**U.S.SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

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

 

**For the Year Ended December 31, 2004**

**Commission File No. 000-31267**

 

**IWTTESORO CORPORATION**

(Exact name of registrant as specified in its charter)

 
| **NEVADA**                                                          | ** ** | **91-2048019**                          |
|---------------------------------------------------------------------|------------|-----------------------------------------|
| (State or 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)(zip code)                  |
|                                                                |
| **(203) 221-2770**                                                  |
| (Registrant’s telephone number, including area code)           |

 

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

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

 

Securities registered under Section 12(g) of the Exchange Act:

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

(Title of Class)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports, and (2) has been subject tosuch filing requirements for the past 90 days. Yes  ý   No  o

 

Indicateby check mark if disclosure of delinquent filers in response to Item 405 ofRegulation S-K is not contained herein will not be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o

 

Indicateby a check mark whether the registrant is an accelerated filer o Yes  ý No

 

Statethe aggregate market value of the voting and non-voting common equity held bynon-affiliates computed by reference to the price at which the common equitywas last sold, or the average bid and asked prices of such common equity, as ofthe last business day of the registrants most recently completed second fiscalquarter:  $7,329,600

 

**APPLICABLE ONLY TO CORPORATE REGISTRANTS**

 

Indicatethe number of shares outstanding of each of the registrant’s classes of commonequity, as of the latest practicable date: 11,697,102 shares as of March 21, 2005 

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Part III of this Form 10-Kincorporates by reference certain information from the registrant’s InformationStatement for its Annual Meeting of Stockholders to be held on May 7,2005.

 

 

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**Table of Contents**

 
|              |                                                                                            | **Page** |
|-------------------|-------------------------------------------------------------------------------------------------|----------|
| **Part I**   |                                                                                            |     |
| Item 1.           | Business                                                                                        | 3        |
| Item 2.           | Properties                                                                                      | 16       |
| Item 3.           | Legal Proceedings                                                                               | 16       |
| Item 4.           | Submission of Matters to a Vote of Security  Holders                                            | 16       |
|              |                                                                                            |     |
| **Part II**  |                                                                                            |     |
| Item 5.           | Market for Registrant’s Common Equity and  Related Stockholder Matter                      | 16       |
| Item 6.           | Selected Financial Data                                                                         | 18       |
| Item 7.           | Management’s Discussion and Analysis of  Financial Condition and Results of Operations     | 19       |
| Item 7A           | Quantitative and Qualitative Disclosures About  Market Risk                                     | 24       |
| Item 8.           | Consolidated Financial Statements and  Supplementary Data                                       | 25       |
| Item 9.           | Changes in and Disagreements with Accountants  on Accounting and Financial Disclosure           | 53       |
| Item 9A           | Controls and Procedures                                                                         | 53       |
| Item 9B           | Other Information                                                                               | 56       |
|              |                                                                                            |     |
| **Part III** |                                                                                            |     |
| Item  10.         | Directors  and Executive Officers of the Registrant                                             | 56       |
| Item 11.          | Executive Compensation                                                                          | 56       |
| Item 12.          | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters | 56       |
| Item 13.          | Certain Relationships and Related Transactions                                                  | 56       |
| Item 14.          | Principal Accountant Fees and Services                                                          | 56       |
|              |                                                                                            | 56       |
| **Part IV**  |                                                                                            |     |
| Item 15.          | Exhibits and Financial Statements Schedules.                                                    | 56       |

 

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**PART I**

 

**FORWARD LOOKING STATEMENTS**

 

Statementsmade in this Annual Report are “forward-looking statements” and are nothistorical facts.  For example,statements regarding our financial position, business strategy and other plansand objectives for future operations, and assumptions and predictions aboutfuture demand for our services and products, supply, costs, marketing andpricing factors are all forward-looking statements. When we use words like “intend,”“would”, “anticipate,” “believe,” “estimate,” “plan” or “expect” or the negativeof these terms and similar expressions we are making forward- lookingstatements.  You should be aware thatthese forward-looking statements are subject to risks and uncertainties.  Additionally, our forward-looking statementsspeak only as of the date of this report. Other than as required by law, we undertake no obligation to update orrevise these statements, whether as a result of new information, future eventsor otherwise.  New factors emerge fromtime to time that may cause our business not to develop as we expect, and it isnot possible for us to predict all of them. Factors that may cause our actual results, performance or achievementsto be materially different from the results, performance or achievementsexpressed or implied by the forward-looking statements include, among otherthings: 

 

•                  Ourability to successfully implement our business plan, including expanding ourmarkets, increasing our product lines, and maintaining high quality customerservice; 

•                  Continuingand cultivating our relationships with current and new vendors; 

•                  Fundingour growth in a manner that is beneficial to our stockholders;  

•                  Trendsaffecting our financial condition or results of operations, the impact ofcompetition, the start-up of certain operations, roll out of products andservices and acquisition opportunities;

•                  Restraintson pricing flexibility due to competitive conditions in the flooring industry,while taking into consideration factors beyond our control such as increases infreight and tariff charges, currency risks, and political conditions; 

•                  Dependingon third party suppliers outside the United States;

•                  Theimpact of adverse weather conditions, both in our targeted markets, as well aswith respect to our foreign suppliers; and

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

 

**ITEM 1.****                       ****DESCRIPTION OF BUSINESS**

 

**Executive Summary**

 

Throughour wholly owned subsidiary, International Wholesale Tile (IWT), IWT TesoroCorporation (Tesoro) is principally a value-added reseller of ceramic floor andwall covering products (primarily ceramic, porcelain and stone tile) to the newconstruction and remodeling industries for commercial and residentialmarketplaces. We distribute our products through four distinct channels:

 

•                  Independentdealers and stocking distributors

•                  Majorhome center distributors

•                  Buyinggroups and design centers

•                  Regionalwholesalers

 

Weare exclusively a wholesaler and do not sell directly to any end user.  We also act as a fulfillment center for manyof our customers.  We purchase ourproducts largely from foreign manufacturers. Our primary source of revenue isfrom selling hard flooring materials. Our principal costs relate to acquiring,warehousing, selling and delivering our products. While we sell our productsthroughout the United States, the majority of our sales are currently in theSoutheastern United States.

 

Ona consolidated basis, we had net sales in 2004 of $44,925,449 and a netloss of $1,209,396.

 

***Background***

 

IWTTesoro Corporation was organized in Nevada on May 3rd, 2000, originallyunder the name “Ponca Acquisition Corporation”. Effective October 1, 2002, Tesoro acquired all of IWT’s commonstock from IWT’s three shareholders. IWT was organized in Florida and has beenin continuous operations since 1994. In exchange for the IWT stock, the IWTshareholders each received 3.0 million Tesoro shares, representing 87% ofTesoro’s then outstanding common stock.

 

Inaddition to IWT, Tesoro’s primary operating subsidiary, Tesoro has threeadditional wholly owned subsidiaries. These include:

 

•                  IWTTesoro Transport, a USDOT licensed common carrier, organized to act as ourfreight carrier outside of Florida and to back

 

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haul non-household goods into Florida to help generate outside revenuewhich, has been insignificant through December 21, 2004;

 

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

 

•                  The Tile Club, Inc., formed in 2004, wasorganized to acquire licensing, manufacturing and distribution rights forhigh-end designer and artistic based decorative tiles and to also act as anagent for foreign manufacturers from whom IWT has acquired exclusivedistribution rights.

 

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

 

**Business and Growth Strategy**

 

Webelieve that we have built our reputation by supplying quality products withsuperior customer service at competitive prices. We strive to stay up-to-datewith the newest styles and trends in the ceramic floor and wall coveringindustry.  We also aim to introduce highquality new products to the marketplace as soon as practicable. We furtherbelieve that we have built confidence and loyalty among our customers bydistributing products only on a wholesale level and not selling directly to theconsumer. While we ship product in quantities that can range from small cutorders to full pallets or complete truckloads or containers, the core of ourbusiness is the cut order, i.e. less than a pallet of mixed floor, wall anddecorative tiles specific to a project. This special handling and thereputation we enjoy as a dependable supplier allows us to maintain aboveaverage margins. We do not operate any retail outlets. This non-competitiverelationship is unique in the ceramic floor and wall tile distributionindustry, has been a key factor in our growth and defines us as a “value addedreseller” rather than merely a distributor. We believe that other keys to our success include actively merchandisingprograms assisting our dealer/customers to meet the consumer’s demand withproducts presented in attractive easy to visualize environments and acting asthe extension of our dealer networks’ stock availability by warehousing levelsconsistent with the dealers’ delivery requirements.  

 

Ourwarehousing and distribution centers contain over 420,000 square feet ofstorage space, in which we maintain over 17.0 million square feet of productready for immediate shipment to our customers. In 2004, we signed an agreement to realign our distribution facilitiesin Palm City, Florida. Realigning these distribution facilities willconsolidate approximately 80,000 square feet of warehouse space currently inmultiple small warehouses into one location, add 70,000 new square feet forfuture expansion and create a single 15-year lease for the Palm Cityfacility.  With this new space, we willhave over 310,000 square feet of storage space, 30 truck bays and room forapproximately 20.0 million square feet of inventory.  Additionally during 2004, we entered into alease for up to 120,000 square feet of warehouse space in Dallas, Texas.  This Texas facility serves our growingMidwest customer base.  As we expand, wewill likely need additional satellite warehouse locations.

 

Wehave created Tesoro The Collection®, a branded collection of high qualityporcelain floor and wall tiles complemented by coordinated decorative bordersand listellos.  We support thiscollection with an extensive merchandising program including grouted displayboards and racks, and institutional marketing and advertising.  We also plan to expand the TesoroÔ line of products by building our proprietaryTesoroÔ brand awareness. We prominently display theTesoroÔ line at all of the national and regional flooringexhibitions in which we participate. We have also placed institutional printmedia and television advertising to educate consumers and to support our dealernetwork.  We further intend to grow byacquiring or merging with existing regional distributors.

 

Tesoro’sgoal is to build a national distribution company that is a value added resellerdelivering our products in three business days. In order to attain this goal,we believe we need to achieve the following objectives:

 

•                  Augmentour client base and market penetration by expanding nationally and duplicatingour Palm City, Florida and Dallas, Texas models into four additional majorcenters for our products,.  These include

 

•                  establishingsub-distribution centers in the West, Midwest and Northeast regions, 

•                  creatingdealer networks in each quadrant, acquiring or starting up one new territoryper year, and 

•                  expandingvalue added services, consistent with the central focus of providing buildingproducts through a network of independent dealers and distributors; 

 

•                  Deepenour current customer base penetration by increasing our market share withcurrent dealer customers, providing customer incentives, and creating a buyinggroup for IWT customers;

 

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•                  Maintainour high level of customer service and satisfaction;

 

•                  Obtainadequate capital to support the inventory levels our customers expect byraising additional capital through debt and equity financing as required, tofund growth within a prudent debt equity relationship;

 

•                  Continuestrengthening our relationships with suppliers to ensure a continuous flow ofhigh quality, contemporary designs that are competitively priced;

 

•                  Ensurea continuous flow of high quality, current design and competitively pricedproducts by increasing our involvement in the manufacturing of products; 

 

•                  Increasethe number of  products we carry and;

 

•                  Strengthenour consolidated balance sheet by reducing our debt to equity ratio. We hope toaccomplish this by using new equity to fund growth and eventually reduce debt.

 

Ona short-term basis, we intend to look to acquire assets of businesses withproducts and services that complement our business.  We further intend to grow by acquiring ormerging with existing regional distributors. We also are expecting to establishsubsidiaries based in Spain and Italy to handle our relationships withmanufacturers located in those countries.

 

**The Ceramic Floor and Wall Tile Covering Industry**

 

Tesorobelieves that the statistical information described in this item (Descriptionof Business) is the most current available.

 

Italiantile and stone have a rich history that dates back thousands of years. TheGreeks constructed temples and ornate statuary with it. The Romans used it topave their halls of power. The enduring quality that these fine stones havebrought to the magnificent palaces and villas of Europe, are now in high demandin the United States.

 

Itis this expression of style and grace that has made tile and stone a sought-afterdesign material in building and remodeling projects across America, the fourthlargest consumer of tile in the global market representing about 20% of globalconsumption. While the United States consumes 20% of the global production, ona per capita basis the United States lags far behind the European community(Europeans consume an average of 55 square feet per year compared to sevensquare feet per year for Americans). Coupled with the robust housing andgeneral construction markets in the United States, this gap in per capitaconsumption has the Italian and Spanish manufacturers searching for ways tofill a perceived vacuum.

 

TheU.S. wholesale market for ceramic floor and wall tile products was$2.5 billion in 2003, up 8.4% from 2002. Market Studies, Inc., arecognized industry market research firm, estimates that the continuing demandfor new housing, the remodeling market expansion and the general movement awayfrom soft flooring materials, such as carpet, will push the market for our productsto $3.4 billion by the end of 2008. While increasing interest rates mayhave a temporary impact on the new home construction industry, studies showthat over any length of time the impact is minimal. This is particularly truein the Sunbelt (southern and southwestern United States) where we have ourstrongest presence. Of course, we cannot assure anyone that these estimateswill be achieved or if met, will occur when expected.

 

TheU.S. ceramic floor and wall covering market has been positively impacted by:

 

•                  U.S.population growth, requiring new and renovated housing and commercial space;

 

•                  Housingstarts reached 1.85 million units in 2003, surging by 8.4%, which was thebest performance in 26 years;

 

•                  In2003, the new construction market rebound was driven by a 10.3% surge in theresidential sector, which included:

 

•                  2003issuance of building permits was up 6.6%, and

 

•                  New,one-family home sales rose 13.8% in the south, our primary market;

 

•                  Mortgagerates at a 40-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 and forremodeling;

 

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

 

•                  Growthin vacation (second) home ownership.

 

Ceramictile usage in the United States doubled in the past eight years, from1.42 billion square feet in 1996 to 2.86 billion square feet in 2003.The compound average growth rates for units sold (measured by square yards) foreach of the floor covering categories above for the period from 1998 through2002 have exceeded the growth rate of the United States’ gross domestic productover the same period. During this time, based on square footage, as cited by July 21,2004 Floor Covering Weekly, the compound average growth rate was 8.7% forceramic tile.

 

Forty-ninepercent of imported ceramic tile comes from Italy, 17% from Spain and 10% fromMexico. The balance originates from a large number of countries includingBrazil, 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 primarily imported and our purchases distributed amonginternational suppliers approximates these national statistics.

 

Theaverage wholesale price of ceramic tile edged lower in 2003, falling to $.89per square foot. This decline was due primarily to a 4.7% reduction in theprices for domestic product. Imported ceramic tile costs rose two cents asquare foot to $.79 in 2003, largely on price increases for Italian tile. 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, Inc. that the demand willremain robust and that prices will stabilize.

 

MarketStudies, Inc. projects that the U.S. ceramic tile market will reach3.76 billion square feet by 2008, posting and annual growth rate of 5.6%.Imports will continue to outpace domestic production, garnering an additional4% market share. The value of this market is expected to reach$3.4 billion by 2008, expanding at a 6% annual pace as prices for ceramictile firm.

 

Longacknowledged for its durability and functionality, ceramic tile now meansfashion. Consumers can chose from soft hues or primary colors, finishes thatresemble stone, wood or fabric, and can incorporate metal and glass accents forflexible design. The high growth rate of ceramic tile relative to otherflooring options has led to more full service distributorships, manufacturers,and retailers adding ceramic tile to their lines. With more floor space beingdevoted to ceramic tile at retail, efforts at product differentiation haveintensified. Licensing, a relatively new strategy in the ceramic tilemarketplace, is heating up, including the following partnerships: ShawIndustries with Martha Stewart and Kathy Ireland; Witex with Laura Ashley,Armstrong’s Liz Claiborne line in partnership with Carpet One, and MarrazziGroup with Benetton.

 

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

 

•                  consumerconfidence;

 

•                  spendingfor durable goods;

 

•                  interestrates;

 

•                  turnoverin housing, the condition of the residential and commercial constructionindustries; and

 

•                  theoverall 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. Thisgrowth rate is higher in the Sun Belt areas, including the Southeastern part ofthe United States, where we currently operate.

 

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% ofthe total, represent the balance of the industry’s 2002 dollars shipped. Theceramic title industry’s two primary markets, residential applications and commercialapplications, represents 72.3% and 27.7% of the industry total, respectively.Of the total residential market, 67% of the dollar shipments are for newconstruction.

 

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**IWT’s Products**

 

Wepurchase our products on the world market. Approximately 50% of our productsare imported from Italy, 30% from Spain and the balance from Brazil, Turkey andChina. Each foreign manufacturer has registered agents in the United Statesthat work with us, as well as with other distributors. We believe that wemaintain close personal contact with our suppliers, visiting the plantsregularly and working with suppliers to influence design, quality andreliability. We do not currently purchase any raw materials, but only finishedgoods. Our principal suppliers and the countries in which each is locatedinclude

 

•                  GruppoCBS, division of Kis Ceramiche, Italy;

•                  CeramicaUDA, Italy

•                  AlfaCeramica, Spain

•                  Imolagres,Italy;

•                  CeramicaGomez, Spain;

•                  CeramicaColli, Italy;

•                  CeramicaFondavalle, Italy; and

•                  CeramicaGaya, 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 areadded to our product line. For example, in 2004, we added granite counter andbacksplash tiles to our product mix. Items are removed when they becomeobsolete, which we define as having minimal sales in any consecutive 12-monthperiod.

 

Wemaintain a wide distribution of price points for our product. Our lowest pricedproducts include red body ceramic tiles to mid priced solid body porcelain tohigher priced natural stone tiles. Pricing strategies are also designed toprovide incentives to customers for purchasing product in larger quantities.While the average wholesale price of ceramic floor and wall tile has continuedto decline, reaching $0.89 per square foot in 2003, according to the industrymagazine, Floor Covering Weekly (July 2004), the market for high- endporcelain tiles and decorative/designer tile has been increasing. Thedevelopment of a dual price point market has given rise to a bimodal environmentfor us, through our branded porcelain collection and natural stone products,has been able to maintain an above average wholesale price. We will continue toemphasize this high-end tile and stone by selectively marketing them to dealersand distributors with customer bases that demand such products. Our uniqueposition as a pure wholesaler gives us a clear advantage in this hourglassshaped market.

 

Weship product to our customers in quantities ranging from “cut order” specificto a consumer’s project to full pallets of a single product to full containerand truckload packages. These larger quantities allow our customers to stocktheir own product to service cash and carry consumers.

 

Weimport a majority of our products into the Port of Miami.  In 2004, we expanded our distributionfacilities to Dallas, Texas.  Productimported for distribution from our Dallas facility arrive via the Port ofHouston. Orders that are shipped directly from the manufacturer to our customersmay enter through any number of U.S. Ports. 

 

**Inventory**

 

Weare committed to maintaining inventory levels that support the sales of ourcustomer network. We currently maintain over 17.0 million square feet ofproduct in inventory, representing over 2,500 SKU’s (individually numberedproduct items). We also act as the warehouse and fulfillment source for many ofour approximately 2,700 dealers and wholesale customers. We target an inventoryturn over rate of 1.5 to 2.0. This turn over rate is established to minimizeout of stock situations and to attain our goal of same day shipping forqualified orders received by 2:00 p.m.

 

Industrytrends toward product packages, 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,

 

•                  factorycost,

•                  freight(international and domestic), and

 

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•                  duties,tariffs, taxes and other regulatory costs.

 

Oceanfreight charges differ from country to country therefore our selling price isbased on factors specific to each international manufacturer. We pay most ofour international manufacturers in U.S. dollars. The strength of the U.S.dollar relative to a specific country’s currency will have an impact on theprice we pay for product. Additionally, we also take into account that title toour products transfers at the port of the originating country. We generallyship between 10 and 20 containers at any one time. We currently estimate thatour maximum exposure for loss would be approximately $150,000. Based onmaritime loss history, cost of ocean marine insurance and our ultimate abilityto subrogate against the freight carrier, we self-insure in the event of lossafter title is taken.

 

Ourin-bound freight cost, gasoline, fuel and other surcharges have increased ourshipping costs of which we have not yet passed on to our customers. As such, ourgross margins may be lower because we are currently absorbing these increasedcosts.

 

Asa result of increasing out-bound freight costs, we organized IWT TesoroTransportation, Inc., a federally licensed freight carrier. By workingwith this affiliate company to supply a portion of our shipping needs, we hopeto have more control over these costs.

 

**IWT’s Customer Base and Distribution Channels**

 

Wecurrently distribute our products through four separate distribution channels.

 

•                  Theindependent retail floor-covering dealer and stocking distributor market is ourlargest channel. This channel currently accounts for about 54% of the salesrevenue. These customers, who sell directly to the public, can be either “cutto order” or “stocking” dealers/regional distributors. We currently serveapproximately 2,000 customers in this channel through our sales personnel. Inaddition, we have sub-distributors that handle specific market territories forlimited numbers of our Tesoro-The Collectionâ product packages.

 

•                  Themajor home center “buy-it-yourself/do-it-yourself” store market makes up oursecond distribution channel. These customers typically operate under blanketpurchase orders. There are three basic programs for home center stores. Thefirst is a special order program. Consumers place orders from sample boardsprovided by us to the store. The store representatives forward these orders tous and we ship the product either directly to the consumer or to the store forpick-up by the consumer. The second program is a stocking program, whichprovides for a home center store to maintain specific product inventories fortheir cash and carry trade.  The thirdprogram is “Special Buys”. Under this program the customers purchase largequantities of specific product for special promotions.  The home center store channel currentlyaccounts for about 8% of our revenue.

 

•                  Ourthird channel, accounting for 16% of our revenues, is made up of nationalbuying groups. These groups support independently owned, branded floor coveringoutlets with coordinated buying agreements that require us to market directlyto each individual retail outlet. This channel also includes large builders,who staff and maintain captive design centers specifically for their owncustomers. 

 

•                  Ourfourth channel is the bulk sale channel. In this channel we service retailbuyers that purchase full truckloads or containers of specific product that ismanufactured for us specifically for this program. These products can bedrop-shipped from our manufacturer directly to the customer. The customer basefor this channel is the United States and Canada. This channel makes up theremaining 22% of our sales.

 

Wemaintain a separate and coordinated sales force for each of the channels ofdistribution. The geographic distribution of our sales is predominately in theSoutheastern United States, which accounts for 80% of our sales, however we domake sales throughout the United States. We also sell different product seriesto each channel to avoid market saturation or channel conflict. Currently, wedo not sell to any single customer, which aggregates to more than 5% of oursales.

 

**Merchandising**

 

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 Ralph Lauren and Laura Ashley. In May 2002, we introduced ourproprietary brand Tesoro-The Collectionâ.Tesoro is a collection of porcelain tiles and decorative inserts, borders, andaccents that will be marketed throughout the United States. We have invested inspecifically designed display racks that communicate the quality and value ofour new brand that we believe assist our dealers in communicating productcombinations to the consumer.  We arecontinually updating these displays with new products. We have a fifteen-yearmanufacturer’s warranty program for Tesoro-The Collectionâ products that we believe elevate the qualityposition of our products.

 

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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 the dealer to easily show our productor 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. We account for the sample packs and displayunits and sample boards, along with the labor and overhead involved in creatingthem, as promotional expenses, when they are distributed to the customers.  Our promotional expense represents asignificant part of our cost of doing business.

 

**Credit and Collection Procedures**

 

Wemaintain strict criteria for credit approval:

 

•                  Potentialcustomers must complete our credit application;

•                  Creditmust be approved by our credit department; and

•                  Wemay require a personal guaranty.

 

Onceapproved, typically our dealers receive 30-day terms. Our bulk truckloadcustomers may be offered extended terms of payment. We have purchased creditinsurance for these extended term customers to offset some of the risk inherentin the extending of longer credit terms.

 

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

 

•                  Havea storefront designed to market tile

•                  Sellto retail customers

•                  Operateat lease one forklift

•                  Capableof accepting material in bulk

 

Whensales orders are entered, our computer system notes if a customer is on credithold. If so, those orders are given to our credit department to determinewhether the products can be shipped. Customers are generally given a15 day grace period and orders are held and not shipped once an invoice is60 days or older.

 

**Marketing, Promotion and Sales**

 

Ourpublic relations and marketing activities focus on creating demand for ourproducts. We have an in-house advertising and marketing staff that develops andcoordinates our sales materials. We use trade magazines articles, specificallydesigned mailer programs and trade shows as our primary communication 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 a twenty-person full time sales force most ofwhom have been with us for five years after spending many years in variousfacets 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 companiessuch as Shaw Industries and Mohawk, the two largest flooring providers, accountfor over 60% of the hard surface market in the U.S. While maintaining theirdominant positions in the carpet market, both companies are moving aggressivelyinto the hard flooring sector. Dal-tile, a subsidiary of Mohawk, manufactures,wholesales and retails tile on a national basis.

 

Regionalcompetitors such as Master Tile, Florida Tile and Arizona Tile act as bothwholesalers and retailers. In their markets, each supplies smaller dealers anddistributors and also operates branded retail outlets. We currently onlydistribute at the wholesale level.

 

Webelieve that our competitive strengths include:

 

•                  *Focusing solely on the wholesale segment of thedistribution process.* We donot own or operate direct to consumer locations. We work exclusively throughdealers and stocking distributors or buying groups who service the buyingpublic. As a result, we do

 

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not compete with our customers. Our customers can buy from us specificmaterials to meet a consumer’s need, i.e. “cut orders” or can stock limitedamounts of product for cash and carry business by purchasing larger quantities.

 

•                  *Getting involved in designing products.* We actively participate in designing andselecting new color, texture and formats for emerging style tends. Our fieldsales force is constantly working with our customers to identify trends in themarket. Feedback from these sources is continuously shared with themanufacturers. Manufacturer’s representatives frequently meet with us and ourmanagement travels to the manufacturing sites to communicate the markets needs.

 

•                  *Building our Tesoro-The Collection**â**brand equity.* We are branding our designs and many of ourproducts with our Tesoro Brand. We incorporate products from differentmanufacturers and different countries into programs that leverage the best ofeach source to create Tesoro collections. Unlike most other tile and ceramicproducts, Tesoro products include a 15-year manufacturer’s warranty againstwear.

 

•                  *Providing superior merchandising and customer supportprograms.* We maintain anactive sampling program to ensure that customers have the latest materials intheir showrooms. Our field sales force continually updates, refreshes andreplaces sales materials. We distribute literature to consumers referencing ourdealer network participants. Our field personnel work with the customer andtrain them on the appropriate use and care of the product. Our goal is to makethe dealers’ job as easy as possible.

 

•                  *Implementing our Distribution Philosophy.* We see ourselves as an extension of thedealer warehouse. We aim to be responsive to our customers’ needs by shippingmost orders the same day they are received. We also carry stock to back-up ourcustomers in the cash and carry market.

 

Bymaintaining these competitive strengths, we currently believe that we canprofitably challenge our competitors for a greater share of our targetedmarket.

 

Additionally,manufacturers generally extend exclusives through their agents to distributorsbased geographically. Therefore, we currently believe specificproduct-to-product competition is rare.

 

**Government Regulations**

 

TheFederal Trade Commission regulates our wholesale operations. The Federal MotorCarriers Administration regulates Transport’s freight activities. Internationalis an exempt company subject to Bermudian commercial law. We do not expect toimport product into Bermuda and will therefore maintain our exempt status. Bothfederal and state authorities regulate the distribution and sale of importedproducts. We have obtained all required federal and state permits, licenses andbonds to operate our businesses. We make no assurances that our operations andprofitability will not be subject to more restrictive regulations, oversight orincreased taxation by foreign, federal, state or local agencies.

 

Wecurrently purchase our products from foreign manufacturers in U.S. dollars. Ourfund transfers are relatively large. The Office of the Comptroller of theCurrency (USOCC) monitors these activities. Should the Euro continue tostrengthen against the US dollar, we could see an increase in our cost ofproduct that we may not be able to pass on to our customers and therefore wecould suffer a detrimental impact on our profitability. Our competitors rely asheavily on imported product as we do. Therefore, we do not see any change inthe competitive landscape for ceramic tile as a result of the strength of theEuro.

 

**Acquisitions and other Interests**

 

Tesorointends to expand its operating activities globally. We have had preliminarydiscussions with manufacturers, product aggregators and agencies in Spain,Italy and Brazil. We expect to take an interest position in several operationsduring 2005. In the United States, we plan to expand our geographical positionby acquiring the assets of similar, but smaller, distributors.  We cannot assure anyone, however, that any ofthese discussions will result in the intended acquisitions or that anyacquisitions, if made, will generate the planned revenue or profits.

 

**Intellectual Property**

 

Weincorporate our proprietary brand Tesoroä in connection with a collection of porcelaintiles and decorative inserts, borders, and accents.  With respect to this brand, we rely on commonlaw and Lanham act protection.  In December 2004,we were granted federal trademark protection for our mark Tesoro The Collectionâ.  Wemake no assurances that any trademark or other protections will be meaningful.We are not aware of any claims of infringement against us and we have not beeninvolved in any related court proceedings.

 

10

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Weare also in preliminary discussions to create unique artwork and high-end tiledesigns for national distribution.

 

**Employees**

 

IWTcurrently employs 115 non-union employees, of which 113 are full-time and 2 arepart-time, including 52 warehouse staff and 23 salespeople covering sales inUnited States and Canada. The remaining 40 employees include customer service,accounting and administrative positions. IWT believes that its relationshipswith its employees are good. Tesoro currently has two employees. Transport hasone employee. Neither International, nor The Tile Club currently has anyemployees.

 

**Important Risk Factors Concerning our Business.**

 

*You should carefully consider the followingrisk factors and all other information contained in this Annual Report inevaluating our business and prospects. The risks and uncertainties described below are not the only ones weface.  Additional risks and uncertaintiesother than those we described below that are not presently known to us or thatwe believe are immaterial may also impair our business operations.  If any of the following risks occur, ourbusiness and financial results could be harmed. You should also refer to the other information contained in this AnnualReport, including our consolidated financial statements and the related notes.*

 

Theceramic, floor and wall tile industry is cyclical and prolonged declines inresidential or commercial construction activity could adversely affect ourbusiness.  

 

Our industry depends on residential and commercial constructionactivity, including both new construction, as well as remodeling. Newconstruction activity and remodeling to a lesser degree, is cyclical in natureand a prolonged decline in residential or commercial construction activitycould have a material adverse effect on our business, financial condition andoperating results. Construction activity is significantly affected by numerousfactors, all of which are beyond our control, including, among others,

 

•                  nationaland local economic conditions;

•                  interestrates;

•                  housingdemand;

•                  employmentlevels;

•                  changesin disposable income;

•                  financingavailability;

•                  commercialrental vacancy rates;

•                  seasonalweather conditions;

•                  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 experiencesimilar downturns in the future, which could have a negative impact on ourbusiness, financial condition and operating results. 

 

Weexpect that we will need to obtain additional financing from both banking andequity financings for future acquisitions and growth.  If we cannot secure these additional funds,we may not be able to expand our business or if we do, in the time frame thatwould be profitable to us.

 

Future events such as the problems, delays, expenses and difficultiesfrequently encountered by wholesale tile and ceramics distributors like us, maylead to increased costs that could make it difficult for us to succeed with ourobjectives. To raise additional capital, we may sell additional equitysecurities, accept debt financing, or obtain financing through a bank or otherentity. There is no limit as to the amount of debt we may incur nor have weadopted a ratio of our equity to debt. If we need to obtain additionalfinancing, it may not be available or it may not be available on termsacceptable to us. Likewise, an offering of our securities may not besuccessful. If additional funds are raised through issuing additional stock,the value of our outstanding stock may 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 

 

11

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products;

•                  Thenumber of different product variations demanded by our customers;

•                  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. 

 

To the extent any new acquisitions cannot be readily integrated intoour business, our existing business could be adversely hampered.

 

A major element of our business strategy is to acquire complementarybusinesses.  To the extent that thesebusinesses cannot be easily integrated into our own, require too much equity ortake away any of our management beyond what is expected, our existing operationscould be adversely affected.

 

Failingto identify suitable acquisition candidates, to complete acquisitions and tointegrate the acquired operations successfully could adversely affect ourbusiness operations.

 

As part of our business strategy, we intend to acquire complementarybusinesses. Although we regularly evaluate acquisition opportunities, we maynot 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 ofspecial risks, some or all of which could have a material and adverse effect onour business, operating results and financial condition. Among these risks are:

 

•                  Beingunable 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. 

 

Weface intense competition in the ceramic floor and wall tile industry, whichcould decrease demand for our products and could have a material adverse affecton our profitability and revenues.

 

The industry is highly competitive. We face competition from a largenumber of domestic and foreign importers and independent distributors of floorcovering products. Some of our existing and potential competitors may be largerand have greater resources and access to capital than we do. Maintaining ourcompetitive position may require us to make substantial investments in ourproduct design efforts, distribution network and sales and marketingactivities. Competitive pressures may also result in decreased demand for ourproducts and in the loss of market share. In addition, we face, and willcontinue to face, pressure on sales prices of our products from competitors, aswell as from large customers. As a result of any of these factors, there couldbe a material adverse effect on our sales and profitability. Hard flooringproducts also face competition from alternative products such as carpet and vinyl.Changes in customer attitudes toward hard flooring and wall covering materialscould also adversely affect our ability to market and sell our productsprofitably.

 

•                  Future events, including the problems, delays,expenses and difficulties frequently encountered by wholesale tile and ceramicsdistributors like us, may lead to increased costs that could make it difficultfor us to succeed with our business plan. These include increased freight and transport changes, particularly asthe cost of fuel continues to rapidly increase, the ability to receive productat U.S. ports that are already overcrowded with international goods andfluctuating quarterly operating results, often times as a result of factorsbeyond our control such as weather conditions and political climate, whichcould result in a lower price for our common stock.

 

•                  Failing to identify suitable acquisitioncandidates, to complete acquisitions and to integrate the acquired operationssuccessfully could adversely affect our business strategy and operations.

 

12

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•                  We may be unable to obtain products on atimely basis, which could materially have an adverse effect on our business.

 

•                  If we are unable to retain our managementteam, our business operations and our growth objectives may be adverselyaffected.

 

Adverse weather conditions, such as the recent hurricanes in Florida,could adversely affect our sales, as well as our ability to provide customerswith product on a timely basis.  

 

The Southeastern part of the United States, particularly Florida,sustained major damage from the recent hurricanes.  While our warehouse facilities were notdamaged, a number of dealers to whom we sell product were unable to do businessfor several weeks.  Additionally, we didnot receive product on a timely basis because of the imclement conditions.  As a result, our sales for the third quarterof 2004 were adversely affected. Additionally, major international catastrophes such as the tsunami andrecent earthquakes could adversely affect our business in a number of ways, allof which are beyond our control and cannot be anticipated.  

 

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.,our Chief Executive Officer, Forrest Jordan, our Chief Financial Officer andSenior Vice President, and Paul F. Boucher and Grey Perna who also are SeniorVice Presidents, as well as other of our management members. While we do havewritten employment agreements with each of these individuals, we currently donot have employment agreements with all our employees. The loss of the servicesof any of these individuals may have a material adverse affect on our business,financial condition and operating results. We may not be able to maintain andachieve our growth objectives should we lose any or all of these individuals’services. 

 

Ourquarterly operating results fluctuate, which could result in a lower price forour 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;

•                  Adverseweather conditions; 

•                  Economicconditions specific to our industry; and

•                  Costsand risks associated with potential acquisitions.

 

Of these conditions, the 1st, 2nd, 4thand 5th factors are largely beyond our control. 

 

Wemay be unable to obtain products on a timely basis, which could materially havean adverse effect on our business. 

 

We currently do not manufacture any of the products we distribute. Ourbusiness depends primarily upon a continuous supply of material from thirdparty suppliers. We currently obtain our products from one domestic and over 40foreign manufacturers. While we believe this large group of suppliers insulatesus from the effect of any one supplier, international supply relationships aresensitive to geo-political situations beyond our control. In particular, wedepend on suppliers in Italy and Spain and any disruption in this supply chaincould put us in a difficult position. Any extended interruption in productsupply would disrupt our operations, which could adversely affect our business,financial condition and operating results. 

 

Because we do not carry any insurance on products in transit, we risklosing entire shipments. 

 

Title to our products transfers either at the port of the originatingcountry or at the foreign factory in the case of inventories held for directshipment to our customers. We self-insure in the event of loss after title istaken. We only ship between ten and twenty containers at any one time. Wecurrently estimate that our current maximum exposure for loss would beapproximately $150,000. Because we often place special orders on behalf of ourcustomers, if any shipments were lost or

 

13

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damaged, our clients would not be able to receive their product in atimely fashion, which, in turn, could adversely affect our relationship withthose customers. To date, we have only incurred minimal losses with respect toproducts that have been lost after we 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 have not had problems obtaining product fromTurkey, although minor problems with product from Dubai have occurred. However,we purchase only limited product from Dubai manufacturers and can obtainsubstitute products, if necessary. Protest strikes in the European Unioncountries such as Spain and Italy may slightly delay shipping of products, butto date, these delays have been very minor. 

 

We may be unable to pass on increases in transportation costs to ourcustomers, which could have a material effect on our profitability.

 

Significant increases in transportation costs could adversely effectour operating margins and our business, financial condition and operatingresults. Although we generally attempt to pass on increases in the costs to ourcustomers, our ability to do so is, to a large extent, depends on the rate andmagnitude of any increase, as well as competitive pressures and market conditionsfor our products. There have been, in the past and may be in the future,periods of time during which increases in this cost cannot be recovered. Duringthese periods, our profitability could be adversely affected. Likewise, theoutbound transportation costs differ depending on how far our products are tobe shipped, which may not always be passed on to our customers. 

 

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, controlsand management resources may not be adequate 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 plan or attain our objectives. Additionally, we cannot assure anyonethat our personnel, systems and controls will be adequate to support futuregrowth. 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. Our distributors do not have a minimum sales requirement andare independent contractors. If we do not competitively price our products, orif the quality of the products is substandard, our distributors may fail toaggressively market our products for us. If our distributors do notsuccessfully sell our products, then our revenue and profits may notmaterialize. 

 

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.

 

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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. Anyobligations we incur defending any such actions could adversely affect our cashflow and profitability. 

 

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 mainly the Euro Dollar. We write a majority of our purchase contracts andpay for materials in U. S. dollars. On those purchase contracts that we pay forin Euro dollars, we have begun feeling the negative impact of the strength ofthe Euro against the U.S. dollar, although not material. To the extent we areunable to pass these fluctuations along we may suffer adverse affects on ourbusiness, financial condition and operating results. The foreign manufacturingfacilities that supply us pay all their expenses in their country’s currency.This means that we realize a benefit when a country’s currency devalues againstthe U.S. dollar, although that country’s inflation rate or internal expensesmay offset this benefit. Any future increases in a country’s inflation rate,which are not offset by devaluation of their currency, may negatively impactour operating results. To the extent that a foreign country’s currencyappreciates against the U.S. dollar, there could be a material adverse effecton our business, financial condition and operating results.

 

Future changes in financial accounting standards may cause adverseunexpected revenue fluctuations and affect our reported results of operations.

 

A change in accounting standards could have a significant effect on ourreported results and may even affect our reporting of transactions completedbefore the change is effective.  TheFinancial Accounting Standards Board has issued a new accounting standard that requirescompanies to record compensation expense in the statement of operations foremployee stock options using the fair value method.  Implementing this requirement could have asignificant negative effect on our reported results or impair our ability touse equity compensation to attract and retain personnel.  New pronouncements and varyinginterpretations of pronouncements have occurred and may occur in thefuture.  Changes to existing rules mayadversely affect our reported financial results or the way we conduct ourbusiness.

 

Compliance with changing regulation of corporategovernance and public disclosure may result in additional expenses. 

 

Changing laws,regulations and standards relating to corporate governance and publicdisclosure, including the Sarbanes-Oxley Act of 2002 and newly enacted SEC regulationsare creating uncertainty for companies such as ours. We are committed tomaintaining high standards of internal controls over financial reporting,corporate governance and public disclosure. As a result, we intend to investappropriate resources to comply with evolving standards, and this investmentmay result in increased general and administrative expenses and a diversion ofmanagement time and attention from revenue-generating activities to complianceactivities. 

 

A few individuals own a significant percentage of ourstock. 

 

As of March 21,2005, our executive officers and directors and their affiliates beneficiallyowned, in the aggregate, approximately 84% of our outstanding commonstock.  Three directors who each serve asTesoro Senior Vice Presidents beneficially owned, approximately 75% of ouroutstanding common stock. The remaining 9% is beneficially owned by ourChairman and Chief Executive Officer and our outside directors.  As a result, our executive officers anddirectors are able to collectively exercise control over matters requiringstockholder approval, such as the election of directors and the approval ofsignificant corporate transactions. These types of transactions includetransactions involving an actual or potential change in control or othertransactions that the non-controlling stockholders may deem to be in their bestinterests and in which such stockholders could receive a premium for theirshares. 

 

**Additional Information**

 

Tesoromakes available free of charge its annual reports on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K and any amendmentsfiled or furnished pursuant to Section 13(a) or 15(d) of theSecurities Exchange Act of 1934 as soon as reasonably practical after they arefiled or furnished to the Securities and Exchange Commission. Such reports areavailable on the Company’s Web site (http://www.iwttesoro.com) or can beobtained by contacting Investors Relations group at 1.203.221.2770 or at IWTTesoro Corporation, 191 Post Road West, Suite 10, Westport, Connecticut06880.  Information contained onour web site is not part of this annual report.

 

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**ITEM 2.****                       ****PROPERTIES**

 

*Executive Office Space – Tesoro - Connecticut*

 

Tesorocurrently subleases office space in Westport, Connecticut. We pay a monthlybase services fee of $2,400 per month and our lease expires September 2005.** **Tesoroanticipates that it will be securing a more permanent space in the foreseeablefuture.  

 

*Warehouse and Office Space – IWT - Florida*

 

InDecember 2004, IWT signed an agreement to realign its distribution centerfacility on April 1, 2005. This agreement consolidates under one 15-yearoperating lease all 310,000 square feet of our Palm City, FL warehousefacilities.  Amongst the consolidation isapproximately 80,000 square feet of warehouse space currently in multiple smallwarehouses. We will expand our warehouse capacity by 70,000 square feet toaccommodate expected growth and integrate into two adjacent warehouses all of the company’s Palm Cityoperations.  Of the total 310,000 squarefeet, 10,000 square feet (on two floors) is for office space. 

 

Weexpect that the additional warehouse space will be ready during the secondquarter of 2005.  The initial lease amount will be approximately $31,000per month for the first year, escalating to $41,000 per month through year 15.

 

*IWT Warehouse Space - Texas*

 

EffectiveDecember 1, 2004, IWT entered into an agreement to lease warehouse spacein Dallas, Texas.  Over the next 18 months, IWT will use 56,000 squarefeet and will subsequently take over an additional 74,000 square feet, for atotal of approximately 120,000 square feet.  The lease is for 64 months.The average monthly lease amount is approximately $40,000, based on the life ofthe lease and includes, in addition to the lease space, common area charges,taxes, insurance and management fees. The new warehouse space is our firstwarehouse facility outside Florida.  IWT expects that it will support itscurrent customers and sales force in Texas and in the Southwest.  This newlocation is also part of IWT’s strategic plan to increase its sales andcustomer service throughout the Sunbelt (southern and southwestern United States).

 

Thetotal costs of our long-term operating leases as of December 31, 2004, areestimated as follows:

 
| 2005                                              |   | $ | 1,462,000  |   |
|---------------------------------------------------|--------|---|------------|--------|
| 2006                                              |   | $ | 1,823,000  |   |
| 2007                                              |   | $ | 1,973,000  |   |
| 2008                                              |   | $ | 2,003,000  |   |
| 2009                                              |   | $ | 2,033,000  |   |
| Thereafter (remaining portion of a 15year  lease) |   | $ | 17,617,000 |   |
| **TOTAL**                                         |   | $ | 26,911,000 |   |

 

**ITEM 3.****                       ****LEGAL PROCEEDINGS**

 

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

 

**ITEM 4.****                       ****SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

 

Wedid not submit any matters to a vote of our security holders during the fourthquarter of 2004. 

 

**PART II**

 

**ITEM 5.****                       ****MARKET PRICE FOR REGISTRANT’SCOMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

 

*(a)**                              **Market Information*

 

We have been filing periodic reports with theSecurities and Exchange Commission since October 2000. Our common stockhas been trading on the OTC Bulletin Board since December 17, 2003 underthe symbol “IWTT” on a limited and sporadic basis and there is no establishedpublic trading market for our common stock nor may there every be. For theperiods indicated, the following table presents the range of high and low saleprices for the common stock as reported by the OTC Bulletin Board.

 

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| ** **                              | ** ** | **High Bid** | ** ** | **Low Bid** | ** ** |
|-----------------------------------------|------------|--------------|------------|-------------|------------|
| **2003**                                | ** ** | ** **   | ** ** | ** **  | ** ** |
| December 17— December 31 |       | $            | 6.50       |        | $          | 6.00 |   |
| **2004**                                | ** ** | ** **   | ** ** | ** **  | ** ** |
| First Quarter                           |       | $            | 6.25       |        | $          | 5.00 |   |
| Second Quarter                          |       | $            | 5.25       |        | $          | 4.00 |   |
| Third Quarter                           |       | $            | 4.25       |        | $          | 2.25 |   |
| Fourth Quarter                          |       | $            | 3.75       |        | $          | 2.48 |   |
| **2005**                                |       |         |       |        |       |
| January 1 –March 21      |       | $            | 2.55       |        | $          | 1.60 |   |

 

TheSecurities 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 transaction involving a penny stock, unless exempt, the rules require

 

(i)                                     that a broker or dealer approve a person’saccount for transactions in penny stocks, and

 

(ii)                                  the broker or dealer receive from the investora written agreement to the transaction, setting forth the identity and quantityof the penny stock to be purchased.

 

Inorder to approve a person’s account for transactions in penny stocks, they must

 

(i)                                     obtain financial information and investmentexperience and objectives of the person, and

 

(ii)                                  make a reasonable determination that thetransactions in penny stocks are suitable for that person and that person hassufficient knowledge and experience in financial matters to be capable ofevaluating the risks of transactions in penny stocks.

 

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

 

(i)                                     sets forth the basis on which the broker ordealer made the suitability determination, and

 

(ii)                                  that the broker or dealer received a signed,written agreement from the investor prior to the transaction. Disclosure alsohas 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 price information for thepenny stock held in the account and information on the limited market in pennystocks.

 

*(b)**                              **Our Stockholders*

 

AtMarch 21, 2005, 11,697,102 shares of common stock were outstanding, whichwere held by approximately 224 stockholders of record.

 

*(c)**                               **Our Dividend Policy*

 

Wehave never paid, and do not expect to pay, any cash dividends on our common stockin the coming year. 

 

(d)                                 *Securities Authorized to beIssued upon our Equity Compensation Plans*

 

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**Equity Compensation Plan Information –**

 
| ** **                                              | ** ** | **(a)  Number of Securities  to be issued upon Exercise  of Outstanding options,  warrants and rights** | ** ** | **(b)  Weighted-average  Exercise price of  outstanding options,  warrants and rights** | ** ** | **(c)  Number of Securities  remaining available for  future issuance under  equity compensation plans  (excluding securities in  column (a))** | ** **    |
|---------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|---------------|
| Equity compensation plans approved by  stockholders     |       | 517,749                                                                                                 |       | $                                                                                       | 3.14       |                                                                                                                                            | 3,329,151     |   |
| Equity compensation plans not approved by  stockholders |       | 0                                                                                                       |       | 0                                                                                       |       | 0                                                                                                                                               |          |
| **Total**                                               | ** ** | **517,749**                                                                                             | **(2)**    | **$**                                                                                   | **3.14**   | ** **                                                                                                                                      | **3,329,151** | **(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 reflects152,700 restricted and 400 registered shares that have been issued all pursuantto the Plan through December 31, 2004. In January 2004, all theshares underlying the Plan were registered pursuant to a registration statementon Form S-8 and those shares already issued were registered for resale,all pursuant to a registration statement on Form S-8.

 

(2)          Of the 517,749 options granted, 331,667 arevested.

 

**ITEM 6.****                       ****SELECTED FINANCIAL DATA**

 

Thefollowing table sets forth the selected financial data of the Company for theperiods indicated, which information is derived from the consolidated financialstatements of the Company.  The selectedfinancial data should be read in conjunction with “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” and the Company’sconsolidate financial statements and notes thereto included elsewhere herein.

 
| ** **                                 | ** ** | **2004**   | ** ** | **2003 (3)**   | ** ** | **2002(1)(2)(3)** | ** ** | **2001 (2)(3)** | ** ** | **2000 (2)(3)** | ** ** |
|--------------------------------------------|------------|------------|------------|----------------|------------|-------------------|------------|-----------------|------------|-----------------|------------|
| ** **                                 | ** ** | ** ** | ** ** | **(restated)** | ** ** | **(restated)**    | ** ** | **(restated)**  | ** ** | **(restated)**  | ** ** |
| Statement of earnings data:                |       |       |       |           |       |              |       |            |       |            |       |
| Net sales                                  |       | 44,925,449 |       | 32,604,546     |       | 25,387,708        |       | 19,626,819      |       | 14,898,423      |       |
| Cost of sales                              |       | 27,790,173 |       | 19,814,514     |       | 15,268,535        |       | 12,629,138      |       | 10,228,039      |       |
| Gross profit                               |       | 17,135,276 |       | 12,790,032     |       | 10,119,173        |       | 6,997,681       |       | 4,670,384       |       |
| Operating expenses                         |       | 17,671,748 |       | 13,562,593     |       | 8,694,101         |       | 5,760,552       |       | 4,688,909       |       |
| Operating Income (loss)                    |       | (536,472   | )          | (772,561       | )          | 1,425,072         |       | 1,237,129       |       | (18,525         | )          |
|                                       |       |       |       |           |       |              |       |            |       |            |       |
| Interest expense                           |       | (627,439   | )          | (480,139       | )          | (328,920          | )          | (424,527        | )          | (513,927        | )          |
| Other income (expense), net                |       | (45,485    | )          | (15,421        | )          | (15,788           | )          | 9,789           |       | (876            | )          |
|                                       |       |       |       |           |       |              |       |            |       |            |       |
| Income (loss) before income taxes          |       | (1,209,396 | )          | (1,268,121     | )          | 1,080,364         |       | 822,391         |       | (533,328        | )          |
| Income taxes benefit                       |       | —     |       | —         |       | 597,174           |       | —          |       | —          |       |
| Net income (loss)                          |       | $          | (1,209,396 | )              | $          | (1,268,121        | )          | $               | 1,677,538  |            | $          | 822,391 |   | $ | (533,328 | ) |
| Earnings (loss) per share                  |       |       |       |           |       |              |       |            |       |            |       |
| Basic and Diluted                          |       | $          | (0.10      | )              | $          | (0.11             | )          | $               | 0.15       |            | $          | 0.09 |   | $ | (.08 | ) |
| Weighted average common shares outstanding |       |       |       |           |       |              |       |            |       |            |       |
| Basic and diluted                          |       | 11,679,028 |       | 11,197,655     |       | 10,845,775        |       | 9,000,000       |       | 6,000,000       |       |
|                                       |       |       |       |           |       |              |       |            |       |            |       |
| Balance sheet data                         |       |       |       |           |       |              |       |            |       |            |       |
| Total assets                               |       | $          | 34,586,744 |           | $          | 22,737,941        |       | $               | 11,062,676 |            | $          | 8,163,779 |   | $ | 8,470,974 |   |
| Working capital                            |       | 14,260,112 |       | 9,612,516      |       | 2,901,965         |       | 3,220,341       |       | 2,225,059       |       |
| Long term obligations                      |       | 16,593,794 |       | 10,129,745     |       | 5,486,800         |       | 4,640,004       |       | 3,851,995       |       |
| Stockholder’s equity                  |       | 753,251    |       | 1,667,722      |       | (1,351,944        | )          | (735,389        | )          | (1,036,334      | )          |

 

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(1)                                  During the first nine months of 2002, IWT wastaxed as an “S” corporation. Accordingly, no provision or liability for Federalincome taxes is reflected. Instead, the stockholders were liable for individualFederal income taxes on their respective share of IWT’s taxable income.

 

(2)                                  Tesoro acquired International Wholesale Tileon October 1, 2002. Financial statements for the years ended December 31,2000, 2001, and 2002 represent pro-forma audited statements.

 

(3)                                  See Note 2 to ConsolidatedFinancial Statements for discussion of restatements.

 

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**ITEM 7.****       ****MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS**

 

**General**

 

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 issuednine million shares of our common stock in exchange for all of the IWT shares.Tesoro has three additional wholly owned subsidiaries. The first is IWT TesoroInternational, Ltd., which was created to own and manage assets relatingto any of our potential future overseas activities. The second is IWT Transport, Inc.,organized to handle our domestic freight operations. Finally, the Tile Club, Inc.,organized in 2004, was formed to acquire licensing, manufacturing anddistribution rights for high-end designer and artistic based decorative tiles,and to act as a domestic agent for selected manufacturers.

 

**Company Overview**

 

TheCompany is a value added distributor of imported ceramic, porcelain and stoneflooring and decorative wall tiles. Our warehousing and distribution centerscontain over 420,000 square feet of storage space and over seventeen millionsquare feet of product ready for immediate shipment to our customers. In 2004,we signed an agreement to realign and expand our Palm City, FL distributioncenter facility.  This agreement consolidatesmultiple agreements into a new single fifteen-year lease.  We expect this realignment and expansion tobe completed early in the second quarter of 2005.  Realigning our Florida distributionfacilities will consolidate approximately 80,000 square feet of warehouse spacecurrently in multiple small warehouses into one single facility, provide anadditional 70,000 square feet of warehouse space for future anticipated growthand create a second facility similar in size and adjacent to our first warehouse.Our total warehouse capacity in Palm City will be approximately 300,000 squarefeet.  In 2004, the Company signed afive-year lease for a warehouse facility in Dallas, Texas.  The Dallas facility contains approximately120,000 square feet.  The Company’sprimary strategy is to be a reliable supplier and not a competitor to itscustomers.

 

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

 

•                  Maintain relationships with and serve agrowing base of independent dealers, distributors and wholesalers by providingadequate stocks of in demand product at reasonable and competitive prices;

•                  Stay ahead of the trends in color, texture andformat that drive demand for our fashion based products; and

•                  Make the correct investments in productinventories, relationships with suppliers and logistics and support services toensure our continuing capability to meet our customers’ expectations.

 

Ourprimary source of revenue is the sale of hard flooring and wall covering materialsand our primary costs relate to the acquisition, warehousing and delivery ofthose products. While sales are made throughout the United States, the majorityof our sales are in the southeastern quadrant of the country. The primarysources of working capital are a $ 25.0 million (US) revolving line of creditfrom a large US commercial bank, our suppliers who extend us payment terms andour stockholders’ equity.

 

OnDecember 17, 2003 we began trading our stock on the OTC Bulletin Boardunder the symbol IWTT. During 2005, we expect to raise additional equitythrough both the public and private markets. Any new capital raised will beused to strengthen our balance sheet and to provide capital for continuedgrowth.

 

Duringthe year ended 2004, the Company continued to expand its distribution channelsbeyond its traditional small and mid

 

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sizedfloor covering dealers in the southeastern United States. These channelsincluded larger regional distributors outside the southeastern United States,home center stores and floor-covering dealers that focus on the builders of newconstruction units.

 

In2004, we formed a new wholly owned subsidiary, The Tile Club, Inc. (TTC).TTC is a Delaware corporation. TTC will serve as a licensor and distributor ofspecialty tiles. It will also act as an agent for some of our foreignmanufactures with whom we have exclusive distribution rights in the UnitedStates and Canada.

 

**Results of Operations**

 

Weare a small distributor in a growing market. We are entering new markets andadding new products. As a result we anticipate being able to grow faster thanthe market as a whole for the next several years. Currently, the ceramic floorand wall tile industry in the United States is $2.54 billion and growingat a seven to ten percent rate. We estimate that our share of this market isapproximately 1.5%.

 

Thefollowing discussions and analyses should be read in conjunction with ourfinancial statements and related notes included in this Annual Report on Form 10-K.

 

*Results of Operations for the Years ended December 31, 2004,2003 and 2002*

 
| ** **                      | ** ** | **For the Years Ended December 31,** | ** ** | ** ** | ** ** |
|---------------------------------|------------|-------------------------------------------|------------|------------|------------|
| ** **                      | ** ** | **2004**                                  | ** ** | ** ** | ** ** | **2003** | ** ** | ** ** | ** ** | **2002** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | ** **                                | ** ** | ** ** | ** ** | **(as restated)** | ** ** | ** ** | ** ** | **(as restated)** | ** ** | ** ** | ** ** |
| Revenues                        |       | $                                         | 44,925,449 |       | 100.0      | % | $ | 32,604,546 |   | 100.0 | % | $ | 25,387,708 |   | 100.0 | % |
| Cost of goods sold              |       | 27,790,173                                |       | 61.9       |       | 19,814,514 |   | 60.8 |   | 15,268,535 |   | 60.1 |   |
| Gross profit                    |       | 17,135,276                                |       | 38.1       |       | 12,790,032 |   | 39.2 |   | 10,119,173 |   | 39.9 |   |
| Operating expenses              |       | 17,671,748                                |       | 39.3       |       | 13,562,593 |   | 41.6 |   | 8,694,101 |   | 34.2 |   |
| Income (loss) from operations   |       | (536,472                                  | )          | -1.2       |       | (772,561 | ) | -2.4 |   | 1,425,072 |   | 5.6 |   |
| Interest expense                |       | (627,439                                  | )          | 1.4        |       | (480,139 | ) | 1.5 |   | (328,920 | ) | 1.3 |   |
| Other (expense)                 |       | (45,485                                   | )          | 0.1        |       | (15,421 | ) | 0.0 |   | (15,788 | ) | 0.1 |   |
| Income (loss) before income tax |       | (1,209,396                                | )          | -2.7       |       | (1,268,121 | ) | -3.9 |   | 1,080,364 |   | 4.3 |   |
| Income tax benefit (expense)    |       | —                                    |       | 0.0        |       | — |   | 0.0 |   | 597,174 |   | 2.4 |   |
| Net income (loss)               |       | (1,209,396                                | )          | -2.7       |       | (1,268,121 | ) | -3.9 |   | 1,677,538 |   | 6.6 |   |
|                                 |            |                                           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |

 

*Year Ended December 31, 2004, as  compared to December 31, 2003*

 

Netsales for the year ended December 31, 2004 were $44,925,400, reflecting anincrease of $12,321,000, or approximately 37.8%, over the $$32,604,500 reportedfor the year ended December 31, 2003. This growth follows a 28.4% increasefor the year ended December 31, 2003 from the year ended December 31,2002.  The Company expects to be able tomaintain its strong growth rate for the foreseeable future. 

 

In2004, we continued to expand our wholesale customer base business. We anticipatedthat sales to this wholesaler business would operate at a somewhat lower grossmargin resulting in a decrease in our gross margin to 38.1% for the year endingDecember 31, 2004 from 39.2% for the year ending December 31, 2003.We anticipate in the future that the wholesaler business will operate at alower operating cost ratio than our dealer business due to the reduced handlingcosts.  The initial products related tothe dealer business were at a lower price point and gross margin, however weexpect the margin for these sales to increase slightly as existing marketsmature and new products are introduced.

 

Ourgross margin is a function of the mix of our products sold and our ability topurchase materials from our suppliers in volumes that produce lower costs.  We distribute products that have a wide rangeof both price point and margin.  Ourhistorical mix has provided the Company with a gross margin of between 38% and40%.  We expect that we will be able tomaintain this margin range as we grow.  However, circumstances beyond our control suchas the increase in import costs and the competitive pricing environment inwhich we operate could adversely affect our ability to maintain our grossmargin.

 

Theaverage selling price per square foot in 2004 was $1.15, down $.05 from $1.20in 2003. This decrease was primarily due to volume variance in our mix ofproducts.

 

20

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Quarterlynet sales and the percentage changes in net sales by quarter for 2004 versus 2003were as follows:

 
| ** **     | ** ** | **2004**   | ** ** | **2003**  | ** ** | **Change** | ** ** |
|----------------|------------|------------|------------|-----------|------------|------------|------------|
| First quarter  |       | $          | 9,534,632  |      | $          | 6,713,810  |       | 42.0 | % |
| Second quarter |       | 11,585,016 |       | 8,477,575 |       | 36.7       | %          |
| Third quarter  |       | 11,052,268 |       | 8,955,693 |       | 23.4       | %          |
| Fourth quarter |       | 12,753,533 |       | 8,457,468 |       | 50.8       | %          |
| Total Year     |       | $          | 44,925,449 |      | $          | 32,604,546 |       | 37.8 | % |

 

Salesgrowth in the third quarter of 2004 was impacted by several hurricanes thatmade landfall over the entire state of Florida, impacting dealer and buildersales markets. During the forth quarter of 2004 our sales returned to expectedlevels.

 

Grossprofit was $17,135,300 (38.1% of net sales) for 2004 and $12,790,000 (39.2% ofnet sales) for 2003. The reduction in percentage was primarily attributable tothe increase in transportation and import costs.

 

Operatingexpenses for 2004 were $17,671,700 (39.3% of net sales) compared to $13,562,600(41.6% of net sales). The Company’s ability to decrease its current percentagerate of operating expenses was due to ongoing efforts to increase efficiencywhile expanding into new markets and new product lines. The increases inwarehouse costs are attributable to the additional warehouse facilitiesrequired to support the increase in sales. The increase in distribution and salescosts are directly related to the increase in sales. The increases in marketingcosts are related to the Company’s effort to expand into three new distributionchannels.

 
| ** **                 | ** ** | **For the Years Ended December 31,** | ** ** | ** ** | ** ** |
|----------------------------|------------|-------------------------------------------|------------|------------|------------|
| ** **                 | ** ** | **2004**                                  | ** ** | ** ** | ** ** | **2003** | ** ** | ** ** | ** ** | **Change** | ** ** | ** ** | ** ** |
| Warehouse and distribution |       | 5,489,263                                 |       | 31.1       | %          | 3,807,845 |   | 28.1 | % | 1,681,418 |   | 44.2 | % |
|                       |       |                                      |       |       |       |   |   |   |   |   |   |   |   |
| Sales and marketing        |       | 6,074,812                                 |       | 34.4       | %          | 4,311,558 |   | 31.8 | % | 1,763,254 |   | 40.9 | % |
|                       |       |                                      |       |       |       |   |   |   |   |   |   |   |   |
| General and administrative |       | 6,107,673                                 |       | 34.6       | %          | 5,443,190 |   | 40.1 | % | 664,483 |   | 12.2 | % |
|                       |       |                                      |       |       |       |   |   |   |   |   |   |   |   |
|                       |       | $                                         | 17,671,748 |       |       |   | $ | 13,562,593 |   |   |   | $ | 4,109,155 |   |   |   |
|                            |            |                                           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |

 

Theoperating loss for 2004 was $536,500 (-1.2% of net sales) compared to theoperating loss for 2003 of $772,561 (-2.4% of net sales). The percentage decreasein operating losses was attributable to the Company’s ability to increaseefficiency while expanding info three new distribution channels..

 

Interestexpense for 2004 was $627,400 compared to $480,100 in 2003. The increase ininterest expense was attributable to the Company’s expansion efforts andincreasing interest rates.

 

*Year Ended December 31, 2003, as  compared to December 31, 2002*

 

Netsales for the year ended December 31, 2003 were $32,604,500, reflecting anincrease of $7,216,800, or approximately 28.4%, over the $25,387,700 reportedfor the year ended December 31, 2002. This growth follows a 29.4% increasefor the year ended December 31, 2002 from the year ended December 31,2001.

 

Quarterlynet sales and the percentage changes in net sales by quarter for 2003 versus2002 were as follows:

 
| ** **     | ** ** | **2003**  | ** ** | **2002**  | ** ** | **Change** | ** ** |
|----------------|------------|-----------|------------|-----------|------------|------------|------------|
| First quarter  |       | $         | 6,713,810  |      | $          | 6,014,020  |       | 11.6 | % |
| Second quarter |       | 8,477,575 |       | 6,803,466 |       | 24.6       | %          |
| Third quarter  |       | 8,955,693 |       | 6,383,981 |       | 40.3       | %          |
| Fourth quarter |       | 8,457,468 |       | 6,186,241 |       | 36.7       | %          |
| Total Year     |       | $         | 32,604,546 |      | $          | 25,387,708 |       | 28.4 | % |

 

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Grossprofit was $12,790,000 (39.2% of net sales) for 2003 and $10,119,200 (39.9% ofnet sales) for 2002. The reduction in percentage was primarily attributable tothe increase in transportation and import costs.

 

Operatingexpenses for 2003 were $13,562,600 (41.6% of net sales) compared to $8,694,100(34.2% of net sales). . The increases in warehouse costs are attributable tothe additional warehouse facilities required to support the increase in sales.The increase in distribution and sales costs are directly related to theincrease in sales. The increases in marketing costs are related to the Company’seffort to expand into three new distribution channels. The increase in generaland administrative expense was primarily attributable to the initial infrastructurecosts necessary for anticipated expansion into national markets.

 
| ** **                 | ** ** | **For the Years Ended December 31,** | ** ** | ** ** | ** ** |
|----------------------------|------------|-------------------------------------------|------------|------------|------------|
| ** **                 | ** ** | **2003**                                  | ** ** | ** ** | ** ** | **2002** | ** ** | ** ** | ** ** | **Change** | ** ** | ** ** | ** ** |
| ** **                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Warehouse and distribution |       | 3,807,845                                 |       | 28.1       | %          | 2,429,795 |   | 27.9 | % | 1,378,050 |   | 56.7 | % |
|                       |       |                                      |       |       |       |   |   |   |   |   |   |   |   |
| Sales and marketing        |       | 4,311,558                                 |       | 31.8       | %          | 3,050,890 |   | 35.1 | % | 1,260,668 |   | 41.3 | % |
|                       |       |                                      |       |       |       |   |   |   |   |   |   |   |   |
| General and administrative |       | 5,443,190                                 |       | 40.1       | %          | 3,213,416 |   | 37.0 | % | 2,229,774 |   | 69.4 | % |
|                       |       |                                      |       |       |       |   |   |   |   |   |   |   |   |
|                       |       | $                                         | 13,562,593 |       |       |   | $ | 8,694,101 |   |   |   | $ | 4,868,492 |   |   |   |
|                            |            |                                           |            |            |            |  |  |  |  |  |  |  |  |  |  |  |

 

Theoperating loss for 2003 was $772,600 (-2.4% of net sales) compared to theoperating income of $1,080,400 (4.3% of net sales) in 2002. The percentagedecrease in operating income was attributable to the Company’s expansionefforts and higher transportation and import costs.

 

Theaverage price per square foot in 2003 was $1.20, down $.05 from $1.25 in 2002.This decrease was primarily due to volume variance in our mix of products.

 

Interestexpense for 2003 was $480,100 compared to $328,900 in 2002. The increase ininterest expense was attributable to the Company’s expansion efforts.

 

**Liquidity and Capital Resources**

 

Wehad cash balances of approximately $507,700 at December 31,2004 and $867,400at December 31, 2004.  We havefinanced our growth with new equity capital and increased borrowings from ourcommercial lender.

 

During2004, we renegotiated our revolving line of credit with our primary commerciallender.  Our line of credit was increasedfrom $17 million to $25 million; an amount the Company expects to be sufficientto support its growth in accounts receivable and inventory through 2005. Ourrapid growth is expected to continue to require the Company to seek outsidecapital to supplement earnings and maintain and strengthen our balance sheet.We believe that the working capital required to finance the necessary growth ininventory will be provided by our existing line of credit. We expect to raiseadditional equity through both the public and private markets during 2005.  However, we cannot assure anyone that we willbe able to obtain outside capital, or if we do, that it will be on termsbeneficial to us.

 

Weexpect that the cost savings resulting from the realignment will offset theadditional warehouse facilities and therefore the expansion will require only amarginal increase in working capital requirements.

 

Duringthe twelve months ended December 31, 2004, Tesoro issued 45,500 shares ofcommon stock in connection with warrants exercised at $3.25 per share for atotal of $147,875. The purchasers were accredited investors and were providedwith or had access to, information about the Company, including financialinformation. The transaction was exempt pursuant to Section 4(2) of theSecurities Act.

 

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

 

22

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Thebalance due at December 31, 2004 to our commercial lender for the use ofthe revolving line of credit was approximately $16.0 million. The loan andsecurity agreement contains certain covenants, which include financialcovenants that require us to maintain a certain leverage ratio, limit ourunfunded capital expenditures, a required minimum fixed charge coverage ratio,and a certain inventory turnover ratio. At December 31, 2004 the Companywas not in compliance with the leverage and fixed charge coverage ratiorequirement. On March 23rd, 2005 the Company obtained a waiverof these covenants from our commercial lender. We believe that our relationshipwith our commercial lender is good and that they will continue to support theCompany.

 

**Contractual Obligations**

 

Forthe year ended 2004, our long-term debt obligations consisted of notes payable,capital leases and a line of credit. The future payment requirements for theseobligations are as follows:

 
| ** **           | ** ** | **Total**  | ** ** | **2005**  | ** ** | **2006**  | ** ** | **2007**  | ** ** | **2008**  | ** ** | **2009**  | ** ** | **Thereafter** | ** ** |
|----------------------|------------|------------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|----------------|------------|
|                 |       |       |       |      |       |      |       |      |       |      |       |      |       |           |       |
| Long-term debt       |       | $          | 16,102,925 |      | $          | 18,218    |       | $         | 16,063,987 |      | $          | 16,906    |       | $              | 3,814      |   | $ | — |   | $ | — |   |
| Capital leases       |       | 251,368    |       | 80,943    |       | 72,092    |       | 57,089    |       | 26,130    |       | 15,114    |       |           |       |
| Operating leases     |       | 26,911,000 |       | 1,462,000 |       | 1,823,000 |       | 1,973,000 |       | 2,003,000 |       | 2,033,000 |       | 17,617,000     |       |
| Related party debt   |       | 338,662    |       | —    |       | —    |       | —    |       | —    |       | —    |       | 338,662        |       |
| Purchase commitments |       | 2,280,000  |       | 1,824,000 |       | 456,000   |       | —    |       | —    |       | —    |       | —         |       |
|                 |       | $          | 45,883,955 |      | $          | 3,385,161 |       | $         | 18,415,079 |      | $          | 2,046,995 |       | $              | 2,032,944  |   | $ | 2,048,114 |   | $ | 17,955,662 |   |

 

Therelated party debt obligations as of December 31, 2004 relate to notespayable to Tesoro’s three principal stockholders who also serve as executiveofficers and directors.  The notesinclude an interest rate of 10% per year and are due on December 31, 2025.The capital leases relate to equipment leases. The other long-term liabilitiesrepresent an existing loan and security agreement for a line of credit with ourcommercial lender. The line matures on September 10, 2006 at which timethe Company plans on renewing the debt. However, we cannot assure anyone thatwe will be able to renew the line of credit, or if we do, that it will be onterms beneficial to us. The Company entered into an agreement to purchase tilefrom a vendor, who is also a stockholder of the Company. The agreement is for aterm of 18 months expiring in March 2006.

 

**Critical Accounting Policies**

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

 

TheCompany’s significant accounting policies are described in Note 1 to theconsolidated financial statements included elsewhere in this report. Some ofthose significant accounting policies require the Company to make subjective orcomplex judgments or estimates. Critical accounting policies are defined asthose that are both most important to the portrayal of a company’s financialcondition and results of operations and require management’s most difficult,subjective, or complex judgment, often as a result of the need to makeestimates about the effect of matters that are inherently uncertain and maychange in subsequent periods.

 

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

 

•                  Accounts receivable and revenues arerecognized when goods are shipped and legal title passes to the customer. TheCompany provides an allowance for expected doubtful accounts based uponhistorical bad debt and claims experience and periodic evaluation of specificcustomer accounts and the aging of accounts receivable. If the financialcondition of the Company’s customers were to deteriorate, resulting in animpairment of their ability to make payments, additional allowances may berequired.

 

•                  Inventories are stated at the average landedcost, which matches current costs with current revenues. Inventories on handare compared against anticipated future usage, which is a function of historicalusage and anticipated future selling price, in order to evaluate obsolescence,excessive quantities, and expected sales below cost. Actual results coulddiffer from assumptions used to value obsolete, excessive inventory orinventory expected to be sold below cost.

 

•                  Deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective tax bases. Deferred tax assets and liabilities are measuredusing enacted tax rates expected to apply to taxable income in the years inwhich the temporary differences are

 

23

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expectedto be recovered or settled. The effect on deferred tax assets and liabilitiesof a change in the tax rates is recognized in earnings (loss) in the periodthat includes the enactment date. Additionally, taxing jurisdictions couldretroactively disagree with the Company’s tax treatment of certain items, andsome historical transactions have income tax effects going forward. Accounting rules requirethese future effects to be evaluated using current laws, rules andregulations, each of which can change at any time and in an unpredictablemanner.

 

**Recent Accounting Pronouncements**

 

InDecember 2003, the Financial Accounting Standards Board (“FASB”) issuedInterpretation No. 46(R), “Consolidation of Variable Interest Entities.”  Interpretation No. 46(R) clarifies theapplication of Accounting Research Bulletin No. 51, “ConsolidatedFinancial Statements,” to certain entities in which equity investors do nothave the characteristics of a controlling financial interest or do not havesufficient equity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties.  Interpretation No. 46(R) was applicablefor all reporting periods after December 15, 2004.  Interpretation No. 46(R) did not have amaterial impact on the Company’s results of operations or financial position. 

 

InNovember, 2004, the FASB issued SFAS No. 151 “Inventory Costs” anamendment to Accounting Research Bulletin No. 43, “Inventory Pricing,” toclarify the accounting for abnormal amounts of idle facility expense, freight,handling costs and wasted material.  ThisStatement requires that those items be recognized as current-period chargesregardless of whether they meet the criterion of “so abnormal.”  Additionally this statement requires thatallocation of fixed production overheads to the costs of conversion be based onthe normal capacity of the production facilities.  The provisions of SFAS No. 152 willbecome effective for fiscal years beginning after June 15, 2005.  The Company has not yet determined the impactof adopting this standard.

 

InDecember 2004, the FASB issued SFAS No. 153, *“Exchanges of Nonmonetary Assets”* anamendment to Accounting Principles Board Opinion No. 29, “*Accounting for Nonmonetary Transactions,”*which is based on the principle that exchanges of nonmonetary assets should bemeasured based on the fair value of the assets exchanged.  The guidance in that Opinion, however,included certain exceptions to that principle. This Statement amends Opinion 29 to eliminate the exception fornonmonetary exchanges of similar productive assets and replaces it with ageneral exception for exchanges in which the future cash flows of the entityare not expected to change significantly as a result of the exchange.  The provisions of SFAS No. 153 willbecome effective for nonmonetary asset exchanges in fiscal periods beginningafter June 15, 2005.  The Companyhas not yet determined the impact of adopting this standard.

 

InDecember 2004, the FASB issued SFAS No. 123 (revised 2004), “*Share-Based Payment*,” (“SFAS No. 123(R)”).  SFAS No. 123(R) requires companies torecognize the compensation cost relating to share-based payment transactions inthe financial statements.  This Statementeliminates the ability to account for share-based compensation transactionsusing Accounting Principles Board Opinion No. 25, and requires insteadthat such transactions be accounted for using a fair-value-based method.  SFAS No. 123 (R) will be effective forthe Company’s third quarter of fiscal 2005. The Company has not yet determinedthe impact of adopting this standard.

 

**Impactof Inflation**

 

Inflationaffects the Company’s distribution costs and operating expenses. The tileindustry has experienced significant inflation in the prices of fuel-relatedand import costs beginning in the first quarter of 2004. In the past the tileindustry experienced moderate inflation in these costs and has generally passedthem along through price increase to its customers.

 

**Seasonality**

 

TheCompany is a calendar year-end company and its results of operations for thefirst and fourth quarter tends to be the weakest. The second and third quarterstypically produce higher net sales and operating income. These results areprimarily due to consumer residential spending patterns for floor covering,which historically have decreased during the last two months of each year andthe first two months of each year. Our recent increase in the market share ofwholesale dealers that purchase in anticipation of retail customers hasweakened the impact of consumer spending trends.

 

**ITEM 7A****                 ****QUANTITATIVE AND QUALITATIVEDISCLOSURE ABOUT MARKET RISK**

 

Financialexposures are managed as an integral part of the Company’s risk managementprogram, which seeks to reduce the potentially adverse effect that thevolatility of the exchange rate and lending markets may have on its operatingresults. The Company does not regularly engage in speculative transactions, nordoes it regularly hold or issue financial instruments for trading purposes. A summary of our market risk exposures ispresented below.

 

24

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*Interest Rate Risk*

 

Wehave revolving line of credit agreement with interest rates that are either apercentage over Prime or Libor therefore to the extent that Prime or Liborchange we are subject to interest rate risk. 

 

*Foreign Currency Risk*

 

Wecurrently purchase our products from foreign manufacturers in U.S. dollars andforeign currencies. Our fund transfers are relatively large. The Office of theComptroller of the Currency (USOCC) monitors these activities. Should the Eurocontinue to strengthen against the U.S. dollar, we could see an increase in ourcost of product that could, in time, be passed on to our customers andtherefore have a detrimental impact on our profitability. The nature of theagreement with our commercial lender would require any hedge or forwardpurchase transactions be offset against our borrowing base therefore, reducingour access to the funds under our borrowing base. We currently do not hedgeagainst the risk of exchange rate fluctuations and do not intend to in theforeseeable future.

 

**ITEM 8.****                       ****FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

Thefinancial statements and supplemental data required by this Item 8 follow theindex of financial statements that appears at the end of Part I of this Form 10-K.

 
|                                                                                                                                       | **Page** |
|--------------------------------------------------------------------------------------------------------------------------------------------|----------|
| Reports  of Independent Registered Public Accounting Firms:                                                                                |     |
| McGladrey &  Pullen, LLP – As of December 31, 2004 and the year then ended.                                             | 26       |
| Kantor, Sewell and Oppenheimer –  as of December 31, 2003 and each of the years in the two year period  then ended.              | 27       |
|                                                                                                                                       |     |
| Consolidated Balance Sheets  as of December 31, 2004 and 2003 (as restated)                                                           | 28       |
| Consolidated  Statements of Operations for the Years ended December 31, 2004, 2003(as  restated) and 2002 (as restated)               | 29       |
| Consolidated  Statements of Stockholders’ Equity for the years ended December 31,  2004, 2003(as restated) and 2002(as restated) | 30       |
| Consolidated  Statements of Cash Flows for the years ended December 31, 2004, 2003(as  restated) and 2002(as restated)                | 32       |
| Notes to  Consolidated Financial Statements                                                                                                | 34       |

 

25

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## REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM

##  

To the Board of Directors

IWT Tesoro Corporation and Subsidiaries

Westport, Connecticut

 

We have audited the accompanying consolidated balance sheet of IWTTesoro Corporation and Subsidiaries as of December 31, 2004 and therelated consolidated statements of operations, stockholders’ equity and cashflows for the year then ended.  Theseconsolidated financial statements are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on these consolidated financial statements based on ouraudit.

 

We conducted our audit in accordance with standards of the PublicCompany Accounting Oversight Board (United States).  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe that our audit provides areasonable basis for our opinion.

 

In our opinion, the 2004 consolidated financial statements referred toabove present fairly, in all material respects, the financial position of IWTTesoro Corporation and Subsidiaries as of December 31, 2004, and theresults of its operations and cash flows for the year then ended in conformitywith U.S. generally accepted accounting principles.

 
| **/s/ McGLADREY &  PULLEN, LLP**                                                                           | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                     |
| ** **                                                                                                     |
| New Haven, Connecticut                                                                                         |
| February 25, 2005 except for the first  paragraph of Note 5,  as to which the date is March 23, 2005 |

 

26

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**REPORT OF INDEPENDENT****REGISTERED PUBLIC ACCOUNTING FIRM**

 

To the Board of Directors

IWT Tesoro Corporation and Subsidiaries

Westport, CT

 

We have audited the accompanying consolidated balance sheets of IWTTesoro Corporation and Subsidiaries as of December 31, 2003 and 2002, andthe related consolidated statements of operations, changes in stockholders’equity, and cash flows for each of the years then ended. These consolidatedfinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.  

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audits to obtain reasonable assurance aboutwhether the consolidated financial statements are free of materialmisstatement.  The Company is notrequired to have, nor were we engaged to perform, an audit of its internalcontrol over financial reporting. Our audit included consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting.  Accordingly, we express nosuch opinion. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the consolidated financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall consolidatedfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of IWT TesoroCorporation and Subsidiaries as of December 31, 2003 and 2002, and theresults of its operations, and its cash flows for each of those years inconformity with accounting principles generally accepted in the United Statesof America.

 

As discussed in Note 2 to the accompanying consolidated financialstatements, the Company has restated the consolidated balance sheets as of December 31,2003 and 2002, and the related consolidated statements of operations, stockholders’equity, and cash flows for the years ended December 31, 2003 and 2002.

 

 
| /s/ KANTOR, GEISLER & OPPENHEIMER, PA                                  |   |
|---------------------------------------------------------------------------------|--------|
|                                                                            |
| Hollywood, Florida                                                              |
| January 23, 2004, except as to Note 2, which is as of March 29,  2005 |

 

27

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**IWT TESORO CORPORATION AND SUBSIDIARIES**

CONSOLIDATEDBALANCE SHEETS

DECEMBER 31, 2004 AND 2003

 
| ** **                                                                                                       | ** ** | **2004**   | ** ** | **2003**       | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|
| ** **                                                                                                       | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| ASSETS                                                                                                           |       |       |       |           |       |
| Current Assets:                                                                                                  |       |       |       |           |       |
| Cash                                                                                                             |       | $          | 507,677    |           | $          | 867,361 |   |
| Accounts receivable, net allowance for  doubtful accounts and returns of $270,013 and $175,000                   |       | 7,883,756  |       | 4,852,705      |       |
| Inventories                                                                                                      |       | 21,578,829 |       | 13,058,839     |       |
| Deposit on purchase of inventories                                                                               |       | 366,667    |       | —         |       |
| Note receivable arising from sale of stock                                                                       |       | —     |       | 550,000        |       |
| Prepaid expenses                                                                                                 |       | 271,104    |       | 754,281        |       |
| Total current assets                                                                                             |       | 30,608,033 |       | 20,083,186     |       |
|                                                                                                             |       |       |       |           |       |
| Property and equipment, net                                                                                      |       | 1,762,065  |       | 1,236,979      |       |
|                                                                                                             |       |       |       |           |       |
| Other assets                                                                                                     |       | 758,997    |       | 382,101        |       |
|                                                                                                             |       | $          | 33,129,095 |           | $          | 21,702,266 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                        |       |       |       |           |       |
| Current Liabilities:                                                                                             |       |       |       |           |       |
| Accounts payable                                                                                                 |       | $          | 15,282,653 |           | $          | 9,859,161 |   |
| Accrued expenses and other liabilities                                                                           |       | 997,432    |       | 536,963        |       |
| Current portion of capital lease  obligations                                                                    |       | 80,943     |       | 63,152         |       |
| Current portion of notes payable, other                                                                          |       | 18,218     |       | 42,719         |       |
| Total current liabilities                                                                                        |       | 16,379,246 |       | 10,501,995     |       |
|                                                                                                             |       |       |       |           |       |
| Long-Term Debt:                                                                                                  |       |       |       |           |       |
| Note payable, revolving line of credit                                                                           |       | 16,047,220 |       | 9,599,340      |       |
| Capital lease obligations                                                                                        |       | 170,425    |       | 149,183        |       |
| Subordinated notes payable, stockholders                                                                         |       | 338,662    |       | 338,662        |       |
| Notes payable, other                                                                                             |       | 37,487     |       | 42,560         |       |
| Total long-term debt                                                                                             |       | 16,593,794 |       | 10,129,745     |       |
| Total liabilities                                                                                                |       | 32,973,040 |       | 20,631,740     |       |
|                                                                                                             |       |       |       |           |       |
| Commitments and Contingencies (Note 9)                                                                           |       |       |       |           |       |
|                                                                                                             |       |       |       |           |       |
| Stockholders’ Equity:                                                                                       |       |       |       |           |       |
| Preferred stock, $0.001 par value,  25,000,000 authorized; none issued                                           |       | —     |       | —         |       |
| Common stock, $0.001 par value, 100 million  shares authorized; 11,697,102 and 11,622,702 issued and outstanding |       | 11,697     |       | 11,623         |       |
| Additional paid in capital                                                                                       |       | 4,178,800  |       | 3,883,949      |       |
| Accumulated deficit                                                                                              |       | (4,034,442 | )          | (2,825,046     | )          |
|                                                                                                             |       | 156,055    |       | 1,070,526      |       |
|                                                                                                             |       | $          | 33,129,095 |           | $          | 21,702,266 |   |

 

See Notes to Consolidated Financial Statements

 

28

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**IWT TESORO CORPORATION ANDSUBSIDIARIES**

CONSOLIDATED STATEMENTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

 
| ** **                                  | ** ** | **2004**   | ** ** | **2003**       | ** ** | **2002**       | ** ** |
|---------------------------------------------|------------|------------|------------|----------------|------------|----------------|------------|
| ** **                                  | ** ** | ** ** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
|                                        |       |       |       |           |       |           |       |
| Net Sales                                   |       | $          | 44,925,449 |           | $          | 32,604,546     |       | $ | 25,387,708 |   |
| Cost of Goods Sold                          |       | 27,790,173 |       | 19,814,514     |       | 15,268,535     |       |
| Gross Profit                                |       | 17,135,276 |       | 12,790,032     |       | 10,119,173     |       |
| Operating Expenses:                         |       |       |       |           |       |           |       |
| Warehouse and distribution                  |       | 5,489,263  |       | 3,807,845      |       | 2,429,795      |       |
| Sales and marketing                         |       | 6,074,812  |       | 4,311,558      |       | 3,050,890      |       |
| General and administrative                  |       | 6,107,673  |       | 5,443,190      |       | 3,213,416      |       |
|                                        |       | 17,671,748 |       | 13,562,593     |       | 8,694,101      |       |
| Income (Loss) from Operations               |       | (536,472   | )          | (772,561       | )          | 1,425,072      |       |
| Other Expenses:                             |       |       |       |           |       |           |       |
| Interest expense                            |       | (627,439   | )          | (480,139       | )          | (328,920       | )          |
| Other                                       |       | (45,485    | )          | (15,421        | )          | (15,788        | )          |
|                                        |       | (672,924   | )          | (495,560       | )          | (344,708       | )          |
| Income (Loss) Before Income Taxes           |       | (1,209,396 | )          | (1,268,121     | )          | 1,080,364      |       |
|                                        |       |       |       |           |       |           |       |
| Income Tax Benefit (Expense)                |       | —     |       | (597,196       | )          | 597,174        |       |
| Net Income (Loss)                           |       | $          | (1,209,396 | )              | $          | (1,865,317     | )          | $ | 1,677,538 |   |
| Earnings (Loss) Per Share:                  |       |       |       |           |       |           |       |
| Basic and Diluted                           |       | $          | (0.10      | )              | $          | (0.17          | )          | $ | 0.15 |   |
|                                        |       |       |       |           |       |           |       |
| Weighted Average Common Shares Outstanding: |       |       |       |           |       |           |       |
| Basic and Diluted                           |       | 11,679,028 |       | 11,197,655     |       | 10,845,775     |       |

 

See Notes to Consolidated Financial Statements

 

29

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**IWT TESORO CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 
| ** **                                                  | ** ** | **Common  Stock** | ** ** | **Additional********Paid in********Capital** | ** ** | **Subscription********Receivable** | ** ** | **Accumulated********Deficit** | ** ** | **Total**  | ** ** |
|-------------------------------------------------------------|------------|-------------------|------------|----------------------------------------------|------------|------------------------------------|------------|--------------------------------|------------|------------|------------|
| ** **                                                  | ** ** | ** **        | ** ** | ** **                                   | ** ** | ** **                         |
| ** **                                                  | ** ** | **Shares**        | ** ** | **Amount**                                   | ** ** | ** **                         | ** ** | ** **                     | ** ** |
|                                                        |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Balance,  December 31, 2001, as restated               |       | 9,000,000         |       | $                                            | 9,000      |                               | $          | 116,400                        |       | $          | (84,000    | ) | $ | (776,789 | ) | $ | (735,389 | ) |
|                                                        |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Year  Ended December 31, 2002:                         |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Distributions,  September 30, 2002                     |       | —            |       | —                                       |       | —                             |       | —                         |       | (1,864,020 | )          | (1,864,020 | ) |
|                                                        |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Payment  of subscription receivable                         |       | —            |       | —                                       |       | —                             |       | 84,000                         |       |       |       | 84,000 |   |
|                                                        |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Net  income, nine months ended September 20,2002       |       | —            |       | —                                       |       | —                             |       | —                         |       | 2,214,239  |       | 2,214,239 |   |
|                                                        |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Balance  September 30, 2002 - Before Recapitalization  |       | 9,000,000         |       | 9,000                                        |       | 116,400                            |       | —                         |       | (426,570   | )          | (301,170 | ) |
|                                                        |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Recapitalization,  October 1, 2002                     |       | 1,800,000         |       | 1,800                                        |       | (116,400                           | )          | —                         |       | 3,542      |       | (111,058 | ) |
|                                                        |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Balance  After Recapitalization on October 1, 2002     |       | 10,800,000        |       | 10,800                                       |       | —                             |       | —                         |       | (423,028   | )          | (412,228 | ) |
|                                                        |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| 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 |       | 134,500           |       | 135                                          |       | 364,360                            |       | —                         |       | —     |       | 364,495 |   |
|                                                        |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Issuance  of shares - private offering                      |       | 83,334            |       | 83                                           |       | 249,917                            |       | —                         |       | —     |       | 250,000 |   |
|                                                        |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Exercise  of warrants                                       |       | 5,000             |       | 5                                            |       | 14,995                             |       | —                         |       | —     |       | 15,000 |   |
|                                                        |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Net  loss 3 months ended December 31, 2002             |       | —            |       | —                                       |       | —                             |       | —                         |       | (536,701   | )          | (536,701 | ) |
|                                                        |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Accretion  of redeemable stock                              |       | —            |       | —                                       |       | (669,907                           | )          | —                         |       | (342,717   | )          | (1,012,624 | ) |
|                                                        |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Balance  December 31, 2002, as Restated                |       | 10,587,834        |       | $                                            | 10,588     |                               | $          | —                         |       | $          | —     |   | $ | (1,362,532 | ) | $ | (1,351,944 | ) |

 

See Notes to Consolidated Financial Statements

 

30

----

 
| ** **                                                           | ** ** | **Common  Stock** | ** ** | **Additional********Paid in********Capital** | ** ** | **Subscription********Receivable** | ** ** | **Accumulated********Deficit** | ** ** | **Total**  | ** ** |
|----------------------------------------------------------------------|------------|-------------------|------------|----------------------------------------------|------------|------------------------------------|------------|--------------------------------|------------|------------|------------|
| ** **                                                           | ** ** | ** **        | ** ** | ** **                                   | ** ** | ** **                         |
| ** **                                                           | ** ** | **Shares**        | ** ** | **Amount**                                   | ** ** | ** **                         | ** ** | ** **                     | ** ** |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Balance,  December 31, 2002, as Restated                        |       | 10,587,834        |       | $                                            | 10,588     |                               | $          | —                         |       | $          | —     |   | $ | (1,362,532 | ) | $ | (1,351,944 | ) |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Year  Ended December 31, 2003:                                  |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Cancellation  of stock repurchase agreement                          |       | 450,000           |       | 450                                          |       | 669,907                            |       |                           |       | 402,803    |       | 1,073,160 |   |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Issuance  of shares - private offering                               |       | 236,668           |       | 237                                          |       | 959,764                            |       | —                         |       | —     |       | 960,001 |   |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Exercise  of warrants                                                |       | 80,000            |       | 80                                           |       | 239,920                            |       | —                         |       | —     |       | 240,000 |   |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Issuance  of shares to employees and directors for services rendered |       | 18,200            |       | 18                                           |       | 55,441                             |       | —                         |       | —     |       | 55,459 |   |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Issuance  of shares - public offering                                |       | 250,000           |       | 250                                          |       | 1,292,250                          |       | —                         |       | —     |       | 1,292,500 |   |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Issuance  of shares - officer’s performance-based stock options |       | —            |       | —                                       |       | 666,667                            |       | —                         |       | —     |       | 666,667 |   |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Net  loss                                                            |       | —            |       | —                                       |       | —                             |       | —                         |       | (1,865,317 | )          | (1,865,317 | ) |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Balance,  December 31, 2003, as Restated                        |       | 11,622,702        |       | 11,623                                       |       | 3,883,949                          |       | —                         |       | (2,825,046 | )          | 1,070,526 |   |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Year  Ended December 31, 2004:                                  |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Exercise  of warrants                                                |       | 45,500            |       | 45                                           |       | 147,830                            |       | —                         |       | —     |       | 147,875 |   |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Issuance  of shares to consultant for services rendered              |       | 17,000            |       | 17                                           |       | 98,333                             |       | —                         |       | —     |       | 98,350 |   |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Issuance  of shares to employees and directors for services rendered |       | 10,400            |       | 10                                           |       | 44,065                             |       | —                         |       | —     |       | 44,075 |   |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Issuance  of shares to customers                                     |       | 1,500             |       | 2                                            |       | 4,623                              |       | —                         |       | —     |       | 4,625 |   |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Net  loss                                                            |       | —            |       | —                                       |       | —                             |       | —                         |       | (1,209,396 | )          | (1,209,396 | ) |
|                                                                 |       |              |       |                                         |       |                               |       |                           |       |       |       |   |   |
| Balance,  December 31, 2004                                     |       | 11,697,102        |       | $                                            | 11,697     |                               | $          | 4,178,800                      |       | $          | —     |   | $ | (4,034,442 | ) | $ | 156,055 |   |

 

See Notes to Consolidated Financial Statements

 

31

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**IWT TESORO CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

 
| ** **                                                                                          | ** ** | **2004**    | ** ** | **2003**       | ** ** | **2002**       | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------|------------|----------------|------------|----------------|------------|
| ** **                                                                                          | ** ** | ** **  | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Cash flows from operating activities:                                                               |       |        |       |           |       |           |       |
| Net income (loss)                                                                                   |       | $           | (1,209,396 | )              | $          | (1,865,317     | )          | $ | 1,677,538 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |       |        |       |           |       |           |       |
| Depreciation and amortization                                                                       |       | 297,324     |       | 341,073        |       | 156,307        |       |
| Deferred income taxes                                                                               |       | —      |       | 597,196        |       | (597,174       | )          |
| Common stock issued for services and  compensation                                                  |       | 147,050     |       | 722,128        |       | 405,145        |       |
| Provision for doubtful accounts and reserve  for returns                                            |       | 226,089     |       | 259,581        |       | 3,085          |       |
| (Gain) loss on disposal of property and  equipment                                                  |       | (21,532     | )          | 18,757         |       | (5,979         | )          |
| Changes in operating assets and  liabilities:                                                       |       |        |       |           |       |           |       |
| (Increase) Decrease in:                                                                             |       |        |       |           |       |           |       |
| Accounts receivable                                                                                 |       | (3,257,140  | )          | (2,236,753     | )          | (786,221       | )          |
| Inventories                                                                                         |       | (8,426,672  | )          | (7,010,963     | )          | (1,062,449     | )          |
| Deposit on purchase of inventories                                                                  |       | (550,000    | )          | —         |       | —         |       |
| Prepaid expenses and other assets                                                                   |       | 186,700     |       | (513,560       | )          | (280,438       | )          |
| Increase in:                                                                                        |       |        |       |           |       |           |       |
| Accounts payable                                                                                    |       | 5,423,492   |       | 4,455,345      |       | 1,242,495      |       |
| Accrued expenses                                                                                    |       | 460,469     |       | 182,120        |       | 203,779        |       |
| Net cash provided by (used in) operating  activities                                                |       | (6,723,616  | )          | (5,050,393     | )          | 956,088        |       |
| Cash flows from investing activities:                                                               |       |        |       |           |       |           |       |
| Acquisitions of property and equipment                                                              |       | (656,464    | )          | (1,029,310     | )          | (58,048        | )          |
| Proceeds from sale of equipment                                                                     |       | 25,000      |       | 20,000         |       | 11,000         |       |
| Net cash used in investing activities                                                               |       | (631,464    | )          | (1,009,310     | )          | (47,048        | )          |
| Cash flows from financing activities:                                                               |       |        |       |           |       |           |       |
| Proceeds from revolving line of credit                                                              |       | 48,840,627  |       | 42,239,607     |       | 26,010,639     |       |
| Payments on revolving line of credit                                                                |       | (42,392,747 | )          | (37,662,341    | )          | (25,105,628    | )          |
| Collection on notes receivable arising from  sale of stock                                          |       | 550,000     |       | —         |       | —         |       |
| Proceeds from issuance of stock                                                                     |       | 147,875     |       | 1,942,500      |       | 349,000        |       |
| Payments of long-term debt                                                                          |       | (126,860    | )          | (128,994       | )          | (113,125       | )          |
| Loan financing costs                                                                                |       | (23,499     | )          | (85,000        | )          | —         |       |
| Proceed from issuance of long-term debt                                                             |       | —      |       | 157,296        |       | —         |       |
| Repayment of stockholder loan                                                                       |       | —      |       | (110,050       | )          | (25,000        | )          |
| Distribution to stockholders                                                                        |       | —      |       | —         |       | (1,864,020     | )          |
| Proceeds from related party note                                                                    |       | —      |       | —         |       | 10,640         |       |
| Net cash provided by (used in) financing  activities                                                |       | 6,995,396   |       | 6,353,018      |       | (737,494       | )          |
| Net Increase (Decrease) in Cash                                                                     |       | (359,684    | )          | 293,315        |       | 171,546        |       |
| Cash, Beginning                                                                                     |       | 867,361     |       | 574,046        |       | 402,500        |       |
| Cash, Ending                                                                                        |       | $           | 507,677    |           | $          | 867,361        |       | $ | 574,046 |   |

 

(Continued)

 

32

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**IWT TESORO CORPORATION AND SUBSIDIARIES**

CONSOLIDATED STATEMENTS OFCASH FLOWS (Continued)

YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

 
| ** **                                                             | ** ** | **2004**   | ** ** | **2003**       | ** ** | **2002**       | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|----------------|------------|----------------|------------|
| ** **                                                             | ** ** | ** ** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Cash Paid (Received) During the Period for:                            |       |       |       |           |       |           |       |
| Interest expense                                                       |       | $          | (627,439   | )              | $          | 473,056        |       | $ | 302,345 |   |
| Income tax                                                             |       | $          | (359,400   | )              | $          | —         |       | $ | — |   |
| Non-Cash Operating Activities:                                         |       |       |       |           |       |           |       |   |   |   |
| Inventory acquired through deposit with  vendor                        |       | $          | 93,318     |           | $          |           |       | $ |   |   |
| Non-Cash Investing and Financing  Activities:                          |       |       |       |           |       |           |       |
| Acquisition of property and equipment  financed through long-term debt |       | $          | 136,319    |           | $          | 172,667        |       | $ | 100,544 |   |
| Note receivable arising from the sale of  stock                        |       | $          | —     |           | $          | 550,000        |       | $ | — |   |
| Recapitalization                                                       |       | $          | —     |           | $          | —         |       | $ | (111,058 | ) |

 

See Notes to Consolidated Financial Statements

 

33

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**IWT T****ESORO C****ORPORATION AND S****UBSIDIARIES**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

###### **DECEMBER 31, 2004,2003**AND 2002

###### ** **

###### **NOTE 1.**                                                 SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES

###### ** **

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

#### ** **

Theconsolidated financial statements include IWT Tesoro Corporation and its whollyowned subsidiaries (collectively the “Company”).

 

IWTTesoro Corporation was incorporated in the state of Nevada on May 3, 2000as Ponca Acquisition Corporation. On September 23, 2002, the Companychanged the name from Ponca Acquisition Corporation to IWT Tesoro Corporation. OnOctober 1, 2002, IWT Tesoro Corporation (an inactive publicly heldcompany) acquired 100% of the outstanding stock of International Wholesale Tile, Inc.(IWT) in exchange for 83% of its outstanding common stock in a transactionaccounted for as a recapitalization of IWT. A total of 9,000,000 shares ofcommon stock were issued for the acquisition. For accounting purposes, theacquisition has been treated as a capital transaction and as a recapitalizationof International Wholesale Tile, Inc. The financial statements becamethose of International Wholesale Tile, Inc., with adjustments to reflectthe changes in equity structure. The operations are those of InternationalWholesale Tile, Inc. for all periods presented, and those of IWT TesoroCorporation from the date of recapitalization.

 

InternationalWholesale Tile, Inc. is principally a value added reseller of ceramicfloor and wall covering products (primarily ceramic, porcelain and stone tile)to the new construction and remodeling industries for commercial andresidential marketplaces. In addition to IWT, Tesoro’s primary operatingsubsidiary, Tesoro has three additional wholly owned subsidiaries. Theseinclude IWT Tesoro Transport, a USDOT licensed common carrier, organized to actas our freight carrier outside of Florida and to back haul non household goodsto Florida. IWT Tesoro International, LTD., a Bermuda corporation to act as aholding company for activities and assets such as agency agreements andinvestments in foreign operations. The Tile Club, Inc., formed in 2004,was organized to acquire licensing, manufacturing and distribution rights forhigh-end designer and artistic based decorative tiles and to also act as anagent for foreign manufacturers from whom IWT has acquired excusivedistribution rights.

 

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

 

Theconsolidated financial statements include IWT Tesoro Corporation and its whollyowned subsidiaries International Wholesale Tile, Inc., IWT Tesoro International,Ltd, IWT Tesoro Transport, Inc. and The Tile Club, Inc. Allsignificant inter-company balances and transactions have been eliminated inconsolidation.

 

#### ***Use ofEstimates***

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements, and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

 

#### ***Cash***

 

Cashequivalents include short-term, highly liquid investments that are readilyconvertible to known amounts of cash and are of an original maturity of threemonths or less.

 

34

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#### ***AccountsReceivable***

#### ** **

Accountsreceivables are carried at the amount billed to a customer, net of theallowance for doubtful accounts and allowance for returns. The allowance for doubtfulaccounts is an estimate for credit losses based on a review of all outstandingamounts on a monthly basis. Management determines the allowance for doubtfulaccounts by regularly evaluating individual customer receivables andconsidering a customer’s financial condition, credit history and currenteconomic conditions. Accounts receivable are written off when deemeduncollectible. Recoveries of accounts receivable previously written off arerecorded when received. The allowance for returns is an estimate for materialreturns estimated at the time revenue is recognized based on historical ratesof returns and allowances. Management determines the allowance for returns byregularly evaluating the returns and their corresponding reason.

 

***Concentration of Credit Risk***

 

Financialinstruments that potentially subject the Company to concentrations of creditrisk are cash and accounts receivable.

 

**Cash**

 

Atvarious times during the year, the Company had deposits in financial institutionsin excess of the federally insured limits. At December 31, 2004, theCompany had deposits in excess of federally insured limits of approximately$709,000. The Company maintains its cash with high quality financialinstitutions which the Company believes limits these risks.

 

**Accounts Receivable**

 

#### **The Company does business andextends credit based on an evaluation of the customers’ financial condition,generally without requiring collateral. Exposure to losses on receivables isexpected to vary by customer due to the financial condition of each customer.The Company monitors exposure to credit losses and maintains allowances foranticipated losses considered necessary under the circumstances. Additionally,the Company maintains credit insurance for certain customer accounts, whichmitigates the credit risk. Allowance for doubtful accounts and returns onaccounts receivable balances were approximately $270,000 and $175,000 as of December 31,2004 and 2003, respectively**.

#### ** **

#### ***Inventories***

#### ** **

Inventoriesare valued at the lower of cost or market, with cost determined on the firstin, first out (FIFO) method and include freight in, duty and handling costs.Inventories consist of finished goods and merchandise in transit from overseasfactories. The Company performs periodic assessments to determine the existenceof obsolete, slow-moving and non-salable inventories, and records necessaryprovisions to reduce such inventories to net realizable value.

 

35

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#### ***Propertyand Equipment***

#### ** **

Propertyand equipment are stated at cost. Equipment under capital leases is stated atthe present value of minimum lease payments at the date of acquisition.Depreciation is calculated on a straight-line basis over the assets’ estimatedremaining useful lives, which range from 3 to 10 years. Leasehold improvementsare capitalized and amortized on the straight-line method over the shorter ofthe lease term or the life of the improvement. Betterments and large renewals,which extend the life of the asset, are capitalized, whereas maintenance andrepairs and small renewals are expensed as incurred.

 

#### ***IncomeTaxes***

 

TheCompany recognizes income taxes under the asset and liability method. Underthis method, deferred tax assets and liabilities are recognized for the futuretax consequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases, and loss carryforwards. Deferred tax assets and liabilities are measuredusing enacted tax rates expected to apply to taxable income in the years inwhich those temporary differences are expected to be recovered or settled. Theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in income in the period that includes the enactment date. Deferredtax assets are reduced by a valuation allowance when, in the opinion ofmanagement, it is more likely than not that some portion or all of the deferredtax assets will not be realized.

 

#### ***RevenueRecognition***

#### ** **

Revenueis recognized when goods are shipped. Allowances for product returns arerecorded as a reduction of sales at the time revenue is recognized based onhistorical data. These allowances are adjusted to reflect actual returns.

 

#### ***Impairmentof Long-Lived Assets***

#### ** **

TheCompany reviews the recoverability of our long-lived assets to determinewhether events or changes in circumstances occurred that indicate the carryingvalue of the asset may not be recoverable. The assessment of possibleimpairment is based on its ability to recover the carrying value of the assetfrom the expected future cash flows of the related operations. If these cashflows are less than the carrying value of such asset, an impairment loss isrecognized for the difference between the estimated fair value and carryingvalue. The measurement of impairment requires management to make estimates ofthese cash flows related to long-lived assets, as well as other fair valuedeterminations.

 

#### ***Shippingand Handling Costs***

 

Shippingand handling costs, included in warehouse and distribution expense in theconsolidated statement of operations, were approximately $2,357,000, $1,775,000and $1,245,000 for the years ended December 31, 2004, 2003 and 2002,respectively.

 

36

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#### ***Advertisingand Promotion***

#### ** **

Advertisingand promotion expenses are charged to expense during the period in which theyare incurred. Promotional merchandise, which includes sample and display boardsand sample packs, are held in other inventories until they are shipped to thecustomer at which point they are expensed. Advertising and promotion expenses,included in sales and marketing expenses in the consolidated statement ofoperations, was approximately $1,978,000, $1,429,000 and $1,112,000 for theyears ended December 31, 2004, 2003 and 2002, respectively.

 

#### ***Stock-BasedCompensation***

#### ** **

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

 

SFASNo. 123 requires companies that continue to follow APB No. 25 toprovide pro forma disclosure of the impact of applying the fair value method ofSFAS No. 123. The Company follows SFAS No. 123 in accounting forstock options issued to non-employees.

 

Proforma information regarding net income and earnings per share is required bySFAS No. 123, “*Accounting for Stock-BasedCompensation*,” and has been determined as if the Company hadaccounted for its stock options under the fair value method of that Statement.The fair value for these options was estimated at the grant date using aBlack-Scholes option pricing model with the following weighted averageassumptions for 2004 and 2002, respectively: risk-free interest rates of 3.47%,and 2.32%, dividend yields of 0% and 0%, volatility factors of the expectedmarket price of the Company’s common stock of 57.4%, and 0.0%; and a weightedaverage expected life of the options of 3 and 5 years. There were no stockoptions issued during 2003.

 

TheBlack-Scholes option valuation model was developed for use in estimating thefair value of traded options, which have no vesting restrictions and are fullytransferable. In addition, option valuation models require the input of highlysubjective assumptions including the expected stock price volatility. Becausethe Company’s employee stock options have characteristics significantlydifferent from those of traded options, and because changes in the subjectiveinput assumptions can materially affect the fair value estimate, in management’sopinion, the existing models do not necessarily provide a reliable singlemeasure of the fair value of its employee stock options. For purposes of proforma disclosures, the estimated fair value of the options is amortized toexpense over the options’ vesting period.

 

37

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Nostock-based employee compensation cost is reflected in net income (loss) forthe years ended December 31, 2004 and 2002 related to non-variable planawards, as all options granted under those plans had an exercise price equal tothe market value of the underlying common stock on the date of the grant andthe number of shares an individual was entitled to was known. The net loss forthe year ended December 31, 2003 includes $666,667 of stock-basedcompensation cost because of performance-based vesting criteria that were metduring 2003 when the market price of the underlying stock was greater than theexercise price of the options. The following table illustrates the effect onnet earnings (loss) and earnings (loss) per share if the Company had appliedthe fair value recognition provisions of SFAS No. 123, “Accounting forStock-Based Compensation”, to non-variable stock-based employee awards.

 
| ** **                                                                                                                        | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                        | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                                                        | ** ** | ** **                        | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Net income (loss)                                                                                                                 |       | $                                 | (1,209,396 | ) | $ | (1,865,317 | ) | $ | 1,677,538 |   |
|                                                                                                                              |       |                              |       |   |   |   |   |
| Add: total stock-based compensation expense  determined under fair value based method for all awards, net of related tax  effects |       | (6,334                            | )          | (2,281 | ) | (2,697 | ) |
|                                                                                                                              |       |                              |       |   |   |   |   |
| Pro forma net income (loss)                                                                                                       |       | $                                 | (1,215,730 | ) | $ | (1,867,598 | ) | $ | 1,674,841 |   |
|                                                                                                                              |       |                              |       |   |   |   |   |
| Earnings (loss) per share – Basic and  Diluted:                                                                              |       |                              |       |   |   |   |   |
| As reported                                                                                                                       |       | $                                 | (0.10      | ) | $ | (0.17 | ) | $ | 0.15 |   |
| Pro forma                                                                                                                         |       | $                                 | (0.10      | ) | $ | (0.17 | ) | $ | 0.15 |   |

 

#### ***Earnings(Loss) Per Share***

 

TheCompany has adopted SFAS Statement No. 128, “*Earnings perShare*”. The statement establishes standards for computing andpresenting earnings per share (EPS). It requires dual presentation of basic anddiluted EPS on the face of the income statement. There is no presentation ofdiluted loss per share in 2004 and 2003 as the effect of common stock optionsand warrants amounts were antidilutive. The diluted earnings per shares for 2002 are not presented as there wereno potentially diluted securities outstanding at that time.

 

Note11 discuss the issuance of warrants issued in connection with equitytransactions.

Note12 discuss options issued through the Company’s stock option plans.

 

38

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#### ***FairValue of Financial Instruments***

#### ** **

The carrying amount of cash and cashequivalents, accounts receivable, accounts payable and accrued expensesapproximate fair value due to short-term maturities of these instruments.Although there are generally no quoted market prices available for affiliatenote receivable, the valuation assessment was based on the respective interestrates, risk-related rate spreads and collateral considerations. The carryingvalue of the Company’s line of credit approximates fair value because theinterest rate used with this instrument fluctuates with the market rate. Thefair values of subordinated long-term debt are estimated based on current ratesoffered to the Company for debt with comparable maturities and similarcollateral requirements (see Note 7). The fair value of all other long-termdebt approximates their carrying value.

 

#### ***SegmentInformation***

#### ** **

TheCompany has adopted SFAS No. 131, “Disclosures about Segments of anEnterprise and Related Information.” SFAS No. 131 establishes standardsfor the way that public business enterprises report information about operatingsegments in annual financial statements and requires those enterprises toreport selected information about operating segments in interim financialreports issued to stockholders. The Company operates in one segment for managementreporting purposes.

 

#### ***RecentAccounting Pronouncements***

#### ** **

InDecember 2003, the Financial Accounting Standards Board (“FASB”) issuedInterpretation No. 46(R), “Consolidation of Variable Interest Entities.” InterpretationNo. 46(R) clarifies the application of Accounting Research Bulletin No. 51,“Consolidated Financial Statements,” to certain entities in which equityinvestors do not have the characteristics of a controlling financial interestor do not have sufficient equity at risk for the entity to finance itsactivities without additional subordinated financial support from otherparties. Interpretation No. 46(R) was applicable for all reporting periodsafter December 15, 2004. Interpretation No. 46(R) did not have amaterial impact on the Company’s results of operations or financial position.

 

InNovember, 2004, the FASB issued SFAS No. 151 *“Inventory Costs”* an amendment to Accounting ResearchBulletin No. 43, *“Inventory Pricing,”*to clarify the accounting for abnormal amounts of idle facility expense,freight, handling costs and wasted material. This Statement requires that thoseitems be recognized as current-period charges regardless of whether they meetthe criterion of “so abnormal.” Additionally this statement requires thatallocation of fixed production overheads to the costs of conversion be based onthe normal capacity of the production facilities. The provisions of SFAS No. 152will become effective for fiscal years beginning after June 15, 2005. TheCompany has not yet determined the impact of adopting this standard.

 

InDecember 2004, the FASB issued SFAS No. 153, *“Exchanges of Nonmonetary Assets”* anamendment to Accounting Principles Board Opinion No. 29, “*Accounting for Nonmonetary Transactions,”*which is based on the principle that exchanges of nonmonetary assets should bemeasured based on the fair value of the assets exchanged. The guidance in thatOpinion, however, included certain exceptions to that principle. This Statementamends Opinion 29 to eliminate the exception for nonmonetary exchanges ofsimilar productive assets

 

39

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andreplaces it with a general exception for exchanges in which the future cashflows of the entity are not expected to change significantly as a result of theexchange. The provisions of SFAS No. 153 will become effective fornonmonetary asset exchanges in fiscal periods beginning after June 15,2005. The Company has not yet determined the impact of adopting this standard.

 

InDecember 2004, the FASB issued SFAS No. 123 (revised 2004), “*Share-Based Payment*,” (“SFAS No. 123(R)”). SFAS No. 123(R)requires companies to recognize the compensation cost relating to share-basedpayment transactions in the financial statements. This Statement eliminates theability to account for share-based compensation transactions using AccountingPrinciples Board Opinion No. 25, and requires instead that suchtransactions be accounted for using a fair-value-based method. SFAS No. 123(R) will be effective for the Company’s third quarter of fiscal 2005. TheCompany has not yet determined the impact of adopting this standard.

 

***Reclassifications***

 

Certainamounts in the 2003 and 2002 financial statements have been reclassified forcomparative purposes to conform to the 2004 presentation.

 

###### **NOTE 2.**                                                 RESTATEMENT OF2003 AND 2002 FINANCIAL STATEMENTS

###### ** **

TheCompany has restated the consolidated balance sheets as of December 31,2003 and 2002, and the consolidated statements of operations, stockholders’equity and cash flows for the years then ended as described below:

 

***Accounts Receivable***

 

Managementdetermined that the Company had been incorrectly ecalculating the allowancesfor product returns. Management revised this calculation and determined thataccounts receivable and net sales were overstated by approximately $55,000 asof and for the year ended December 31, 2003.

 

***Accrued Expenses***

 

Managementdetermined that the Company had been incorrectly calculating the accruals forsales commissions. Management revised this calculation and determined thataccrued expenses were understated by approximately $400,000 and $204,000 as of December 31,2003 and 2002, respectively.

 

40

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***Sample and Display Boards***

 

Managementreassessed its methodology for accounting for sample and display boards anddetermined that this promotional merchandise should have been expensed whendistributed rather than capitalized and depreciated. The adjustments resultingfrom the restatement increased the net loss for 2003 by approximately $758,000and decreased net income for 2002 by approximately $616,000. This change alsoreduced property and equipment as of December 31, 2003 and 2002 byapproximately $2,980,000 and $2,223,000, respectively.

 

***Deferred Taxes***

 

Inconnection with the restatements for accounts receivable, accrued expenses andsample and display boards described above, the related tax effect was recordedresulting in gross deferred tax assets and recorded a valuation allowance, asneeded, to reduce net deferred tax assets to an amount considered by managementmore likely than not to be realized.

 

***Stockholders Equity***

 

Aspart of the recapitalization transaction of IWT effective October 1, 2002(see Note 1), the Company and each of the three stockholders of InternationalWholesale Tile, Inc. entered into a repurchase agreement to commence on January 1,2003. The maximum number of redeemable shares under the repurchase agreementwas 450,000. On June 26, 2003, the Company voted to cancel the repurchaseagreement. The transaction was accounted for by reducing additional paid incapital to the extent a balance existed with the remaining portion of thetransaction applied to accumulated deficit as of December 31, 2002.

 

The effects of these changes are summarized asfollows:

 
| ** **                  | ** ** | **2003**                     | ** ** | **2002**        | ** ** |
|-----------------------------|------------|------------------------------|------------|-----------------|------------|
| ** **                  | ** ** | **As  Previously  Reported** | ** ** | **Adjustments** | ** ** | **As  Restated** | ** ** | **As  Previously  Reported** | ** ** | **Adjustments** | ** ** | **As  Restated** | ** ** |
| As of December 31:     | ** ** | ** **                   | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Consolidated Balance Sheet: |       |                         |       |            |       |   |   |   |   |   |   |   |   |
| Accounts receivable         |       | $                            | 4,907,705  |            | $          | (55,000 | ) | $ | 4,852,705 |   | $ | 2,875,532 |   | $ | — |   | $ | 2,875,532 |   |
| Property and equipment, net |       | 4,217,268                    |       | (2,980,289      | )          | 1,236,979 |   | 2,712,422 |   | (2,222,920 | ) | 489,502 |   |
| Deferred tax assets         |       | 249,397                      |       | (249,397        | )          | — |   | 34,348 |   | 562,848 |   | 597,196 |   |
| Accrued expenses            |       | 137,292                      |       | 399,671         |       | 536,963 |   | 151,064 |   | 203,799 |   | 354,863 |   |
|                        |       |                         |       |            |       |   |   |   |   |   |   |   |   |
| Deferred tax liability      |       | 148,594                      |       | (148,594        | )          | — |   | — |   | — |   | — |   |
|                        |       |                         |       |            |       |   |   |   |   |   |   |   |   |
| Additional paid in capital  |       | 4,972,820                    |       | (1,088,871      | )          | 3,883,949 |   | — |   | 686,068 |   | (686,068 | ) |
|                        |       |                         |       |            |       |   |   |   |   |   |   |   |   |
| Accumulated Deficit         |       | (380,146                     | )          | (2,444,900      | )          | (2,825,046 | ) | (184,740 | ) | (1,177,792 | ) | (1,362,532 | ) |
|                             |            |                              |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

41

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| ** **                            | ** ** | **2003**                     | ** ** | **2002**        | ** ** |
|---------------------------------------|------------|------------------------------|------------|-----------------|------------|
| ** **                            | ** ** | **As  Previously  Reported** | ** ** | **Adjustments** | ** ** | **As  Restated** | ** ** | **As  Previously  Reported** | ** ** | **Adjustments** | ** ** | **As  Restated** | ** ** |
| For the Year Ended December 31:  |       |                         |       |            |       |   |   |   |   |   |   |   |   |
| Consolidated Statement of Operations: |       |                         |       |            |       |   |   |   |   |   |   |   |   |
| Net Sales                             |       | $                            | 32,659,546 |            | $          | (55,000 | ) | 32,604,546 |   | $ | 25,387,708 |   | $ | — |   | $ | 25,387,708 |   |
| Gross profit                          |       | 12,845,032                   |       | (55,000         | )          | 12,790,032 |   | 10,119,173 |   | — |   | 10,119,173 |   |
| Operating expenses                    |       | 12,609,330                   |       | 953,263         |       | 13,562,593 |   | 7,874,786 |   | 819,315 |   | 8,694,101 |   |
| Income (loss) before income taxes     |       | (259,861                     | )          | (1,008,260      | )          | (1,268,121 | ) | 1,899,679 |   | (819,315 | ) | 1,080,364 |   |
| Income tax benefit (expense)          |       | 64,455                       |       | (661,651        | )          | — |   | 34,348 |   | 562,826 |   | 597,174 |   |
| Net Income (loss)                     |       | (195,406                     | )          | (1,669,911      | )          | (1,268,121 | ) | 1,934,027 |   | (256,489 | ) | 1,677,538 |   |
|                                  |       |                         |       |            |       |   |   |   |   |   |   |   |   |
| Earnings (loss) per share:            |       |                         |       |            |       |   |   |   |   |   |   |   |   |
| Basic and Diluted                     |       | $                            | 0.02       |            | $          | (0.12 | ) | $ | (0.10 | ) | $ | 0.19 |   | $ | (0.04 | ) | $ | 0.15 |   |
|                                       |            |                              |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

###### **NOTE 3.**                                                 INVENTORIES

 

Inventoriesconsisted of the following:

 
| ** **        | ** ** | **2004** | ** ** | **2003**  | ** ** |
|-------------------|------------|----------|------------|-----------|------------|
|              |       |     |       |      |       |
| Tiles             |       | $        | 17,034,540 |      | $          | 11,102,115 |   |
| In Transit        |       | 4,544289 |       | 1,956,724 |       |
| Total inventories |       | $        | 21,578,829 |      | $          | 13,058,839 |   |

 

Inventoryin transit consists of merchandise purchased overseas, which has not yet beenreceived in the warehouse.

TheCompany obtains legal title at the shipping point.

 

42

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###### **NOTE 4.**                                                 PROPERTY ANDEQUIPMENT

###### ** **

Propertyand equipment consisted of the following:

 
| ** **                    | ** ** | **2004**   | ** ** | **2003**       | ** ** |
|-------------------------------|------------|------------|------------|----------------|------------|
| ** **                    | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
|                          |       |       |       |           |       |
| Furniture and fixtures        |       | $          | 412,316    |           | $          | 307,247 |   |
| Machinery and equipment       |       | 634,531    |       | 477,996        |       |
| Vehicles                      |       | 233,501    |       | 211,215        |       |
| Office and computer equipment |       | 447,866    |       | 329,747        |       |
| Leasehold improvements        |       | 730,534    |       | 409,125        |       |
|                          |       | 2,458,748  |       | 1,735,330      |       |
| Less accumulated depreciation |       | 696,683    |       | 498,351        |       |
|                          |       | $          | 1,762,065  |           | $          | 1,236,979 |   |

 

Depreciationexpense for the years ended December 31, 2004, 2003 and 2002 wasapproximately $264,000, $267,000 and $129,000, respectively.

 

###### **NOTE 5.**                                                 NOTE PAYABLE,REVOLVING LINE OF CREDIT

###### ** **

OnDecember 31, 2004, the Company amended and restated the existing revolvingline of credit agreement providing up to $25,000,000 with interest rates ofeither (1) LIBOR plus 3.00% or (2) the base rate plus 0.50% (interestrates ranging from 5.03% to 5.75% at December 31, 2004) payable monthly. Theline of credit is limited by a borrowing base which is comprised of apercentage of eligible accounts receivable and eligible inventories, as defined,and is collateralized by substantially all the assets of the Company. Thebalance due at December 31, 2004 and December 31, 2003 was$16,047,220 and $9,599,340, respectively. The line matures September 10,2006 and contains certain covenants requiring the Company to maintain a certainleverage ratio, a required minimum fixed charge coverage ratio, and certaininventory turnover ratio. At December 31, 2004 the Company was not incompliance with the leverage and fixed charge coverage ratio requirement. On March 23rd,2005 the Company obtained a waiver of these covenants from our commerciallender.

 

Forthe years ended December 31, 2004, 2003 and 2002, interest expense relatedto the revolving line of credit amounted to $578,000, $413,000 and $227,000 respectively.

 

43

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###### **NOTE 6.**                                                 CAPITAL LEASEOBLIGATIONS

###### ** **

TheCompany leases certain machinery and equipment under capital leases whichexpire at various dates through 2009. The future minimum lease payments requiredare as follows:

 
| 2005                                    |   | $       | 90,103  |   |
|-----------------------------------------|--------|---------|---------|--------|
| 2006                                    |   | 77,017  |    |
| 2007                                    |   | 59,648  |    |
| 2008                                    |   | 27,103  |    |
| 2009                                    |   | 25,580  |    |
|                                    |   | 279,451 |    |
| Less amount representing interest       |   | 28,083  |    |
| Present value of minimum lease payments |   | 251,368 |    |
| Less current portion                    |   | 80,943  |    |
|                                    |   | $       | 170,425 |   |

 

Assetsacquired under capital lease are presented in property and equipment in theaccompanying balance sheet. Balances of assets under capital leases at December 31,2004 and 2003 were as follows:

 
| ** **                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
|                          |       |     |       |     |       |
| Property and equipment        |       | $        | 437,716    |     | $          | 394,326 |   |
| Less accumulated depreciation |       | 98,639   |       | 94,665   |       |
|                          |       | $        | 339,077    |     | $          | 299,661 |   |

 

###### **NOTE 7.**                                                 SUBORDINATEDNOTES PAYABLE, STOCKHOLDERS

 
| ** **                                                                                                                                                         | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                                                               |       |     |       |     |       |
| Notes payable to three majority  stockholders; interest rate 10% per year; due December 31, 2025;  subordinated to the revolving line of credit (see Note 5). |       | $        | 338,662    |     | $          | 338,662 |   |
|                                                                                                                                                                    |            |          |            |          |            |  |  |

 

Interestexpense related to the subordinated notes payable was approximately $34,000 forthe years ended December 31, 2004 and 2003, and approximately $56,000 forthe year ended December 31, 2002.

 

Thefair value of the Company’s Subordinated long-term debt is based on theavailable market information and management’s estimate of current marketconditions of similar instruments.

 
| ** **                               | ** ** | **Carrying Amount** | ** ** | **Fair Value** | ** ** |
|------------------------------------------|------------|---------------------|------------|----------------|------------|
| ** **                               | ** ** | **2004**            | ** ** | **2003**       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                     |       |                |       |           |       |   |   |   |   |
| Subordinated Notes Payable, Stockholders |       | $                   | 338,662    |           | $          | 338,662 |   | $ | 519,589 |   | $ | 645,440 |   |
|                                          |            |                     |            |                |            |  |  |  |  |  |  |  |  |

 

44

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###### **NOTE 8.**                                                 NOTES PAYABLE,OTHER

 
| ** **                                                                                                                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                                         |       |     |       |     |       |
| Various equipment notes, payable in monthly  installments ranging from $882 to $1,455; maturing at various dates through December 2008. |       | $        | 55,705     |     | $          | 85,279 |   |
|                                                                                                                                         |       |     |       |     |       |
| Less current portion                                                                                                                         |       | 18,218   |       | 42,719   |       |
|                                                                                                                                         |       | $        | 37,487     |     | $          | 42,560 |   |

 
| Year ending December 31: |   |   |   |
|-------------------------------|--------|--------|--------|
| 2005                          |   | $      | 18,218 |   |
| 2006                          |   | 16,767 |   |
| 2007                          |   | 16,906 |   |
| 2008                          |   | 3,814  |   |
|                          |   | $      | 55,705 |   |

 

###### **NOTE 9.**                                                 COMMITMENTS ANDCONTINGENCIES

###### ** **

***Operating Leases***

 

TheCompany leases office and warehouse facilities in Palm City, Florida, Dallas,Texas and Westport, Connecticut under operating leases expiring through March 31,2020.

 

Futureminimum lease payments under non-cancelable operating leases are estimated asfollows:

 
| 2005           |   | $          | 1,462,000  |   |
|----------------|--------|------------|------------|--------|
| 2006           |   | 1,823,000  |       |
| 2007           |   | 1,973,000  |       |
| 2008           |   | 2,003,000  |       |
| 2009           |   | 2,033,000  |       |
| Thereafter     |   | 17,617,000 |       |
| Total payments |   | $          | 26,911,000 |   |

 

Rentexpense was approximately $1,435,000, $1,032,000 and $480,000 for the yearsended December 31, 2004, 2003 and 2002, respectively.

 

***Purchase Commitments***

 

On December 29, 2003, the Companyentered into an agreement to purchase tile from a vendor, who is also astockholder of the Company, and paid a deposit of $550,000 on this purchasecommitment during 2004, which is reduced by 20% of each purchase throughout theterm of the agreement. The agreement is for a term of 18 months from the dateof the initial delivery and commits the Company to purchase a total of$2,750,000 of tile. As of December 31, 2004, the Company had a remainingpurchase commitment under the agreement of approximately $2,280,000 and the

 

45

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remainingbalance of deposits on future purchases is approximately $456,000. Thiscommitment will expire March 2006.

 

***401K Employee Benefit Plan***

 

TheCompany sponsors a 401(k) plan known as the International Wholesale Tile, Inc.401(k) Profit Sharing Plan & Trust (the “401K Plan”). The 401K Planprovides tax deferred salary redeductions for eligible employees. Employeesbecome eligible sixty days after the date hired, as defined in the 401K Plan.The Company provides matching contributions equal to 100% of the employee’scontributions up to a maximum of 3% of eligible pay. The contribution expenserelated to the 401K Plan was approximately $121,000, $76,000 and $59,000 forthe years ended December 31, 2004, 2003 and 2002, respectively.

 

###### **NOTE 10.**                                          STOCKHOLDERS’EQUITY

###### ** **

***Public Offering***

 

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. The first wasthe offer and sale of 250,000 units at $5.50 per unit. Each unit consisted ofone share of the Company’s common stock and a warrant to purchase one commonshare at $7 per share through June 17, 2006. These units were offeredinitially to then current stockholders of the Company. The second offering wasto register on behalf of certain the Company’s stockholders an aggregate of1,243,502 shares for resale. Of this total, 443,500 were not subject to anylock-up period, 699,002 shares were subject to a six-month lock-up periodcommencing as of the effective date of the registration statement, and theremaining 101,000 shares were subject to a 12 month lock-up period through June 17,2004. All contractual lookup periods have expired.

 

Underthis offering, the Company raised $1,292,500, net of offering costs of $82,500.

 

### ***Private Offering***

### ** **

DuringMarch 2003, the Company completed a private placement of its securities,which was initiated in 2002. The offering resulted in the Company issuing anaggregate of 220,002 shares of common stock at $3 per share or $660,000. Underthe offering, the Company issued 83,334 shares for $250,000 during 2002 and136,668 shares for $410,000 during 2003.

 

Additionally,as part of this offering, the Company issued 330,000 warrants at an initialprice of $3 per share. The price of the warrants will increase by $.25 pershare each at the beginning of each calendar quarter. These warrants expire 5years from the date of issuance. During the years ended December 31, 2003and 2002, 80,000 and 5,000 shares of common stock were issued pursuant towarrants exercised, respectively.

 

46

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***Note Receivable Arising from Sale of Stock***

 

InDecember 2003, the Company completed a private placement of securities andsigned an agreement with an investor to purchase 100,000 units at $5.50 perunit. Each unit consisted of one share of common and one warrant to purchaseone additional share at $7 per share. In addition, the investor signed a stockpledge agreement and a promissory note for $550,000, at 3% interest per year,with a maturity date of March 31, 2004. In March 2004, the Companyreceived full payment for the promissory note.

 

### ***Common Stock***

### ** **

Duringthe year ended December 31, 2004, the Company issued 45,500 shares ofcommon stock pursuant to warrants exercised at $3.25 per share, for a total of$147,875.

 

Duringthe year ended December 31, 2004, the Company issued 17,000 shares ofcommon stock to consultants for services rendered, based on the trading priceat the date of issuance, for a total of $98,350, resulting in an equivalentcharge to operations.

 

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

 

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

 

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

 

Duringthe year ended December 31, 2004, the Company issued 1,500 shares ofcommon stock to existing customers as a promotional project, based on thetrading price at the dates of issuance for a total of $4,625, resulting in anequivalent charge to operations.

 

***Other Matters***

 

Aspart of the recapitalization transaction of IWT (see note 1), the Company andeach of the three stockholders of International Wholesale Tile, Inc.entered into a repurchase agreement to commence on January 1, 2003 forthree years, under which the three stockholders may sell a certain amount ofthe Company’s common stock back to the Company for a price based on an amountequal to 88% of the average trading price of the Company’s common stock so longas the stock is trading. The maximum number of redeemable shares under therepurchase agreement is 450,000. On June 26, 2003, the Company voted tocancel the repurchase agreement.

 

47

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###### **NOTE 11.**                                          COMMON STOCKWARRANTS

###### ** **

Asummary of warrants issued and outstanding in connection with equitytransactions as discussed above is presented below. Upon exercise, warrants areconvertible into an equal number of the Company’s common stock. The warrantsare exercisable immediately.

 
| ** **                       | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------|------------|----------------------------------|------------|
| ** **                       | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                       | ** ** | **Warrants**                     | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Warrants** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Warrants** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| Outstanding at beginning of year |       | 595,000                          |       | $ | 5.35 |   | 120,000 |   | $ | 3.00 |   | — |   | $ | — |   |
| Granted                          |       | —                           |       | $ | 3.42 |   | 555,000 |   | $ | 5.52 |   | 125,000 |   | $ | 3.00 |   |
| Exercised                        |       | (45,500                          | )          | $ | 3.25 |   | (80,000 | ) | $ | 3.00 |   | (5,000 | ) | $ | 3.00 |   |
| Outstanding at end of year       |       | 549,500                          |       | $ | 5.91 |   | 595,000 |   | $ | 5.35 |   | 120,000 |   | $ | 3.00 |   |
| Exercisable at year-end          |       | 549,500                          |       | $ | 5.91 |   | 595,000 |   | $ | 5.35 |   | 120,000 |   | $ | 3.00 |   |

###### ** **

Thefollowing tables summarize information for warrants outstanding at December 31,2004 and 2003:

 

| ** **           | ** ** | **Warrants Outstanding at December 31, 2004** | ** ** |
|----------------------|------------|----------------------------------------------------|------------|
| **Exercise  Prices** | ** ** | **Number  Outstanding  at 12/31/04**               | ** ** | **Weighted-  Average  Years  Remaining** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
|                 |       |                                               |       |   |   |   |   |
| $                    | 4.00       |                                               |       | 199,500 |   | 3.0 |   | $ | 4.00 |   |
| $                    | 7.00       |                                               |       | 350,000 |   | 1.9 |   | $ | 7.00 |   |
|                      |            |                                                    |            |  |  |  |  |  |  |  |  |

 

| ** **           | ** ** | **Warrants Outstanding at December 31, 2003** | ** ** |
|----------------------|------------|----------------------------------------------------|------------|
| **Exercise  Prices** | ** ** | **Number  Outstanding  at 12/31/04**               | ** ** | **Weighted-  Average  Years  Remaining** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
|                 |       |                                               |       |   |   |   |   |
| $                    | 3.00       |                                               |       | 245,000 |   | 3.0 |   | $ | 3.00 |   |
| $                    | 7.00       |                                               |       | 350,000 |   | 1.9 |   | $ | 7.00 |   |
|                      |            |                                                    |            |  |  |  |  |  |  |  |  |

 

48

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###### **NOTE 12.**                                          STOCK OPTIONPLAN

###### ** **

TheCompany entered into a Stock Incentive Plan on December 27, 2001. The planprovides that eligible employees, consultants, and affiliates may be grantedshares of common stock. Under the plan, the options granted are non-qualifiedstock options, incentive stock options and restricted stock. The aggregatetotal common stock that may be issued under the plan is 4,000,000 shares. Therestricted shares issued to employees were recorded at the fair value on thegrant date.

 

Underthe Plan, a total of 28,900, 18,200 and 134,500 restricted shares were issuedto employees, directors, customers and consultants for services rendered forthe years ended December 31, 2004, 2003 and 2002, respectively.

 

A summary of the Company’s stock option plan is presented below:

 
| ** **                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|
| ** **                                 | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                 | ** ** | **Shares**                       | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding at the beginning of the period |       | 306,667                          |       | $ | 3.00 |   | 440,000 |   | $ | 3.00 |   | — |   |   |   |
| Granted at fair value                      |       | 216,082                          |       | $ | 3.42 |   | — |   | — |   | 440,000 |   | $ | 3.00 |   |
| Forfeited                                  |       | (5,000                           | )          | $ | 6.00 |   | (133,333 | ) | $ | 3.00 |   | — |   | — |   |
| Outstanding at the end of the period       |       | 517,749                          |       | $ | 3.14 |   | 306,667 |   | $ | 3.00 |   | 440,000 |   | $ | 3.00 |   |

 
| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|
| ** **                                      | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                      | ** ** | **Shares**                       | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Options exercisable at the end of the  period   |       | 331,667                          |       | $ | 3.03 |   | 306,667 |   | $ | 3.00 |   | 20,000 |   | $ | 3.00 |   |
|                                            |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Weighted average fair value of options  granted |       |                             |       | $ | 1.01 |   |   |   | $ | — |   |   |   | $ | 0.20 |   |

 

Thefollowing table summarizes information for stock options outstanding at December 31,2004:

 
| ** **                      | ** ** | **Options Outstanding**              | ** ** | **Options Exercisable**                  | ** ** |
|---------------------------------|------------|--------------------------------------|------------|------------------------------------------|------------|
| **Range  of  Exercise  Prices** | ** ** | **Number  Outstanding  at 12/31/04** | ** ** | **Weighted-  Average  Years  Remaining** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Number  Exercisable  at 12/31/04** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
|                            |       |                                 |       |                                     |       |   |   |   |   |   |   |
| $2.48-$3.00                     |       | 467,749                              |       | 6.9                                      |       | 2.84 |   | 306,667 |   | $ | 3.00 |   |
| $6.00                           |       | 50,000                               |       | 4.0                                      |       | 6.00 |   | 25,000 |   | $ | 6.00 |   |
|                                 |            |                                      |            |                                          |            |  |  |  |  |  |  |  |  |

 

49

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The following table summarizes information for stock optionsoutstanding at December 31, 2003:

 
| ** **                      | ** ** | **Options Outstanding**              | ** ** | **Options Exercisable**                  | ** ** |
|---------------------------------|------------|--------------------------------------|------------|------------------------------------------|------------|
| **Range  of  Exercise  Prices** | ** ** | **Number  Outstanding  at 12/31/03** | ** ** | **Weighted-  Average  Years  Remaining** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Number  Exercisable  at 12/31/03** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
|                            |       |                                 |       |                                     |       |   |   |   |   |   |   |
| $                               | 3.00       |                                 |       | 306,667                                  |       | 8.9 |   | 3.00 |   | 306,667 |   | $ | 3.00 |   |
|                                 |            |                                      |            |                                          |            |  |  |  |  |  |  |  |  |  |

 

###### **NOTE 13.**                                          INCOME TAXES

 

Significantcomponents of the benefit for income taxes are as follows:

 
| ** **          | ** ** | **Year Ended December 31,** | ** ** |
|---------------------|------------|----------------------------------|------------|
| ** **          | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **          | ** ** | ** **                       | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Income Tax Benefit: |       |                             |       |   |   |   |   |
| Current             |       | $                                | —     |   | $ | — |   | $ | — |   |
| Deferred            |       | —                           |       | — |   | 597,174 |   |
|                |       |                             |       |   |   |   |   |
| Income Tax Benefit  |       | $                                | —     |   | $ | — |   | $ | 597,174 |   |

 

Duringthe first nine months of 2002, International Tile Wholesale, Inc.’s netincome was $2,214,239 which was taxed as an S corporation according to theprovisions of the Internal Revenue Code. Accordingly, no tax provision orliability for income taxes is reflected in the accompanying consolidatedfinancial statements for that period of time.

 

The following is a reconciliation of income tax computed at the FederalStatutory rate to the benefit for income taxes:

 
| ** **                             | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**       | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|----------------|------------|
| ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                             | ** ** | **Amount** | ** ** | **%**      | ** ** | **Amount**     | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                   |       |       |       |       |       |           |       |   |   |   |   |   |   |
| Income tax (benefit) at statutory rate |       | $          | (411,193   | )          | (34.0      | )              | $          | (431,162 | ) | (34.0 | ) | $ | (201,994 | ) | (34.0 | ) |
|                                   |       |       |       |       |       |           |       |   |   |   |   |   |   |
| Permanent items                        |       | 29,925     |       | 2.5        |       | 34,981         |       | 2.8 |   | 6,321 |   | 1.0 |   |
|                                   |       |       |       |       |       |           |       |   |   |   |   |   |   |
| State taxes, net of federal benefit    |       | (40,706    | )          | (3.4       | )          | (42,298        | )          | (3.3 | ) | (20,891 | ) | (3.5 | ) |
|                                   |       |       |       |       |       |           |       |   |   |   |   |   |   |
| Effect of S-Corporation conversion     |       | —     |       | —     |       | —         |       | — |   | (380,610 | ) | (64.0 | ) |
|                                   |       |       |       |       |       |           |       |   |   |   |   |   |   |
| Change in valuation Allowance          |       | $          | 421,974    |       | —     |           | $          | 1,035,675 |   | — |   | $ | — |   | — |   |
|                                   |       |       |       |       |       |           |       |   |   |   |   |   |   |
| Income tax provision (benefit)         |       | $          | —     |       |       |           | $          | 597,196 |   |   |   | $ | (597,174 | ) | 100.5 | % |

 

50

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Deferredtax assets and liabilities are determined based on the estimated future taxeffects of temporary differences between the financial statement and tax basesof assets and liabilities, as measured by the current enacted tax rates.Deferred tax expense (benefit) is the result of changes in the deferred taxasset and liability. A valuation allowance is recorded to reduce the carryingamounts of deferred tax assets to amounts considered by management more likelythan not to be realized.

 

Thetax effects of temporary differences that give rise to significant componentsof deferred tax assets and deferred tax liabilities at December 31, 2004and December 31, 2003 are presented below:

 
| ** **                            | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                            | ** ** | ** **                  | ** ** | **(Restated)**              | ** ** |
|                                  |       |                        |       |                        |       |
| Current deferred tax asset:           |       |                        |       |                        |       |
| Net operating loss carryforward       |       | $                           | 571,649    |                        | $          | 327,403 |   |
| Accounts receivable                   |       | 56,450                      |       | 45,156                      |       |
| Accrued expenses                      |       | 72,956                      |       | 40,219                      |       |
| Deferred compensation - stock options |       | 250,867                     |       | 250,867                     |       |
| Accumulated depreciation              |       | 499,195                     |       | 368,704                     |       |
| Other                                 |       | 6,532                       |       | 3,326                       |       |
|                                  |       | 1,457,649                   |       | 1,035,675                   |       |
| Less: Valuation Allowance             |       | 1,457,649                   |       | 1,035.675                   |       |
| Net deferred tax asset                |       | $                           | —     |                        | $          | — |   |

 

A summary of the classification of deferred taxes atDecember 31, 2004 and 2003 are presented below

 
| ** **             | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|------------------------|------------|------------|------------|------------|------------|
|                   |       |       |       |       |       |
| Current                |       | 129,406    |       | 85,375     |       |
| Non-current            |       | 1,328,243  |       | 950,300    |       |
| Total                  |       | 1,457,649  |       | 1,035,675  |       |
| Valuation allowance    |       | (1,457,649 | )          | (1,035,675 | )          |
| Net deferred tax asset |       | $          | —     |       | $          | — |   |
|                        |            |            |            |            |            |  |  |

 

At December 31, 2004, the Company had net operating losscarryforwards for federal income tax purposes of approximately $1,519,000,which are available to offset future federal taxable income through 2024.

 

51

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**NOTE14.****                                         ****QUARTERLY FINANCIAL INFORMATION(UNAUDITED)**

 
| ** **                        | ** ** | **Quarter Ended** | ** ** |
|-----------------------------------|------------|-------------------|------------|
| ** **                        | ** ** | **March 31** | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| ** **                        | ** ** | **(Restated)**    | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| 2004                              |       |              |       |   |   |   |   |   |   |
| Net sales                         |       | $                 | 9,534,632  |   | $ | 11,585,016 |   | $ | 11,052,268 |   | $ | 12,753,533 |   |
| Gross profit                      |       | 3,724,218         |       | 4,440,610 |   | 4,318,359 |   | 4,652,089 |   |
| Net loss                          |       | $                 | (434,117   | ) | $ | (201,585 | ) | $ | (318,328 | ) | $ | (255,366 | ) |
|                              |       |              |       |   |   |   |   |   |   |
| Basic and diluted loss per share: |       | $                 | (0.04      | ) | $ | (0.02 | ) | $ | (0.03 | ) | $ | (0.02 | ) |

 
| ** **                                  | ** ** | **Quarter Ended** | ** ** |
|---------------------------------------------|------------|-------------------|------------|
| ** **                                  | ** ** | **March 31** | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| ** **                                  | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| 2003 (Restated)                             |       |              |       |   |   |   |   |   |   |
| Net sales                                   |       | $                 | 6,713,810  |   | $ | 8,477,575 |   | $ | 8,955,693 |   | $ | 8,457,468 |   |
| Gross profit                                |       | 2,634,202         |       | 3,465,576 |   | 3,582,445 |   | 3,107,809 |   |
| Net income (loss)                           |       | $                 | (51,988    | ) | $ | 337,512 |   | $ | (108,921 | ) | $ | (2,041,920 | ) |
|                                        |       |              |       |   |   |   |   |   |   |
| Basic and diluted earnings (loss) per share |       | $                 | (0.00      | ) | $ | 0.03 |   | $ | (0.01 | ) | $ | (0.18 | ) |
|                                             |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                  | ** ** | **Quarter Ended** | ** ** |
|---------------------------------------------|------------|-------------------|------------|
| ** **                                  | ** ** | **March 31** | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| 2002 (Restated)                             |       |              |       |   |   |   |   |   |   |
| Net sales                                   |       | $                 | 6,014,020  |   | $ | 6,803,466 |   | $ | 6,383,981 |   | $ | 6,186,241 |   |
| Gross profit                                |       | 2,401,704         |       | 2,609,983 |   | 2,596,265 |   | 2,511,221 |   |
| Net income (loss)                           |       | $                 | 681,763    |   | $ | 493,100 |   | $ | 1,039,376 |   | $ | (536,701 | ) |
|                                        |       |              |       |   |   |   |   |   |   |
| Basic and diluted earnings (loss) per share |       | $                 | 0.06       |   | $ | 0.05 |   | $ | 0.09 |   | $ | (0.05 | ) |
|                                             |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

52

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**ITEM 9.****                       ****CHANGES IN AND DISAGREEMENTSWITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

a.                                       Resignation ofKantor, Sewell & Oppenheimer, PA. In September 2004.

 

EffectiveSeptember 13, 2004, Kantor, Sewell & Oppenheimer, PA (KSO)resigned as the independent public accountant for IWT Tesoro Corporation. The decision to accept KSO’s resignation was made by Tesoro’s audit committee.

 

KSO’sresignation follows Tesoro’s filing of its quarterly report on Form 10-Qfor the quarter ended June 30, 2004, which report did not contain anyadverse opinion or disclaimer of opinion, nor was it qualified or modified asto uncertainty, audit scope, or accounting principles.

 

Forthe fiscal years ended December 31, 2003 and December 31, 2002, and throughthe date of this Annual Report on Form 10-K, there have been nodisagreements with KSO on any matter of accounting principles or practices,financial statement disclosure or auditing scope or procedure whichdisagreements, if not resolved to KSO’s satisfaction, would have caused it tomake references thereto in its report on Tesoro’s financial statements as ofand for the fiscal years ended December 31, 2003 and December 31,2002.

 

b.                                      Appointment ofMcGladrey & Pullen, LLP (McGladrey) in September 2004.

 

EffectiveSeptember 10, 2004, McGladrey & Pullen, LLP was appointed asTesoro’s independent public accountant. McGladrey will report on Tesoro’sconsolidated statements of financial condition as of December 31, 2004 andthe consolidated statement of operations, changes in stockholders’ equity andcash flows for the same fiscal period.

 

Duringthe fiscal years ended December 31, 2003 and December 31, 2002 andthe subsequent interim period prior to McGladrey’s engagement, Tesoro has notengaged McGladrey as either the principal accountant to audit Tesoro’sfinancial statements, or as an independent public accountant to audit any ofTesoro’s significant subsidiaries and on whom McGladrey is expected to expressreliance in its report.  Additionally, neither Tesoro nor anyone on itsbehalf consulted with McGladrey regarding (i) either: the application ofaccounting principles to a specified transaction, either completed or proposed;or the type of audit option that might be rendered on Tesoro’s financial statements,or (ii) any matter that was either the subject of a disagreement or areportable item during Tesoro’s two most recent fiscal years or any subsequentinterim period.

 

c.                                       Appointmentof Kantor, Sewell and Oppenheimer, P.A. in December 2003, successor toSewell & Company, P.A.

 

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.  KSOmaintains the same facilities as Sewell and Company and is a Florida SECqualified accounting firm.  Sewell reported on and audited the financialstatements prepared by the Registrant 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.

 

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.

 

**ITEM 9A.****              ****CONTROLS AND PROCEDURES**

 

*Disclosure Controls and Procedures*

 

(a)                                  Tesoro’s management, with participationof the Company’s principal executive officer and principal financial officer,have performed an evaluation of the Company’s disclosure controls andprocedures, (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (“Exchange Act”)) to ensurethat information required to be disclosed by Tesoro in the reports that Tesorofiles or submits under the Exchange Act is recorded, processed, summarized, andreported within the time periods specified by the SEC’s rules and forms.

 

Based on that evaluation,Tesoro’s principal executive officer and principal financial officer haveconcluded that its disclosure controls and procedures were not effective inensuring that information required to be disclosed by the Company in thereports that it files or submits under the Exchange Act is recorded, processed,summarized, and reported within the time periods specified by the SEC’s rules andforms. At this time, management has determined that the Company’s currentsystem of disclosure controls and procedures may not be sufficient i) to ensurethat data errors, control problems, or acts of

 

53

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fraud are detected and ii) to confirm that appropriatecorrective action, including process improvements, is undertaken in a timelymanner.

 

**Deficiencies in the Company’sControls and Procedures**

 

In connection withpreparing its Annual Report on Form 10-K for the fiscal year ended December 31,2004, Tesoro’s management identified deficiencies in its methodologies that itconsidered being material weaknesses in the effectiveness of Tesoro’s internaldisclosure controls pursuant to standards established by the American Instituteof Certified Public Accountants. A “material weakness” is a reportablecondition in which the design or operation of one or more of the specificinternal control components has a defect or defects that could have a materialadverse effect on the Company’s ability to record, process, summarize andreport financial data in the financial statements in a timely manner. Thematerial weaknesses identified by Tesoro include the following:

 

•                                                             Promotional merchandise should have beenexpensed when distributed rather than capitalized and depreciated;

 

•               Tesoro had incorrectly estimated the accrualsfor sales related expenses; and

 

•               Incorrectly estimated its allowances forproduct returns and the allowances.

 

As a result, Tesoro’s management concludedthat certain accounting errors occurred in its previously issued financialstatements for the fiscal year ended December 31, 2002, each of the threefiscal quarters ended March 31, 2003, June 30, 2003 and September 30,2003, the fiscal year ended December 31, 2003 and each of the three fiscalquarters ended March 31, 2004, June 30, 2004 and September 30,2004.

 

Based upon the results ofmanagement’s investigation of the accounting errors, the Company’s principalexecutive officer and principal financial officer concluded that the accountingerrors resulted from material weaknesses in the Company’s disclosure controlsand procedures, particularly in the areas of documented policies and proceduresalong with competent personnel. Detailed validation work was performed by theCompany’s internal personnel in order to substantiate the financial informationcontained in the Company’s consolidated financial statements and relateddisclosures that are contained in financial statements noted above.

 

**Management’s Response and Plan forImprovement**

 

Management discussed theproposed restatement of the specified financial statements and information withTesoro’s Audit Committee, financial consultants and both current and formerindependent auditors who concur with management’s assessments. On March 19,2005, the Audit Committee reported on its discussions with its management andthe current auditors to Tesoro’s Board of Directors with respect to therestatements who supported their conclusions.                              On March 21, 2005,Tesoro’s filed a report on Form 8-K concerning these errors and advisedthat its Consolidated Financial Statements for the years ended 2003 and 2002and for the interim periods should no longer be relied upon and that therestatement would not have any effect on the Company’s gross revenue for any periodsor on its cash flow.

 

As a result managementhas responded to these deficiencies by developing a plan to implement thefollowing controls and procedural enhancements, designed to improve the Company’sdisclosure controls:

 
| • |   | Capitalization  and amortization of asset balances - i) regular detailed analyses of fixed  assets and accumulated depreciation accounts should be performed by preparing  detailed account reconciliations, and ii) on a timely basis, account  reconciliations and other significant transactions should be reviewed by an  appropriate member of management; |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                            |
| • |   | Recording  and processing transactions - transactions must be supported by i)  appropriate transaction documentation and ii) appropriate documentation of  review by management;                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                            |
| • |   | Reconciliation  of accounts - detailed reconciliations of subsidiary accounts to the general  ledger must be performed on a regular basis, and quarterly accounting review  procedures must be enhanced by requiring an appropriate member of management  to perform an independent review of material general ledger accounts and  reserves;                   |

 

54

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| • |   | Management  review of journal entries, account balances and financial statements - all  material journal entries must be reviewed and approved by an appropriate  member of management;                                                                                                                                                                                                    |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                       |
| • |   | Internal  audit function - an internal audit function should conduct audit procedures  and test internal controls in order to ensure that the Company’s policies and  procedures for transactional recording, transactional review, segregation of  duties, and review of significant transactions at the appropriate level of  management are both effective and being followed; and |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                       |
| • |   | Competent  personnel - staffing should be enhanced to provide sufficient resources to  accomplish the foregoing objectives.                                                                                                                                                                                                                                                                |

 

**Status of Management’s Plan forImprovement**

 

As of March 21,2005, Tesoro has made the following progress in the implementation of its planfor improvement: 
| • |   | Recording  and processing transactions - controls are being implemented which require  transactions to be supported by i) appropriate transaction documentation and  ii) documentation that the transaction has been reviewed and approved by an  appropriate member of management;                                                                                                                                                                                                                                                                                                                                                                              |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| • |   | Reconciliation  of accounts - policies and controls are being implemented which require  regular reconciliations of subsidiary accounts to the general ledger, with  timely review by an appropriate member of management. Procedures regarding  the quarterly accounting review are being enhanced by requiring independent  reviews of account reconciliations, material general ledger accounts, and  reserves;                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| • |   | Management  review of journal entries, account balances and financial statements -  controls and procedures are being implemented which require that all material  journal entries are reviewed and approved by an appropriate member of  management;                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| • |   | Internal  audit function - the Company has engaged a registered public accounting firm,  which is not affiliated with the Company’s independent registered public  accounting firm, to perform the internal audit function (the “Internal  Auditor”). The Internal Auditor has conducted, and will continue to conduct,  internal audit procedures and tests of internal controls to ensure that the Company’s  controls and procedures for transactional recording, transactional review,  segregation of duties, and review of significant transactions at the  appropriate level of management are both effective and being followed; and |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| • |   | Competent  personnel - the Company has made, and will continue to make, appropriate  staffing enhancements in order to provide sufficient resources to accomplish  the Company’s objectives of recording, processing, summarizing and reporting,  on a timely basis, Tesoro’s financial information.                                                                                                                                                                                                                                                                                                                                                   |

 

Management believes thatthe disclosure controls and procedures, which have been, and are continuing tobe, implemented, are addressing the identified deficiencies in Tesoro’s systemof disclosure controls. Management will, on an ongoing basis, further monitorand assess the implementation of its plan to improve the effectiveness of itsdisclosure controls and procedures, and will take action as appropriate.

 

(b)                                 There have been no significant changes in ourinternal controls or in other factors that could significantly affect thesecontrols subsequent to the date of the evaluation described in the precedingsection.

 

We are in the process of implementing the requirementsof Section 404 of the Sarbanes-Oxley Act of 2002 which requires our managementto assess the effectiveness of our internal control over financial reportingand include an assertion in our 2005 annual report as to the effectiveness ofour internal controls over financial reporting. Subsequently, our independentregistered public accounting firm, McGladrey & Pullen LLP, will berequired to attest to whether our assessment of the effectiveness of ourinternal controls over financial reporting is fairly stated in all materialrespects and separately report on whether it believes we maintained, in allmaterial respects, effective internal control over financial reporting as of December 31,2006. We are in the process of performing the system and process documentation,evaluation and testing required for management to make this assessment and forthe registered public accounting firm to provide its attestation report. Wehave not completed this process or its assessment, and this process willrequire significant amounts of management time and resources. In the course ofevaluation and testing, management may identify deficiencies that would need tobe addressed and remediated.

 

55

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**ITEM 9B.****              ****OTHER INFORMATION**

 

None

 

**PART III.**

 

**ITEM 10.****     ****DIRECTORS, EXECUTIVEOFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH 16(a).**

 

Theresponse to this item is incorporated by reference from our discussion in “ProposalNo. 1-To Elect Nine Directors to Serve Until the Next Annual Meeting ofStockholders or Until Their Responsive Successors are Elected and Qualified”(Proposal No.1) in Tesoro’s Definitive Information Statement relating to the2005 Annual Meeting of Stockholders, which will be filed in April 2005 (“InformationStatement”). The headings to these sections include “Nominees for Directors”, “StockholderCommunication with our Board”, “Corporate Governance”, “Board and CommitteeMeetings” and “Section 16(a) Beneficial Ownership ReportingCompliance”.

 

**ITEM 11.****                ****EXECUTIVE COMPENSATION**

 

Informationabout executive and director compensation is incorporated by reference from thediscussion under Proposal No 1 in our Information Statement under the headings “ExecutiveCompensation-Summary Compensation Table”, “-Option/SAR Grants in Last FiscalYear”, “Tesoro Stock Incentive Plan”, “Directors’ Compensation”, “Employmentand Consulting Agreements” and “Performance Graph”.

 

**ITEM 12.****                ****SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT**

 

Informationabout Tesoro security ownership is incorporated by reference from thediscussion under the heading “Outstanding Voting Stock of Tesoro” in theInformation Statement.

 

**ITEM 13.****                ****CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS**

 

Informationabout certain relationships and related party transactions are incorporated byreference under the heading “Certain Relationships and Related Transactions” inour Information Statement.

 

**ITEM 14.****                ****PRINCIPAL ACCOUNTANT FEES ANDSERVICES.**

 

Thediscussion in response to this item is incorporated by reference in “Proposal No. 2-ToRatify Appointing McGladrey & Pullen LLP as our Independent RegisteredPublic Accounting Firm” in the Information Statement under the headings “Changesin Independent Public Accountants”, “Audit Fees’, “Tax Fees”, “All Other Fees”,and “Audit Committee Review and Approval”.

 

**ITEM 15.****                 EXHIBITS andFINANCIAL STATEMENT SCHEDULES**

 

**(a)**        **Documents filed as part of this report:**

 

(1)          Financial Statements

 

Reference is made to the Index to Consolidated Financial Statements ofIWT Tesoro Corporation under Item 8 of Part II hereof.

 

(2)          ConsolidatedFinancial Statement Schedules

 

(i)              ReportOf Independent Registered Public Accounting Firm on Financial StatementSchedule:

McGladrey & Pullen, LLP- As of December 31, 2004 and the year then ended.

Kantor, Sewell andOppenheimer - as of December 31, 2003 and each of the years in the twoyear period then ended.

 

(ii)           ScheduleII-Consolidated Valuation and Qualifying Accounts

 

(3)          **Exhibits**

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

 

56

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|   |   | Securities  and Exchange Commission on February 4, 2003)                                                                                                                                                                                                                                 |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.3.4  |   | Nominating  And Governing Committee Charter (filed as an Exhibit to the Company’s  Report on Form 8-K, filed with the Securities and Exchange Commission on  February 4, 2003)                                                                                            |
| 3.4.1  |   | Code  of Ethics for Senior Financial Officers (filed as an Exhibit to the  Company’s Registration Statement, filed with the Securities and Exchange  Commission on April 11, 2003)                                                                                             |
| 4.1.1  |   | Form of  Warrant Agreement (filed as an Exhibit to the Company’s Registration  Statement, filed with the Securities and Exchange Commission on April 11,  2003)                                                                                                           |
| 4.1.2  |   | Form of  Stock Certificate (filed as an Exhibit to the Company’s Registration  Statement, filed with the Securities and Exchange Commission on April 11,  2003)                                                                                                           |
| 10.3   |   | 2001  Ponca Acquisition Corporation Stock Incentive Plan. (filed as an  Exhibit to the Company’s Report on Form 8-K, filed with the  Securities and Exchange Commission on September 11, 2002)                                                                            |
| 10.4   |   | Employment  Agreement Between Ponca Acquisition Corporation And Henry Jr.  Boucher, Jr. Dated As Of December 29, 2002 (filed as an  Exhibit to the Company’s Report on Form 8-K, filed with the  Securities and Exchange Commission on September 11, 2002)      |
| 10.5   |   | Memorandum  Of Understanding Between Ponca Acquisition Corporation And The Stockholders  Of International Wholesale Tile, Inc. (filed as an Exhibit to the  Company’s Report on Form 8-K, filed with the Securities and Exchange  Commission on September 11, 2002)  |
| 10.6   |   | Stock  Purchase Agreement Among The Stockholders Of International Wholesale  Tile, Inc., and Ponca Acquisition Corporation effective October 1,  2002 (filed as an Exhibit on Form 8-K, filed with the Securities  and Exhibit Commission on October 15, 2002). |
| 10.9   |   | Form of  Indemnity Agreement (filed as an Exhibit to the Company’s Registration  Statement, filed with the Securities and Exchange Commission on April 11,  2003)                                                                                                         |
| 10.10  |   | Employment  Agreement between International Wholesale Tile, Inc. and Forrest Jordan  (exhibits omitted) (filed as an Exhibit to the Company’s Registration  Statement, filed with the Securities and Exchange Commission on May 21,  2003)                                |
| 10.11  |   | Employment  Agreement between International Wholesale Tile, Inc. and Paul F. Boucher  (this document is omitted as it is substantially similar to Forrest Jordan’s  Employment Agreement with the exception of the employee’s name and address)                                |
| 10.12  |   | Employment  Agreement between International Wholesale Tile, Inc. and Grey Perna  (this document is omitted as it is substantially similar to Forrest Jordan’s  Employment Agreement with the exception of the employee’s name and address)                                     |
| 10.13  |   | Subordination  Agreement between Congress Financial Corporation (Florida). and Forrest  Jordan (filed as an Exhibit to the Company’s Registration Statement,  filed with the Securities and Exchange Commission on May 21, 2003)                                               |
| 10.14  |   | Subordination  Agreement between Congress Financial Corporation (Florida). and Paul F.  Boucher (this document is omitted as it is substantially similar to Forrest  Jordan’s Subordination Agreement with the exception of the employee’s name  and address)                       |
| 10.15  |   | Subordination  Agreement between Congress Financial Corporation (Florida). and Grey Perna  (this document is omitted as it is substantially similar to Forrest Jordan’s  Subordination Agreement with the exception of the employee’s name and address)                             |
| 10.16  |   | Amended and Restated Loan and Security Agreement  between by and between Fleet  Capital Corporation, IWT Tesoro Corporation and International Wholesale  Tile, Inc. effective December 31, 2004*                                                                                    |
| 13     |   | Annual report to security holders*                                                                                                                                                                                                                                                            |
| 16     |   | Letter  from Kantor Sewell & Oppenheimer, P.A., concurring with statements  concerning their resignation (filed as an exhibit to the Company Report on  Form 8-K filed with the Securities and Exchange Commission on September 14,  2004).                                |
| 21     |   | Subsidiaries of Registrant*                                                                                                                                                                                                                                                                   |
| 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.*                                                                                                                                                                            |

 

----

| * |   | Included in this filing. |
|---|--------|--------------------------|

 

57

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| (b)    |   | Reference is  made to Section 15(a)(3) above. |
|--------|--------|---------------------------------------------------------|
|   |   |                                                    |
| (c)    |   |                                                    |

 

SIGNATURES

 

Inaccordance with Section 13 or 15(d) of the Exchange Act of 1934, theCompany caused this Registration Statement to be signed on its behalf by theundersigned thereunto duly authorized.

 

IWTTESORO CORPORATION

 
| By:                                                                                                                                                                           | /s/  Henry J. Boucher, Jr.        |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------|--------|
|                                                                                                                                                                          | Henry  J. Boucher, Jr., President |
|                                                                                                                                                                          |                                   |
| Date:  April 15, 2005                                                                                                                                                         |
|                                                                                                                                                                          |                                   |
| 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.                                                                                                                                               | April 15, 2005                         |
| Henry  J. Boucher, Jr., Principal Executive Officer                                                                                                                      |
|                                                                                                                                                                          |                                   |
| /s/  Forrest Jordan                                                                                                                                                           | April 15, 2005                         |
| Forrest  Jordan, Principal Financial Officer                                                                                                                                  |
|                                                                                                                                                                          |                                   |
| /s/ Henry J. Boucher, Jr.                                                                                                                                                | April 15, 2005                         |
| Henry  J. Boucher, Jr., Director                                                                                                                                         |
|                                                                                                                                                                          |                                   |
| /s/  James R. Edwards, Director                                                                                                                                               | April 15, 2005                         |
| James  Edwards, Director                                                                                                                                                      |
|                                                                                                                                                                          |                                   |
| /s/  Paul F. Boucher                                                                                                                                                          | April 15, 2005                         |
| Paul  F. Boucher, Director                                                                                                                                                    |
|                                                                                                                                                                          |                                   |
| /s/  Forrest Jordan                                                                                                                                                           | April 15, 2005                         |
| Forrest  Jordan, Director                                                                                                                                                     |
|                                                                                                                                                                          |                                   |
| /s/  Grey Perna                                                                                                                                                               | April 15, 2005                         |
| Grey  Perna, Director                                                                                                                                                         |
|                                                                                                                                                                          |                                   |
| /s/  Joseph Equale                                                                                                                                                            | April 15, 2005                         |
| Joseph  Equale, Director                                                                                                                                                      |
|                                                                                                                                                                          |                                   |
| /s/  Allen Rosenberg                                                                                                                                                          | April 15, 2005                         |
| Allen  Rosenberg, Director                                                                                                                                                    |
|                                                                                                                                                                          |                                   |
| /s/  Carl G. Anderson, Jr.                                                                                                                                               | April 15, 2005                         |
| Carl  G. Anderson, Jr., Director                                                                                                                                         |
|                                                                                                                                                                          |                                   |
| /s/  Robert Rogers                                                                                                                                                            | April 15, 2005                         |
| Robert  Rogers, Director                                                                                                                                                      |
|                                                                                                                                                                          |
|                                                                                                                                                                               |                                        |        |  |

 

58

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**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

**ON FINANCIAL STATEMENT SCHEDULE**

 

 

To the Board of Directors

IWT Tesoro Corporation andSubsidiaries

Westport, Connecticut

 

Our audit was made for thepurpose of forming an opinion on the basic consolidated financial statementstaken as a whole.  The consolidatedfinancial statements Schedule II for the year ended December 31, 2004is presented for purposes of complying with the Securities and ExchangeCommission’s rules and is not a part of the basic consolidated financialstatements.  This schedule has beensubjected to the auditing procedures applied in our audit of the basicconsolidated financial statements and, in our opinion, is fairly stated in allmaterial respects in relation to the basic consolidated financial statementstaken as a whole.

 
| **/S/  McGLADREY & PULLEN, LLP**                    | ** ** |
|--------------------------------------------------------------|------------|
|                                                         |
|                                                         |
| New Haven,  Connecticut                                      |
| February 25,  except for the first paragraph of Note 5, |
| as to which the date is March 23, 2005                  |

 

 

 

 

 

 

 

McGladrey & Pullen, LLP is a member firm of RSM International,

an affiliation of separate and independent legal entities.

 

59

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**INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM**

** **

**REPORT ON FINANCIAL STATEMENT SCHEDULE**

** **

** **

To the Board of Directors

IWT Tesoro Corporation andSubsidiaries

Westport, Connecticut

 

 

Our audit was made for the purposeof forming an opinion on the basic consolidated financial statements taken as awhole.  The consolidated financialstatements Schedule II for the year ended December 31, 2003 and 2002are presented for purposes of complying with the Securities and ExchangeCommission’s rules and are not a part of the basic consolidated financialstatements.  This schedule has beensubjected to the auditing procedures applied in our audit of the basicconsolidated financial statements and, in our opinion, is fairly stated in allmaterial respects in relation to the basic consolidated financial statementstaken as a whole.

 
| **/s/ KANTOR, GEISLER & OPPENHEIMER, PA** | ** ** |
|----------------------------------------------------|------------|

 

 

Hollywood, Florida

January 23, 2005 exceptfor the first paragraph of Note 2,

  as to which the date is March 29, 2005

 

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Schedule II

 

**IWT TESORO CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS**

**YEARS ENDED DECEMBER 31, 2004 , 2003 AND 2002**

 
| ** **                                           | ** ** | **Balance**      | ** ** | **Additions**  | ** ** | ** **         | ** ** | **Balance** | ** ** |
|------------------------------------------------------|------------|------------------|------------|----------------|------------|--------------------|------------|-------------|------------|
| ** **                                           | ** ** | **at Beginning** | ** ** | **Charged**    | ** ** | ** **         | ** ** | **at End**  | ** ** |
| **Description**                                      | ** ** | **of Year**      | ** ** | **to Expense** | ** ** | **Deductions (1)** | ** ** | **of Year** | ** ** |
| Year ended December 31, 2002 (as  restated):    |       |             |       |           |       |               |       |        |       |
| Allowance for doubtful accounts                      |       | $                | 54,500     |           | 31,827     |               | 3,082      |        | $          | 83,245 |   |
|                                                 |       |             |       |           |       |               |       |        |       |
| Year ended December 31, 2003 (as  restated):    |       |             |       |           |       |               |       |        |       |
| Allowance for returns, claims and doubtful  accounts |       | $                | 83,245     |           | 259,581    |               | 167,826    |        | $          | 175,000 |   |
|                                                 |       |             |       |           |       |               |       |        |       |
| Year ended December 31, 2004                    |       |             |       |           |       |               |       |        |       |
| Allowance for returns, claims and doubtful  accounts |       | $                | 175,000    |           | 196,102    |               | 101,089    |        | $          | 270,013 |   |

 

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(1)Represents charge offs, netof recoveries, to the valuation account

 

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