**UNITED STATES**


**SECURITIES AND EXCHANGE COMMISSION**


**WASHINGTON, D.C. 20549**








**FORM 10-QSB**







| | [X] Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
| | --------------------------------------------------------------------------------------------
| | For the quarterly period ended: September 30, 2004                                          

or


| | []Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
| | -------------------------------------------------------------------------------------------



Commission File Number: 0-24684




**ZENEX INTERNATIONAL, INC.**


(Name of small business issuer in its charter)


|Colorado
(State of incorporation)                                                       | 73-1587867
(I.R.S. Employer ID no.)
|--------------------------------------------------------------------------------------- | -----------------------------------
|14220 S. Meridian Ave.
Oklahoma City, Oklahoma
(Address of Principal Executive Offices) | 73173
(Zip Code)                   



Issuers telephone number, including area code: 405- 692-2300




Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 at least the past 90 days: Yes [X] No [  ]




Shares of Common Stock, $.001 par value, outstanding as of November 15, 2004: 47,836,558




Transitional Small Business Disclosure Format: Yes [  ] No [X]


1








**ZENEX INTERNATIONAL, INC.**








**TABLE OF CONTENTS**





****
****
**PART I. FINANCIAL INFORMATION**Item 1.
Financial StatementsIndependent Accountants Review Report
4Financial Statements:Consolidated Balance Sheets
5-6Consolidated Statements of Operations
7-8Consolidated Statements of Cash Flows
9-10Notes to the Financial Statements
11-23Item 2.
Managements Discussion and Analysis
24-29Item 3.
Controls and Procedures
29**PART II.OTHER INFORMATION**Item 6.
Exhibits
30Signatures
30


2






**ZENEX INTERNATIONAL, INC.**







**PART I - FINANCIAL INFORMATION**











**Item 1. Financial Statements - September 30, 2004 and 2003**






This quarterly report on Form 10-QSB should be read in conjunction with Zenex International, Inc.s Annual Report on Form 10-KSB for the year ended December 31, 2003.









3





**Independent Accountant's Review Report**





Board of Directors and Stockholders
 Zenex International, Inc.
 Oklahoma City, Oklahoma
 
 
 We have reviewed the accompanying consolidated balance sheets of Zenex International, Inc. as of September 30, 2004, and the related consolidated statements of operations for the three-month and nine-month periods ended September 30, 2004 and 2003 and the consolidated statements of cash flows for the nine months then ended. These interim financial statements are the responsibility of the Company's management.
  We conducted our review in accordance with the Standards of 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 for 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 review, we are not aware of any material modifications that should be made to the accompanying interim financial statements for them to be in conformity with U.S. generally accepted accounting principles.
 
 The December 31, 2003 financial statements for Zenex International, Inc. were audited by us and we expressed an unqualified opinion in our report dated March 16, 2004, but we have not performed any auditing procedures since that date.
 
 
 
 /s/Sutton Robinson Freeman & Co., P.C.
 Sutton Robinson Freeman & Co., P.C.
 Certified Public Accountants
 
 October 29, 2004
 Tulsa, OK


4








**Zenex International, Inc.****Consolidated Balance Sheets****September 30, 2004******


**September 30,****2004**


**December 31,******


**(unaudited)**


**2003****Assets****Current Assets**Cash

$
325,793

$
400,407Accounts receivable


6,404,230


3,210,159Costs and estimated earnings in excessof billings on uncompleted contracts


780,507


941,635Officer receivable


218,404


214,562Prepaid expenses


173,117


96,337Employee and other receivables


104,998


95,4548,007,049


4,958,554**Non-Current Related Party Receivable**


1,699,230


1,669,343**Property and Equipment**


1,883,145


1,779,557Less: accumulated depreciation


(1,341,690
)

(1,219,301
)541,455


560,256**Other**Marketable equity securities


4,141


4,510Deferred tax asset


1,197,500


1,047,0001,201,641


1,051,510$
11,449,375

$
8,239,663See accompanying notes and accountant's review report.


5   **Zenex International, Inc.****Consolidated Balance Sheets****September 30, 2004****September 30,**
****
****
****
********
****
****
**2004**
****
****
**December 31,**
********
****
****
**(unaudited)**
****
****
**2003****Liabilities and Stockholder's Equity****Current Liabilities**Advances on line of credit

$
2,411,467

$
733,743Current portion of long-term debt


794,707


872,401Accounts and subcontract payables


2,240,196


1,696,051Accrued liabilities


420,504


285,179Insurance payable


103,886


42,579Income tax payable


161,597


161,597Billings in excess of costs and estimatedearnings on uncompleted contracts


1,697,161


202,6387,829,518


3,994,188**Long-Term Debt (Net of Current Portion)**


198,657


419,166**Stockholders' Equity**Preferred stock ($0.001 par value,20,000,000 shares authorized, no sharesissued and outstanding)


-


-Common stock ($0.001 par value,100,000 000 shares authorized,47,836,558 shares issued and outstandingat September 30, 2004 andDecember 31, 2003


47,836


47,836Paid-in capital


4,861,532


4,861,532Unrealized gain (loss) on available for salesecurities


(19,313
)

(18,945
)Retained earnings (deficit)


(1,468,855
)

(1,064,114
)3,421,200


3,826,309$
11,449,375

$
8,239,663See accompanying notes and accountant's review report.
 6
   **Zenex International, Inc.****************************************Consolidated Statements of Operations****************************************September 30, 2004 and 2003****Three Months Ended**
**Nine Months Ended****September 30,**
**September 30,****2004**
**2003**

**2004**

**2003****(Unaudited)**


**(Unaudited**)****
****

**(Unaudited**)****


**(Unaudited**)****
******Revenues**

$
5,392,243

$
6,817,313

$
11,770,216

$
14,769,609**Operating Expenses**Cost of sales


5,343,369


5,669,227


11,188,606


12,122,363Selling, general and administrative


100,195


108,444


1,087,052


780,137Warranty


16,254


33,474


78,383


65,5745,459,818


5,811,145


12,354,041


12,968,074**Operating Income (Loss)**


(67,575
)

1,006,168


(583,825
)

1,801,535**Other Income (Expense)**Interest income


662


17,607


38,273


56,923Gain (loss) on sale of assets


(15,550
)

-


(20,548
)

5,000Other income


5,238


5,604


18,006


12,377(9,650
)

23,211


35,731


74,300**Net Income (Loss) from Operations****Before Income Taxes**


(77,225
)

1,029,379


(548,094
)

1,875,835Income tax (expense) benefit


44,223


(679,450
)

130,805


(508,447
)**Net Income (Loss) Before****Discontinued Operations and****Sale of Discontinued Business**


(33,002
)

349,929


(417,289
)

1,367,388**Discontinued Operations**Gain (loss) on forgiveness of debt fromoperations net of income taxes


-


-


-


1,312,777Gain (loss) on sale of discontinuedoperations net of income taxes


-


(63,321
)

-


(1,190,335
)**Net Income (Loss)**


(33,002
)

286,608


(417,289
)

1,489,830See accompanying notes and accountant's review report
 7
   **Zenex International, Inc.********************************************************Consolidated Statements of Operations********************************************************September 30, 2004 and 2003******


**Three Months Ended**


**Nine Months Ended******


**September 30,**


**September 30,****2004**


**2003**


**2004**


**2003******


**(Unaudited)**


**(Unaudited**)****


**(Unaudited**)****
****

**(Unaudited**)****
******Other Comprehensive Income:**Unrealized holding gain (losses)


(82
)

2,460


(368
)

-Reclassification adjustment





-





-**Comprehensive Income (Loss)**

$
(33,084
)
$
289,068

$
(417,657
)
$
1,489,830**Primary Earnings (Loss) per Share**


nil

$
0.01

$
(0.01
)
$
0.03**Fully Diluted Earnings (Loss) per Share**

$
-

$
-

$
-

$
0.02**Earnings (Loss) per Share from****Discontinued Operations**

$
-

$
-

$
-

$
-**Earnings (Loss) per Share from****Continuing Operations**

$
-

$
0.01

$
-

$
0.03See accompanying notes and accountant's review report
 8   **Zenex International, Inc.****Consolidated Statements of Cash Flows********************September 30, 2004 and 2003****Nine Months Ended****September 30,****2004**


**2003****Cash Flows from Operating Activities**Net income (loss)

$
(417,289
)
$
1,489,830Reconciliation of net income to net cashprovided by operating activities:Depreciation and amortization


135,724


132,355Investments transferred for compensation





-Gain on sale of property and equipment


13,335


1,127,014Realized gain on forgiveness of debt


-


(1,317,777
)(Increase) Decrease from changes in:Accounts receivable


(3,194,071
)

(2,674,734
)Costs and estimated earnings in excess ofbillings on uncompleted contracts


161,128


(301,690
)Shareholder receivable


(3,842
)

1,828Officer receivable


-


1,759Income tax receivable


-


136,592Related party receivable


(29,887
)

(39,169
)Deferred taxes


(150,500
)

88,559Prepaid expenses


(76,780
)

56,959Employee and other receivables


(9,544
)

180,113Accounts payable


544,145


1,561,123Accrued liabilities


135,325


249,876Insurance payable


61,307


(106,055
)Billings in excess of costs and estimatedearnings on uncompleted contracts


1,494,523


(136,953
)Net adjustments to net income


(919,137
)

(1,040,200
)Net cash used by operating activities


(1,336,426
)

449,630See accompanying notes and accountant's review report  9
 **Zenex International, Inc.********************************Consolidated Statements of Cash Flows********************************September 30, 2004 and 2003****Nine Months Ended****September 30,****2004**


**2003****Cash Flows from Investing Activities**Proceeds from sale of property and equipment


-


5,000Purchase of property and equipment


(117,709
)

(81,383
)Net cash used by investing activities


(117,709
)

(76,383
)**Cash Flows from Financing Activities**Net change in line of credit


1,677,724


(424,990
)Proceeds from long-term debt


-


225,535Retirement of long-term debt


(298,203
)

(431,055
)Net cash provided by financing activities


1,379,521


(630,510
)**Net Increase (Decrease) in Cash**


(74,614
)

(257,263
)**Cash at Beginning of Period**


400,407


612,844**Cash at End of Period**

$
325,793

$
355,581**Supplemental Disclosure of Cash Flow****Information**Cash paid for:Interest

$
105,979

$
113,216Taxes

$
-

$
989**Supplemental Schedule of Non-Cash****Investing and Financing Activities**Fixed asset additions

$
-

$
38,803Liabilities assumed or incurred

$
-

$
38,803Common stock issued for services

$
-

$
35,000See accompanying notes and accountant's review report
 10





**Zenex International, Inc.**
**Notes to the Consolidated Financial Statements**
**September 30, 2004**





Note 1 -Summary of Significant Accounting Policies





**Organization and Nature of Business**




Zenex International, Inc. (formerly Zenex Telecom, Inc.) was incorporated on March 4, 1991, in the state of Colorado. On November 15, 2001, the shareholders approved the change of the corporate name from Lone Wolf Energy, Inc. to Zenex Telecom, Inc., which was changed on August 3, 2002, to Zenex International, Inc. (the "Company").




The Company, through a subsidiary, Aduddell Roofing & Sheet Metal, Inc., ("Aduddell Roofing"), is engaged in the commercial and industrial roofing and re-roofing businesses. The Company has been engaged in the telecommunications services industry through Zenex Long Distance, Inc. (d/b/a Zenex Communications, Inc.) ("Zenex Communications"). Aduddell Roofing was acquired in October 2002, and the Company subsequently discontinued the operations of Zenex Communications.




In accordance with the Agreement and Plan of Split-Off and Merger (the "Agreement"), the Company acquired Aduddell Roofing, through a transaction approved by the Boards of Directors of the Company and Aduddell Roofing. The Agreement was signed on September 27, 2002, and qualified as reorganization under the meaning of Section 368(a) of the Internal Revenue Service Code. Prior to closing the transaction, Aduddell Roofing formed a separate wholly owned subsidiary, Aduddell Holdings, and transferred and split-off certain non-operating assets and liabilities that were not retained in Aduddell Roofing after the merger. Tim Aduddell, the owner of 100% of the Aduddell Roofing common stock, transferred a portion of his common stock of Aduddell Roofing to Aduddell Roofing in exchange for 100% of the common shares of Aduddell Holdings to effect the split-off of the non-operating assets of Aduddell Roofing. Tim Aduddell also transferred his remaining common stock of Aduddell Roofing to a newly formed subsidiary of the Company, AR Acquisition Corp. ("Sub") in exchange for 10.0 million shares of common stock and options to purchase 30.0 million shares of common stock for $0.04 per share. The purchase method of accounting was used for the business combination. The transaction was recorded at $2,928,840, the fair value of the acquired net assets of Aduddell Roofing. Subsequent to the exchange, Aduddell Roofing merged into the Sub and Aduddell Roofing became the surviving corporation. Subsequent to the merger, Aduddell Roofing became a wholly owned subsidiary of the Company and Aduddell Holdings a 100% owned company of Tim Aduddell.




The purpose of the merger was to effect the acquisition by the Company of Aduddell Roofing & Sheet Metal, Inc., after splitting off the non-operating assets of Aduddell Roofing into a separate company to be owned by Tim Aduddell.


11   **Zenex International, Inc.**
**Notes to the Consolidated Financial Statements**
**September 30, 2004**


Note 1 -Summary of Significant Accounting Policies(continued)






Zenex Communications entered into agreements (the "Red River Agreements") as discussed in Note 17 with Red River Networks, LLC ("Red River") to effectively transfer the operations of the telecommunication segment of the Companys operations to Red River on November 25, 2002.




The Companys September 30, 2004 and December 31, 2003 consolidated balance sheets include Aduddell Roofing. The assets of Zenex Communications and approximately $407,900 of note and accounts payable were sold and assumed in April 2003 pursuant to the Red River Agreements. The consolidated statements of operations for the three and nine months ended September 30, 2004 includes Aduddell Roofing. The consolidated statements of operations for the three and nine months ended September 30, 2003, includes Aduddell Roofing and the discontinued operations of Zenex Communications. All significant inter-company accounts have been eliminated in the consolidated financial statements. The consolidated financial statements include all adjustments, which, in the opinion of management are necessary in order to make the statements not misleading.




**Revenue Recognition**




Aduddell Roofing recognizes fixed price contract revenues on the percentage-of-completion method of accounting, measured by the percentage of cost incurred to date to the estimated total cost for each contract. Management uses this method because total cost is considered to be the best available measure of progress on the contracts. Revenues from cost-plus-fee contracts are recognized on the basis of costs incurred during the period plus the fee earned, measured by the cost-to-cost method.




Contract costs include all direct material and labor costs and those indirect costs related to contract performance such as indirect labor, interest, depreciation and supplies. General and administrative costs are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions, and estimated profitability may result in revisions to costs and income, which are recognized in the period in which the revisions are determined.




The asset "Costs and estimated earnings in excess of billings on uncompleted contracts" represents revenues recognized in excess of amounts billed. The liability, "Billings in excess of costs and estimated earnings on uncompleted contracts" represents billings in excess of revenues recognized.


12   **Zenex International, Inc.**
**Notes to the Consolidated Financial Statements**
**September 30, 2004**


**Cash and Cash Equivalents**




The Company considers all highly liquid debt or equity instruments purchased with an original maturity at the date of purchase of 90 days or less to be cash equivalents.




**Fair Value of Financial Instruments**




The Compan ys financial instruments include cash, receivables, notes receivable, marketable securities, short-term payables and notes payable. The carrying amounts of cash, receivables, and short-term payables approximate fair value due to their short-term nature. Marketable equity securities fair values are estimates based on quoted market prices. The carrying amounts of notes receivable and payable approximate fair value based on interest rates currently available.




**Advertising Cost**




Advertising costs are expensed when incurred as selling, general and administrative expenses in the accompanying statements of operations.




**Income Taxes**




The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. This statement prescribes the use of the liability method whereby deferred tax assets and liabilities are determined based on the differences between financial reporting and tax bases of assets and liabilities and measured at tax rates that will be in effect when the differences are expected to reverse. Valuation allowances are established, when necessary, to reduce deferred tax assets when it is more likely than not that the deferred tax asset will not be realized.




**Net Income (Loss) Per Share**




The Company computes net income (loss) per share in accordance with SFAS No. 128, Earnings per Share and SEC Staff Accounting Bulletin No. 98 ("SAB 98"). Under the provisions of SFAS No. 128 and SAB 98, basic net income (loss) per share is calculated by dividing net income (loss) available to common shareholders for the period by the weighted average number of common shares outstanding during the period.




**Concentrations**




In connection with providing service to customers, Aduddell Roofing does not have contractual agreements with suppliers. The material and supplies used in the business are readily available from several vendors.


13   **Zenex International, Inc.**
**Notes to the Consolidated Financial Statements**
**September 30, 2004**




Note 1 -Summary of Significant Accounting Policies(continued)




Although Aduddell Roofing had a significant number of customers for the period ended September 30, 2004, four customers accounted for 68% revenue. Two customers accounted for 64% of the revenue for the period ended September 30, 2003.




The Companys receivables at September 30, 2004, and December 31, 2003, are from a small number of companies in various industries, which could be subject to business cycle variations. As of September 30, 2004, the Company had four customers that accounted for 73% of the customer accounts receivable. As of December 31, 2003, the Company had four customers that accounted for 79% of the customer accounts receivable. This concentration subjects the Company to a credit risk if the general economy or the companies fail to perform.




**Use of Estimates**




The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.




**Segment Information**




Effective January 1, 1998, the Company adopted the provisions of SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. The Company identifies its operating segments based upon business activities, management responsibilities and geographical location. Net income from continuing operations reflects the operations of Aduddell Roofing, the single business segment in which the Company operates at September 30, 2004.




**Reclassifications**




Certain reclassifications have been made to the prior period financial statements to conform to the current period presentations. No reclassifications have been made within the current period presentations.


14   **Zenex International, Inc.**
**Notes to the Consolidated Financial Statements**
**September 30, 2004**


Note 2 -Contract Receivables




**Billed contract receivables consist of:**


**September 30,**

**December 31,****2004**


**2003**Completed contracts

$
2,080,596

$
896,850Contracts in progress


4,056,729


1,933,418Retainage


266,905


379,891Less allowance for doubtful amounts


**-**


-$
6,404,230

$
3,210,159


Note 3 -Shareholder and Related Party Receivable




Advances to a company partially owned by the Companys majority shareholder totaled $1,669,343 as of September 30, 2004, and December 31, 2003. The advances are secured by marketable securities and shareholder guaranty bearing interest at the federal mid-term rate. The note matures on January 1, 2007.




Note 4 -Uncompleted Contracts




Costs, estimated earnings, and billings on uncompleted contracts, are as follows:


**September 30,**

**December 31,****2004**

**2003**Costs incurred on uncompleted contracts

$
4,126,638

$
5,895,844Estimated earnings (loss)


2,506,490


503,1196,633,128


6,398,963Billings to date


7,549,783


5,659,966$
(916,655
)
$
738,997
 15   **Zenex International, Inc.**
**Notes to the Consolidated Financial Statements**
**September 30, 2004** ****
 **Note 4 - Uncompleted Contracts (continued)**





Included in the accompanying balance sheet under the following captions:


**September 30,**

**December 31,****2004**


**2003**Costs and estimated earnings in excess ofbillings on uncompleted contracts

$
780,506

$
941,635Billings in excess of costs and estimatedearnings on uncompleted contracts


(1,697,161
)

(202,638
)$
(916,655
)
$
738,997


Note 5 -Property and Equipment




Property and equipment are recorded at cost. Expenditures for repairs and maintenance are charged to operations when incurred. Major improvements and renewals that extend the useful life of the related asset are capitalized and depreciated over the remaining useful life. Depreciation and amortization are computed for financial and income tax reporting purposes using straight-line and accelerated methods over estimated useful lives ranging from five to ten years. Depreciation expense for the nine months ended September 30, 2004, was $145,223.




The following table summarizes the classifications of property and equipment, total accumulated depreciation and the related estimated useful lives:


**September 30,**

**December 31,****2004**


**2003**


**Years**Machinery and equipment

$
465,869

$
489,129


5-10Office furniture and equipment


191,433


162,345


5-7Transportation equipment


1,196,434


1,098,674


5Leasehold improvements


29,409


29,409


51,883,145


1,779,557Less: accumulated depreciation


1,341,690


1,219,301Net property and equipment

$
541,455

$
560,256
 16  **Zenex International, Inc.**
**Notes to the Consolidated Financial Statements**
**September 30, 2004**


Note 6 -Marketable Equity Securities




The Companys securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities. Trading securities are recorded at fair value on the balance sheet in current assets, with the change in fair value during the period included in earnings. Securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and recorded at amortized cost in investments. Securities not classified as held-to-maturity or trading are classified as available-for-sale. Available-for-sale securities are recorded at fair value on the balance sheet with the change in fair value during the period excluded from earnings and reported as a separate component of Shareholders Equity. All of the Companys securities are classified available-for-sale at September 30, 2004 and December 31, 2003. Unrealized holding losses on these securities totaled $19,313 and $18,945 at September 30, 2004 and December 31, 2003, respectively.




Note 7 -Line of Credit




The Company has $3,500,000 in revolving lines of credit. The lines bears interest at 1.25% and 2.25% over the Wall Street Journal Prime Rate (currently 7% and 6%) and is secured by all accounts, property and equipment and shareholder guaranty. The line matures on November 14, 2004. Outstanding advances totaled $2,411,467 and $733,743 at September 30, 2004 and December 31, 2003, respectively.




Note 8 -Long-Term Debt




The Company has the following long-term debt as of:


September 30,
2004

December 31,
2003Note payable secured by all assets of Zenex Communications and the personal guaranty of certain Directors, bearing interest at 1.5% over Wall Street Journal Prime with a minimum of 6% due in monthly installments of $8,673 through June 30, 2006

$
398,060

$
450,000Note payable secured by all accounts,equipment and general intangibles, bearing
interest at 2.75% over New York Prime(6.75%) due in monthly installments of
$17,581 through November 2006


418,108


565,473


17




**Zenex International, Inc.**
**Notes to the Consolidated Financial Statements**
**September 30, 2004**




Note 8 -Long-Term Debt(continued)





September 30,
2004


December 31,
2003Notes payable to shareholder bearing interest at 5% due in monthly installments of $5,000 through March 2005 with a balloon payment of $120,000 in September 2005


145,883

204,5690% to 8.99% fixed rate notes secured by transportation equipment due in varying monthly installments through Sept. 2005


31,313

64,3794% fixed rate note secured by equipment, due in monthly installments of $1,825 through May 2004


-

7,146993,364

1,291,567Less: current portion of long-term debt


794,707

872,401$
198,657

$419,166




Maturities of long-term debt as of September 30, 2004, are as follows:


Year

Amount2006

$
176,0082007


22,649$
198,657




Interest expense for the nine months ended September 30, 2004 was $105,979.




Note 9 -Income Taxes




At December 31, 2003, the Company had net operating losses of approximately $3,700,000 available to reduce future federal and state taxable income. Unless utilized, the carry forward amounts will begin to expire in 2012. For federal and state tax purposes, some of the Companys net operating loss carry forward amounts are subject to an annual limitation due to a greater than 50% change in stock ownership, as defined by federal and state tax law.




Under the provisions of FAS-109, Accounting for Income Taxes, deferred tax liabilities and assets are measured using the applicable tax rate based on the taxable and deductible temporary differences and operating loss carry forward


18




**Zenex International, Inc.**
**Notes to the Consolidated Financial Statements**
**September 30, 2004**




Note 9 -Income Taxes(continued)




amounts. Taxable temporary differences result principally from the excess of depreciation for tax purposes over the amount deducted for financial reporting purposes. Deductible temporary differences and the operating loss carry forward, giving rise to the deferred tax assets, are reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax assets will not be realized.




The components of the net deferred tax asset are as follows:


**September 30,**

**December 31,****2004**

**2003**Deferred tax liability on depreciation




$
(50,000
)
$
(48,000
)Deferred tax asset for loss carry





1,420,000


1,340,150Deferred tax asset





1,370,000


1,292,150Less: valuation allowance





172,500


245,150Net deferred tax asset




$
1,197,500

$
1,047,000


The Company has established a valuation allowance for a portion of its net deferred tax asset due to the ownership changes limitation on the use of the loss carry forward.




Note 10 -Backlog




The estimated gross revenue on work performed on signed contracts at September 30, 2004, was $9,073,000.





Note 11 -Earn-Out Conversion




Prestige, a wholly owned subsidiary of the Company, acquired Zenex Communications on February 19, 1999. The terms of the acquisition included a provision whereby the sellers may earn additional amounts if the cumulative collected gross sales revenue reaches certain levels, (the "earn-out rights"). In accordance with the Agreement, $317,647 in earn-out rights was due on December 30, 2001.


19   **Zenex International, Inc.**
**Notes to the Consolidated Financial Statements**
**September 30, 2004**


Note 11 -Earn-Out Conversion(continued)






In August 2002, an Agency Agreement was signed with a related party, (the "Agent") for assistance in commercial debt restructuring and conversion of the earn-out rights obligation into equity. Under the terms of the Agency Agreement, the Agent contacted and offered a Conversion Agreement to the former shareholders of Prestige. The Agent is to be compensated with 700,000 shares of common stock. The deemed value of the conversion is $0.52 per share. Under the terms of the Conversion Agreement, certain former Prestige shareholders converted their earn-out rights to Company stock. 1,794,268 shares of common stock were issued for the conversion and 700,000 shares issued under the Agency Agreement. As of September 30, 2004, approximately 89% of the former Prestige shareholders agreed to the conversion.




Note 12 -Commitments and Contingencies




In regard to the Red River sale discussed in Note 17, the Company is the guarantor on notes totaling approximately $317,000. In the event that Red River does not sign the option agreement and execute an operating agreement, the Company will be required to service approximately $7,000 in monthly principal and interest payments.




The Company warrants its work in the normal course of business. In management's opinion, there were no outstanding claims, which would have a material effect on the Company's operations or financial position.




The Company maintains cash balances at several banks. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $100,000. Any amounts in excess of this would not be insured if the institution should fail.




20   **Zenex International, Inc.**
**Notes to the Consolidated Financial Statements**
**September 30, 2004**





Note 13 -Earnings Per Share


**September 30,**

**September 30,****2004**


**2003**Primary earnings per share: (in thousands)Common shares outstanding


47,836,558


47,836,558Weighted average shares outstanding


47,836,558


47,836,558Earnings (loss) per share

$
(0.01
)
$
0.030Fully Diluted earnings per share:Common shares outstanding


78,536,558


78,536,558Weighted average shares outstanding


78,536,558


78,536,558Earnings (loss) per share

$
-

$
0.017


Note 14 -Letter of Credit




At September 30, 2004 the Company had a $175,000 letter of credit issued to its insurance carrier that matures on January 16, 2005.




Note 15 -Stock Options




In accordance with the terms of a January 2001 loan agreement with a shareholder, a five-year option was granted for the purchase of 1,200,000 shares of the Companys common stock for $0.10 per share.




In connection with the terms of the Agreement and Plan of Split Off and Merger, signed September 27, 2002, Tim Aduddell was granted an option to purchase 30,000,000 shares of common stock for $0.04 per share.




In connection with the financing of certain equipment, 200,000 options at $0.08 per share were granted.




Note 16 -Related Party Transaction




Aduddell Roofing leases office and warehouse space from Aduddell Holdings, Inc., a corporation wholly-owned by Tim Aduddell, a majority shareholder of the Company. The lease is for one year and expires on September 30, 2004. The




21


**Zenex International, Inc.**
**Notes to the Consolidated Financial Statements**
**September 30, 2004**





Note 16 -Related Party Transaction(continued)




monthly lease payments are $16,250. For the nine months ended September 30, 2004 rent expense totaled $146,250.




Note 17 -Discontinued Operations




Zenex Communications, a subsidiary of the Company, entered into three agreements (the "Red River Agreements") with Red River Networks, LLC ("Red River"), an Oklahoma limited liability company, effective November 25, 2002. Red River provides consulting and related services in the long distance telecommunications industry. Zenex Communications is the owner of direct long distance services and prepaid accounts and is in the business of providing long distance telecommunications, in part, by means of its own switching equipment. Zenex Communications was unable to pay the amount owed to Global Crossings Bandwidth, Inc. ("Global"), Zenex Communications primary carrier of long distance traffic. In an attempt to prevent the termination of services from Global and to allow Zenex Communications to continue to operate in a limited fashion and windup its affairs in an orderly manner, Zenex Communications and Red River agreed that (a) Red River would acquire Zenex Communications Customers (Book of Business) under the Purchase Agreement (b) Zenex Communications would issue to Red River an option to acquire Zenex Communications equipment under the terms of an Option Agreement, and (c) Zenex Communications would retain Red River to provide certain services on the terms and conditions set forth in the Service Agreement. The three agreements effectively terminated the telecommunications segment of the Company.




**Purchase Agreement**




Under the terms of the Purchase Agreement, Red River agreed to pay Global $27,843 to prevent the immediate termination of Zenex Communications long distance services and to buy Zenex Communications Book of Business, which includes all of the Customers and pre-paid accounts of Zenex Communications.




**Option Agreement**




Under the terms of the Option Agreement (the "Option"), Zenex Communications granted Red River the exclusive and irrevocable option to purchase all of Zenex Communications rights, title, and interest in certain switching and telecommunications equipment used in the direct long distance service provided by Zenex Communications. Additionally, Red River was to assume certain promissory notes with a remaining balance of approximately $317,000. The




22


**Zenex International, Inc.**
**Notes to the Consolidated Financial Statements**
**September 30, 2004**




Note 17 -Discontinued Operations(continued)




option expired on April 30, 2003, and there is no assurance that Red River will sign the option agreement.




**Service Agreement**




Under the terms of the Service Agreement, Red River agreed to provide to Zenex Communications on a nonexclusive basis, services relating to the operations of the equipment under the Option Agreement for the benefit of the Book of Business purchased by Red River under the Purchase Agreement. Zenex Communications agreed to pay Red River a fee in the amount of the accounts receivable outstanding at November 25, 2002, approximately $632,000, and all accounts receivable arising during the term of the Service Agreement. Additionally, Zenex Communications directed Red River to pay certain operating and debt service costs of Zenex Communications.























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**Item 2. Managements Discussion and Analysis**




We are engaged in the commercial and industrial roofing and re-roofing businesses through Aduddell Roofing & Sheet Metal, Inc. ("Aduddell Roofing"). The terms "Zenex", "we", "our" and "us" and other similar terms refer to Zenex International, Inc. and its direct and indirect subsidiaries, unless we specify otherwise. Zenex (R) is our registered trademark. All other trade names, trademarks and product names in this report are the property of their respective owners.




**Forward-Looking Statements**




This quarterly report on Form 10-QSB includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), which can be identified by the use of forward-looking terminology such as: "may", "might", "could", "would", "believe", "expect", "intend", "plan", "seek", "anticipate", "estimate", "project" or "continue" or the negative thereof or other variations thereon or comparable terminology. All statements other than statements of historical fact included in this quarterly report on Form 10-QSB, including without limitation, the statements under "Item 2. Managements Discussion and Analysis " regarding our financial position and liquidity, are forward-looking statements. These forward-looking statements also include, but are not limited to:




·
our ability to expand Zenexs business;




·
actions of our competitors; and




·
statements regarding our anticipated revenues, expense levels, liquidity and capital resources and projections of when we will achieve break-even or positive operating cash flow.




Although we believe the expectations reflected in such forward-looking statements are reasonable, we can give no assurance such expectations will prove to have been correct. Important factors with respect to any such forward-looking statements, including certain risks and uncertainties that could cause actual results to differ materially from our expectations (Cautionary Statements), are disclosed in this quarterly report on Form 10-QSB.




These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the Cautionary Statements. See "Risk Factors" in our annual report on Form 10-KSB for further information regarding risks and uncertainties related to our businesses.


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The following discussion should be read in conjunction with our consolidated financial statements and notes thereto.




**Introduction**




Our revenues are derived primarily from comprehensive roofing services, including re-roofing, restoration and repair, new roof construction, sheet metal fabrication and waterproofing. We also provide limited residential roofing services. We also offer maintenance services, which provide recurring revenues and ongoing interaction with our customers. Almost all our revenues for the nine months ended September 30, 2004, were derived from re-roofing, restoration, and repair services.




Revenues from fixed-price construction and renovation contracts are generally accounted for on a percentage-of-completion basis using the cost-to-cost method. The cost-to-cost method measures the percentage completion of a contract based on total costs incurred to date compared to total estimated costs to completion. Cost of revenues consists primarily of compensation and benefits to field staff, materials, subcontracted services, parts and supplies, depreciation, fuel and other vehicle expenses and equipment rentals. Our gross profit percentage, which is gross profit expressed as a percentage of revenues, depends primarily on the relative proportions of costs related to labor and materials. On jobs in which a higher percentage of the cost of revenues consists of labor costs, we typically achieve higher gross margins than on jobs where materials represent more of the cost of revenues. Margins are also affected by the competitive bidding process and the technical difficulty of the project. New roof construction work is more likely to be competitively bid than re-roofing, restoration and repair. Typically, re-roofing, restoration and repair jobs are more labor intensive and have higher margins than new roof construction.




**Seasonal and Climatic Factors Affecting the Commercial Roofing Industry**




The construction industry, including the roofing industry, is influenced by seasonal factors, as construction activities are usually lower during winter months than other periods. We attempt to increase winter productivity by concentrating our business in the southern half of the United States and by expanding our sales and marketing efforts. Nevertheless, we expect our revenues and operating results generally will be lower in the first and fourth quarters. The roofing industry is also affected by natural disasters, such as tornadoes, hurricanes and other windstorms. Because of the need for immediate repairs and since the costs of repair are typically covered by insurance, the margins are higher on disaster-related work than on discretionary work. Since disaster-related work requires an immediate response, we must maintain a capacity sufficient to respond to these needs. The absence of natural disasters will result in lower revenues, unused capacity, the acceptance of low margin work, and higher relative operating expenses.




**Retention**




Retention is typically required by roofing contracts for commercial construction. Retention (defined as amounts withheld from progress billings until final and satisfactory contract completion) is typical on new commercial construction work for both the sheet metal


25




and roofing operations. Retention typically ranges from 5% to 10% of the contract, and may be reduced at the time of final billing of our portion of the contract. The balance may be held until final closeout of the project, including the work of other subcontractors. The amount of retention will vary based upon the mix and timing of contract completion.




**Discontinued Operations**




Before the acquisition of Aduddell Roofing effective October 1, 2002, we were primarily engaged in the wholesale of telecommunication services through a subsidiary, Zenex Communications. In 2001, Zenex Communications lost its largest customer, and never fully recovered in a struggling industry.




To facilitate continued service to its customers and permit an orderly winding up of its affairs, Communications entered into several agreements with Red River Networks, LLC, an unaffiliated entity, in November 2002. Under these agreements, Red River purchased Communications service contracts (its customers) for $27,843 and acquired an option to purchase Communications switching and other telecommunications equipment for the assumption of office leases and $525,000 in borrowings that are guaranteed by a third party and the Company. The bank was unwilling to refinance the loans to Red River and therefore required the third party guarantor to refinance the loans. The Red River option expired on April 30, 2003. While the parties have continued negotiations since the expiry and management believes the Red River transaction will be closed, there is no assurance that Red River will sign an operating lease to provide funds to pay the obligations. In the event Red River does not agree to continue operating the business, we would again become responsible for paying the borrowing obligations that Red River is currently paying.




**Critical Accounting Policies and Estimates**




General. Our discussion and analysis of financial condition and results of operations are based upon our December 31, 2003 consolidated balance sheet, which was prepared in accordance with accounting principles generally accepted in the United States, and our financial statements for the nine months ended as of September 30, 2004 and 2003, that are reviewed in accordance with The Standards of the Public Company Accounting Oversight Board (United States). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to allowance for doubtful accounts, the useful lives of fixed assets, impairment of long-lived assets and income taxes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.




We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.


26




*Revenue Recognition.* We recognize fixed price contract revenues on the percentage-of-completion method of accounting, measured by the percentage of cost incurred to date to the estimated total cost for each contract. We consider the total cost method to be the best available measure of progress on the contracts. We recognize revenues from cost-plus-fee contracts based on costs incurred during the period plus the fee earned, measured by the cost-to-cost method.




We are working in Florida under Federal Emergency Management Agency arrangements made in response to the hurricane damage that occurred this summer. These arrangements pay providers based on the square footage of roofing material installed. There is no contract and we are accruing revenues as costs are incurred.




Contract costs include all direct material and labor costs and those indirect costs related to contract performance, such as indirect labor, interest, depreciation and supplies. Our general and administrative costs are charged to expense as incurred. We make provisions for estimated losses on uncompleted contracts in the period in which such losses are determined. Changes in job performance, job conditions, budgeting variances and estimated profitability may result in revisions to costs and income, which we recognize in the period in which the revisions are determined.




The asset "Costs and estimated earnings in excess of billings on uncompleted contracts" represents revenues recognized in excess of amounts billed. This asset occurs when revenues, as determined by the percentage-of-completion method, exceed the actual billings. The liability "Billings in excess of costs and estimated earnings on uncompleted contracts" represents billings in excess of revenues recognized. This liability occurs when actual billings exceed accrued revenues. Property and Equipment. Property and equipment are stated at cost, net of accumulated depreciation and amortization. Property and equipment are depreciated using straight-line and accelerated methods over the estimated useful lives of the assets, which range from five to ten years.




*Changes from the Prior Period.* We have not made any material changes to our critical accounting estimates or assumptions or the judgments affecting the application of those estimates or assumptions.




**Results of Operations**




*Revenues for the Quarter Ended.* The revenues for the three months ended September 30, 2004, were $5,392,243 compared to revenues of $6,817,313 for the period ended September 30, 2003. Our revenues are significantly affected by the presence and absence of tornado, hurricane and other storm damage within the southern United States. Our third quarter 2003 revenues were higher than expected due to substantial tornado and storm damage in Oklahoma. Storm damage did not significantly affect our third quarter 2004 revenues. We have a large amount of hurricane related work in Florida, but this work did not begin in earnest until mid-September 2004. Our third quarter results reflect the some seasonal variation, in which revenues in the second and third quarters - when the warmer weather favors construction activity - generally improve over the first and fourth quarters. The hurricane related work will, however, result in an exception to the season trends. We expect at least $6.0 million in hurricane related revenue in the fourth quarter, which will depart from prior fourth quarter trends.


27




*Operating Expenses for the Quarter Ended.* Operating expenses for the three months ended September 30, 2004, were $5,459,818 compared to expenses of $5,811,145 for the three months ended September 30, 2003. Operating expenses as a percentage of sales for the three months ended September 30, 2004 and 2003 were 101% and 85%, respectively. Since we must maintain capacity to perform when natural disasters occur, our costs are less elastic and do not normally move in direct correlation with our revenues. Operating expenses were relatively static, but were affected by increases in insurance costs, specifically workers compensation and general liability, higher fuel costs and labor costs.  We are expanding our market and building relationships, which we believe will improve our profit margins over the long term.




*Net Loss/Income for the Quarter Ended.* The net loss for the three months ended September 30, 2004, was $33,002 compared to net income of $286,608 for the three months ended September 30, 2003. The decrease in income was attributable to relative absence of storm related roofing work in the 2004 period compared to the 2003 period.




*Revenues for the Nine Months Ended.* The revenues for the nine months ended September 30, 2004, were $11,770,216 compared to revenues of $14,769,609. Our revenues for the first nine months of 2003 were higher than the 2004 period due to the high revenues realized in the second quarter of 2003, which resulted from substantial tornado and storm damage during that quarter. We see similar events beginning in the third quarter of 2004 and carrying over to the fourth quarter 2004 resulting from the hurricane related activity in Florida. This work did not begin in earnest, however, until mid-September 2004. The revenues for the nine months ended September 30, 2003, were aided substantially by roofing work generated due to tornado damage during the second quarter of that year. We have expanded our sales and marketing efforts in both existing and new markets. We believe that this strategy will offset some of the seasonal variations and afford improved long-term results.




*Operating Expenses for the Nine Months Ended.* Operating expenses for the nine months ended September 30, 2004, were $12,354,041 compared to expense of $12,968,074 for the nine months ended September 30, 2003. Operating expenses as a percentage of sales for the nine months ended September 30, 2004 and 2003 were 105% and 88% , respectively. The 2004 expenses were slightly higher due to the relative absence of storm related roofing work, the need to maintain sufficient response capacity, and our relatively inelastic labor and overhead costs. Again, our operating expenses were also adversely affected by increases in insurance costs, specifically workers compensation and general liability, travel costs (including added fuel expense) and labor costs. We were particularly impacted by lower profit margins on work that we sought to expand our market base and keep employees working.




*Net Loss/Income for the Nine Months Ended.* The net loss for the nine months ended September 30, 2004, was $417,289 compared to net income of $1,489,830 for the nine months ended September 30, 2003. The net income for the first nine months of 2003 includes $122,442 from the disposition and discontinued operations of Zenex Communications.


28




*Discontinued Operations.* The operations of Zenex Communications were discontinued in the fourth quarter of 2002. The discontinued operations had no affect upon 2004 operations. For the nine months ended September 30, 2003, we realized a net gain of $122,442 from the disposition and discontinued operations. The net gain includes a loss on the sale of discontinued operations $1,190,335 and a gain from the forgiveness of debt due to the insolvency filing of Zenex Communications of $1,312,777.




*Off-Balance Sheet Arrangements.* There have been no material changes to the off-balance sheet arrangements (consisting of operating leases and a loan guaranty) that we discussed in our annual report on Form 10-KSB.




**Liquidity and Capital Resources**




From December 31, 2003 to September 30, 2004, total assets increased from $8,239,663 to $11,449,375, current liabilities increased from $3,994,188 to $7,829,518 and shareholders equity decreased from $3,826,309 to $3,421,200. Cash and accounts receivables increased from $3,610,566 to $6,730,023. The increase in assets generally results from a nearly doubling in the accounts receivable from $3,210,159 to 6,404,230. The increase in current liabilities results from an increase in our credit line from $733,743 to $2,411,467 and in our accounts payables from $1,696,051 to $2,240,196. The changes largely result from our hurricane related work in Florida. The work only began in earnest in mid-September 2004 and at September 30, 2004, and during the periods then ended, has had a greater affect on our balance sheet than our income statement.




For the nine months ended September 30, 2004, net cash used by operating activities was $1,336,426. Net cash used for investing activities was $117,709. Net cash provided by financing activities during this period was $1,379,521, which came from line of credit advances. At September 30, 2004, we had working capital of $117,531 compared to $964,366 at December 31, 2003.




The decrease in working capital was due to the operating loss sustained during the nine months ended September 30, 2004 and excess billings on contracts. The operating loss in 2004 was primarily attributable to the absence of weather related roofing work during much of the period (the hurricane activity began in earnest in mid-September 2004), in greater over-billings than under-billings ($916,655), and the costs of maintaining capacity sufficient to respond to roofing damage resulting from natural disasters. Despite the working capital decrease, our liquidity is sufficient and we have sufficient capital resources, including excess capacity under our line of credit. We expect work-in-progress in Florida will significantly increase liquidity in the fourth quarter 2004.




**Item 3. Controls and Procedures**




As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of the filing date of this report, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. This evaluation was carried out under the supervision and with the participation of our principal executive officer and our principal financial officer, who concluded that our disclosure controls and procedures are effective. There have been no significant changes in our internal controls or in other factors, which could significantly affect internal controls subsequent to the date we carried out our evaluation.


29




Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commissions rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including our principal executive officer and our principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.




**PART II - OTHER INFORMATION**








**Item 6. Exhibits**






31.1  Rule 13a-14(a) Certifications




32.1  Section 1350 Certification




**SIGNATURES**







In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.




Zenex International, Inc.Date: 
November 19, 2004
By:
/s/ Ron CarteRon CartePresident







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**EXHIBIT INDEX**














Exhibit No. Description




31.1  Section 302 Certifications




32.1  Section 1350 Certification































31