U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

For the Year Ended December 31, 2004

Commission File No. 000-31267

 

IWT TESORO 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)

 

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

 

Title of Each Class		Name of Each Exchange on Which Registered
NONE		NONE

 

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

Common Stock, $.001 par value

(Title of Class)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports, and (2) has been subject to such filing requirements for the past 90 days.  Yes  ý   No  o

 

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

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

 

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

 

APPLICABLE ONLY TO CORPORATE REGISTRANTS

 

Indicate the number of shares outstanding of each of the registrant’s classes of common equity, 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-K incorporates by reference certain information from the registrant’s Information Statement for its Annual Meeting of Stockholders to be held on May 7, 2005.

 

 

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

 

Statements made in this Annual Report are “forward-looking statements” and are not historical facts.  For example, statements regarding our financial position, business strategy and other plans and objectives for future operations, and assumptions and predictions about future demand for our services and products, supply, costs, marketing and pricing factors are all forward-looking statements. When we use words like “intend,” “would”, “anticipate,” “believe,” “estimate,” “plan” or “expect” or the negative of these terms and similar expressions we are making forward- looking statements.  You should be aware that these forward-looking statements are subject to risks and uncertainties.  Additionally, our forward-looking statements speak only as of the date of this report.  Other than as required by law, we undertake no obligation to update or revise these statements, whether as a result of new information, future events or otherwise.  New factors emerge from time to time that may cause our business not to develop as we expect, and it is not possible for us to predict all of them.  Factors that may cause our actual results, performance or achievements to be materially different from the results, performance or achievements expressed or implied by the forward-looking statements include, among other things:

 

•                  Our ability to successfully implement our business plan, including expanding our markets, increasing our product lines, and maintaining high quality customer service;

•                  Continuing and cultivating our relationships with current and new vendors;

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

•                  Trends affecting our financial condition or results of operations, the impact of competition, the start-up of certain operations, roll out of products and services and acquisition opportunities;

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

•                  Depending on third party suppliers outside the United States;

•                  The impact of adverse weather conditions, both in our targeted markets, as well as with respect to our foreign suppliers; and

•                  Other risks referenced from time to time in our SEC filings.

 

ITEM 1.                        DESCRIPTION OF BUSINESS

 

Executive Summary

 

Through our wholly owned subsidiary, International Wholesale Tile (IWT), IWT Tesoro Corporation (Tesoro) is principally a value-added reseller of ceramic floor and wall covering products (primarily ceramic, porcelain and stone tile) to the new construction and remodeling industries for commercial and residential marketplaces. We distribute our products through four distinct channels:

 

•                  Independent dealers and stocking distributors

•                  Major home center distributors

•                  Buying groups and design centers

•                  Regional wholesalers

 

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

 

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

 

Background

 

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

 

In addition to IWT, Tesoro’s primary operating subsidiary, Tesoro has three additional wholly owned subsidiaries.  These include:

 

•                  IWT Tesoro Transport, a USDOT licensed common carrier, organized to act as our freight carrier outside of Florida and to back

 

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

 

•                  IWT Tesoro International, Ltd., a Bermuda corporation to act as a holding company for activities and assets such as agency agreements and investments in foreign operations; and

 

•                  The Tile Club, Inc., formed in 2004, was organized to acquire licensing, manufacturing and distribution rights for high-end designer and artistic based decorative tiles and to also act as an agent for foreign manufacturers from whom IWT has acquired exclusive distribution rights.

 

Our principal executive office is located at 191 Post Road West, Suite 10, Westport, CT 06880.  Our telephone number is (203) 221-2770.  Our web site can be found at http://www.iwttesoro.com.  Information contained on our web site is not part of this report. 

 

Business and Growth Strategy

 

We believe that we have built our reputation by supplying quality products with superior customer service at competitive prices. We strive to stay up-to-date with the newest styles and trends in the ceramic floor and wall covering industry.  We also aim to introduce high quality new products to the marketplace as soon as practicable. We further believe that we have built confidence and loyalty among our customers by distributing products only on a wholesale level and not selling directly to the consumer. While we ship product in quantities that can range from small cut orders to full pallets or complete truckloads or containers, the core of our business is the cut order, i.e. less than a pallet of mixed floor, wall and decorative tiles specific to a project. This special handling and the reputation we enjoy as a dependable supplier allows us to maintain above average margins. We do not operate any retail outlets. This non-competitive relationship is unique in the ceramic floor and wall tile distribution industry, has been a key factor in our growth and defines us as a “value added reseller” rather than merely a distributor.  We believe that other keys to our success include actively merchandising programs assisting our dealer/customers to meet the consumer’s demand with products presented in attractive easy to visualize environments and acting as the extension of our dealer networks’ stock availability by warehousing levels consistent with the dealers’ delivery requirements. 

 

Our warehousing and distribution centers contain over 420,000 square feet of storage space, in which we maintain over 17.0 million square feet of product ready for immediate shipment to our customers.  In 2004, we signed an agreement to realign our distribution facilities in Palm City, Florida. Realigning these distribution facilities will consolidate approximately 80,000 square feet of warehouse space currently in multiple small warehouses into one location, add 70,000 new square feet for future expansion and create a single 15-year lease for the Palm City facility.  With this new space, we will have over 310,000 square feet of storage space, 30 truck bays and room for approximately 20.0 million square feet of inventory.  Additionally during 2004, we entered into a lease for up to 120,000 square feet of warehouse space in Dallas, Texas.  This Texas facility serves our growing Midwest customer base.  As we expand, we will likely need additional satellite warehouse locations.

 

We have created Tesoro The Collection®, a branded collection of high quality porcelain floor and wall tiles complemented by coordinated decorative borders and listellos.  We support this collection with an extensive merchandising program including grouted display boards and racks, and institutional marketing and advertising.  We also plan to expand the TesoroÔ line of products by building our proprietary TesoroÔ brand awareness. We prominently display the TesoroÔ line at all of the national and regional flooring exhibitions in which we participate. We have also placed institutional print media and television advertising to educate consumers and to support our dealer network.  We further intend to grow by acquiring or merging with existing regional distributors.

 

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

 

•                  Augment our client base and market penetration by expanding nationally and duplicating our Palm City, Florida and Dallas, Texas models into four additional major centers for our products,.  These include

 

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

•                  creating dealer networks in each quadrant, acquiring or starting up one new territory per year, and

•                  expanding value added services, consistent with the central focus of providing building products through a network of independent dealers and distributors;

 

•                  Deepen our current customer base penetration by increasing our market share with current dealer customers, providing customer incentives, and creating a buying group for IWT customers;

 

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•                  Maintain our high level of customer service and satisfaction;

 

•                  Obtain adequate capital to support the inventory levels our customers expect by raising additional capital through debt and equity financing as required, to fund growth within a prudent debt equity relationship;

 

•                  Continue strengthening our relationships with suppliers to ensure a continuous flow of high quality, contemporary designs that are competitively priced;

 

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

 

•                  Increase the number of  products we carry and;

 

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

 

On a short-term basis, we intend to look to acquire assets of businesses with products and services that complement our business.  We further intend to grow by acquiring or merging with existing regional distributors. We also are expecting to establish subsidiaries based in Spain and Italy to handle our relationships with manufacturers located in those countries.

 

The Ceramic Floor and Wall Tile Covering Industry

 

Tesoro believes that the statistical information described in this item (Description of Business) is the most current available.

 

Italian tile and stone have a rich history that dates back thousands of years. The Greeks constructed temples and ornate statuary with it. The Romans used it to pave their halls of power. The enduring quality that these fine stones have brought to the magnificent palaces and villas of Europe, are now in high demand in the United States.

 

It is this expression of style and grace that has made tile and stone a sought-after design material in building and remodeling projects across America, the fourth largest consumer of tile in the global market representing about 20% of global consumption. While the United States consumes 20% of the global production, on a per capita basis the United States lags far behind the European community (Europeans consume an average of 55 square feet per year compared to seven square feet per year for Americans). Coupled with the robust housing and general construction markets in the United States, this gap in per capita consumption has the Italian and Spanish manufacturers searching for ways to fill a perceived vacuum.

 

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

 

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

 

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

 

•                  Housing starts reached 1.85 million units in 2003, surging by 8.4%, which was the best performance in 26 years;

 

•                  In 2003, the new construction market rebound was driven by a 10.3% surge in the residential sector, which included:

 

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

 

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

 

•                  Mortgage rates at a 40-year low made homes affordable for an expanding number of households while the refinancing of existing mortgages improved consumers’ financial positions and provided increased funds for spending and for remodeling;

 

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

 

•                  Growth in vacation (second) home ownership.

 

Ceramic tile usage in the United States doubled in the past eight years, from 1.42 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) for each of the floor covering categories above for the period from 1998 through 2002 have exceeded the growth rate of the United States’ gross domestic product over 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% for ceramic tile.

 

Forty-nine percent of imported ceramic tile comes from Italy, 17% from Spain and 10% from Mexico. The balance originates from a large number of countries including Brazil, Turkey, China and Portugal. The United States’ market is the fourth largest consumer of tile in the global market representing about 20% of global consumption. Our products are primarily imported and our purchases distributed among international suppliers approximates these national statistics.

 

The average wholesale price of ceramic tile edged lower in 2003, falling to $.89 per square foot. This decline was due primarily to a 4.7% reduction in the prices for domestic product. Imported ceramic tile costs rose two cents a square foot to $.79 in 2003, largely on price increases for Italian tile. The strong demand for new and remodeled housing in the United States, coupled with the continuing shift by the consumer away from carpet and toward hard surfaces, has resulted in a forecast by Market Studies, Inc. that the demand will remain robust and that prices will stabilize.

 

Market Studies, Inc. projects that the U.S. ceramic tile market will reach 3.76 billion square feet by 2008, posting and annual growth rate of 5.6%. Imports will continue to outpace domestic production, garnering an additional 4% 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 ceramic tile firm.

 

Long acknowledged for its durability and functionality, ceramic tile now means fashion. Consumers can chose from soft hues or primary colors, finishes that resemble stone, wood or fabric, and can incorporate metal and glass accents for flexible design. The high growth rate of ceramic tile relative to other flooring options has led to more full service distributorships, manufacturers, and retailers adding ceramic tile to their lines. With more floor space being devoted to ceramic tile at retail, efforts at product differentiation have intensified. Licensing, a relatively new strategy in the ceramic tile marketplace, is heating up, including the following partnerships: Shaw Industries with Martha Stewart and Kathy Ireland; Witex with Laura Ashley, Armstrong’s Liz Claiborne line in partnership with Carpet One, and Marrazzi Group with Benetton.

 

Sales in the ceramic tile industry are influenced by economic and market factors including:

 

•                  consumer confidence;

 

•                  spending for durable goods;

 

•                  interest rates;

 

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

 

•                  the overall strength of the economy.

 

“US Ceramic Tile Market- 2004 Edition”, published by Market Studies, pointed to a market growth rate for ceramic tile of approximately 5% to 7% per year. This growth rate is higher in the Sun Belt areas, including the Southeastern part of the United States, where we currently operate.

 

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

 

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IWT’s Products

 

We purchase our products on the world market. Approximately 50% of our products are imported from Italy, 30% from Spain and the balance from Brazil, Turkey and China. Each foreign manufacturer has registered agents in the United States that work with us, as well as with other distributors. We believe that we maintain close personal contact with our suppliers, visiting the plants regularly and working with suppliers to influence design, quality and reliability. We do not currently purchase any raw materials, but only finished goods. Our principal suppliers and the countries in which each is located include

 

•                  Gruppo CBS, division of Kis Ceramiche, Italy;

•                  Ceramica UDA, Italy

•                  Alfa Ceramica, Spain

•                  Imolagres, Italy;

•                  Ceramica Gomez, Spain;

•                  Ceramica Colli, Italy;

•                  Ceramica Fondavalle, Italy; and

•                  Ceramica Gaya, S.A., Spain.

 

Our product types include ceramic tile, porcelain tile, tumbled marble, mosaic listellos and medallions, honed and filled marble, unfilled marble, resin travertine listellos, and polished medallions. Each year, new products are added to our product line. For example, in 2004, we added granite counter and backsplash tiles to our product mix. Items are removed when they become obsolete, which we define as having minimal sales in any consecutive 12-month period.

 

We maintain a wide distribution of price points for our product. Our lowest priced products include red body ceramic tiles to mid priced solid body porcelain to higher priced natural stone tiles. Pricing strategies are also designed to provide incentives to customers for purchasing product in larger quantities. While the average wholesale price of ceramic floor and wall tile has continued to decline, reaching $0.89 per square foot in 2003, according to the industry magazine, Floor Covering Weekly (July 2004), the market for high- end porcelain tiles and decorative/designer tile has been increasing. The development of a dual price point market has given rise to a bimodal environment for us, through our branded porcelain collection and natural stone products, has been able to maintain an above average wholesale price. We will continue to emphasize this high-end tile and stone by selectively marketing them to dealers and distributors with customer bases that demand such products. Our unique position as a pure wholesaler gives us a clear advantage in this hourglass shaped market.

 

We ship product to our customers in quantities ranging from “cut order” specific to a consumer’s project to full pallets of a single product to full container and truckload packages. These larger quantities allow our customers to stock their own product to service cash and carry consumers.

 

We import a majority of our products into the Port of Miami.  In 2004, we expanded our distribution facilities to Dallas, Texas.  Product imported for distribution from our Dallas facility arrive via the Port of Houston. Orders that are shipped directly from the manufacturer to our customers may enter through any number of U.S. Ports. 

 

Inventory

 

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

 

Industry trends toward product packages, floor and wall tile combinations and the pre-organized tile, borders, decorative listellos, bull nose and end caps, increases the number of parts we must carry in stock to ensure that our dealers can meet the demand of their consumer.

 

Freight and Transportation Costs

 

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

 

•                  factory cost,

•                  freight (international and domestic), and

 

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•                  duties, tariffs, taxes and other regulatory costs.

 

Ocean freight charges differ from country to country therefore our selling price is based on factors specific to each international manufacturer. We pay most of our 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 the price we pay for product. Additionally, we also take into account that title to our products transfers at the port of the originating country. We generally ship between 10 and 20 containers at any one time. We currently estimate that our maximum exposure for loss would be approximately $150,000. Based on maritime loss history, cost of ocean marine insurance and our ultimate ability to subrogate against the freight carrier, we self-insure in the event of loss after title is taken.

 

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

 

As a result of increasing out-bound freight costs, we organized IWT Tesoro Transportation, Inc., a federally licensed freight carrier. By working with this affiliate company to supply a portion of our shipping needs, we hope to have more control over these costs.

 

IWT’s Customer Base and Distribution Channels

 

We currently distribute our products through four separate distribution channels.

 

•                  The independent retail floor-covering dealer and stocking distributor market is our largest channel. This channel currently accounts for about 54% of the sales revenue. These customers, who sell directly to the public, can be either “cut to order” or “stocking” dealers/regional distributors. We currently serve approximately 2,000 customers in this channel through our sales personnel. In addition, we have sub-distributors that handle specific market territories for limited numbers of our Tesoro-The Collectionâ product packages.

 

•                  The major home center “buy-it-yourself/do-it-yourself” store market makes up our second distribution channel. These customers typically operate under blanket purchase orders. There are three basic programs for home center stores. The first is a special order program. Consumers place orders from sample boards provided by us to the store. The store representatives forward these orders to us and we ship the product either directly to the consumer or to the store for pick-up by the consumer. The second program is a stocking program, which provides for a home center store to maintain specific product inventories for their cash and carry trade.  The third program is “Special Buys”. Under this program the customers purchase large quantities of specific product for special promotions.  The home center store channel currently accounts for about 8% of our revenue.

 

•                  Our third channel, accounting for 16% of our revenues, is made up of national buying groups. These groups support independently owned, branded floor covering outlets with coordinated buying agreements that require us to market directly to each individual retail outlet. This channel also includes large builders, who staff and maintain captive design centers specifically for their own customers.

 

•                  Our fourth channel is the bulk sale channel. In this channel we service retail buyers that purchase full truckloads or containers of specific product that is manufactured for us specifically for this program. These products can be drop-shipped from our manufacturer directly to the customer. The customer base for this channel is the United States and Canada. This channel makes up the remaining 22% of our sales.

 

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

 

Merchandising

 

The market for ceramic tiles, once characterized by little or no brand recognition, is beginning to enter into branding agreements with well-known designer names such as Ralph Lauren and Laura Ashley. In May 2002, we introduced our proprietary brand Tesoro-The Collectionâ. Tesoro is a collection of porcelain tiles and decorative inserts, borders, and accents that will be marketed throughout the United States. We have invested in specifically designed display racks that communicate the quality and value of our new brand that we believe assist our dealers in communicating product combinations to the consumer.  We are continually updating these displays with new products. We have a fifteen-year manufacturer’s warranty program for Tesoro-The Collectionâ products that we believe elevate the quality position of our products.

 

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In addition to the display units, we provide our customers with display boards that 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 product or take it to the installation site. Our sales force distributes lose sample packs, usually an assortment of colors for a single product line, whenever a line or dealer needs restocking. We account for the sample packs and display units and sample boards, along with the labor and overhead involved in creating them, as promotional expenses, when they are distributed to the customers.  Our promotional expense represents a significant part of our cost of doing business.

 

Credit and Collection Procedures

 

We maintain strict criteria for credit approval:

 

•                  Potential customers must complete our credit application;

•                  Credit must be approved by our credit department; and

•                  We may require a personal guaranty.

 

Once approved, typically our dealers receive 30-day terms. Our bulk truckload customers may be offered extended terms of payment. We have purchased credit insurance for these extended term customers to offset some of the risk inherent in the extending of longer credit terms.

 

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

 

•                  Have a storefront designed to market tile

•                  Sell to retail customers

•                  Operate at lease one forklift

•                  Capable of accepting material in bulk

 

When sales orders are entered, our computer system notes if a customer is on credit hold. If so, those orders are given to our credit department to determine whether the products can be shipped. Customers are generally given a 15 day grace period and orders are held and not shipped once an invoice is 60 days or older.

 

Marketing, Promotion and Sales

 

Our public relations and marketing activities focus on creating demand for our products. We have an in-house advertising and marketing staff that develops and coordinates our sales materials. We use trade magazines articles, specifically designed mailer programs and trade shows as our primary communication devices.

 

Our commission based sales force work with dealers to place the products in show rooms, educate the dealers regarding the quality and variety of product available to them and work with our internal customer service staff to facilitate delivery. We employ a twenty-person full time sales force most of whom have been with us for five years after spending many years in various facets of the tile business.

 

Competition

 

We compete in the flooring industry with both large national companies that supply both soft and hard materials and with smaller regional distributors that focus specifically on ceramic, porcelain and stone. Vertically integrated companies such as Shaw Industries and Mohawk, the two largest flooring providers, account for over 60% of the hard surface market in the U.S. While maintaining their dominant positions in the carpet market, both companies are moving aggressively into the hard flooring sector. Dal-tile, a subsidiary of Mohawk, manufactures, wholesales and retails tile on a national basis.

 

Regional competitors such as Master Tile, Florida Tile and Arizona Tile act as both wholesalers and retailers. In their markets, each supplies smaller dealers and distributors and also operates branded retail outlets. We currently only distribute at the wholesale level.

 

We believe that our competitive strengths include:

 

•                  Focusing solely on the wholesale segment of the distribution process. We do not own or operate direct to consumer locations. We work exclusively through dealers and stocking distributors or buying groups who service the buying public. As a result, we do

 

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

 

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

 

•                  Building our Tesoro-The Collectionâ brand equity. We are branding our designs and many of our products with our Tesoro Brand. We incorporate products from different manufacturers and different countries into programs that leverage the best of each source to create Tesoro collections. Unlike most other tile and ceramic products, Tesoro products include a 15-year manufacturer’s warranty against wear.

 

•                  Providing superior merchandising and customer support programs. We maintain an active sampling program to ensure that customers have the latest materials in their showrooms. Our field sales force continually updates, refreshes and replaces sales materials. We distribute literature to consumers referencing our dealer network participants. Our field personnel work with the customer and train them on the appropriate use and care of the product. Our goal is to make the dealers’ job as easy as possible.

 

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

 

By maintaining these competitive strengths, we currently believe that we can profitably challenge our competitors for a greater share of our targeted market.

 

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

 

Government Regulations

 

The Federal Trade Commission regulates our wholesale operations. The Federal Motor Carriers Administration regulates Transport’s freight activities. International is an exempt company subject to Bermudian commercial law. We do not expect to import product into Bermuda and will therefore maintain our exempt status. Both federal and state authorities regulate the distribution and sale of imported products. We have obtained all required federal and state permits, licenses and bonds to operate our businesses. We make no assurances that our operations and profitability will not be subject to more restrictive regulations, oversight or increased taxation by foreign, federal, state or local agencies.

 

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

 

Acquisitions and other Interests

 

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

 

Intellectual Property

 

We incorporate our proprietary brand Tesoroä in connection with a collection of porcelain tiles and decorative inserts, borders, and accents.  With respect to this brand, we rely on common law and Lanham act protection.  In December 2004, we were granted federal trademark protection for our mark Tesoro The Collectionâ.  We make 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 been involved in any related court proceedings.

 

10

 

We are also in preliminary discussions to create unique artwork and high-end tile designs for national distribution.

 

Employees

 

IWT currently employs 115 non-union employees, of which 113 are full-time and 2 are part-time, including 52 warehouse staff and 23 salespeople covering sales in United States and Canada. The remaining 40 employees include customer service, accounting and administrative positions. IWT believes that its relationships with its employees are good. Tesoro currently has two employees. Transport has one employee. Neither International, nor The Tile Club currently has any employees.

 

Important Risk Factors Concerning our Business.

 

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

 

The ceramic, floor and wall tile industry is cyclical and prolonged declines in residential or commercial construction activity could adversely affect our business. 

 

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

 

•                  national and local economic conditions;

•                  interest rates;

•                  housing demand;

•                  employment levels;

•                  changes in disposable income;

•                  financing availability;

•                  commercial rental vacancy rates;

•                  seasonal weather conditions;

•                  federal and state income tax policies; and

•                  consumer confidence.

 

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

 

We expect that we will need to obtain additional financing from both banking and equity 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 that would be profitable to us.

 

Future events such as the problems, delays, expenses and difficulties frequently encountered by wholesale tile and ceramics distributors like us, may lead to increased costs that could make it difficult for us to succeed with our objectives. To raise additional capital, we may sell additional equity securities, accept debt financing, or obtain financing through a bank or other entity. There is no limit as to the amount of debt we may incur nor have we adopted a ratio of our equity to debt. If we need to obtain additional financing, it may not be available or it may not be available on terms acceptable to us. Likewise, an offering of our securities may not be successful. 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:

 

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

•                  The volume of sample material and product we must have in place with our customers to help merchandise our

 

11

 

products;

•                  The number of different product variations demanded by our customers;

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

•                  The rate at which we expand our operations; and

•                  The occurrence, timing, size and success of acquisitions.

 

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

 

A major element of our business strategy is to acquire complementary businesses.  To the extent that these businesses cannot be easily integrated into our own, require too much equity or take away any of our management beyond what is expected, our existing operations could be adversely affected.

 

Failing to identify suitable acquisition candidates, to complete acquisitions and to integrate the acquired operations successfully could adversely affect our business operations.

 

As part of our business strategy, we intend to acquire complementary businesses. Although we regularly evaluate acquisition opportunities, we may not be able to:

 

•                  Successfully identify suitable acquisition candidates;

•                  Obtain sufficient financing on acceptable terms to fund acquisitions;

•                  Complete acquisitions; or

•                  Profitably manage acquired businesses.

 

Additionally, acquired operations may not achieve levels of sales, operating income or productivity comparable to those of our existing operations, or perform as expected. Acquisitions may also involve a number of special risks, some or all of which could have a material and adverse effect on our business, operating results and financial condition. Among these risks are:

 

•                  Being unable to integrate operations, systems and procedures and to eliminate redundancies and excess costs effectively;

•                  Diverting management’s attention and resources; and

•                  Difficulty retaining and training acquired key personnel.

 

We face intense competition in the ceramic floor and wall tile industry, which could decrease demand for our products and could have a material adverse affect on our profitability and revenues.

 

The industry is highly competitive. We face competition from a large number of domestic and foreign importers and independent distributors of floor covering products. Some of our existing and potential competitors may be larger and have greater resources and access to capital than we do. Maintaining our competitive position may require us to make substantial investments in our product design efforts, distribution network and sales and marketing activities. Competitive pressures may also result in decreased demand for our products and in the loss of market share. In addition, we face, and will continue to face, pressure on sales prices of our products from competitors, as well as from large customers. As a result of any of these factors, there could be a material adverse effect on our sales and profitability. Hard flooring products also face competition from alternative products such as carpet and vinyl. Changes in customer attitudes toward hard flooring and wall covering materials could also adversely affect our ability to market and sell our products profitably.

 

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

 

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

 

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

 

•                  If we are unable to retain our management team, our business operations and our growth objectives may be adversely affected.

 

Adverse weather conditions, such as the recent hurricanes in Florida, could adversely affect our sales, as well as our ability to provide customers with 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 not damaged, a number of dealers to whom we sell product were unable to do business for several weeks.  Additionally, we did not receive product on a timely basis because of the imclement conditions.  As a result, our sales for the third quarter of 2004 were adversely affected.  Additionally, major international catastrophes such as the tsunami and recent earthquakes could adversely affect our business in a number of ways, all of which are beyond our control and cannot be anticipated. 

 

If we are unable to retain our management team, our business operations and our growth objectives may be adversely affected.

 

Our success in achieving our growth objectives depends upon the efforts of our top management team including the efforts of Henry J. Boucher, Jr., our Chief Executive Officer, Forrest Jordan, our Chief Financial Officer and Senior Vice President, and Paul F. Boucher and Grey Perna who also are Senior Vice Presidents, as well as other of our management members. While we do have written employment agreements with each of these individuals, we currently do not have employment agreements with all our employees. The loss of the services of 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 and achieve our growth objectives should we lose any or all of these individuals’ services.

 

Our quarterly operating results fluctuate, which could result in a lower price for our stock.

 

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

 

•                  Introducing new products or pricing programs by our competitors;

•                  Increased transportation costs;

•                  Increases in selling and marketing expenses, as well as other operating expenses;

•                  Adverse weather conditions;

•                  Economic conditions specific to our industry; and

•                  Costs and risks associated with potential acquisitions.

 

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

 

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

 

We currently do not manufacture any of the products we distribute. Our business depends primarily upon a continuous supply of material from third party suppliers. We currently obtain our products from one domestic and over 40 foreign manufacturers. While we believe this large group of suppliers insulates us from the effect of any one supplier, international supply relationships are sensitive to geo-political situations beyond our control. In particular, we depend on suppliers in Italy and Spain and any disruption in this supply chain could put us in a difficult position. Any extended interruption in product supply 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 risk losing entire shipments.

 

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

 

13

 

damaged, our clients would not be able to receive their product in a timely fashion, which, in turn, could adversely affect our relationship with those customers. To date, we have only incurred minimal losses with respect to products that have been lost after we acquired title.

 

If the conflict in the Middle East escalates, we may have difficulty obtaining products from certain foreign manufacturers.

 

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

 

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

 

Significant increases in transportation costs could adversely effect our operating margins and our business, financial condition and operating results. Although we generally attempt to pass on increases in the costs to our customers, our ability to do so is, to a large extent, depends on the rate and magnitude of any increase, as well as competitive pressures and market conditions for 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. During these periods, our profitability could be adversely affected. Likewise, the outbound transportation costs differ depending on how far our products are to be shipped, which may not always be passed on to our customers.

 

If we grow too quickly, we could encounter problems related to increased customer demands on our limited resources.

 

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

 

•                  implement additional management information systems,

•                  develop further our operating, administrative, financial and accounting systems, and

•                  maintain close coordination between departments.

 

If we cannot manage our growth, we could limit our ability to capitalize on new business opportunities that may arise or to implement our business plan or attain our objectives. Additionally, we cannot assure anyone that our personnel, systems and controls will be adequate to support future growth. Our inability to manage growth or to maintain the quality of our products and services could cause us to lose customers and could significantly increase our operating expenses.

 

We depend on outside distributors for product sales.

 

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

 

Generally, we must pay all costs and expenses incurred with defending any actions alleged against any of our directors. 

 

Our articles of incorporation and bylaws provide that we may indemnify our Officers and Directors against losses sustained or liabilities incurred arising from any transaction in that Officer’s or Director’s respective managerial capacity unless that Officer or Director

 

•                  violates a duty of loyalty,

•                  did not act in good faith,

•                  engages in intentional misconduct or knowingly violated the law, or

•                  derives an improper benefit from the transaction.

 

14

 

Additionally, we have also entered into separate indemnity agreements with each of our Executive Officers and Directors to provide added protection unless that person committed any of the prohibited acts described above. Any obligations we incur defending any such actions could adversely affect our cash flow and profitability.

 

Future exchange rate fluctuations or inflation could have a material adverse effect on our operating results. 

 

We import most of the product we sell from countries whose currency is the mainly the Euro Dollar. We write a majority of our purchase contracts and pay for materials in U. S. dollars. On those purchase contracts that we pay for in Euro dollars, we have begun feeling the negative impact of the strength of the Euro against the U.S. dollar, although not material. To the extent we are unable to pass these fluctuations along we may suffer adverse affects on our business, financial condition and operating results. The foreign manufacturing facilities 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 against the U.S. dollar, although that country’s inflation rate or internal expenses may offset this benefit. Any future increases in a country’s inflation rate, which are not offset by devaluation of their currency, may negatively impact our operating results. To the extent that a foreign country’s currency appreciates against the U.S. dollar, there could be a material adverse effect on our business, financial condition and operating results.

 

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

 

A change in accounting standards could have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective.  The Financial Accounting Standards Board has issued a new accounting standard that requires companies to record compensation expense in the statement of operations for employee stock options using the fair value method.  Implementing this requirement could have a significant negative effect on our reported results or impair our ability to use equity compensation to attract and retain personnel.  New pronouncements and varying interpretations of pronouncements have occurred and may occur in the future.  Changes to existing rules may adversely affect our reported financial results or the way we conduct our business.

 

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

 

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

 

A few individuals own a significant percentage of our stock.

 

As of March 21, 2005, our executive officers and directors and their affiliates beneficially owned, in the aggregate, approximately 84% of our outstanding common stock.  Three directors who each serve as Tesoro Senior Vice Presidents beneficially owned, approximately 75% of our outstanding common stock. The remaining 9% is beneficially owned by our Chairman and Chief Executive Officer and our outside directors.  As a result, our executive officers and directors are able to collectively exercise control over matters requiring stockholder approval, such as the election of directors and the approval of significant corporate transactions. These types of transactions include transactions involving an actual or potential change in control or other transactions that the non-controlling stockholders may deem to be in their best interests and in which such stockholders could receive a premium for their shares.

 

Additional Information

 

Tesoro makes available free of charge its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practical after they are filed or furnished to the Securities and Exchange Commission. Such reports are available on the Company’s Web site (http://www.iwttesoro.com) or can be obtained by contacting Investors Relations group at 1.203.221.2770 or at IWT Tesoro Corporation, 191 Post Road West, Suite 10, Westport, Connecticut 06880.  Information contained on our web site is not part of this annual report.

 

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ITEM 2.                        PROPERTIES

 

Executive Office Space – Tesoro - Connecticut

 

Tesoro currently subleases office space in Westport, Connecticut. We pay a monthly base services fee of $2,400 per month and our lease expires September 2005.  Tesoro anticipates that it will be securing a more permanent space in the foreseeable future. 

 

Warehouse and Office Space – IWT - Florida

 

In December 2004, IWT signed an agreement to realign its distribution center facility on April 1, 2005. This agreement consolidates under one 15-year operating lease all 310,000 square feet of our Palm City, FL warehouse facilities.  Amongst the consolidation is approximately 80,000 square feet of warehouse space currently in multiple small warehouses. We will expand our warehouse capacity by 70,000 square feet to accommodate expected growth and  integrate into two adjacent warehouses all of the company’s Palm City operations.  Of the total 310,000 square feet, 10,000 square feet (on two floors) is for office space.

 

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

 

IWT Warehouse Space - Texas

 

Effective December 1, 2004, IWT entered into an agreement to lease warehouse space in Dallas, Texas.  Over the next 18 months, IWT will use 56,000 square feet and will subsequently take over an additional 74,000 square feet, for a total 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 of the lease and includes, in addition to the lease space, common area charges, taxes, insurance and management fees. The new warehouse space is our first warehouse facility outside Florida.  IWT expects that it will support its current customers and sales force in Texas and in the Southwest.  This new location is also part of IWT’s strategic plan to increase its sales and customer service throughout the Sunbelt (southern and southwestern United States).

 

The total costs of our long-term operating leases as of December 31, 2004, are estimated 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

 

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

 

ITEM 4.                        SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

We did not submit any matters to a vote of our security holders during the fourth quarter of 2004.

 

PART II

 

ITEM 5.                        MARKET PRICE FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

 

(a)                               Market Information

 

We have been filing periodic reports with the Securities and Exchange Commission since October 2000. Our common stock has been trading on the OTC Bulletin Board since December 17, 2003 under the symbol “IWTT” on a limited and sporadic basis and there is no established public trading market for our common stock nor may there every be. For the periods indicated, the following table presents the range of high and low sale prices 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

 

The Securities and Exchange Commission has adopted Rule 15g-9 which establishes 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 or with an exercise price of less than $5.00 per share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, the rules require

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

(ii)                                  that the broker or dealer received a signed, written agreement from the investor prior to the transaction. Disclosure also has to be made about the risks of investing in penny stocks in both public offerings and in secondary trading, and about commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and the rights and remedies available to an investor in cases of fraud in penny stock transactions.

 

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

 

(b)                               Our Stockholders

 

At March 21, 2005, 11,697,102 shares of common stock were outstanding, which were held by approximately 224 stockholders of record.

 

(c)                                Our Dividend Policy

 

We have never paid, and do not expect to pay, any cash dividends on our common stock in the coming year.

 

(d)                                 Securities Authorized to be Issued 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)

 

(1)          Tesoro’s Stock Incentive Plan includes the right to grant options and to issue restricted stock and the Plan was approved by Tesoro’s then sole stockholder in December 2001. This number reflects 152,700 restricted and 400 registered shares that have been issued all pursuant to the Plan through December 31, 2004. In January 2004, all the shares underlying the Plan were registered pursuant to a registration statement on 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 are vested.

 

ITEM 6.                        SELECTED FINANCIAL DATA

 

The following table sets forth the selected financial data of the Company for the periods indicated, which information is derived from the consolidated financial statements of the Company.  The selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s consolidate 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		)

 

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

 

(2)                                  Tesoro acquired International Wholesale Tile on 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 Consolidated Financial Statements for discussion of restatements.

 

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

 

General

 

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

 

Effective October 1, 2002, we acquired International Wholesale Tile, Inc. (IWT) through a share exchange and IWT became our wholly owned subsidiary. We issued nine 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 Tesoro International, Ltd., which was created to own and manage assets relating to 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 and distribution rights for high-end designer and artistic based decorative tiles, and to act as a domestic agent for selected manufacturers.

 

Company Overview

 

The Company is a value added distributor of imported ceramic, porcelain and stone flooring and decorative wall tiles. Our warehousing and distribution centers contain over 420,000 square feet of storage space and over seventeen million square feet of product ready for immediate shipment to our customers. In 2004, we signed an agreement to realign and expand our Palm City, FL distribution center facility.  This agreement consolidates multiple agreements into a new single fifteen-year lease.  We expect this realignment and expansion to be completed early in the second quarter of 2005.  Realigning our Florida distribution facilities will consolidate approximately 80,000 square feet of warehouse space currently in multiple small warehouses into one single facility, provide an additional 70,000 square feet of warehouse space for future anticipated growth and 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 square feet.  In 2004, the Company signed a five-year lease for a warehouse facility in Dallas, Texas.  The Dallas facility contains approximately 120,000 square feet.  The Company’s primary strategy is to be a reliable supplier and not a competitor to its customers.

 

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

 

•                  Maintain relationships with and serve a growing base of independent dealers, distributors and wholesalers by providing adequate stocks of in demand product at reasonable and competitive prices;

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

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

 

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

 

On December 17, 2003 we began trading our stock on the OTC Bulletin Board under the symbol IWTT. During 2005, we expect to raise additional equity through both the public and private markets. Any new capital raised will be used to strengthen our balance sheet and to provide capital for continued growth.

 

During the year ended 2004, the Company continued to expand its distribution channels beyond its traditional small and mid

 

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sized floor covering dealers in the southeastern United States. These channels included larger regional distributors outside the southeastern United States, home center stores and floor-covering dealers that focus on the builders of new construction units.

 

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

 

Results of Operations

 

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

 

The following discussions and analyses should be read in conjunction with our financial 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

 

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

 

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

 

Our gross margin is a function of the mix of our products sold and our ability to purchase materials from our suppliers in volumes that produce lower costs.  We distribute products that have a wide range of both price point and margin.  Our historical mix has provided the Company with a gross margin of between 38% and 40%.  We expect that we will be able to maintain this margin range as we grow.  However, circumstances beyond our control such as the increase in import costs and the competitive pricing environment in which we operate could adversely affect our ability to maintain our gross margin.

 

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

 

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Quarterly net sales and the percentage changes in net sales by quarter for 2004 versus 2003 were 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	%

 

Sales growth in the third quarter of 2004 was impacted by several hurricanes that made landfall over the entire state of Florida, impacting dealer and builder sales markets. During the forth quarter of 2004 our sales returned to expected levels.

 

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

 

Operating expenses 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 percentage rate of operating expenses was due to ongoing efforts to increase efficiency while expanding into new markets and new product lines. The increases in warehouse costs are attributable to the additional warehouse facilities required to support the increase in sales. The increase in distribution and sales costs are directly related to the increase in sales. The increases in marketing costs are related to the Company’s effort to expand into three new distribution channels.

 

		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

 

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

 

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

 

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

 

Net sales for the year ended December 31, 2003 were $32,604,500, reflecting an increase of $7,216,800, or approximately 28.4%, over the $25,387,700 reported for the year ended December 31, 2002. This growth follows a 29.4% increase for the year ended December 31, 2002 from the year ended December 31, 2001.

 

Quarterly net sales and the percentage changes in net sales by quarter for 2003 versus 2002 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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Gross profit was $12,790,000 (39.2% of net sales) for 2003 and $10,119,200 (39.9% of net sales) for 2002. The reduction in percentage was primarily attributable to the increase in transportation and import costs.

 

Operating expenses 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 to the additional warehouse facilities required to support the increase in sales. The increase in distribution and sales costs are directly related to the increase in sales. The increases in marketing costs are related to the Company’s effort to expand into three new distribution channels. The increase in general and administrative expense was primarily attributable to the initial infrastructure costs 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

 

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

 

The average 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.

 

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

 

Liquidity and Capital Resources

 

We had cash balances of approximately $507,700 at December 31,2004 and $867,400 at December 31, 2004.  We have financed our growth with new equity capital and increased borrowings from our commercial lender.

 

During 2004, we renegotiated our revolving line of credit with our primary commercial lender.  Our line of credit was increased from $17 million to $25 million; an amount the Company expects to be sufficient to support its growth in accounts receivable and inventory through 2005. Our rapid growth is expected to continue to require the Company to seek outside capital to supplement earnings and maintain and strengthen our balance sheet. We believe that the working capital required to finance the necessary growth in inventory will be provided by our existing line of credit. We expect to raise additional equity through both the public and private markets during 2005.  However, we cannot assure anyone that we will be able to obtain outside capital, or if we do, that it will be on terms beneficial to us.

 

We expect that the cost savings resulting from the realignment will offset the additional warehouse facilities and therefore the expansion will require only a marginal increase in working capital requirements.

 

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

 

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

 

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The balance due at December 31, 2004 to our commercial lender for the use of the revolving line of credit was approximately $16.0 million. The loan and security agreement contains certain covenants, which include financial covenants that require us to maintain a certain leverage ratio, limit our unfunded capital expenditures, a required minimum fixed charge coverage ratio, and a certain inventory turnover ratio. At December 31, 2004 the Company was not in compliance with the leverage and fixed charge coverage ratio requirement. On March 23^rd, 2005 the Company obtained a waiver of these covenants from our commercial lender. We believe that our relationship with our commercial lender is good and that they will continue to support the Company.

 

Contractual Obligations

 

For the year ended 2004, our long-term debt obligations consisted of notes payable, capital leases and a line of credit. The future payment requirements for these obligations 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

 

The related party debt obligations as of December 31, 2004 relate to notes payable to Tesoro’s three principal stockholders who also serve as executive officers and directors.  The notes include 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 liabilities represent an existing loan and security agreement for a line of credit with our commercial lender. The line matures on September 10, 2006 at which time the Company plans on renewing the debt. However, we cannot assure anyone that we will be able to renew the line of credit, or if we do, that it will be on terms beneficial to us. The Company entered into an agreement to purchase tile from a vendor, who is also a stockholder of the Company. The agreement is for a term of 18 months expiring in March 2006.

 

Critical Accounting Policies

In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, the Company must make decisions which impact the reported amounts of assets, liabilities, revenues and expenses, and related disclosures. Such decisions include the selection of appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. In reaching such decisions, the Company applies judgment based on its understanding and analysis of the relevant circumstances and historical experience. Actual amounts could differ from those estimated at the time the consolidated financial statements are prepared.

 

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

 

The Company believes the following accounting policies require it to use judgments and estimates in preparing its consolidated financial statements and could represent critical accounting policies.

 

•                  Accounts receivable and revenues are recognized when goods are shipped and legal title passes to the customer. The Company provides an allowance for expected doubtful accounts based upon historical bad debt and claims experience and periodic evaluation of specific customer accounts and the aging of accounts receivable. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

 

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

 

•                  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are

 

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expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in the tax rates is recognized in earnings (loss) in the period that includes the enactment date. Additionally, taxing jurisdictions could retroactively disagree with the Company’s tax treatment of certain items, and some historical transactions have income tax effects going forward. Accounting rules require these future effects to be evaluated using current laws, rules and regulations, each of which can change at any time and in an unpredictable manner.

 

Recent Accounting Pronouncements

 

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

 

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

 

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets” an amendment to Accounting Principles Board Opinion No. 29, “Accounting for Nonmonetary Transactions,” which is based on the principle that exchanges of nonmonetary assets should be measured 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 for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges in which the future cash flows of the entity are not expected to change significantly as a result of the exchange.  The provisions of SFAS No. 153 will become effective for nonmonetary asset exchanges in fiscal periods beginning after June 15, 2005.  The Company has not yet determined the impact of adopting this standard.

 

In December 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-based payment transactions in the financial statements.  This Statement eliminates the ability to account for share-based compensation transactions using Accounting Principles Board Opinion No. 25, and requires instead that such transactions 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. The Company has not yet determined the impact of adopting this standard.

 

Impact of Inflation

 

Inflation affects the Company’s distribution costs and operating expenses. The tile industry has experienced significant inflation in the prices of fuel-related and import costs beginning in the first quarter of 2004. In the past the tile industry experienced moderate inflation in these costs and has generally passed them along through price increase to its customers.

 

Seasonality

 

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

 

ITEM 7A                  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

Financial exposures are managed as an integral part of the Company’s risk management program, which seeks to reduce the potentially adverse effect that the volatility of the exchange rate and lending markets may have on its operating results. The Company does not regularly engage in speculative transactions, nor does it regularly hold or issue financial instruments for trading purposes. A summary of our market risk exposures is presented below.

 

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Interest Rate Risk

 

We have revolving line of credit agreement with interest rates that are either a percentage over Prime or Libor therefore to the extent that Prime or Libor change we are subject to interest rate risk.

 

Foreign Currency Risk

 

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

 

ITEM 8.                        FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

The financial statements and supplemental data required by this Item 8 follow the index 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

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors

IWT Tesoro Corporation and Subsidiaries

Westport, Connecticut

 

We have audited the accompanying consolidated balance sheet of IWT Tesoro Corporation and Subsidiaries as of December 31, 2004 and the related consolidated statements of operations, stockholders’ equity and cash flows for the year then ended.  These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

 

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

 

In our opinion, the 2004 consolidated financial statements referred to above present fairly, in all material respects, the financial position of IWT Tesoro Corporation and Subsidiaries as of December 31, 2004, and the results of its operations and cash flows for the year then ended in conformity with 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

 

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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 IWT Tesoro Corporation and Subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. 

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of IWT Tesoro Corporation and Subsidiaries as of December 31, 2003 and 2002, and the results of its operations, and its cash flows for each of those years in conformity with accounting principles generally accepted in the United States of America.

 

As discussed in Note 2 to the accompanying consolidated financial statements, 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

 

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IWT TESORO CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE 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

 

IWT TESORO CORPORATION AND SUBSIDIARIES

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

 

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