UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-K

Commission file number 1-5725

Q UANEX CORPORATION

(Exact name of registrant as specified in its charter)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

NONE

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ý  No o

The aggregate market value of the voting common equity held by non-affiliates as of April 30, 2004, computed by reference to the closing price for the Common Stock on the New York Stock Exchange, Inc. on that date, was $664,151,147. Such calculation assumes only the registrant’s officers and directors were affiliates of the registrant.

At November 30, 2004, there were outstanding 16,621,222 shares of the registrant’s Common Stock, $.50 par value.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive Proxy Statement, to be filed with the Commission within 120 days of October 31, 2004, for its Annual Meeting of Stockholders to be held on February 24, 2005, are incorporated herein by reference in Items 10, 11, 12, and 13 of Part III of this Annual Report.

TABLE OF CONTENTS

PART I

Item 1.            Business

General

Quanex was organized in 1927 as a Michigan corporation under the name Michigan Seamless Tube Company. The Company reincorporated in Delaware in 1968 under the same name and then changed its name to Quanex Corporation in 1977. The Company’s executive offices are located at 1900 West Loop South, Suite 1500, Houston, Texas 77027. References made to the “Company” or “Quanex” include Quanex Corporation and its subsidiaries unless the context indicates otherwise.

The Company’s businesses are managed on a decentralized basis. Each operating division has administrative, operating and marketing functions. The Company measures each division’s return on investment and seeks to reward superior performance with incentive compensation, which is a significant portion of total compensation for salaried employees. Intercompany sales are conducted on an arms-length basis.  Operational activities and policies are managed by corporate officers and key division executives. Also, a small corporate staff provides corporate accounting, financial and treasury management, tax, legal and human resource services to the operating divisions.

Quanex is a technological leader in the production of engineered carbon and alloy steel bars, aluminum flat-rolled products, flexible insulating glass spacer systems, and precision-formed metal and wood products which primarily serve the vehicular products and building products markets. The Company uses state-of-the-art manufacturing technologies, low-cost production processes, and engineering and metallurgical expertise to provide customers with specialized products for specific applications. Quanex believes these capabilities also provide the Company with unique competitive advantages. The Company’s growth strategy is focused on the continued development of its two target markets, vehicular products and building products, and protecting, nurturing and growing its core businesses that serve those markets.

Business Developments

In the Company’s Vehicular Products segment, rotary centrifugal continuous casters are used at two of the plants (Fort Smith, Arkansas and Jackson, Michigan) with an in-line manufacturing process to produce bearing grade quality, seam-free, engineered carbon and alloy steel bars that enable Quanex to participate in the higher margin portions of the vehicular products market. Since 1990, the Company has invested approximately $310 million to enhance its steel bar manufacturing and refining processes, to improve rolling and finishing capability, and to expand shipping capacity to approximately 740,000 tons per year, 285,000 of which is value-added MACPLUS capacity. Phases I through VII of the MACSTEEL expansions have been completed.

On December 31, 2003, the Company completed the acquisition of a mini-mill steel facility, renamed MACSTEEL Monroe, that can produce 500,000 tons of special bar quality and engineered steel bars in diameters from 0.5625 to 3.25 inches.  The Monroe facility supports and benefits a core business and expands the range of high quality engineered steel bar products available to the Company’s customers.  MACSTEEL Monroe’s production of smaller diameter bars complements the Company’s existing 1.5 inch to 6 inch size range and expands the customer base and product offerings.

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The Phase VIII capital project was announced in September 2004.  Phase VIII will increase the annual capacity of the Ft. Smith, Arkansas facility by 40,000 tons, thereby increasing total engineered bar shipping capacity to more than 1.3 million tons.  In addition to an increase in capacity, the Phase VIII modernization will improve production flow and further enhance quality.  Specifically included in the project are upgrades to the rotary continuous caster, direct rolling mill, and metallurgical refining areas.

On December 31, 2003, the Company completed the acquisition of TruSeal Technologies, Inc. (“TruSeal”), a manufacturer of patented and trademarked flexible insulating glass spacer systems and sealants for vinyl, aluminum, and wood windows.  TruSeal has been integrated into the Engineered Products division within the Building Products segment.  The Company acquired TruSeal to further expand the broad range of high quality components and products currently supplied to existing customers and to provide customer diversification.  TruSeal has a broad presence in the vinyl and aluminum window markets, whereas prior to the acquisition, the Company’s niche was primarily with the wood window original equipment manufacturers (“OEMs”).

In the third quarter of fiscal 2004, the Company announced its plan to restructure and sell the Piper Impact division.  Prior to the announcement, Piper Impact included two impact-extrusion facilities in New Albany, Mississippi, dedicated to aluminum and steel impact-extruded products.  As part of the plan, the production was consolidated from the two facilities into a single location during the latter half of fiscal 2004.  This was necessary because of the decline in business with its major automotive and ordnance customers. Going forward, Piper will concentrate on promising, high growth market opportunities; however, their market focus will no longer align with Quanex’s strategic direction of serving the vehicular products and building products markets and therefore, we plan to sell the division.  The Company received a Letter of Interest from a potential buyer and is currently in the process of negotiating a definitive agreement.

On September 30, 2004, the Company completed the sale of its Nichols Aluminum Golden operation located in Fort Lupton, Colorado.  Operations at the facility include scrap melting and casting aluminum into sheet, cold rolling to specific gauge, annealing, leveling, custom coating and slitting to width. Nichols Aluminum Golden manufactures high quality aluminum sheet from scrap, then finishes the sheet for specialized applications primarily for food packaging markets.  While the business was profitable, it did not fit with the long-term strategic direction of Quanex.  As evidenced by the planned sale of Piper Impact and the completed sale of Nichols Aluminum Golden, the Company intends to focus on its core businesses.

On December 9, 2004, Quanex Corporation completed the acquisition of all of the outstanding stock, through a subsidiary merger, of Mikron Industries, Inc. (“Mikron”), a privately-held Washington corporation.  Mikron, an industry-leading manufacturer of engineered vinyl and thermoplastic alloy composite (MikronWood™) window components, window coverings and door components, serves the residential building and remodeling markets.  Headquartered in the Seattle suburb of Kent, WA, Mikron operates modern and highly automated extrusion facilities located in the Kent area; Winnebago, IL; and Richmond, KY.  Mikron’s 2004 revenues are approximately $215 million.  Mikron will be integrated into the Company’s Building Products segment.

Manufacturing Processes, Markets, and Product Sales by Business Segment

Quanex has 20 manufacturing facilities in 11 states in the United States. These facilities feature efficient plant design and flexible manufacturing processes, enabling the Company to produce a wide variety of custom engineered products and materials for the vehicular products and building products markets. The Company is able to maintain minimal levels of finished goods inventories at most locations because it typically manufactures products upon order to customer specifications.

The majority of the Company’s products are sold into the vehicular products and building products markets, with minimal sales to the industrial machinery and capital equipment markets.

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For financial information regarding each of Quanex’s business segments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein and Note 12 to the Consolidated Financial Statements. For net sales of the Company by major product lines see Note 12 to the Consolidated Financial Statements. For the years ended October 31, 2004, 2003, and 2002, no one customer accounted for 10% or more of the Company’s sales.

Vehicular Products Segment

The Vehicular Products segment includes engineered steel bar manufacturing, impact-extrusion operations, steel bar and tube heat-treating services, steel bar and tube corrosion and wear resistant finishing services, and aluminum extrusion and metal products fabricating.

The Company’s engineered steel bar operations, which represent the majority of the segment’s sales and operating income, include three plants, one located in Arkansas and two in Michigan, which in aggregate are capable of shipping over 1.3 million tons of hot finished, precision engineered, carbon and alloy steel bars annually.  The Company believes that it has the only two plants in North America using continuous rotary centrifugal casting technology. This casting process produces seam-free bars, without surface defects or inclusions, thereby reducing the need for subsequent surface conditioning. The continuous casting and automated in-line manufacturing operations at the plants substantially reduce labor and energy costs by eliminating the intermittent steps that characterize manufacturing operations at most other steel mills.

The Company produces various grades of customized, engineered steel bars by melting steel scrap and casting it through a rotary centrifugal continuous caster.  Prior to casting, molten steel benefits from secondary refining processes that include argon stirring, ladle injection, and vacuum arc degassing. These processes enable the production of higher quality, “cleaner” steel. The Company believes that it is the lowest cost producer of engineered carbon and alloy steel bars in North America. The Company believes that its energy costs are significantly lower than those of its competitors because at the two plants that utilize continuous rotary centrifugal casting technology, bars move directly from the caster to the rolling mill before cooling, reducing the need for costly reheating. This highly automated manufacturing process enables the Company to produce finished steel bars using less than two man-hours of labor per ton compared with an estimated industry average of four man-hours per ton for U.S. integrated steel producers.

Products are custom manufactured primarily for customers within the vehicular product markets serving the passenger car, light truck, sport utility vehicle, heavy truck, anti-friction bearing, off-road and farm equipment industries. These customers use engineered steel bars in critical applications such as camshafts, crankshafts, transmission gears, wheel spindles and hubs, bearing components, steering components, hydraulic mechanisms and seamless tube production.

The Vehicular Products segment also includes three additional facilities. The first is a heat treating plant in Indiana that uses custom designed, in-line equipment to provide tube and bar heat-treating and related services, such as quench and temper, stress relieving, normalizing, “cut-to-length,” and metallurgical testing. This plant primarily serves customers in the vehicular products and energy markets.  The second, located in Wisconsin, treats steel bars and tubes using the patented Nitrotec process to improve the metal’s corrosion and wear resistance properties while providing a more environmentally friendly, non-toxic alternative to chrome plating. This plant’s products are made for specific customer applications and are primarily used for fluid power applications in the vehicular products markets.  The third facility is an aluminum extrusion and metal fabrication plant located in Minnesota, primarily serving the recreational vehicle market.

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Building Products Segment

The Building Products segment is comprised of five fabricated metal components operations, two wood fenestration operations, an aluminum sheet casting operation, three stand-alone aluminum finishing operations and a flexible insulating glass spacer operation. The segment produces mill finished and coated aluminum sheet and various engineered products for the building products markets.  Products include flexible insulating glass spacer, window and patio door screens, window outer frames, residential exterior products, custom wood window grilles and accessories, and a broad line of custom designed, roll-formed aluminum components and stamped aluminum shapes for manufacturers of windows for the home improvement, residential, and light commercial construction markets.  Additional products include rain carrying systems, soffit, exterior housing trim, roofing products, exterior door thresholds, astragals, patio door systems, custom hardwood architectural moulding and flooring and coated and/or painted aluminum sheet in many colors, sizes, and finishes.  The operations combine strong product design and development expertise with reliable just-in-time delivery.

The Company’s aluminum mini-mill uses an in-line casting process that can produce 350 million pounds of reroll (hot-rolled aluminum sheet) annually. The mini-mill converts aluminum scrap to reroll through melting, continuous casting, and in-line hot rolling processes. It also has shredding and blending capabilities, including two rotary barrel furnaces and a dross recovery system that broaden its sources of raw material, allowing it to melt cheaper grades of scrap, which improves raw material yields. Delacquering equipment improves the quality of the raw material before it reaches the primary melt furnaces by burning off combustibles in the scrap. In addition, scrap is blended using computerized processes to most economically achieve the desired molten aluminum alloy composition.

The Company believes its production capabilities result in a significant manufacturing advantage and savings from reduced raw material costs, optimized scrap utilization, reduced unit energy cost and lower labor costs.

Raw Materials and Supplies

The Vehicular Products segment’s operations purchase their principal raw material, steel scrap or substitutes such as pig iron, beach iron and hot briquetted iron, on the open market. Secondary raw materials, including aluminum billet, bars and slugs, are also purchased on the open market and amounts vary based upon market conditions.  Collection and transportation of these raw materials to the Company’s plants can be adversely affected by extreme weather conditions. Prices for the steel scrap also vary in relation to the general business cycle and global demand.

The Building Products segment purchases a diverse range of raw materials.  In terms of value, the segment’s most significant raw material is aluminum scrap purchased on the open market, where availability and delivery can be adversely affected by extreme weather conditions. Physical hedges are primarily used to hedge against fluctuations in the price of aluminum scrap required to manufacture products for fixed-price sales contracts.  To a lesser extent, aluminum ingot futures contracts are bought and sold on the London Metal Exchange to hedge aluminum scrap requirements.

Other key raw materials include coated and uncoated aluminum sheet, wood (both hardwood and softwood), vinyl and epoxy resin.  Except for the aluminum sheet, the raw materials are available in most cases from several suppliers at market prices.  Aluminum sheet is transferred within the segment at prices based upon arms-length negotiations.

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Backlog

At October 31, 2004, Quanex’s backlog of orders to be shipped in the next twelve months was approximately $492 million, comprised of $421 million for the Vehicular Products segment and $71 million for the Building Products segment.  This compares to approximately $164 million at October 31, 2003, comprised of $125 million for the Vehicular Products segment and $39 million for the Building Products segment. Excluding MACSTEEL Monroe, the backlog increased $144 million due to an increase in overall volume coupled with increased average prices realized during fiscal 2004. Because many of the markets in which Quanex operates have short lead times, the Company does not believe that backlog figures are reliable indicators of annual sales volume or operating results.

Competition

The Company’s products are sold under highly competitive conditions.  Quanex competes with a number of companies, some of which have greater financial resources. Competitive factors include product quality, price, delivery, and the ability to manufacture to customer specifications. The amounts of engineered steel bars, aluminum mill sheet products, engineered products and impact extruded products manufactured by the Company represent a small percentage of annual domestic production.

The Company’s Vehicular Products segment’s operations compete with several large integrated and non-integrated steel producers. Although these producers may be larger and have greater resources than the Company, Quanex believes that the technology used at the Company’s facilities permits it to compete effectively in the markets it serves.

The operations of the Building Products segment compete with a range of small and midsize metal and wood fabricators and wood moulding facilities in addition to small and large aluminum sheet manufacturers, some of which are divisions or subsidiaries of major corporations with substantially greater resources than the Company. The Company competes in coil-coated and mill finished products, primarily on the basis of the breadth of product lines, the quality and responsiveness of its services, and price.  Competition in the other portions of the segment is primarily based on custom engineering, product development, quality, service and price.  The operations also compete with in-house operations of vertically integrated fenestration (door and window) OEMs.

Sales and Distribution

The Company has sales organizations with sales representatives in many parts of the United States. Engineered steel bars are primarily sold to tier-one or tier-two suppliers through the Company’s direct sales organization and a limited number of manufacturers’ representatives. The Building Products segment’s products are sold primarily to OEMs, except for some residential building products, which are sold through distributors.

Seasonal Nature of Business

Sales for the Building Products segment’s products are seasonal. The primary markets for these products are in the Northeast and Midwest regions of the United States, where winter weather typically reduces homebuilding and home improvement activity. This segment typically experiences its lowest sales during the Company’s first fiscal quarter. Profits tend to be lower in quarters with lower sales because a high percentage of their manufacturing overhead and operating expense is due to labor and other costs that are generally semi-variable throughout the year.

Sales for the other businesses are generally not seasonal. However, due to the number of holidays in the Company’s first fiscal quarter, sales have historically been lower in this period as some customers reduce production schedules. As a result of reduced production days combined with the effects of seasonality, the Company generally expects that, absent unusual activity, its lowest sales will occur in the first fiscal quarter.

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Service Marks, Trademarks, Trade Names, and Patents

The Company’s Quanex, Quanex design, Seam-Free design, NitroSteel, MACGOLD, MACSTEEL, MACSTEEL design, MACPLUS, Ultra-Bar, TruSeal Technologies, Swiggle, Duraseal, GridLoc, Insuledge, Homeshield, Homeshield design, and “The Best Alloy & Specialty Bars” marks are registered trademarks or service marks. The Company’s Piper Impact name is used as a service mark, but is not yet registered in the United States. The trade name Nichols-Homeshield and the Homeshield design trademarks are used in connection with the sale of the Company’s aluminum mill sheet products and residential building products. The Homeshield, Piper Impact, Colonial Craft, MACSTEEL, TruSeal Technologies and Quanex word and design marks and associated trade names are considered valuable in the conduct of the Company’s business. The business conducted by the Company generally does not depend upon patent protection. Although the Company holds numerous patents, in some cases, the proprietary technology that the Company has developed for using the patents is more important than the patents themselves.

Research and Development

Expenditures for research and development of new products or services during the last three years were not significant. Although not technically defined as research and development, a significant amount of time, effort and expense is devoted to (a) custom engineering which qualifies the Company’s products for specific customer applications and (b) developing superior, proprietary process technology.

Environmental Matters

Quanex is subject to extensive laws and regulations concerning the discharge of materials into the environment and the remediation of chemical contamination.  To satisfy such requirements, Quanex must make capital and other expenditures on an ongoing basis.  The cost of environmental matters has not had a material adverse effect on Quanex’s operations or financial condition in the past, and management is not aware of any existing conditions that it currently believes are likely to have a material adverse effect on Quanex’s operations, financial condition, or cash flow.

Remediation

Under applicable state and federal laws, the Company may be responsible for, among other things, all or part of the costs required to remove or remediate wastes or hazardous substances at locations Quanex has owned or operated at any time.  The Company is currently participating in environmental investigations or remediation at several such locations.

From time to time, Quanex also has been alleged to be liable for all or part of the costs incurred to clean up third-party sites where it is alleged to have arranged for disposal of hazardous substances.  The Company currently is involved at several such locations.

Total remediation reserves, at October 31, 2004, for Quanex’s current plants, former operating locations, and disposal facilities were approximately $8.5 million.  Of that, approximately $2.0 million represents administrative costs; the balance represents estimated costs for investigation, studies, cleanup, and treatment.  On the balance sheet, $8.2 million of the remediation reserve is included in non-current liabilities with the remainder in accrued liabilities (current).  The Company currently expects to pay the accrued remediation reserve through at least fiscal 2024.

The total remediation reserve at October 31, 2004 is approximately $8.3 million less than the balance as at October 31, 2003.  The difference is primarily attributable to the reduction during the third quarter of fiscal 2004 in the remediation reserve for the Piper Impact division from approximately $13.3 million to approximately $5.0 million.  This reduction was based on the Company’s experience to date at the Piper Impact locations, the

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Company’s decision to stop manufacturing at the Highway 15 location, and an updated technical assessment of environmental conditions at the Piper Impact locations.

Approximately 60% of the total remediation reserve remains allocated to cleanup and other corrective measures at the Piper Impact division.  At present, the largest component is for remediation of groundwater contamination from prior operators at the Highway 15 location.  The Company voluntarily implemented a state-approved remediation action plan there and continues to monitor its performance.

The final remediation costs and the timing of the expenditures at Piper Impact and other sites will depend upon such factors as the nature and extent of contamination, the cleanup technologies employed, and regulatory concurrences.  While actual remediation costs therefore may be more or less than amounts accrued, and the timing may be accelerated or delayed, management believes it has established adequate reserves for all probable and reasonably estimable remediation liabilities.

Compliance

Quanex incurred expenses of approximately $3.4 million and capitalized an additional $2.4 million during fiscal 2004 in order to comply with existing environmental regulations.  This compares to $3.5 million of expense and $1.7 million of capital incurred during fiscal 2003.  For 2005, the Company estimates expenses at its facilities will be approximately $2.9 million for continuing environmental compliance.  In addition, the Company estimates that capital expenditures for environmental compliance in fiscal 2005 will be approximately $2.7 million, which includes amounts for upgrades related to the coating systems emission compliance standards at two of its Nichols Aluminum facilities.  Further expenditures relating to environmental matters will necessarily depend upon the application to Quanex and its facilities of future regulations and government decisions.  Quanex will continue to have expenditures in connection with environmental matters beyond 2005, but it is not possible at this time to reasonably estimate the amount of those expenditures, except as discussed above.

Employees

The Company employed 3,421 persons at October 31, 2004 and approximately 3,430 persons at December 15, 2004.  Of the total employed, approximately 45% are covered by collective bargaining agreements.  None of such collective bargaining agreements expire in fiscal 2005.  Following is a table of collective bargaining agreements currently in place.

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Financial Information about Foreign and Domestic Operations

For financial information on the Company’s foreign and domestic operations, see Note 12 of the Financial Statements contained in this Annual Report on Form 10-K.

Website

The Company’s website is www.quanex.com.  The Company’s required Securities Exchange Act filings such as Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports are available free of charge through our website, as soon as reasonably practicable after they have been filed with or furnished to the Securities and Exchange Commission (“SEC”) pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 (the “1934 Act”).  Forms 3, 4 and 5 filed with respect to equity securities under Section 16(a) of the 1934 Act are also available on the website.  All of these materials are located at the “Financial Information” link.

The Company’s website also includes the following corporate governance materials, at the link “Corporate Governance:” the Corporate Governance Guidelines, Code of Business Conduct & Ethics, and charters of each Board committee, including the Audit Committee, the Compensation and Management Committee, and the Nominating and Corporate Governance Committee. You may also obtain a printed copy of any of the materials referenced above by contacting the Company through the website or at the following address: Quanex Corporation, 1900 West Loop South, Suite 1500, Houston, TX 77027.

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Item 2.            Properties

The following table lists Quanex’s principal properties together with their locations, general character and the industry segment which uses the facility. Listed facilities are owned by the Company, unless indicated otherwise. (See Item 1, “Business,” for discussion of the capacity of various facilities.)

The Company considers that its properties are generally in good condition, are well maintained, and are generally suitable and adequate to carry on the Company’s business.  In 2004, the Company’s manufacturing plants, taken as a whole, operated moderately below capacity.

Item 3.            Legal Proceedings

The Company believes there are no new material legal proceedings to which Quanex, its subsidiaries, or their property is subject. For a discussion of environmental issues, see Note 18 to the Consolidated Financial Statements.

Item 4.            Submission of Matters to Vote of Security Holders

None.

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PART II

Item 5.            Market for Registrant’s Common Equity and Related Stockholder Matters

Quanex’s common stock, $.50 par value, is traded on the New York Stock Exchange, under the ticker symbol NX. The following tables present the quarterly common stock dividends and the high and low bids for the Company’s common stock during each fiscal quarter within the two most recent fiscal years.

Quarterly Common Stock Dividends^(*)

Quarterly Common Stock Sales Price (High & Low) ^(*)

(*)                                 On December 2, 2004 the Board of Directors declared a three-for-two stock split in the form of a 50% stock dividend, payable on December 31 to holders of record on December 17.  The amounts above are presented without giving effect to such stock split.

The terms of Quanex’s revolving credit agreement do not specifically limit the total amount of dividends or other distributions to its shareholders. However, the covenant to maintain a certain fixed charge coverage ratio and the tangible net worth covenant indirectly impact the Company’s ability to pay dividends.(1) As of October 31, 2004, the aggregate amount available for dividends under the credit facility was approximately $53.5 million.

There were 7,446 holders of Quanex common stock (excluding individual participants in securities positions listings) on record as of November 30, 2004.

(1)  Increasing the dividend impacts the fixed charge coverage ratio and tangible net worth and thus indirectly limits the amount of dividends that could be declared and paid while still satisfying the covenants.

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Issuer Purchases of Equity Securities

On December 5, 2002, the Board of Directors approved a program to purchase up to a total of 1 million shares of its common stock in the open market or in privately negotiated transactions. During the year ended October 31, 2003, the Company repurchased 438,600 shares, or 43.9% of the shares authorized to be purchased, at a cost of approximately $13.5 million.  On August 26, 2004, the Board of Directors authorized the Company to reload its stock buyback program, increasing the existing authorization up to 1 million shares.  The Company purchased no shares in fiscal 2004.

Equity Compensation Plan Information

The following table summarizes as of October 31, 2004, certain information regarding equity compensation to our employees, officers, directors and other persons under our equity compensation plans.

Equity Compensation Plan Information

(1)          The Quanex Corporation 1997 Key Employee Stock Plan was approved by the Company’s Board of Directors in October 1997. This plan provides for the granting of stock options to eligible persons employed by the Company who are not executive officers of the Company. Under the plan, the total number of stock options which may be granted is 400,000 shares. Stock options may be granted at not less than the fair market value (as defined in the plan) on the date the options are granted and generally become exercisable over three years in one-third annual increments. The options expire ten years after the date of grant. The Board of Directors may amend, terminate or suspend the plan at any time.

Item 6.            Selected Financial Data

Glossary of Terms

The exact definitions of commonly used financial terms and ratios vary somewhat among different companies and investment analysts. The following list gives the definition of certain financial terms that are used in this report:

Asset turnover:  Net sales divided by average total assets.

Current ratio:  Current assets divided by current liabilities.

Return on common stockholders’ equity:  Net income attributable to common stockholders divided by average common stockholders’ equity.

Return on investment:  The sum of net income and the after-tax effect of interest expense less capitalized interest divided by the sum of the averages for short and long-term debt and stockholders’ equity.

Working Capital:  Current assets less current liabilities.

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Selected Financial Data 2000-2004

(1)          In the third quarter of 2004, the Company committed to a plan to sell its Piper Impact business and in the fourth quarter of 2004, sold its Nichols Aluminum – Golden business.  Accordingly, the assets and liabilities of Piper Impact and Nichols Aluminum – Golden are reported as discontinued operations in the Consolidated Balance Sheets for all periods presented, and their operating results are reported as discontinued operations in the Consolidated Statements of Income for all periods presented (see Note 19)

(2)          Beginning in fiscal 2001, freight costs are no longer netted against sales; they are included in cost of sales. Prior year’s net sales and sales ratios have been restated to conform to this presentation.

(3)          Included in operating income are gains on sale of land of $0.5 million and $0.4 million in fiscal 2004 and 2003, respectively.

(4)          Fiscal 2003 and 2002 include gains associated with retired executive life insurance proceeds of $2.1 million and $9.0 million, respectively. This represents the excess of life insurance proceeds over (a) the cash surrender value and (b) liabilities to beneficiaries of deceased executives, on whom the Company held life insurance policies.

(5)          Includes effects in fiscal 2000 of Piper Impact’s $56.3 million (pretax) asset impairment charge in accordance with SFAS No. 121 and the $14.3 million (pretax) loss on sale of Piper Impact Europe, net of gain on related range forward foreign currency agreement.

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

The discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the Selected Financial Data and the Consolidated Financial Statements of the Company and the accompanying notes.

Private Securities Litigation Reform Act

Certain of the statements contained in this document and in documents incorporated by reference herein, including those made under the caption “Management’s Discussion and Analysis of Results of Operations and Financial Condition” are “forward-looking” statements as defined under the Private Securities Litigation Reform Act of 1995. Generally, the words “expect,” “believe,” “intend,” “estimate,” “anticipate,” “project,” “will” and similar expressions identify forward-looking statements, which generally are not historical in nature. All statements which address future operating performance, events or developments that we expect or anticipate will occur in the future, including statements relating to volume, sales, operating income and earnings per share, and statements expressing general optimism about future operating results, are forward-looking statements. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our Company’s historical experience and our present projections or expectations. As and when made, management believes that these forward-looking statements are reasonable. However, caution should be taken not to place undue reliance on any such forward-looking statements since such statements speak only as of the date when made and there can be no assurance that such forward-looking statements will occur. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Factors exist that could cause the Company’s actual results to differ materially from the expected results described in or underlying our Company’s forward-looking statements. Such factors include domestic and international economic activity, prevailing prices of steel and aluminum scrap and other raw material costs, the rate of change in prices for steel and aluminum scrap, energy costs, interest rates, construction delays, market conditions, particularly in the vehicular, home building and remodeling markets, any material changes in purchases by the Company’s principal customers, labor supply and relations, environmental regulations, changes in estimates of costs for known environmental remediation projects and situations, world-wide political stability and economic growth, the Company’s successful implementation of its internal operating plans, acquisition strategies and integration, performance issues with key customers, suppliers and subcontractors, and regulatory changes and legal proceedings. Accordingly, there can be no assurance that the forward-looking statements contained herein will occur or that objectives will be achieved. All written and verbal forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by such factors.

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Results of Operations

Summary Information as % of Sales

(*)                                 All periods presented exclude Nichols Aluminum – Golden and Piper Impact which are included in discontinued operations.

Overview

Net sales for the year ended October 31, 2004 were up 63% over a year ago.  Included in the year over year increases were $355.0 million for the year of net sales from the Company’s recent acquisitions of MACSTEEL Monroe and TruSeal.  Demand at the Vehicular Products and Building Products segments remained strong throughout the year, and backlogs remained healthy at the end of the fiscal year.

Income from continuing operations for the year ended October 31, 2004 was up 31% over last year.  MACSTEEL Monroe’s and TruSeal’s combined earnings contributed $1.02 (after interest expense) to earnings per share for the year (10 months results).  Also included in the results were LIFO charges of $20.4 million or $0.75 per diluted share for the year.  This compares to a LIFO charge of $6.1 million, or $0.24 per diluted share, for last year.

Business Segments

Business segments are reported in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 131. SFAS No. 131 requires that the Company disclose certain information about its operating segments where operating segments are defined as “components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.” Generally, financial information is required to be reported on the basis that it is used internally for evaluating segment performance and deciding how to allocate resources to segments.

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Quanex has two market-focused segments:  Vehicular Products and Building Products.  The Vehicular Products segment produces engineered steel products and extruded products for the light vehicle, heavy duty truck, agricultural, military, recreational and energy markets.  The Vehicular Products segment’s main market drivers are North American light vehicle builds and, to a lesser extent, heavy duty truck builds.  The Building Products segment produces engineered products and aluminum sheet for window and door components used by the residential building and remodeling markets.  The main market drivers of this segment are residential housing starts and remodeling expenditures.

Vehicular Products – Three Years Ended October 31, 2004

The following table sets forth selected operating data for the Vehicular Products segment:

(1)                                  Fiscal 2004 includes MACSTEEL Monroe’s operations as of January 1, 2004.

(2)                                  All periods presented exclude Piper Impact which is included in discontinued operations.

North American light vehicle builds were down about 2% during the fiscal fourth quarter compared to the same period last year.  Demand from the Company’s heavy duty truck customers was very strong again this quarter, with overall builds up approximately 38% over the fiscal fourth quarter last year.  For the quarter ended October 31, 2004, the Company’s engineered steel bar operations ran at utilization rates near capacity.  Fourth quarter and fiscal year operating income for the segment benefited from new customer programs, conversion cost improvements and the December 31, 2003 acquisition of MACSTEEL Monroe.

Excluding the impact of MACSTEEL Monroe, net sales for fiscal 2004 were higher than fiscal 2003 by 30.5% due to an 8.2% increase in volume, combined with increased average prices of approximately 20.6% in the form of scrap surcharges.   Net sales for the segment increased from fiscal 2002 to fiscal 2003 due to a 2.2% increase in volume and a 3.8% increase in average prices.  Strong demand in the segment has persisted over the past several years.  The strong demand, coupled with the Company’s ability to consistently improve productivity, have been the largest factors in the steady volume growth.  The average price increases realized over the last three years are primarily the result of two items.  First, the Company is focused on increasing sales of the segment’s value-added MACPLUS products.  This contributed to the increases from fiscal 2002 to 2003 and part of the increase from fiscal 2003 to 2004.  The largest contributing factor for the increase from fiscal 2003 to 2004 is the overall price increases from higher steel scrap surcharges.  Steel scrap prices increased dramatically over the latter half of calendar 2003 and all of fiscal 2004.  As a result of the increases, surcharges came into effect beginning on January 1, 2004 and have been adjusted quarterly (see further discussion of surcharge lag in “Commodity Price Risk” of Item 7A).

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Excluding the impact of MACSTEEL Monroe, operating income for fiscal 2004 increased 7.0% above fiscal 2003.  The sales volume and average sales price increases experienced during fiscal 2004 were able to more than offset the increased costs.  Cost of sales increased 37.5% coupled with a 3.8% and 2.5% increase in selling, general and administrative expenses and depreciation and amortization, respectively, all exclusive of the acquisition.  The increase in the cost of sales was due primarily to the continued run-up of raw material costs experienced within the segment.  Raw material increases are also the principal factor for the reduced operating income in fiscal 2003 compared to 2002.  The Company was able to absorb more of the increase in fiscal 2004 than in 2003 because during fiscal 2003 raw materials increased, but did not exceed the minimum threshold that triggers the surcharges.  The surcharges did not become significant until January 1, 2004, and thus there was no real offset to higher raw material prices in the early stages of the run-up.

The reduction of the operating income margin over the past three years is directly attributable to the raw material increases experienced over the past several years.  As raw material prices rise, the Company experiences short term compression of the operating margin since the surcharges are adjusted on a quarterly basis based upon raw material indexes from the previous three months.  As raw material prices level off, the Company would expect the Vehicular Products segment’s operating income margin to improve initially.  Declines in raw material costs will increase the margin in the short term as the surcharges lag behind.

Building Products – Three Years Ended October 31, 2004

The following table sets forth selected operating data for the Building Products segment:

(1)                                  Fiscal 2004 includes TruSeal’s operations as of January 1, 2004.

(2)                                  All periods presented exclude Nichols Aluminum - Golden which is included in discontinued operations.

Housing starts and remodeling activity during the Company’s fourth quarter were strong as demand at the window and door components businesses remained brisk.  The Company’s aluminum sheet business had an exceptionally robust fourth quarter.  While sales to the Company’s traditional building and construction customers remained excellent, sales to capital equipment, service center, and transportation customers were improved over last year.  A more favorable industry supply/demand equation bolstered the Company’s spread.

Excluding the impact of TruSeal, net sales for fiscal 2004 were higher than 2003 by 15.9%.  The increase in net sales was a result of the increased volumes across the entire segment combined with an 11.7% increase in aluminum sheet prices.  The increase in net sales from fiscal 2002 to 2003 is related to the February 2002 acquisition of COLONIAL CRAFT.  Excluding the three additional months of net sales from COLONIAL CRAFT in fiscal 2003, net sales actually declined slightly from fiscal 2002 due to the decision to exit low margin product lines.  The volume increase in fiscal 2004 was driven by strong demand in the building products market and new programs with fenestration customers.  The increase in aluminum sheet prices is a result of reduced industry capacity that put upward pressure on pricing.

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Excluding the impact of TruSeal, operating income for fiscal 2004 increased 47.2% above fiscal 2003.  The increase is a result of expenses growing to a lesser extent than net sales.  Net sales for fiscal 2004 increased 15.9% over fiscal 2003, while cost of sales increased by only 15.3%.  This, coupled with increased volumes, led to strong growth in operating income for the year.  The reduction of operating income from fiscal 2002 to fiscal 2003 is a direct reflection of the higher prices paid for aluminum scrap, energy and outside processing combined with some production and quality problems encountered at one of the facilities in the Building Products segment.

The operating income margin declined from fiscal 2002 to fiscal 2003 as a result of the higher prices of raw materials discussed previously as well as the production and quality issues.  By the start of fiscal 2004, the production and quality problems had been corrected and demand increased such that the upward price pressure realized in the market was able to stay ahead of the increasing raw material costs.  The associated margin expansion realized during fiscal 2004 coupled with the volume increases resulted in further expansion of the operating income margin.  The acquisition of TruSeal during fiscal 2004 contributed slightly to the increased margin realized in 2004.

Corporate and Other – Three Years Ended October 31, 2004

Corporate and other operating expenses, not included in the two operating segments mentioned above, include the consolidated LIFO inventory adjustments (calculated on a combined pool basis), corporate office expenses and inter-segment eliminations.  The increase in raw material costs experienced during fiscal 2003 and 2004 resulted in increased expense each year associated with increasing the LIFO inventory reserve.  For the years ended October 31, 2004, 2003 and 2002, the amount of LIFO inventory adjustment expensed was $20.4 million, $6.1 million and $2.4 million, respectively.   Changes associated with the LIFO inventory adjustment tend to comprise a majority of the change from year to year in corporate and other expenses.  During fiscal 2004, corporate and other expenses increased as a result of increased professional services related to the implementation of various procedures arising from the Sarbanes-Oxley Act of 2002 beginning in fiscal 2003.

Interest expense for fiscal 2004 was $6.1 million compared to $2.8 million from fiscal 2003 and $14.5 million in fiscal 2002.  The increase from 2003 to 2004 is a result of an increase in the average debt outstanding for the comparative period that is primarily attributable to the acquisitions that were completed in the first quarter of fiscal 2004.

Other, net (on the income statement) for fiscal 2004 was income of $0.3 million compared to income of $2.7 million in fiscal 2003 and $1.9 million in fiscal 2002.  The change from 2003 to 2004 is related to $1.7 million less of income associated with the cash surrender value of life insurance, net of the change in the liability for supplemental retirement, combined with $0.5 million of additional expenses recognized in fiscal 2004 for deferred compensation as a direct result of the increase in the Company’s stock price.

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Income (loss) from discontinued operations, net of taxes for fiscal 2004 was a loss of $3.1 million compared to a loss of $1.1 million for fiscal 2003 and income of $1.7 million for fiscal 2002.  The increased loss from fiscal 2003 to fiscal 2004 is related to the $0.6 million loss on sale of Nichols Aluminum – Golden combined with the net $3.5 million write down of Piper Impact.  The decrease from 2002 to 2003 is primarily related to the erosion of demand for Piper Impact’s airbag components.  See Note 19 for further information regarding the composition of discontinued operations.

Outlook

Overall, customer demand in the Company’s two target markets, vehicular products and building products, is expected to remain strong in 2005.

Vehicular Products segment – 2005 North American light vehicle builds are expected to be approximately 16 million builds, essentially flat to 2004.  Heavy-duty truck builds for 2005 are expected to be up significantly over 2004 levels while secondary markets are also expected to remain at high levels.

Building Products segment – Key market drivers are expected to remain healthy in 2005.  Housing starts are expected to be off approximately 5% from 2004’s record levels, while remodeling activity is expected to remain very strong.

Quanex expects to post improved results in fiscal 2005 compared to fiscal 2004.  This expectation is based on an improving economy, market share gains at both operating segments and the earnings benefit from the acquisitions of MACSTEEL Monroe and TruSeal.  The earnings outlook for the first quarter remains favorable.  The Company expects first quarter diluted earnings per share from continuing operations to be in the range of $1.00 to $1.15, up from the $0.40 reported in the first quarter of 2004.  Quanex cautions that the combination of short cycle businesses and volatile raw material input costs makes forecasting problematic.

Liquidity and Capital Resources

Sources of Funds

The Company’s principal sources of funds are cash on hand, cash flow from operations, and borrowings under its secured $310.0 million Revolving Credit Agreement (“Bank Agreement”). At October 31, 2004, the Company had no borrowings under the Bank Agreement. This represents a $10.0 million decrease from October 31, 2003 borrowing levels.  During the first quarter of fiscal 2004, the Company’s borrowings under the Bank Agreement increased $210.0 million in order to fund the acquisitions of MACSTEEL Monroe and TruSeal.  During the third quarter of fiscal 2004, the Company issued $125.0 million of 2.50% Convertible Senior Debentures due May 15, 2034 (the “Debentures”).  The Company used approximately $122.0 million of proceeds from the issuance of the Debentures to repay a portion of what was then outstanding under the Bank Agreement.  The Company repaid the remainder of the outstanding balance throughout fiscal 2004 using cash flow from operations.

The Company believes that it has sufficient funds and adequate financial sources available to meet its anticipated liquidity needs. The Company also believes that cash flow from operations, cash balances and available borrowings will be sufficient for the foreseeable future to finance anticipated working capital requirements, capital expenditures, debt service requirements, environmental expenditures, dividends and the stock purchase program.

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The Company’s working capital was $140.1 million at October 31, 2004 compared to $92.8 million at October 31, 2003. $28.2 million of the $47.3 million total increase in working capital is associated with the non-recurring transactions that occurred during fiscal 2004 (a $42.0 million increase related to the MACSTEEL Monroe and TruSeal acquisitions offset by a $13.8 million decrease from the Nichols Aluminum – Golden divestiture).  Excluding the impact of the above referenced transactions, working capital increased $19.1 million, primarily a result of the $19.5 million increase in cash and equivalents.

Operating Activities

Cash provided by operating activities during the year ended October 31, 2004 was $124.2 million compared to $102.8 million and $81.1 million for 2003 and 2002, respectively. The increase from fiscal 2002 to fiscal 2003 was the result of lower working capital requirements, whereas the increase from fiscal 2003 to fiscal 2004 is primarily attributable to the $13.6 million increase in income from continuing operations.  Accounts receivable, inventory and accounts payable were impacted significantly by the increase in raw material prices experienced throughout fiscal 2003 and 2004.  While the run-up in raw material costs increased inventory prices, the Company was successful in reducing overall inventory volumes, which helped to keep total working capital in line with the previous year.

Investment Activities

Net cash used for investment activities during the year ended October 31, 2004 was $213.1 million compared to $22.5 million and $29.8 million for fiscal 2003 and 2002, respectively. Investment activities for the year ended October 31, 2004 included the acquisition of MACSTEEL Monroe for $102.1 million and TruSeal for $112.5 million. The cost of the acquisitions was partially offset by the $22.3 million received from the sale of Nichols Aluminum – Golden.  The Company expects to receive proceeds from the sale of Piper Impact in fiscal 2005 (see Note 19 for further explanation).

Capital expenditures have decreased steadily over the last three years from $31.4 million in fiscal 2002 to $25.4 million in fiscal 2003 to $19.5 million in fiscal 2004. In light of the announcement in September 2004 of the $20.0 million Phase VIII expansion at the MACSTEEL Arkansas facility, the Company expects 2005 capital expenditures to increase to approximately $55.0 million.  At October 31, 2004, the Company had commitments of approximately $5.2 million for the purchase or construction of capital assets. The Company plans to fund these capital expenditures through cash flow from operations.

The final contributing factor to the increased use of cash from investing activities is the proceeds received from Company owned life insurance policies and property sales.  In 2003, proceeds from such items totaled $9.3 million, which is $8.6 million more than was received during fiscal 2004.

Financing Activities

Cash from financing activities for the year ended October 31, 2004 was a source of cash of $108.5 million compared to uses of cash in both 2003 and 2002 of $76.5 million and $62.6 million, respectively. The most significant contributing factor to the increase is the $210.0 million of borrowings that occurred in the first quarter of 2004 that were used to fund the MACSTEEL Monroe and TruSeal acquisitions. During the third quarter of fiscal 2004, the Company used approximately $122.0 million of proceeds from the issuance of the Debentures to repay a portion of what was then outstanding under the Bank Agreement.  It is important to note that apart from the reduction through the Debenture offering, the Company repaid approximately $98.0 million of the Bank Agreement during 2004 compared to $55.0 million and $82.0 million in 2003 and 2002, respectively.

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On August 26, 2004, the board of directors of the Company increased the quarterly dividend from $0.17 to $0.19 per common share outstanding. This increase was effective with the Company’s third quarter dividend paid on September 30, 2004. While the impact of the dividend change resulted in an increase of roughly $0.6 million in dividends paid, this increase was more than offset by the $6.5 million increase in proceeds received from stock issuances related to the exercise of stock options.  Total amounts paid for dividends will increase in fiscal 2005 since there was only a single dividend distribution in fiscal 2004 following the increase in the quarterly dividend.

Debt Structure and Activity

Refer to Note 10 “Long-Term Debt and Financing Arrangements” for a discussion of the Company’s debt structure.

Stock Purchase Program

Refer to Note 14 “Stock Repurchase Program and Treasury Stock” for a discussion of the Company’s stock purchase program.

Contractual Obligations and Commercial Commitments

The following tables set forth certain information concerning the Company’s unconditional obligations and commitments to make future payments under contracts with remaining terms in excess of one year, such as debt and lease agreements, and under contingent commitments.

Payments Due by Period

The long-term debt is primarily comprised of the $125.0 million of Debentures due in 2034.  Operating leases cover a range of items from facilities, fork trucks and cars to fax machines and other miscellaneous equipment.  The unconditional purchase obligations are made up of $14.8 million of natural gas contracts and $35.2 million of aluminum scrap contracts.

Amount of Commitment Expiration per Period

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Off-Balance Sheet Arrangements

The Company does not have any off-balance sheet arrangements, as such term is defined in the rules promulgated by the Securities and Exchange Commission, that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors

Effects of Inflation

Inflation has not had a significant effect on earnings and other financial statement items.

Critical Accounting Policies

The preparation of these financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying footnotes. Estimates and assumptions about future events and their effects cannot be perceived with certainty. Estimates may change as new events occur, as more experience is acquired, as additional information becomes available and as the Company’s operating environment changes. Actual results could differ from estimates.

The Company believes the following are the most critical accounting policies used in the preparation of the Company’s consolidated financial statements as well as the significant judgments and uncertainties affecting the application of these policies.

Revenue Recognition and Allowance for Doubtful Accounts

The Company recognizes revenue when the products are shipped and the title and risk of ownership pass to the customer. Selling prices are fixed based on purchase orders or contractual agreements. Inherent in the Company’s revenue recognition policy is the determination of collectibility. This requires management to make frequent judgments and estimates in order to determine the appropriate amount of allowance needed for doubtful accounts. The Company’s allowance for doubtful accounts is estimated to cover the risk of loss related to accounts receivable. This allowance is maintained at a level the Company considers appropriate based on historical and other factors that affect collectibility. These factors include historical trends of write-offs, recoveries and credit losses, the careful monitoring of portfolio credit quality, and projected economic and market conditions. Different assumptions or changes in economic circumstances could result in changes to the allowance.

Inventory

The Company records inventory valued at the lower of cost or market value. Inventory quantities are regularly reviewed and provisions for excess or obsolete inventory are recorded primarily based on the Company’s forecast of future demand and market conditions. Significant unanticipated changes to the Company’s forecasts could require a change in the provision for excess or obsolete inventory.

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Environmental Contingencies

Quanex is subject to extensive laws and regulations concerning the discharge of materials into the environment and the remediation of chemical contamination. To satisfy such requirements, Quanex must make capital and other expenditures on an ongoing basis. The Company accrues its best estimates of its remediation obligations and adjusts such accruals as further information and circumstances develop.  Those estimates may change substantially depending on information about the nature and extent of contamination, appropriate remediation technologies, and regulatory approvals.  Costs of future expenditures for environmental remediation are not discounted to their present value, unless the amount and timing of the expenditures are fixed or reliably determinable.  When environmental laws might be deemed to impose joint and several liability for the costs of responding to contamination, the Company accrues its allocable share of liability taking into account the number of parties participating, their ability to pay their shares, the volumes and nature of the wastes involved, the nature of anticipated response actions, and the nature of the Company’s alleged connections.  Unanticipated changes of future assessments and/or regulatory laws could result in expenses being incurred in future periods in addition to an increase in actual cash required to remediate the contamination.

Long-Lived Assets

Property, Plant and Equipment

The Company makes judgments and estimates in conjunction with the carrying value of property, plant and equipment, other intangibles, and other assets, including amounts to be capitalized, depreciation and amortization methods and useful lives. Additionally, carrying values of these assets are periodically reviewed for impairment and further reviewed whenever events or changes in circumstances indicate that carrying value may be impaired. The carrying values are compared with the fair value of such assets calculated based on the anticipated future cash flows related to those assets. If the carrying value of a long-lived asset exceeds its fair value, an impairment charge is recorded in the period in which such review is performed. This requires the Company to make long-term forecasts of its future revenues and costs related to the assets subject to review. Forecasts require assumptions about demand for the Company’s products and future market conditions. Future events and unanticipated changes to assumptions could require a provision for impairment in a future period.

Goodwill

The purchase method of accounting for business combinations requires the Company to make use of estimates and judgments to allocate the purchase price paid for acquisitions to the fair value of the net tangible and identifiable intangible assets. The Company performs a goodwill impairment test annually as of August 31.  In addition, goodwill would be tested more frequently if changes in circumstances or the occurrence of events indicates that a potential impairment exists. The impairment test requires the Company to compare the fair value of business reporting units to carrying value including assigned goodwill.  The Company primarily uses the present value of future cash flows to determine fair value and validates the result against the cost and market approaches. Future cash flows are typically based upon a five-year future period for the businesses and an estimated residual value. Management judgment is required in the estimation of future operating results and to determine the appropriate residual values. The residual values are determined from comparable industry transactions. Future operating results and residual values could reasonably differ from the estimates and could require a provision for impairment in a future period.

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Income Taxes

The Company records the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and the amounts reported in the Company’s consolidated balance sheet, as well as operating loss and tax credit carry forwards. The carrying value of the net deferred tax liability reflects the Company’s assumption that the Company will be able to generate sufficient future taxable income in certain jurisdictions to realize its deferred tax assets. If the estimates and assumptions change in the future, the Company may be required to record a valuation allowance against a portion of its deferred tax assets. This could result in additional income tax expense in a future period in the consolidated statement of income.

Insurance

The Company manages its costs for portions of workers’ compensation, group medical, general liability and vehicle liability exposure through a combination of retentions and insurance coverage. The amounts in excess of the retention levels are fully insured by third party insurers.  Liabilities associated with the Company’s portion of these exposures are estimated in part by considering historical claims experience, severity factors and other assumptions. Projections of future loss expenses are inherently uncertain because of the random nature of insurance claims occurrences and could be significantly affected if future occurrences and claims differ from these assumptions and historical trends.

Retirement and Pension Plans

The Company sponsors a number of defined benefit pension plans and an unfunded postretirement plan that provides health care and life insurance benefits for eligible retirees and dependents. The measurement of liabilities related to these plans is based on management’s assumptions related to future events, including expected return on plan assets, rate of compensation increases and health care cost trend rates. The discount rate, which is determined using a model that matches corporate bond securities, is applied against the projected pension and postretirement disbursements. Actual pension plan asset investment performance will either reduce or increase unamortized pension losses at the end of any fiscal year, which ultimately affects future pension costs.

Discontinued Operations

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company presents the results of operations, financial position and cash flows of operations that have either been sold or that meet the criteria for “held for sale accounting” as discontinued operations. At the time an operation qualifies for held for sale accounting, the operation is evaluated to determine whether or not the carrying value exceeds its fair value less cost to sell. Any loss as a result of carrying value in excess of fair value less cost to sell is recorded in the period the operation meets held for sale accounting.  Management judgment is required to (1) assess the criteria required to meet held for sale accounting, and (2) estimate fair value.  Changes to the operation could cause it to no longer qualify for held for sale accounting and changes to fair value could result in an increase or decrease to previously recognized losses.

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New Accounting Pronouncements

In December 2003, the FASB issued the revised SFAS No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” The revised SFAS No. 132 retains the disclosures required by the original issuance of SFAS No. 132 and requires additional annual disclosures describing the types of plan assets, investment strategy, measurement date, plan obligations, and cash flows. The Company included the revised SFAS No. 132 annual disclosures in this Annual Report on Form 10-K for the fiscal year ending October 31, 2004. The revised SFAS No. 132 also requires additional interim period disclosures, including the components of net periodic benefit cost and changes in planned contributions. The Company included the required disclosures in the notes to the interim financial statements beginning with the second quarter of fiscal 2004.

In September 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue 04-08, “Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effects on Diluted Earnings Per Share,” which was ratified by the FASB in October 2004.  Issue 04-08 becomes effective for periods after December 15, 2004, which will be the Company’s first fiscal quarter of 2005.  Under the consensus, companies will be required to retroactively restate diluted earnings per share numbers applying the “if converted” method of accounting from the issuance date of the contingently convertible bond.  On May 5, 2004, the Company issued $125.0 million of 2.50% Convertible Senior Debentures due May 15, 2034.  As it relates to Quanex, EITF Issue 04-08 would mean an additional 2.2 million shares of earnings dilution and have an annualized earnings per share impact of approximately $0.30 - $0.35 per common share. However, the Company could elect to settle its convertible obligation with either common stock, cash or a combination of the two.  If the Company elects to settle its entire convertible obligation with cash and can demonstrate its ability to do so, it would not be required to show the dilutive impact of the higher share count in the calculation of its earnings per share for periods after such election.

Item 7A.                          Quantitative and Qualitative Disclosures about Market Risk

The following discussion of the Company and its subsidiaries’ exposure to various market risks contains “forward looking statements” that involve risks and uncertainties. These projected results have been prepared utilizing certain assumptions considered reasonable in light of information currently available to the Company. Nevertheless, because of the inherent unpredictability of interest rates, foreign currency rates and metal commodity prices as well as other factors, actual results could differ materially from those projected in such forward looking information. The Company does not use derivative financial instruments for speculative or trading purposes. For a description of the Company’s significant accounting policies associated with these activities, see Notes 1 and 16 to the Consolidated Financial Statements.

Interest Rate Risk

The Company and its subsidiaries have a Bank Agreement and other long-term debt which subject the Company to the risk of loss associated with movements in market interest rates.  At October 31, 2004 and 2003, the Company had fixed-rate debt totaling $128.9 million and $4.1 million, respectively. This debt is fixed-rate and, therefore, does not expose the Company to the risk of earnings loss due to changes in market interest rates.

The Company and certain of its subsidiaries’ floating-rate obligations totaled $2.0 million and $15.7 million at October 31, 2004 and 2003, respectively. Based on the floating-rate obligations outstanding at October 31, 2004, a one percent increase or decrease in the average interest rate would result in a change to pre-tax interest expense of approximately $20,000.

For 2002, the Company had $100.0 million of swap agreements in place to limit the exposure of this obligation to increases in short-term interest rates. These swap agreements effectively fixed the interest rate, thus limiting the potential impact that increasing interest rates would have on earnings. Under these swap agreements, payments were made based on a fixed rate ($50.0 million at 7.025%, and $50.0 million at 6.755%) and received on a LIBOR based variable rate (1.82% at October 31, 2002). At October 31, 2002, the fair market value related

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to the interest rate swap agreements was a loss of $4.0 million.

To the extent that floating rate obligations are in excess of or less than $100.0 million, the Company was subject to changes in the underlying interest rates. For the year ended October 31, 2002, the Company’s floating rate obligations were $28.8 million less than the $100.0 million swap agreement. Increases or decreases in the underlying interest rate of the swap agreement would have had a direct impact on interest expense for this differential in balances.

These swap agreements expired on July 29, 2003 and the final settlement payment was made. The Company has not entered into any other interest swap agreements and as such is subject to the variability of interest rates on its variable rate debt.

Commodity Price Risk

The Vehicular Products segment has a scrap surcharge program in place, which is a practice that is well established within the engineered steel bar industry.  The scrap surcharge is based on a three month trailing average of #1 bundle scrap prices.  The Company’s long-term exposure to changes in scrap prices is significantly reduced because of the surcharge program.  Over time, the Company recovers the majority of its scrap cost increases, though there is a level of exposure to short-term volatility because of the three month lag.

Within the Building Products segment, the Company uses various grades of aluminum scrap as well as minimal amounts of prime aluminum ingot as raw materials for its manufacturing process.  The price of this aluminum raw material is subject to fluctuations due to many factors in the aluminum market.  In the normal course of business, Nichols Aluminum enters into firm price sales commitments with its customers.  In an effort to reduce the risk of fluctuating raw material prices, the Company enters into firm price raw material purchase commitments (which are designated as “normal purchases” under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”) as well as option contracts on the London Metal Exchange (“LME”).  The Company’s risk management policy as it relates to these LME contracts is to enter into contracts to cover the raw material needs of the Company’s committed sales orders, net of fixed price purchase commitments.

Through the use of firm price raw material purchase commitments and LME contracts, the Company intends to protect cost of sales from the effects of changing prices of aluminum.  To the extent that the raw material costs factored into the firm price sales commitments are matched with firm price raw material purchase commitments, changes in aluminum prices should have no effect.  During fiscal 2004, the Company primarily relied upon firm price raw material purchase commitments to protect cost of sales tied to firm price sales commitments.  There were no outstanding LME hedges as of October 31, 2004.

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Item 8.                                   Financial Statements and Supplementary Data

RESPONSIBILITY FOR FINANCIAL REPORTING

The accompanying consolidated financial statements of Quanex Corporation and subsidiaries were prepared by management, which is responsible for their integrity and objectivity. The statements were prepared in accordance with accounting principles generally accepted in the United States of America and include amounts that are based on management’s best judgments and estimates.

Quanex’s system of internal controls is designed to provide reasonable assurance, at justifiable cost, as to the reliability of financial records and reporting and the protection of assets. The system of controls provides for appropriate division of responsibility and the application of policies and procedures that are consistent with high standards of accounting and administration. Internal controls are monitored through recurring internal audit programs and are updated as our businesses and business conditions change.

The Audit Committee, composed solely of outside, independent directors, determines that management is fulfilling its financial responsibilities by meeting periodically with management, the independent auditors, and Quanex’s internal auditors, to review internal accounting controls and assess the effectiveness of our disclosure controls and procedures. The Audit Committee is responsible for appointing the independent auditors and reviewing the scope of all audits and the accounting principles applied in our financial reporting. Deloitte & Touche LLP has been engaged by the Audit Committee as independent auditors to audit the accompanying consolidated financial statements and issue the report thereon, which appears on the following page.  Our internal auditors and Deloitte & Touche LLP have full and free access to meet with the Audit Committee, without management present, to discuss the results of their audits, the quality of our financial reporting and the adequacy of our internal controls and disclosure controls and procedures.

We believe that Quanex’s system of internal controls, combined with the activities of the internal auditors and the Audit Committee, provides reasonable assurance of the integrity of our financial reporting.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Quanex Corporation

Houston, Texas

We have audited the accompanying consolidated balance sheets of Quanex Corporation and subsidiaries (the “Company”) as of October 31, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended October 31, 2004.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of October 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended October 31, 2004, in conformity with accounting principles generally accepted in the United States of America.

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QUANEX CORPORATION

CONSOLIDATED BALANCE SHEETS