |   |     |    |     |   |
| As  reported                                                                                                                         |   | $        | 0.04    |     | $      | 0.18 |   |
| Pro-forma                                                                                                                            |   | $        | 0.04    |     | $      | 0.18 |   |

 

Advertising

 

Advertising costs arecharged to operations in the year incurred and were $120,939 and $203,838 forthe years ended December 31, 2003 and 2002, respectively.

 

Shipping and HandlingExpenses

 

The Company offers freedelivery on sales over 100 sq. ft. which is the bulk of the sales, thereforemost invoices billed to customers do not include shipping and handlingcharges.  When shipping and handlingcharges are billed to customers, they are included in revenue.  The cost incurred to ship the products tocustomers through common carriers is included in the Statement of Operationsunder Delivery Expense. At December 31, 2003 and 2002 the total amount ofDelivery Expense was $1,576,816 and $1,245,174, respectively.

 

F-13

----

 

Cost of Goods Sold

 

The Company includes incost of goods sold the following expenses: cost of merchandise sold, inventoryadjustments, in-bound freight, duty and fees and discounts taken. AtDecember 31, 2003 and 2002 the total amount of cost of goods sold was$19,814,514 and $15,268,535, respectively.

 

Earnings per Share

 

Basic earnings per shareare computed based on the weighted average number of common shares outstandingduring each year.

 

Diluted earnings pershare are computed based on the weighted average number of common sharesoutstanding plus all potential dilutive common shares outstanding (stockoptions) during each year.

 

At December 31, 2002all common stock equivalents were antidilutive and therefore diluted earningsper share equaled basic earnings per share.

 

At December 31, 2003and 2002, the total number of additional shares that could potentially dilute basicEPS in the future, but were not included in the computation of diluted EPSbecause of their antidilutive effect, was 350,000 and 560,000, respectively.

 

Concentration of CreditRisk

 

Financial instrumentswhich potentially subject the Company to concentrations of credit risk consistsof cash on deposit with two financial institutions amounting to $867,361 atDecember 31, 2003, which was insured for up to $100,000 per financialinstitution by the U.S. Federal Deposit Insurance Corporation.

 

The Company believesconcentration of accounts receivable credit risk are limited due to the numberof customers.  It is the policy ofmanagement to obtain detailed credit evaluations of customers and establishcredit limits as required.  The Companyroutinely assesses the financial strength of its customers.  Outstanding accounts receivable are reviewedat the end of each reporting period, as well as the bad debt write-offsexperienced in the past, and establish an allowance for doubtful accounts foruncollectible amounts.  There is nodisproportionate concentration of credit risk. The Company purchased credit insurance for specific customers whopurchase bulk materials and are offered extended terms.

 

Accounting Pronouncements

 

Statement No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets* supersedes Statement No. 121, *Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to be Disposed of* (SFAS No. 121).  Though it retains the basic requirements ofSFAS No. 121 regarding when and how to measure an impairment loss, SFAS No. 144provides additional implementation guidance. SFAS No. 144 excludes goodwill andintangibles not being amortized among other exclusions.  SFAS No. 144 also supersedes the provisionsof APB No. 30, *Reporting the Results ofOperations*, pertaining to discontinued operations.  Separate reporting of a discontinuedoperation is still required, but SFAS No. 144 expands the presentation toinclude a component of an entity, rather than strictly a business segment asdefined in SFAS No. 131, *Disclosures aboutSegments of an Enterprise and Related Information*.

 

F-14

----

 

SFAS No. 144 alsoeliminates the current exemption to consolidation when control over asubsidiaries is likely to be temporary. This statement is effective for all fiscal years beginning afterDecember 15, 2001.  The Companybelieves that the implementation of SFAS No. 144 did not have a material effecton the Company’s financial position, results of operations or liquidity.

 

In December 2002,the FASB issued SFAS No. 148, *Accounting forStock-Based Compensation – Transition and Disclosure,* which amendedSFAS No. 123, *Accounting for Stock-BasedCompensation.*  The newstandard provides alternative methods of transition for a voluntary change tothe fair value based method of accounting for stock-based employeecompensation.  Additionally, thestatement amends the disclosure requirements of SFAS No. 123 to require prominentdisclosures in the annual and interim financial statements about the method ofaccounting for stock-based employee compensation and the effect of the methodused in reported results.  Thisstatement is effective for financial statements for fiscal years ending afterDecember 15, 2002.  In compliancewith SFAS No. 148, the Company has elected to continue to follow the intrinsicvalue method in accounting for its stock-based employee compensationarrangement as defined by APB No. 25.

 

**NOTE 2****                                                    FAIRVALUE OF FINANCIAL INSTRUMENTS**

 

The carrying values ofcash and cash equivalents, accounts receivable, accounts payable and short-termdebt approximate fair value.  The fairvalue of long-term debt was estimated by discounting the future cash flow usingcurrent borrowing rates for similar types and maturities of debt, except forthe revolving credit agreements with floating rates, for which the carryingamounts were considered a reasonable estimate of fair value.

 

Debt:

The fair value andcarrying amount of long-term debt was as follows:

 
|             |   | **December 31** |       |
|------------------|--------|----------------------|------------|
|             |   | **2003**             |       | **2002** |   |
|             |   |                 |       |   |   |
| Fair  Value      |   | $                    | 9,890,702  |   | $ | 5,162,608 |   |
| Carrying  amount |   | $                    | 10,129,745 |   | $ | 5,486,800 |   |

 

**NOTE 3****                                                    INVENTORIES**

 

Inventories consisted ofthe following:

 
|                  |   | **December 31** |       |
|-----------------------|--------|----------------------|------------|
|                  |   | **2003**             |       | **2002** |   |
|                  |   |                 |       |   |   |
| Tiles                 |   | $                    | 11,102,115 |   | $ | 4,692,974 |   |
| Inventory  in transit |   | 1,956,724            |       | 1,354,902 |   |
|                  |   |                 |       |   |   |
|                  |   | $                    | 13,058,839 |   | $ | 6,047,876 |   |

 

F-15

----

 

Inventory in transitconsists of merchandise purchased overseas, which is not yet received in thewarehouse.  The Company obtains legaltitle at the shipping point.  Inventorycost includes the purchase price and in-bound freight.

 

**NOTE 4****                                                    NOTERECEIVABLE**

 

The note receivable is apromissory note for $550,000.  The notebears interest at 3% per year with a maturity date of June 30, 2004. (SeeNote 10)  The note was paid in full inMarch 2004.

 

**NOTE 5****                                                    PROPERTYAND EQUIPMENT**

 

Property and equipmentconsisted of the following:

 
|                           |   | **December 31** |      |
|--------------------------------|--------|----------------------|-----------|
|                           |   | **2003**             |      | **2002** |   |
|                           |   |                 |      |   |   |
| Furniture  and fixtures        |   | $                    | 307,235   |   | $ | 89,227 |   |
| Machinery  and equipment       |   | 477,996              |      | 326,165 |   |
| Vehicles                       |   | 211,215              |      | 207,071 |   |
| Display  boards                |   | 1,098,199            |      | 607,978 |   |
| Sample  boards                 |   | 3,128,750            |      | 2,379,533 |   |
| Computer  equipment            |   | 323,010              |      | 131,407 |   |
| Leasehold  improvements        |   | 409,125              |      | 108,220 |   |
|                           |   |                 |      |   |   |
|                           |   | 5,962,260            |      | 3,849,601 |   |
| Less  accumulated depreciation |   | (1,678,742           | )         | (1,137,179 | ) |
|                           |   |                 |      |   |   |
|                           |   | $                    | 4,283,518 |   | $ | 2,712,422 |   |

 

Depreciation of propertyand equipment charged to operations amounted to $634,984 and $422,435, for theyears December 31, 2003 and 2002, respectively. (See Note 8)

 

F-16

----

 

**NOTE 6****                                                    NOTESPAYABLE**

 

The Company hasoutstanding notes payable as follows:

 
|                                                                                                                                                                                     |   | **December 31** |    |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|---------|
|                                                                                                                                                                                     |   | **2003**             |    | **2002** |   |
| Notes  Payable – Related Parties                                                                                                                                                    |   |                 |    |   |   |
|                                                                                                                                                                                     |   |                 |    |   |   |
| Notes  payable to three majority stockholder; interest rate 10% per year; due  December 31, 2025; no prepayment penalty; subject to Subordination  Agreement of new line of credit. |   | $                    | 338,662 |   | $ | 448,712 |   |
|                                                                                                                                                                                          |        |                      |         |  |  |  |  |

 

Interest expense relatedto these loans was $35,235 and $56,532 for the years ended December 31,2003 and 2002, respectively.

 
|                                                                                                                                                                                      |   | **December 31** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|--------|
|                                                                                                                                                                                      |   | **2003**             |   | **2002** |   |
| Notes  Payable – Unrelated Parties                                                                                                                                                   |   |                 |   |   |   |
|                                                                                                                                                                                      |   |                 |   |   |   |
| Various  equipment notes, payable in monthly installments ranging from $882 to $1,457;  maturing September 2004 through December 2005; interest rates  ranging from 0 to 8.95%. |   | $                    | 85,279 |   | $ | 113,652 |   |
|                                                                                                                                                                                      |   |                 |   |   |   |
| Less  current portion                                                                                                                                                                     |   | (42,719              | )      | (48,780 | ) |
|                                                                                                                                                                                      |   |                 |   |   |   |
|                                                                                                                                                                                      |   | $                    | 42,560 |   | $ | 64,872 |   |

 

Interest expense relatedto these loans was $6,763 and $9,361 for the years ended December 31, 2003and 2002, respectively.

 

Maturities of long-termdebt are as follows:

 
| 2004       |   | $       | 42,719  |   |
|------------|--------|---------|---------|--------|
| 2005       |   | 26,410  |    |
| 2006       |   | 8,528   |    |
| 2007       |   | 7,622   |    |
| 2008       |   | 0       |    |
| Thereafter |   | 338,662 |    |
|       |   |    |    |
|       |   | $       | 423,941 |   |

 

F-17

----

 

**NOTE 7****                                                    LINEOF CREDIT**

 

Anexisting loan and security agreement for a line of credit was restatedeffective November 13, 2002, whereas the amount of the maximum credit wasincreased from $5,000,000 to $7,500,000. The average interest rate was about 5% for the year endedDecember 31, 2002, continuing through September 9, 2003.  IWT owed $4,864,778 on this creditline at December 31, 2002.

 

OnSeptember 10, 2003, the Company entered into a new loan and securityagreement with a financial institution for a revolving line of credit with amaximum limit of $17,000,000.  Theagreement specifies that proceeds from this revolving credit loan must be usedsolely to satisfy the Company’s previous existing line of credit in the amountof $7,288,903, and for general working capital needs.  All present and future assets of the Company collateralize thisloan. The rate of interest in effect for this agreement is calculated withreference to the Base Rate and/or LIBOR (London Interbank Offered Rate).  The balance due at December 31, 2003was $9,599,340.

 

BaseRate advances bear a fluctuating interest rate per annum equal to prime plus0.50%.  LIBOR advances bear a fixed rateper annum equal to 3.00% plus the LIBOR for the applicable interest period.  At December 31, 2003 the Base Rate andthe LIBOR rate were 4.50% and 4.19%, respectively.

 

Theloan and security agreement contains certain amended and restated covenants,which include financial covenants that require the Company to maintain acertain leverage ratio, a required minimum fixed charge coverage ratio, and acertain inventory turnover ratio.  AtDecember 31, 2003, the Company is in compliance with all requiredcovenants, as amended and restated in agreement with the financial institution.

 

For the years endedDecember 31, 2003 and 2002, interest expense related to the credit lines amounted to $413,164 and$227,022, respectively.  Interestexpense at December 31, 2003 includes a termination fee of $75,000assessed for prepayment of the prior credit line.

 

TheCompany incurred a closing fee of $85,000 for the new revolving line of credit,which was deferred and will be amortized using the straight-line method overthe 3-year life of the loan, with a charge to interest expense.  A total of $7,083 was amortized during theyear ended December 31, 2003.

 

**NOTE 8****                                                    LEASES**

 

Capital Leases

 

The Company has variouscapital leases included in property and equipment (See Note 5) which aresummarized as follows:

 
|                                       |   | **2003** |    | **2002** |   |
|--------------------------------------------|--------|----------|---------|----------|--------|
|                                       |   |     |    |     |   |
| Equipment                                  |   | $        | 394,326 |     | $      | 266,672 |   |
| Less:  Accumulated  depreciation |   | (94,655  | )       | (58,724  | )      |
|                                       |   |     |    |     |   |
| Net  assets under capital leases           |   | $        | 299,671 |     | $      | 207,948 |   |

 

F-18

----

 

Operating Leases

 

The Company leases officeand warehouse space under a non-cancelable operating lease, which has aninitial term in excess of one year.  InMay 2003, the Company took occupancy of a new warehouse and office facility inPalm City, Florida with a combined total of 147,000 square feet of space.  In addition, the Company entered into a newlease agreement for over 48,000 square feet of warehouse space at the oldlocation, and a one-year sub-lease agreement for 20,000 square feet ofwarehouse space was signed effective August 1st, 2003. TheCompany also leases office space in Westport, Connecticut for its corporateheadquarters.

 

At December 31,2003, future minimum annual lease payments under operating and capital leasesare as follows:

 
|       |   | **Operating  Lease** |      | **Capital  Leases** |   |
|------------|--------|----------------------|-----------|---------------------|--------|
|       |   |                 |      |                |   |
| 2004       |   | $                    | 908,639   |                | $      | 63,151 |   |
| 2005       |   | 851,887              |      | 63,586              |   |
| 2006       |   | 872,437              |      | 49,127              |   |
| 2007       |   | 893,800              |      | 30,175              |   |
| 2008       |   | 915,650              |      | 6,295               |   |
| Thereafter |   | 4,451,373            |      | 0                   |   |
|       |   |                 |      |                |   |
|       |   | $                    | 8,893,786 |                | $      | 212,334 |   |

 

Total lease expense underoperating leases was $1,031,559 and $479,905 for the years endedDecember 31, 2003 and 2002, respectively.

 

Total interest expenseunder capital leases was $18,075 and $9,429 for the years endedDecember 31, 2003 and 2002, respectively.

 

**NOTE 9****                                                    INCOMETAXES**

 

At December 31, 2003the Company had a federal net operating loss carryforward of approximately$686,000 in large part due to the IRS Regulation 168(k) – BonusDepreciation.  The loss carryforward issubject to annual limitations prescribed by the Internal Revenue Code, whichare available to offset future taxable income through 2003. No valuationallowance has been recorded to offset the net deferred taxes due to thecertainty of the Company’s ability to generate future taxable income.

 

During the first ninemonths of 2002, the subsidiary, International Wholesale Tile Inc. was taxed asan S corporation according to the provisions of the Internal Revenue Code.  Accordingly, no provision or liability forincome taxes is reflected in the accompanying statements for that period oftime.  Instead, the stockholders wereliable for individual Federal income taxes on their respective share of theCompany’s taxable income.  Scorporations pay distribution of profits in lieu of dividends.

 

F-19

----

 

The provision (benefit)for income taxes is comprised of the following:

 
|                                        |   | **2003** |   | **2002** |   |
|---------------------------------------------|--------|----------|--------|----------|--------|
|                                        |   |     |   |     |   |
| Current  taxes                              |   | $        | 0      |     | $      | 0 |   |
| Deferred  tax expense (benefit)             |   | 36,749   |   | (34,347  | )      |
|                                        |   |     |   |     |   |
| Total  provision (benefit) for income taxes |   | $        | 36,749 |     | $      | (34,347 | ) |

 

Deferred income taxesreflect the net tax effect of temporary differences between the carryingamounts of assets and liabilities for financial reporting purposes and theamounts used for income tax purposes. Significant components of the net deferred tax assets (liabilities) wereas follows:

 
|                                   |   | **2003** |    | **2002** |   |
|----------------------------------------|--------|----------|---------|----------|--------|
|                                   |   |     |    |     |   |
| Deferred  tax assets                   |   |     |    |     |   |
| Loss  carryforward                     |   | $        | 230,143 |     | $      | 76,546 |   |
| Accounts  receivable                   |   | 40,800   |    | 2,934    |   |
| Other                                  |   | 3,390    |    | 0        |   |
|                                   |   |     |    |     |   |
| Total  deferred tax assets             |   | 274,333  |    | 79,480   |   |
| Deferred  tax liabilities              |   |     |    |     |   |
| Accelerated  depreciation              |   | 276,735  |    | (45,133  | )      |
|                                   |   |     |    |     |   |
| Total  deferred tax liabilities        |   | 276,735  |    | (45,133  | )      |
|                                   |   |     |    |     |   |
| Net  deferred tax assets (liabilities) |   | $        | (2,402  | )        | $      | 34,347 |   |

 

A reconciliation of thefederal statutory rate and the Company’s effective tax rate is presented asfollows:

 
|                                                   |   | **2003** |   | **2002** |   |
|--------------------------------------------------------|--------|----------|--------|----------|--------|
|                                                   |   |     |   |     |   |   |   |   |   |
| Computed  expected tax expense                         |   |     |   |     |   |   |   |   |   |
| Federal                                                |   | $        | 31,100 |     | 31.00  | % | $ | (29,496 | ) | 31.00 | % |
| State  income taxes, net of Federal income tax benefit |   | 5,649    |   | 5.00     | %      | (4,851 | ) | 5.00 | % |
|                                                   |   |     |   |     |   |   |   |   |   |
| Effective income taxes (benefit)                       |   | $        | 36,749 |     | 34.00  | % | $ | (34,347 | ) | 34.00 | % |

 

F-20

----

 

**NOTE 10****                                             STOCKHOLDERS’EQUITY**

 

Common Stock

 

DuringMarch 2003, the Company completed a private placement of its securities,which was initiated in 2002.  As aresult, the Company issued an aggregate of 220,000 shares of its unregisteredcommon stock at $3.00 per unit, resulting in aggregate proceeds of$660,000.  (See Note 13)

 

DuringDecember 2003, the Company completed a public offering of its securities.  As a result, the Company issued an aggregateof 250,000 shares of its registered common stock at $5.50 per unit, resultingin aggregate net proceeds of $1,292,250 after offering costs of $82,500.  (See Note 14)

 

InDecember 2003, the Company completed a private placement of itsunregistered securities and signed a subscription agreement with an investor topurchase 100,000 units at $5.50 per unit. Each unit consisted of one (1) share of common stock and one warrant topurchase one additional share at $7.00 per share.  In addition, the investor signed a stock pledge agreement and apromissory note for $550,000, at 3.0% interest per year, with a maturity dateof June 30, 2004.  The investorpledged the 100,000 shares to IWT Tesoro Corporation until the promissory noteis paid in full.

 

InMarch 2004, the Company received full payment for the promissory note.

 

Warrants

 

As it relates to theprivate placement, 330,000 warrants were issued at an initial price of $3.00per share.  These warrants will expirein 5 years from the date of issuance. Through December 31, 2003, 85,000 of these outstanding warrantswere exercised for a total of $255,000.

 

As it relates to theinitial public offering, 250,000 warrants were issued at $7.00 per shareexpiring on June 17, 2006.  AtDecember 31, 2003 all warrants were outstanding.

 

Through another privateoffering, 100,000 warrants were issued during 2003, at an exercise price of$7.00 per share, expiring three years from the date of sale. AtDecember 31, 2003 all of these warrants were outstanding.

 

For purpose of valuingwarrants, the Company used the Black-Scholes option pricing model with thefollowing assumptions for the years ended December 31:

 

|                       |   | **2003** |   | **2002** |   |
|----------------------------|--------|----------|--------|----------|--------|
|                       |   |     |   |     |   |
| Expected  dividend yield   |   | 0        | %      | 0        | %      |
| Risk  free interest rate   |   | 2.12     | %      | 2.27     | %      |
| Expected  time of exercise |   | 2 years  |   | 3 years  |   |
| Expected  volatility       |   | 0.01     | %      | 0        | %      |

 

The average value of thewarrants at the issue date was $0.01 and $0.29 during 2003 and 2002,respectively.

 

F-21

----

 

Changes during the yearsare presented as follows:

 
|                               |   | **Number of  Warrants** |   | **Common  Stock** |   | **Weighted  Average  Exercise Price** |   |
|------------------------------------|--------|-------------------------|--------|-------------------|--------|---------------------------------------|--------|
|                               |   |                    |   |              |   |                                  |   |
| Balance  at January 1, 2002   |   | —                  |   | —            |   | $                                     | — |   |
| Issued                             |   | 125,000                 |   | 125,000           |   | 3.00                                  |   |
| Exercised                          |   | 5,000                   |   | 5,000             |   | 3.00                                  |   |
| Forfeited                          |   | —                  |   | —            |   | —                                |   |
| Balance  at December 31, 2002 |   | 120,000                 |   | 120,000           |   | 3.00                                  |   |
|                               |   |                    |   |              |   |                                  |   |
| Issued                             |   | 555,000                 |   | 555,000           |   | 5.52                                  |   |
| Exercised                          |   | 80,000                  |   | 80,000            |   | 3.00                                  |   |
| Forfeited                          |   | —                  |   | —            |   | —                                |   |
| Balance  at December 31, 2003 |   | 595,000                 |   | 595,000           |   | $                                     | 5.52   |   |

 

Warrants outstanding andexercisable at December 31, 2003 are as follows:

 
|                          |   | **WARRANTS  OUTSTANDING** |   | **WARRANTS  EXERCISABLE**                         |   |
|-------------------------------|--------|---------------------------|--------|---------------------------------------------------|--------|
| **Range of  Exercise  Price** |   | **Number  Outstanding**   |   | **Weighted  Average  Remaining  Contracted Life** |   | **Weighted  Average  Exercise  Price** |   | **Number  Exercisable** |   | **Weighted  Average  Exercise  Price** |   |
|                          |   |                      |   |                                              |   |   |   |   |   |   |   |
| $3.00-7.00                    |   | 245,000                   |   | 4.6 years                                         |   | $ | 4.04 |   | 245,000 |   | $ | 4.04 |   |
| $7.00                         |   | 350,000                   |   | 2.8 years                                         |   | $ | 7.00 |   | 350,000 |   | $ | 7.00 |   |

 

**NOTE 11****                                             STOCKOPTIONS AND COMPENSATION PLAN**

 

Stock Compensation Plan

 

On December 27,2001, IWT Tesoro Corporation adopted the Stock Incentive Plan (the Plan).  The Plan provides that eligible employees,consultants, and affiliates may be granted shares of common stock.  Under the Plan, the options granted arenon-qualified stock options, incentive stock options, and restrictedstock.  The aggregate total common stockthat may be issued under the Plan is 4,000,000 shares.  The restricted shares issued to employeeswere recorded at the fair value on the grant date. Under the Plan, a total of18,200 and 134,500 restricted shares were issued to employees, directors andconsultants for services rendered for the years ended December 31 2003 and2002, respectively.

 

Under the Plan, allunissued restricted shares were registered after the balance sheet date and allissued restricted shares were registered for resale without any additionalrestrictions imposed by the Compensation Committee.  (See Note 17)

 

F-22

----

 

On November 23,2002, the Company granted 40,000 options to directors at an exercise price of$3.00 per share, expiring in ten years. At December 31, 2003, the options were fully vested.

 

On November 23,2002, the Company granted 400,000 options to officers at an exercise price of$3.00 per share, expiring in ten years. The options vest as follows: (a) 33% atsuch time as the Company’s common stock commences trading on theOver-The-Counter (OTC) Bulletin Board (equivalent); (b) 33% at such time as theCompany attains no less than a $50 million market cap for ten consecutivetrading days; and (c) 33% when the Company achieves its 2003 revenue and profittargets.  At December 31, 2003 theoptions were 66% vested.

 

During 2002, all optionswere granted to employees, and accounted for according to APB 25; therefore nocompensation expense was recognized.  Nooptions were granted during 2003.

 

For financial statementdisclosure purposes, the fair market value of each stock option granted toofficers and employees during 2002 was established at the date of grant usingthe Black-Scholes option pricing model in accordance with Statement No. 123,with the following assumptions:

 

| Expected  dividend yield   |   | 0       | %      |
|----------------------------|--------|---------|--------|
| Risk  free interest rate   |   | 2.32    | %      |
| Expected  time of exercise |   | 3 years |   |
| Expected  volatility       |   | 0       | %      |

 
|     |   | **Number of  Securities  Underlying  Options** |   | **Percent of  Total Authorized  Options Available  Under the Plan  in Fiscal Year** |   | **Exercise  or  Base Price** |   | **Expiration  Date** |       | **Value of  Options  at Grant Date  Using an Option  Pricing Model** |   |
|----------|--------|------------------------------------------------|--------|-------------------------------------------------------------------------------------|--------|------------------------------|--------|----------------------|------------|----------------------------------------------------------------------|--------|
|     |   |                                           |   |                                                                                |   |                         |   |                 |       |                                                                 |   |
| Officers |   | 306,668                                        |   | 11                                                                                  | %      | $                            | 3.00   |                 | 11/23/2012 |                                                                 | $      | 0.20 |   |
|          |        |                                                |        |                                                                                     |        |                              |        |                      |            |                                                                      |        |  |  |

 

No options weregranted.  During 2003, 133,332 optionsexpired.

 

Optionsoutstanding and exercisable at December 31, 2003 are as follows:

 
|                          |   | **OPTIONS  OUTSTANDING** |       | **OPTIONS  EXERCISABLE**                          |       |
|-------------------------------|--------|--------------------------|------------|---------------------------------------------------|------------|
| **Range of  Exercise  Price** |   | **Number  Outstanding**  | ** ** | **Weighted  Average  Remaining  Contracted Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $                             | 3.00   |                     | 306,668    |                                              | 8.9        |   | $ | 3.00 |   | 306,668 |   | $ | 3.00 |   |
|                               |        |                          |            |                                                   |            |  |  |  |  |  |  |  |  |  |

 

F-23

----

 

**NOTE 12****                                             ACQUISITION**

 

On October 1, 2002,the Company acquired International Wholesale Tile, Inc. In connection with thelegal form of this transaction, International Wholesale Tile, Inc. became awholly owned subsidiary of IWT Tesoro Corporation.  A total of 9,000,000 shares of common stock were issued for theacquisition.  For accounting purposes,the acquisition has been treated as a capital transaction and as a recapitalizationof International Wholesale Tile, Inc. The financial statements became those of International Wholesale Tile,Inc., with adjustments to reflect the changes in equity structure.  The operations are those of InternationalWholesale Tile, Inc. for all periods presented, and those of IWT TesoroCorporation from the recapitalization date. The accompanying consolidated balance sheets reflect the assets andliabilities at historical cost of IWT Tesoro Corporation and InternationalWholesale Tile, Inc. at December 31, 2002; and the assets and liabilitiesat historical cost of International Wholesale Tile, Inc. at December 31,2001.

 

As part of thetransaction, the Company and each of the three shareholders of InternationalWholesale Tile, Inc. entered into a repurchase agreement, to commence onJanuary 1, 2003 for three years, by which the three shareholders may sella certain amount of the Company’s common stock back to the Company for a pricebased on an amount equal to 88% of the average trading price of the Company’scommon stock so long as the stock is trading. The amount of stock is generally up to 25,000 shares for the first year,up to 50,000 shares for the second year, and up to 75,000 shares for the thirdyear.  The repurchase agreement iscontingent upon trading of the Company’s stock on the NYSE, the ASE, theNASDAQ, the Over the Counter Bulletin Board, or the “Pink Sheets.” The maximumnumber of redeemable shares under the repurchase agreement is 450,000.

 

On June 26, 2003 theCompany voted to cancel the repurchase agreement.

 

**NOTE 13****                                             PRIVATEOFFERING**

 

TheCompany adopted a subscription agreement on October 1, 2002 to commence aprivate offering of its common stock to accredited investors only for up to 1.0million units at $3.00 per unit; each consisting of one (1) share of commonstock and warrants to purchase 11⁄2 shares initially at $3.00 per share.  The price of the warrants will increase by$.25 per share at the beginning of each calendar quarter following the firstpublic sale of the common stock of IWT Tesoro Corporation pursuant to theCompany’s form 211 to be filed with the National Association of SecuritiesDealers (NASD).

 

Underthis private offering, the Company raised $660,000 in units sold, and throughDecember 31, 2003, 85,000 warrants were exercised for a total of $255,000.

 

F-24

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**NOTE 14****                                             PUBLICOFFERING**

 

OnApril 11, 2003, the Company filed a registration statement with theSecurities and Exchange Commission that was declared effective on June 17,2003. Two offerings were included in the registration statement. Thefirst was the offer and sale of 250,000 units at $5.50 per unit.  Each unit consists of one share of Tesorocommon stock and a warrant to purchase one share at $7.00 per share throughJune 17, 2006.  ThroughJuly 7, 2003, these units were offered exclusively to current stockholdersof the Company.  The second offering wasto register on behalf of certain Tesoro stockholders an aggregate of 1,243,502shares for resale; of this total 443,500 have no lock-up period, 699,002 aresubject to a six-month lock-up period, and 101,000 are subject to a 12-monthlock-up period.  The Company elected toextend this offering to December 14, 2003.

 

Underthe first public offering, the Company raised $1,292,500, net of offering cost,through the sale of the 250,000 units. At December 31, 2003, no warrants were exercised under thisoffering.

 

**NOTE 15****                                             SEGMENTINFORMATION**

 

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

 

**NOTE 16****                                             PENSIONPLAN**

 

TheCompany sponsors a 401(k) plan known as the International Wholesale Tile 401(k)Profit Sharing Plan & Trust. (the Pension Plan).  The Pension Plan provides tax deferred salary deductions foreligible employees.  Employees maycontribute from 1% to 12% of their annual compensation to the Pension Plan,limited to an annual maximum amount as set periodically by the Internal RevenueService.  The Company provides matchingcontributions equal to 100% of the employee’s contributions up to a maximum of3% of eligible pay.  The contributionexpense related to the Pension Plan amounted to $76,249 and $59,352 for theyears ended December 31, 2003 and 2002, respectively.

 

**NOTE 17****                                             SUBSEQUENTEVENTS**

 

TheCompany filed form S-8 with the Securities and Exchange Commission on January 26,2004, registering 4,000,000 shares of common stock that are issued or intendedto be issued to employees, consultants and others under the 2001 StockIncentive Plan.

 

On January 10, 2004,the Company granted 50,000 options to directors at an exercise price of $6.00per share, expiring in ten years.  Theoptions will become vested and exercisable as follows: (a) 50% will vestimmediately; and (b) the remaining 50% will vest on the anniversary date of theoption grant.

 

F-25

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