UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

(Mark One)

 

IWT TESORO CORPORATION

(Exact Name of Small Business Issuer in Its Charter)

 

 

101 Post Road West, Suite 10, Westport, CT  06880

(Address of principal executive offices)

 

(203) 221-2770

(Issuer’s Telephone Number, including area code)

 

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

 

Securities registered pursuant to Section 12(b) of the Exchange Act:  NONE

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

 

Check whether the issuer: (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:

ýYes             oNo

 

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

 

State the number of shares outstanding of each of the issuer’s class of common equity, as of August 12, 2004:  11,695,612 shares

 

Transitional Small Business Disclosure Format:   oYes                  ýNo

 

 

PART 1

 

ITEM 1:                             FINANCIAL STATEMENTS

 

IWT TESORO CORPORATION AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2004

 

 

 

TABLE OF CONTENTS

 

 

Report of Independent Accountants
Consolidated Balance Sheets June 30, 2004 (unaudited) and December 31, 2003
Consolidated Statements of Operations for the Six months ended June 30, 2004 and 2003 (unaudited)
Consolidated Statements of Stockholders’ Equity for the Six months ended June 30, 2004 and 2003 (unaudited)
Consolidated Statements of Cash Flows for the Six months ended June 30, 2004 and 2003 (unaudited)
Notes to Consolidated Financial Statements (unaudited)

 

1

 

REPORT OF INDEPENDENT ACCOUNTANTS

 

 

To the Board of Directors

IWT Tesoro Corporation

Westport, Connecticut

 

We have reviewed the accompanying consolidated balance sheet of IWT Tesoro Corporation and its wholly-owned subsidiaries as of June 30, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the three month and six-month periods then ended.  These financial statements are the responsibility of the Company’s management.

 

We conducted our review in accordance with standards established by the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim consolidated financial statements for them to be in conformity with U.S. generally accepted accounting principles.

 

 

KANTOR, SEWELL & OPPENHEIMER, PA

Certified Public Accountants

 

Hollywood, Florida

July 23, 2004

 

2

 

IWT TESORO CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

 

Assets

 

		June 30, 2004			December 31, 2003 Restated
		(Unaudited)			(Audited)
Current assets
Cash		$	661,144		$	867,361
Accounts receivable, net		7,322,910			4,907,705
Inventory		15,427,926			13,058,839
Due from shareholder		—			550,000
Deferred tax asset		—			146,193
Prepaid expenses		1,059,825			754,289
Total current assets		24,471,805			20,284,387
Property and equipment, net		5,271,853			4,217,268
Other assets
Deposits		120,145			59,609
Deferred tax assets		76,972			101,205
Other receivables		113,473			69,370
Other assets		354,103			253,120
		664,693			483,304
		$	30,408,351		$	24,984,959

 

See notes to financial statements.

 

3

 

IWT TESORO CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

 

Liabilities and Stockholders’ Equity

 

		June 30, 2004			December 31, 2003 Restated
		(Unaudited)			(Audited)
Current liabilities
Accounts payable		$	12,092,307		$	9,859,161
Accrued expenses		209,644			137,292
Deferred tax liability		13,768			—
Current portion of lease payable		34,106			63,151
Current portion of notes payable - unrelated parties		34,458			42,719
Total current liabilities		12,384,283			10,102,323
Deferred tax liability - non current		—			148,594
Long term lease payable		156,835			149,183
Long term notes payable - related parties		338,662			338,662
Long term notes payable - unrelated parties		47,959			42,560
Long term loan payable		12,411,294			9,599,340
		12,954,750			10,278,339
Stockholders’ equity
Preferred stock, $0.001 par value, 25,000,000 authorized; none issued		—			—
Common stock, $0.001 par value, 100 million shares authorized, 11,695,102 and 11,622,702 issued and outstanding		11,695			11,623
Additional paid in capital		4,594,256			4,306,153
Additional paid in capital - outstanding options		666,667			666,667
Accumulated deficit		(203,300		)	(380,146		)
		5,069,318			4,604,297
		$	30,408,351		$	24,984,959

 

See notes to financial statements.

 

4

 

IWT TESORO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

 

		For the period ended June 30,
		Three months ended						Six months ended
		2004			2003			2004			2003
Revenue
Sales, net of discounts and returns		$	11,616,257		$	8,504,860		$	21,172,404		$	15,239,624
Cost of goods sold		7,144,406			5,012,000			12,954,820			9,091,608
Gross profit		4,471,851			3,492,860			8,217,584			6,148,016
Expenses
Payroll		1,736,098			1,248,358			3,344,143			2,431,763
Delivery		535,117			413,074			1,093,739			749,119
Lease expenses		390,810			198,254			753,738			332,634
Depreciation and amortization		236,138			158,603			450,638			295,127
General and administrative		276,862			188,331			547,149			334,902
Insurance		209,284			85,138			369,882			159,966
Sales expenses		245,989			147,041			445,551			229,300
Bad debts		22,598			50,570			45,209			53,817
Repairs and maintenance		129,837			87,808			230,522			170,293
Advertising		58,006			19,050			151,763			40,925
Travel and entertainment		88,535			75,653			177,142			130,112
Professional fees		81,455			113,795			164,561			237,742
		4,010,729			2,785,675			7,774,037			5,165,700
Income from operations		461,122			707,185			443,547			982,316
Other income/(expenses)
Interest expense		(139,111		)	(98,632		)	(261,377		)	(174,581		)
Other income (expense), net		23,823			(4,617		)	30,276			(9,135		)
		(115,288		)	(103,249		)	(231,101		)	(183,716		)
Income before taxes		345,834			603,936			212,446			798,600
Income tax (expense) benefit- deferred		84,400			(32,000		)	(35,600		)	(64,000		)
Income tax - current		—			(65,000		)	—			(65,000		)
Net income		$	430,234		$	506,936		$	176,846		$	669,600
Earnings per share - basic		$	0.04		$	0.05		$	0.02		$	0.06
Earnings per share - diluted		$	0.04		$	0.04		$	0.01		$	0.06

 

See notes to financial statements.

 

5

 

IWT TESORO CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

SIX MONTHS ENDED JUNE 30, 2003

(UNAUDITED)

 

		Common Stock					Additional Paid in			Subscription			Retained Earnings
		Shares		Amount			Capital			Receivable			(Deficit)			TOTAL
Balance, January 1, 2003		10,587,834		$	10,588		$	686,068		$	—		$	(184,740	)	$	511,916
Issuance of shares  - private offering		136,668		136			409,864			—			—			410,000
Exercise of warrants ($3.00)		10,000		10			29,990			—			—			30,000
Issuance of shares to employees and directors for services rendered (SIP)		21,000		21			56,889			—			—			56,910
Issuance of shares - public offering		3,750		4			20,621			—			—			20,625
Cancellation of stock repurchase agreement		450,000		450			1,072,710			—			—			1,073,160
Net income													669,600			669,600
Balance, June 30, 2003 (Unaudited)		11,209,252		$	11,209		$	2,276,142		$	—		$	484,860		$	2,772,211

 

See accompanying notes to financial statements.

 

6

 

IWT TESORO CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

SIX MONTHS ENDED JUNE 30, 2004

(UNAUDITED)

 

										Additional
		Common Stock					Additional Paid in			Paid in Capital Outstanding			Retained Earnings
		Shares		Amount			Capital			Options			(Deficit)			TOTAL
Balance, January 1, 2004, as restated		11,622,702		$	11,623		$	4,306,153		666,667			$	(380,146	)	$	4,604,297
Exercise of warrants ($3.25)		45,500		45			147,830			—			—			147,875
Issuance of shares to consultants for services rendered  ($5.99)		15,000		15			89,835			—			—			89,850
Issuance of shares to director		10,000		10			42,490			—			—			42,500
Issuance of shares to consultants for services rendered  ($4.25)		2,000		2			8,498			—			—			8,500
Canceled shares		(100	)	—			(550		)	—			—			(550		)
Net income													176,846			176,846
Balance, June 30, 2004 (Unaudited)		11,695,102		$	11,695		$	4,594,256		$	666,667		$	(203,300	)	$	5,069,318

 

See accompanying notes to financial statements.

 

7

 

IWT TESORO CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

		Six months ended June 30,
		2004			2003
Cash flows from operating activities:
Net Income		$	176,846		$	669,600
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation		450,638			295,127
(Gain) loss on asset disposal		21,533			5,352
Deferred taxes		35,600			—
Compensation in exchange for stock		140,300			—
Bad debt		45,209			53,817
(Increase) decrease in operating assets
Accounts receivable		(2,460,414		)	(1,707,843		)
Inventory		(2,369,087		)	(4,874,201		)
Prepaid expenses		(305,536		)	(44,440		)
Other assets		(247,134		)	33,339
Increase (decrease) in operating liabilities
Accounts payable and accrued expenses		2,299,162			3,797,846
Other liabilities		6,335			39,735
Total adjustments		(2,383,394		)	(2,401,268		)
Net cash used in operating activities		(2,206,548		)	(1,731,668		)
Cash flows from investing activities:
Proceeds from sale of equipment		25,000			—
Acquisition of property and equipment
Displays and sample boards		(987,934		)	(536,773		)
Other property and equipment		(473,214		)	(766,399		)
Net cash used in investing activities		(1,436,148		)	(1,303,172		)
Cash flows from financing activities:
Proceeds from loans from related party		—			10,640
Proceeds from issuance of stocks		697,875			460,625
Proceeds from new borrowings		21,330,000			16,228,000
Payments to stockholder loans		—			(110,050		)
Payments on new borrowings		(18,518,046		)	(13,782,136		)
Principal payment on notes payable and capital leases		(73,350		)	(27,553		)
Net cash provided by financing activities		3,436,479			2,779,526
Net decrease in cash and cash equivalents		(206,217		)	(255,314		)
Cash and cash equivalents, beginning of period		867,361			574,046
Cash and cash equivalents, end of period		$	661,144		$	318,732
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest expense		$	261,377		$	174,581

 

See notes to financial statements.

 

8

 

IWT TESORO CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2004

 

 

NOTE 1                            PRINCIPLES OF CONSOLIDATION

 

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, International Wholesale Tile, Inc. (IWT), IWT Tesoro International, Inc. (International), IWT Tesoro Transport, Inc. (Transport) and The Tile Club, Inc. (TCI), (collectively the “Company”).  All significant inter-company balances and transactions have been eliminated.

 

 

NOTE 2                            BASIS OF PRESENTATION

 

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

 

The accompanying consolidated financial statements of the Company have been prepared in accordance with the instructions to Form 10-Q and, therefore, omit or condense certain footnotes and other information normally included in financial statements prepared in accordance with generally accepted accounting principles.  It is suggested that these condensed financial statements should be read in conjunction with the Company’s financial statements and notes thereto included in the Company’s audited financial statements on Form 10-K for the fiscal year ended December 31, 2003.

 

 

NOTE 3                            SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Stock Options

The Company accounts for stock options under the provisions of Accounting Principles Board Opinion (APB) No. 25 Accounting For Stock Issued to Employees and related interpretations.  Accounting for the issuance of stock options under the provisions of APB No. 25 typically does not result in compensation expense for the Company since the exercise price of options is normally established at the market price of the Company’s common stock on the date granted.  Statement of Financial Accounting Standards (SFAS) No. 123 Accounting for Stock-Based Compensation provides that the related expense may be recorded in the basic financial statements or the pro forma effect on earnings may be disclosed in the financial statements.

 

A total of 50,000 options were granted to directors of the Company during the six months ended June 30, 2004.   No options were granted during the six months ended June 30, 2003.

 

9

 

The effect on net income (loss) and earnings per share if the Company had applied the fair value recognition provision of the SFAS No. 123, consisted of the following:

 

		Six months ended June 30, 2004
Net loss as reported		$	176,846
Plus total stock-based compensation cost, net of related tax effects, included in the determination of net loss as reported		42,500
Less stock-based compensation cost, net of related tax effects, determined under fair value based method for all awards		(97,063		)
Pro-forma net loss		$	122,283
Basic earnings per share
As reported		$	0.02
Pro-forma		$	0.01
Diluted earnings per share
As reported		$	0.02
Pro-forma		$	0.01

 

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

 

Recent Accounting Pronouncements

In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, which provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation as prescribed in SFAS No. 123. Additionally, SFAS No. 148 requires more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. The provisions of this Statement are effective for fiscal years ending after December 15, 2002.  Management does not expect the adoption of this Statement to have a material impact on the Company’s financial condition or results of operations.

 

Earnings per Share

Basic earnings per share are computed based on the weighted average number of common shares outstanding during each year.  Diluted earnings per share are computed based on the weighted average number of common shares outstanding plus all potential dilutive common shares outstanding (stock options) during each year.

 

10

 

NOTE 4                            INVENTORIES

 

Inventories consisted of the following:

 

 

Inventory in transit consists of merchandise purchased overseas, which is not yet received in the warehouse.  The Company obtains legal title at the shipping point.  Inventory cost includes the purchase price and in-bound freight.

 

 

NOTE 5                            DEPOSIT ON EXCLUSIVE AGREEMENT

 

During February 2004, the Company entered into an agreement with an Italian supplier to develop an exclusive line of tile.  The agreement required a deposit of $550,000, and the initial shipment is anticipated in July 2004.

 

 

NOTE 6                            PROPERTY AND EQUIPMENT

 

Property and equipment consisted of the following:

 

 

Depreciation expense for the six months ended June 30, 2004 and 2003 was $450,638 and $295,127, respectively.

 

11

 

NOTE 7                            LOANS PAYABLE

 

The Company has a loan and security agreement with a financial institution for a revolving line of credit with a maximum limit of $17,000,000.  The agreement specifies that proceeds from this revolving credit loan be used for general working capital needs.  All present and future assets of the Company collateralize this loan. The rate of interest in effect for this agreement is calculated with reference to the Base Rate and/or LIBOR (London Interbank Offered Rate).  The balance due at June 30, 2004 and December 31, 2003 was $12,411,294 and $9,599,340, respectively.

 

Base Rate advances bear a fluctuating interest rate per annum equal to prime plus 0.50%.  LIBOR advances bear a fixed rate per annum equal to 3.00% plus the LIBOR for the applicable interest period.  At June 30, 2004, the Base Rate and the LIBOR rate were 4.50% and 4.59%, respectively.

 

The loan and security agreement contains certain covenants, which include financial covenants that require the Company to maintain a certain leverage ratio, a required minimum fixed charge coverage ratio, and a certain inventory turnover ratio.  At June 30, 2004, the Company is in compliance with the covenants set forth with the financial institution.

 

For the six months ended June 30, 2004 and 2003, interest expense related to the credit lines amounted to $257,987 and $143,534, respectively.

 

 

NOTE 8                            STOCKHOLDERS’ EQUITY

 

Common Stock

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

 

During the six months ended June 30, 2004, the Company issued 17,000 shares of common stock to consultants for services rendered, based on the trading price at the date of issuance, for a total of $98,350, resulting in an immediate charge to operations.

 

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

 

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

 

12

 

NOTE 9                            SEGMENT INFORMATION

 

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

 

 

NOTE 10                     NEW SUBSIDIARY

 

Subsequent to the fiscal quarter ended March 31, 2004, the Company organized The Tile Club, Inc. (TCI).  TCI will license the distribution rights to designer and artistic based decorative wall tiles.

 

 

NOTE 11                     RESTATEMENTS

 

The Company will restate the consolidated balance sheet at December 31, 2003 and the consolidated statements of operations, stockholders’ equity and cash flows for the year then ended.  The restatement is being made to reflect the proper accounting in accordance with accounting principles generally accepted in the United States in connection with options granted to four executive officers and to reflect the impairment of certain sample boards identified as a result of additional auditing procedures.

 

The effect on the financial statements of the Company is as follows:

 

		As Restated			As Originally Reported
Accumulated deficit – December 31, 2002		$	(184,740	)	$	(184,740	)
Net Income (Loss)		(195,406		)	436,305
Retained Earnings (Deficit) – December 31, 2003		$	(380,146	)	$	251,565

 

13

 

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

 

The following discussion should be read along with our financial statements, which are included in another section of this filing.

 

Forward Looking Statements

 

 Some of the statements made constitute “forward-looking statements”. For example, statements included in this prospectus 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,” “anticipate,” “believe,” “estimate,” “plan” or “expect,” we are making forward- looking statements.  These forward-looking statements are subject to risks and uncertainties and other 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. You should not unduly rely on these statements. Forward-looking statements involve assumptions and describe our plans, strategies, and expectations. This report contains forward-looking statements that address, among other things,

 

•our business and financing plans;

•regulatory environments in which we operate or plan to operate; and

•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.

 

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

 

•our ability to raise capital;

•our ability to continue distributing our products;

•our ability to provide our products at competitive rates;

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

•our degree of financial leverage;

•regulatory considerations and risks related to international economics,

•risks related to market acceptance and demand for our products and services;

•our dependence on third party suppliers;

•the impact of competitive services; and

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

 

We believe that the assumptions and expectations reflected in this prospectus are reasonable, based on information available to us in this report.  However, we cannot assure anyone that these assumptions and expectations will prove to have been correct or that we will take any action that we may presently be planning. We assume no obligation to update forward-looking statements or reflect unanticipated future events.

 

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 the Company’s potential future overseas activities.  The second is IWT Transport, Inc., organized to handle our domestic freight operations.  The Tile Club, Inc., organized in 2004, was organized to acquire licensing, manufacturing and distribution rights for high-end designer and artistic based decorative tiles.

 

Company Overview

 

The Company is a value added distributor of imported ceramic, porcelain and stone flooring and decorative wall tile.  Our warehousing and distribution center contains over 220,000 square feet of storage space and over seven million square feet of product ready for immediate shipment to our customers.  The company’s primary strategy is to be a reliable supplier not a competitor to its customers.

 

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

 

14

 

•                  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 the drive demand for our fashion based products

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

 

Our primary source of revenue is the sale of hard flooring and wall covering materials and our primary costs relate to the acquisition, sales and delivery of those products.  While sales are made throughout the United States, to date the majority of our sales are in the southeastern quadrant of the country.  The primary sources of working capital are a $ 17 million (US) revolving line of credit from a division of a large US commercial bank, our suppliers who extend us terms and our stockholders equity.

 

On December 17, 2003 we began trading our stock on the OTCBB under the symbol IWTT.  During 2004, we expect to raise additional equity through the public market.  Any new equity raised will be used to strengthen our balance sheet and to provide capital for continued growth.

 

During the quarter ended June 30, 2004, the Company continued to expand its distribution channels beyond its traditional small and mid sized floor covering dealers in the southeastern United States. These new 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.

 

Results of Operations for the Quarters ending June 30, 2002, 2003 and 2004.

 

The following discussion and analysis should be read in conjunction with the financial statements and notes thereto that appear elsewhere in this document. The table below sets forth certain operating data as, with gross margins as a percentage of total revenue for the periods indicated.

 

		Quarter Ending June 30,
		2002			2003			2004
Revenues		$	6,803,466		$	8,504,860		$	11,616,257
Cost of Goods Sold		4,193,483			5,012,000			7,144,406
Gross Margin		2,609,983			3,492,860			4,471,851
Gross Margin Percentage		38.36		%	41.07		%	38.50		%
Operating Expenses		1,972,281			2,785,675			4,010,729

 

Quarter ended June 30, 2004 Compared to Quarter Ended June 30, 2003

 

Sales for the quarter ended June 30,2004 were $11,616,257, a 36% increase over sales for the quarter ended June 30, 2003. This growth follows a 25% growth from 2002 to 2003. We are a relatively small player in a growing market. We are entering new markets and adding new products; therefore, we expect to be able to grow faster than the market as a whole for the next several years. Our share of this market is approximately 1.5%.  The tile market in the United States is approximately $2.5 billion and is growing at a seven to ten percent rate.

 

As we grow, we have been able to purchase product at lower prices and have consequently lowered our cost of goods to 60% for the year ended December 2003, from 60% in 2002 and 64% in 2002.  While there are certainly finite limits to improving our gross margin percentage, it is imperative that we maintain these ratios as we grow.  The gross margin for the quarter ended June 30, 2004 was $4,471,850, a 28% increase over gross margin for the quarter ended June 30, 2003.  This increase in gross margin resulted primarily from the increase in sales, somewhat offset by a slight increase in our cost of goods to 61.5% ending June 30, 2004.

 

Our operating expenses for the quarter ended June 30, 2004 have increased by $1,225,054 over the same period in 2003.  Our commissions and outbound freight costs vary with sales and represent approximately $310,000 of this increase.  The balance of the cost increase relates to the expansion of our distribution channels to include home center stores and builder-based dealers.   We currently maintain between ten and twelve million square feet of product in our warehouse.  Our inventory turns in 2003 were approximately 1.5 times.  We expect to maintain turns during 2004 to 2.0.  However, we cannot assure anyone that we will be successful in attaining these expectations. Availability of product is a key success factor in maintaining these turn ratios.

 

In May 2003, we commenced bulk sales of products, made exclusively for IWT, to wholesale distributors throughout the United States.  The sales of these products are made in full truckload or container load volumes, with some product being delivered directly to the customer from the factory (drop-shipped).  The gross margin on these sales could be lower than our traditional business; however, we believe that the lower handling costs may offset the lost gross margin.  For the quarter ended June 30, 2004, truck bulk sales represented approximately 20% of our total sales.

 

Making it easy for our customers to sell product is also a key success factor for us. We have an extensive sampling and display program that augments the training and marketing support we provide our customers. Our inventory of samples in the field with our customers

 

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represents a significant investment that is capitalized as property and equipment. The net value on June 30, 2004 and December 31, 2003 were approximately $3,646,557 and $2,726,949, respectively on our balance sheet.

 

Another success factor for us is maintaining our position as a dependable supplier not only to meet customer demand but also to ensure leading edge design and technical superiority of the product.  We established International as our subsidiary, which is responsible for dealing with the global array of manufacturers that supply us with product.  We continue to develop key relationships in Europe and South America and have begun to sell some of these new items through IWT’s network of dealers and distributors.

 

Liquidity and Capital Resources

 

We had cash balances of $661,144 and $867,361 at the end of June 30, 2004 and December 31, 2003, respectively.  We have financed our growth with new equity capital and increased borrowings from our commercial lender.  Thus, we have not generated positive cash flows from operations during the quarter ended June 30, 2004.  Tesoro expects to continue to grow and make use of outside capital for the foreseeable future.  We cannot assure anyone, however, that we will be able to obtain outside capital or if we do, that it will be on terms beneficial us.

 

During the six months ended June 30, 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, 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.

 

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

 

The balance due at June 30, 2004 to our commercial lender for the use of the revolving line of credit was approximately $12.4 million.  The loan and security agreement contains certain covenants, which include financial covenants that require us to maintain a certain leverage ratio, a required minimum fixed charge coverage ratio, and a certain inventory turnover ratio.  At June 30, 2004, we are in compliance with the covenants set forth in our agreement with the financial institution.

 

Critical Accounting Policies

 

Please refer to the Notes to the Financial Statements regarding Tesoro’s Form 10-KSB for the fiscal year ended December 31, 2003 and filed with the Securities and Exchange Commission on March 30, 2004.

 

Segment Information

 

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

 

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

 

Quantitative and Qualitative Disclosures About Market Risk

 

 The Company is exposed to market risk from changes in interest rates and foreign currency exchange rates since it funds its operations through short-term investments and has business transactions in Euros. A summary of the Company’s market risk exposures is presented below.

 

Interest Rate Risk

 

Tesoro has fixed income investments consisting of cash equivalents and short-term investments, which may be affected by changes in market interest rates. The Company does not use derivative financial instruments in its investment portfolio. The Company places its cash equivalents and short-term investments with high-quality financial institutions, limits the amount of credit exposure to any one institution and has established investment guidelines relative to diversification and maturities designed to maintain safety and liquidity. Investments are reported at amortized cost, which approximates fair value.

 

Foreign Currency Risk

 

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 could, in time,  pass on to our customers and therefore have 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

 

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competitive landscape for ceramic tile as a result of the strength of the EURO.  Tesoro does not currently hedge against the risk of exchange rate fluctuations.

 

ITEM 4 – CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

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

 

(b)                                 There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation described in the preceding paragraph.

 

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PART II

 

ITEM 1:                                                    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 2:                 CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

During the six months ended June 20, 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, 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.

 

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

 

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

 

The balance due at June 30, 2004 to our commercial lender for the use of the revolving line of credit was approximately $12.4 million.  The loan and security agreement contains certain covenants, which include financial covenants that require us to maintain a certain leverage ratio, a required minimum fixed charge coverage ratio, and a certain inventory turnover ratio.  At June 30, 2004, we are in compliance with the covenants set forth in our agreement with the financial institution.

 

ITEM 3:                                                    DEFAULT UPON SENIOR SECURITIES.

 

Not applicable

 

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

 

On June 19, 2004, Tesoro held its Annual Stockholders Meeting.  An information statement was provided to each of Tesoro’s stockholders that included the proposal to elect the slate of directors proposed by Tesoro’s Nominating and Governance Committee.  A majority of Tesoro stockholders had previously approved the nominations.

 

ITEM 5:                                                    OTHER INFORMATION

 

Not applicable

 

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ITEM 6:                                                    EXHIBITS AND REPORTS ON FORM 8-K

 

(a)                                  Exhibits

 

 

a.                                       Exhibits

 

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

 

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

 

*                                         Filed herewith.

 

(b)                                 Reports on Form 8-K

 

Form 8-K, filed on April 1, 2004, regarding the resignation of a director and the appointment of a new director.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

			IWT TESORO CORPORATION
August 13, 2004			/s/ Henry J. Boucher, Jr.
			Henry J. Boucher, Jr., President
August 13, 2004			/s/Forrest P. Jordan
			Forrest P. Jordan, Chief Financial Officer

 

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