UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-K

(Mark One)

For the fiscal year ended October 31, 2005

or

Commission file number 1-5725

QUANEX CORPORATION

(Exact name of registrant as specified in its charter)

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

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

The aggregate market value of the voting common equity held by non-affiliates as of April 30, 2005, computed by reference to the closing price for the Common Stock on the New York Stock Exchange, Inc. on that date, was $1,261,791,393.  Such calculation assumes only the registrant’s officers and directors were affiliates of the registrant.

At December 14, 2005, there were outstanding 25,465,896  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, 2005, for its Annual Meeting of Stockholders to be held on February 23, 2006, are incorporated herein by reference in 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. The businesses are organized into two segments:  Vehicular Products and Building Products.  Both operating segments have administrative, operating and marketing functions. The Company measures each segment’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, internal audit and human resource services to the operating divisions.

Quanex is a technological leader in the production of engineered carbon and alloy steel bars, heat treated bars, aluminum flat-rolled products, flexible insulating glass spacer systems, extruded profiles, and precision-formed metal and wood products which primarily serve the North American 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 steel bar plants (Fort Smith, Arkansas and Jackson, Michigan), each 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 higher margin niches of the vehicular products bar market. Since 1990, the Company has invested approximately $410 million through internal growth and an acquisition (Macsteel Monroe) to enhance its steel bar manufacturing and refining processes, to improve rolling and finishing capability, and to expand shipping capacity from 420 thousand tons to approximately 1.2 million tons per year, 300,000 of which is value-added MACPLUS capacity. Phases I through VII of the MACSTEEL expansions have been completed.

The Phase VIII capital project was announced in September 2004 and is scheduled for completion in December 2006.  Phase VIII will increase the annual capacity of the Fort Smith, Arkansas facility by approximately 40,000 tons, thereby increasing total engineered bar shipping capacity to more than 1.2 million tons.  In addition to an increase in capacity, the Phase VIII modernization will improve production flow and further enhance metallurgical quality.  Specifically included in the project are upgrades to the rotary continuous caster, direct rolling mill, and metallurgical refining areas.

In February 2005, the Company announced the Phase IX capital project which calls for the construction of a value-added bar processing center at Macsteel Monroe to eliminate outside processing for straightening, heat

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treating, testing, and bar turning services.  The project will include two straightening and testing lines, two heat treat furnaces and a MACPLUS bar turning line, all housed in a new building.  The project is expected to be completed in December 2006.

On December 9, 2004 the Company 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 were approximately $208 million.  Mikron has been integrated into the Company’s Building Products segment.

On January 25, 2005, the Company completed the sale of Piper Impact, a cold forged impact extrusion business in New Albany, Mississippi. The facility used impact extrusion presses to produce large volumes of near-net shaped components for automotive airbags, ordnance and other commercial uses.

On March 21, 2005, the Company completed the purchase of Besten Incorporated (Besten), located in Cleveland, Ohio.  Besten is a manufacturer and supplier of equipment used for assembling and glazing insulating glass components like those manufactured at TruSeal Technologies, Inc. (TruSeal), another of Quanex’s Building Products businesses.  Besten’s 2004 sales were roughly $6 million, and it currently has approximately 40 employees.

During the fourth fiscal quarter of 2005, the Company classified Temroc Metals Inc. (Temroc), located in Hamel, Minnesota, as held for sale.  In December 2005, the Company announced the pending sale of Temroc.  The business produces aluminum extrusions and fabricated products primarily for the recreational vehicle market.

Manufacturing Processes, Markets, and Product Sales by Business Segment

Quanex has 23 manufacturing facilities in 12 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.

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, 2005, 2004, and 2003, 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, steel bar and tube heat-treating services, and steel bar and tube corrosion and wear resistant finishing services.

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 1.2 million tons of hot finished, precision engineered, carbon and alloy steel bars annually.

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The Company believes that it has the only two bar 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 both static and rotary centrifugal continuous casters.  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, in part because its average energy costs are significantly lower than those of its competitors; 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. Its highly automated manufacturing processes enable the Company to produce finished steel bars using less than two man-hours of labor per ton.

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

The Vehicular Products segment also includes two additional, complementary operations. 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 market.

Building Products Segment

The Building Products segment is comprised of an aluminum sheet casting operation, three stand-alone aluminum sheet finishing operations, five fabricated metal components operations, two facilities producing wood fenestration (door and window) products, three vinyl extrusion facilities, a flexible insulating glass spacer business with a production facility and a facility that produces glass spacer installation systems.  The segment produces mill finished and coated aluminum sheet and various engineered products for the building and remodeling markets.  Products include flexible insulating glass spacer systems, window and patio door screens, window cladding frames, residential exterior products, custom wood window grilles and accessories, engineered vinyl and thermoplastic alloy composite window components, 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.  The aluminum sheet may be coated and / or painted, slit to various widths and finished with a variety of textures.  Customer end-use applications, exterior housing trim, exterior door thresholds, astragals, patio door systems, and custom hardwood architectural mouldings.  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 approximately 400 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

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capabilities, including two rotary barrel furnaces and a dross recovery system that broaden its use of raw materials, allowing it to melt lesser grades of scrap, while improving 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.

Aluminum sheet finishing capabilities include reducing coil to specific gauge, annealing, slitting and custom coating.  The product is packaged and delivered just in time for use by various customers in the building and construction markets, as well as other capital goods markets.

The Building Products segment’s operations also produce window and door systems and components for original equipment manufacturers (OEMs).  The extrusion operations use highly automated production facilities to manufacture vinyl profiles and composites, the window and door structural frames used by high-end fenestration OEMs.  The value added capabilities include tooling design and fabrication, laser welding, roll forming, poly laminating, stamping, and end-product assembly to produce a variety of fenestration products.  These businesses also produce custom window grilles and trim in a variety of woods.  In addition, the insulating glass business uses composite and laminating technology to produce highly engineered window spacer products used to separate two panes of glass in a window sash to improve thermal performance.

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. 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’s operations purchase 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, among other things, extreme weather conditions. Physical hedges are used on a limited basis 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), polyvinyl chloride and epoxy resin.  In most cases the raw materials are available from several suppliers at market prices.  One exception is aluminum sheet which is transferred within the segment at prices based upon arms-length transactions.  Sole sourcing arrangements are entered into from time to time if beneficial savings can be realized and only when it is determined that a vendor can reliably supply all of the Company’s raw material requirements.

Backlog

At October 31, 2005, Quanex’s backlog of orders to be shipped in the next twelve months was approximately $330 million, comprised of $273 million for the Vehicular Products segment and $57 million for the Building Products segment.  This compares to approximately $489 million at October 31, 2004, comprised of $419 million for the Vehicular Products segment and $70 million for the Building Products segment, at which time customers at its large process businesses were on allocation. Excluding backlogs associated with the acquisitions completed during fiscal 2005 and 2004, the October 31, 2005 backlog is $85 million lower than

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October 31, 2004 and $60 million higher than at October 31, 2003.  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 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, vinyl and wood fabricators and wood moulding facilities in addition to mid-size and large aluminum sheet manufacturers, some of which are divisions or subsidiaries of major corporations with substantially greater resources than the Company.  The Company also competes against sealant firms and other insulated glass panel fabrications. 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 regional presence, custom engineering, product development, quality, service and price.  The operations also compete with in-house operations of vertically integrated fenestration 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 force and a limited number of manufacturers’ representatives. The Building Products segment’s products are sold primarily to OEMs through company direct sales force, along with the limited use of distributors to market aluminum steel and wood moldings.

Seasonal Nature of Business

Sales for the Building Products segment’s products are seasonal. The 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 federally registered trademarks or service marks include QUANEX, QUANEX and design, SEAM-FREE and design, NITROSTEEL, MACGOLD, MACSTEEL, MACSTEEL THE MIGHTY MITE and design, MAC+, ULTRA-BAR, TRUSEAL TECHNOLOGIES, EDGETHERM, INSULEDGE, COLONIAL CRAFT, MIKRON, MIKRONWOOD, MIKRONWOOD A PAINTABLE COMPOSITE and design, M design, MIKRONBLEND, MIKRON BLEND and design, SPECTUSBLEND, SPECTUS BLEND and design, K2 MIKRON and design, BUILDER & REMODELER EXECUTIVE, WINDOW EXECUTIVE, HOMESHIELD, HOMESHIELD and design, STORM SEAL, MACPRIME, NITRO-100, and “THE BEST ALLOY & SPECIALTY BARS” marks. The trade name Nichols-Homeshield and the HOMESHIELD trademarks are used in connection with the sale of the Company’s aluminum mill sheet products and residential building products. The HOMESHIELD, COLONIAL CRAFT, MACSTEEL, TRUSEAL TECHNOLOGIES, MIKRON 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 other than at its vinyl extrusion business. Although the Company holds numerous patents, in some cases, the proprietary technology that the Company has developed from 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.  At present, the Company is involved at several such facilities.

During the third quarter of 2005, the United States Department of Justice filed a complaint against the Company for recovery of cleanup costs incurred at the “Jepscor” Superfund site in Dixon, Illinois.  The United States Environmental Protection Agency has indicated that it incurred approximately $2.6 million in exposures to remove processing residue and other materials from that former metal recovery plant.  Of the Jepscor site’s former owners, operators, and many customers, the government is asserting liability for cleanup only against the

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Company.  During the fourth fiscal quarter of 2005, the Company and the Department of Justice reached a tentative agreement to settle this matter.  If that settlement cannot be finalized, the Company intends to defend itself vigorously against the government’s Jepscor allegations.

Total remediation reserves, at October 31, 2005, for Quanex’s current plants, former operating locations, and disposal facilities were approximately $8.9 million, which is within $0.3 million of the reserve at October 31, 2004.  Of the current remediation reserve, approximately $2.0 million represents administrative costs; the balance represents estimated costs for investigation, studies, cleanup, and treatment. On the balance sheet, $6.7 million of the remediation reserve is included in non-current liabilities with the remainder in current accrued liabilities.

Approximately 51% of the total remediation reserve is currently allocated to cleanup work related to Piper Impact. During the first quarter of 2005, the Company sold the operating assets of the Piper Impact business, including its only active plant on Barkley Drive in New Albany, Mississippi.  In the fourth fiscal quarter of 2005, the Company sold the location on Highway 15 in New Albany where Piper Impact previously had operated a plant (the Highway 15 location), but as part of the sale retained environmental liability for pre-closing contamination there.  At present, the largest component of the Piper Impact remediation reserve is for remediation of soil and groundwater contamination from prior operators of the Highway 15 location in New Albany.  The Company voluntarily implemented a state-approved remedial action plan there that includes natural attenuation together with a groundwater collection and treatment system.  The Company continues to monitor conditions at the site and to evaluate performance of that remedy.

Included in the current reserve is the estimated cost of operating the existing groundwater remediation system at the Highway 15 location over the next 20 years, which was discounted to a net present value using an interest rate of 3.0%.  The Company has estimated the annual cost of operating the existing system to be approximately $0.2 million and has assumed that the existing system will continue to be effective.

The final remediation costs and the timing of the expenditures at the Highway 15 location 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, the Company believes it has established adequate reserves for all probable and reasonably estimable remediation liabilities.  It is not possible at this point to reasonably estimate the amount of any obligation for remediation in excess of current accruals because of uncertainties as to the extent of environmental impact, cleanup technologies, and concurrence of governmental authorities.  The Company currently expects to pay out the accrued remediation reserve through at least fiscal 2025, although some of the same factors discussed earlier could accelerate or extend the timing.

Compliance

Quanex incurred expenses of approximately $4.7 million and capitalized an additional $2.9 million during fiscal 2005 in order to comply with existing environmental regulations.  This compares to $3.4 million of expense and $2.4 million of capital incurred during fiscal 2004.  For 2006, the Company estimates expenses at its facilities will be approximately $3.4 million for continuing environmental compliance.  In addition, the Company estimates that capital expenditures for environmental compliance in fiscal 2006 will be approximately $0.2 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 2006, but it is not possible at this time to reasonably estimate the amount of those expenditures, except as discussed above.

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Employees

The Company had 4,530 employees at October 31, 2005 and approximately 4,540 at December 15, 2005.  Of the total employed, approximately 33% are covered by collective bargaining agreements.  None of such collective bargaining agreements expire in fiscal 2006.  Following is a table of collective bargaining agreements currently in place.

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.

Communication with the Company

The Company’s website is www.quanex.com.  Quanex invites inquiries to the Company and its Board of Directors.  Interested persons may contact the appropriate individual or department by choosing one of the options below.

General

Investor Information:

For Investor Relations matters or to obtain a printed copy of the Company Code of Ethics, Corporate Governance Guidelines or charters for the Audit, Compensation and Management Development, and Nominating and Corporate Governance Committees of the Board of Directors, send a request to the Company’s principal address below or inquiry@quanex.com.  This material may also be obtained from the Company website at www.quanex.com by following the “Corporate Governance” link.

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 the Company’s 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 Company’s website.  All of these materials are located at the “Financial Information” link.  They can also be obtained free of charge upon request to inquiry@quanex.com or to the Company’s principal address:  Quanex Corporation, 1900 West Loop South, Suite 1500, Houston, TX 77027.

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Communications with the Company’s Board of Directors:

Persons wishing to communicate to the Company’s Board of Directors or specified individual directors may do so by sending them in care of Raymond A. Jean, The Chairman of the Board of Directors, at the Company’s principal address below or hotline@quanex.com.

Hotline

Accounting Issues:

Persons who have concerns or complaints regarding questionable accounting, internal accounting controls or auditing matters may submit them to the Senior Vice President – Finance & Chief Financial Officer at the Company’s principal address or hotline@quanex.com.

Such communications will be kept confidential to the fullest extent possible. If the individual is not satisfied with the response, they may contact the Audit Committee of the Board of Directors of the Company. If concerns or complaints require confidentiality, then this confidentiality will be protected, subject to applicable laws.

Reporting Illegal or Unethical Behavior:

Employees, officers and directors who suspect or know of violations of the Company Code of Business Conduct or Ethics, or illegal or unethical business or workplace conduct by employees, officers or directors have an obligation to report it. If the individuals to whom such information is conveyed are not responsive, or if there is reason to believe that reporting to such individuals is inappropriate in particular cases, then the employee, officer or director may contact the Chief Compliance Officer, Chief Financial Officer, Director of Internal Audit, or any corporate officer in person, by telephone, letter to the Company’s principal address or e-mail below.  Quanex also encourages persons who are not affiliated with the Company to report any suspected illegal or unethical behavior.

Such communications will be kept confidential to the fullest extent possible. If the individual is not satisfied with the response, they may contact the Nominating and Corporate Governance Committee of the Board of Directors of the Company. If concerns or complaints require confidentiality, then this confidentiality will be protected, subject to applicable laws.

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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 believes 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 fiscal 2005, the Company’s manufacturing plants generally operated close to capacity.

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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.

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 cash dividends and the high and low closing prices for the Company’s common stock during each fiscal quarter within the two most recent fiscal years.  Share amounts set forth below and elsewhere in this report have been adjusted to reflect the results of the December 2004 three-for-two stock split in the form of a stock dividend.

Quarterly Common Stock Cash Dividends

Quarterly Common Stock Sales Price (High & Low Closing Price)

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, 2005, the aggregate amount available for dividend increases under the credit facility was approximately $137.3 million.

(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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There were approximately 3,696 holders of Quanex common stock (excluding individual participants in securities positions listings) on record as of December 14, 2005.

Issuer Purchases of Equity Securities

On August 26, 2004, the Company’s Board of Directors approved an increase in the number of authorized shares in the Company’s existing stock buyback program, up to 1.5 million shares.  No shares were purchased during fiscal 2005, nor were any purchased during fiscal 2004.  At October 31, 2005 there were no shares of treasury stock.

Equity Compensation Plan Information

The following table summarizes as of October 31, 2005, certain information regarding equity compensation to our employees, officers, directors and other persons under our equity compensation plans.

Equity Compensation Plan Information

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(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 600,000 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.  This plan was terminated at the December 2005 Board of Directors’ meeting.

Item 6.           Selected Financial Data

The following selected consolidated financial data for the years ended October 31, 2001 through October 31, 2005 is derived from the Company’s audited consolidated financial statements. The operating results data includes two reclassifications to conform to current period presentations with no impact on net income. First, all periods have been adjusted on a retroactive basis to give effect for the Company’s December 2004 three-for-two stock split in the form of a stock dividend.  In addition, the Company classified Temroc as held for sale in 2005 and thus is reporting Temroc as discontinued operations for all periods presented.  The data set forth should be read in conjunction with the Company’s consolidated financial statements and accompanying notes to the consolidated financial statements included in Item 8 of this Form 10-K. The historical information is not necessarily indicative of the results to be expected in the future.

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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 2001 - 2005

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(1)          During the fourth quarter of 2005, the Company committed to a plan to sell its Temroc business.  In the first quarter of 2005, the Company sold its Piper Impact business and in the fourth quarter of 2004 sold its Nichols Aluminum – Golden business.  Accordingly, the assets and liabilities of Temroc, 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)          In December 2004, the Company acquired Mikron and accounted for the acquisition under the purchase method of accounting.  Accordingly, Mikron’s estimated fair value of assets acquired and liabilities assumed in the acquisition and the results of operations are included in the Company’s consolidated financial statements as of the effective date of the acquisition.  For more information see Note 2 of the consolidated financial statements in Item 8 of this Form 10-K.

(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.  In

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addition, as of November 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”  (SFAS 142). Under SFAS 142, goodwill is no longer amortized, but is tested for impairment annually by assessing the fair value of reporting units, generally one level below reportable segments.  The transitional impairment test of goodwill during fiscal 2002 indicated that goodwill was not impaired.  Also, operating income does not reflect any goodwill amortization beginning with fiscal year 2002.  For more information regarding goodwill, see Note 4 to the consolidated financial statements in Item 8 of this Form 10-K.

(4)          Fiscal 2003 and 2002 include gains associated with retired executive life insurance proceeds of $2.2 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 2005 of Temroc’s $13.1 million (pretax and after-tax) asset impairment charge in accordance with SFAS 142 and SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144).

(6)          Cash dividends per share presented include cash dividends approved by the Board of Directors at the Company’s February, May, August and December board meetings as such declared dividends were attributable to the previously completed fiscal quarter’s financial performance.  Accordingly, cash dividends per share presented will be different than cash dividends paid during the respective fiscal year.  See Consolidated Statements of Stockholders’ Equity in Item 8 of this Form 10-K for cash dividends paid during fiscal 2005, 2004 and 2003.

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 the 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

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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

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

Overview

Fiscal 2005 was a record year.  Record net sales of $1,969.0 million was an increase of 36.9% over the previous record level in fiscal 2004.  The net sales increases over the last several years is attributable to strong demand in 2004, increased average selling prices in 2005, and improved mix for both 2004 and 2005 coupled with the addition of acquisitions during both fiscal 2004 and fiscal 2005.  Excluding the impact of the recent acquisitions (Macsteel Monroe, TruSeal and Mikron), net sales increased 23.3% and 16.7% in fiscal 2004 and 2005, respectively.

Diluted earnings per share from continuing operations for fiscal 2005 were $6.75, almost triple year ago results of $2.29 per share.  Fiscal 2005 diluted earnings per share were $5.92 per share.  Fiscal 2004 results benefited from particularly strong demand that was offset by significant raw material increases, whereas fiscal 2005 was a year of somewhat weaker demand with margin expansion due to higher base prices coupled with a decline of ferrous and aluminum scrap costs.

Business Segments

Business segments are reported in accordance with Statement of Financial Accounting Standards (SFAS) No. 131 (SFAS 131). SFAS 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 bars for the light vehicle, heavy duty truck, agricultural, defense, capital goods, recreational and energy markets.  The Vehicular Products segment’s primary 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 components serving the window and door industry, and mill finished and coated aluminum sheet serving the broader building products markets.  The main market drivers of this segment are residential housing starts and remodeling expenditures.

Vehicular Products – Three Years Ended October 31, 2005

The Vehicular Products segment reported record net sales and operating income in fiscal 2005.  The segment’s primary market drivers are North American light vehicle production (approximately 65% of sales) and Class 8 heavy duty truck production (approximately 15% of sales).  Vehicle builds have ranged from 15.5 million to 16.0 million over the last several years.  Calendar 2005 vehicle builds are expected to be some 15.7 million.  The segment experienced excellent customer demand in 2005, particularly in the first half of the year, when demand for the segment’s engineered steel bar products outstripped our ability to fully supply customers.  The segment also benefited from higher base selling prices and falling steel scrap costs for much of the year.

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

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(1)                                  All periods presented exclude Piper Impact and Temroc, which are included in discontinued operations.

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

Net sales for fiscal 2005 were higher than fiscal 2004 by 27.9% due to the combination of a 34.0% increase in average selling prices (including surcharges), increased sales as a result of two additional months of business at Macsteel Monroe during fiscal 2005, offset by a 10.6% decline in volume excluding Macsteel Monroe.  The increase from fiscal 2003 to fiscal 2004 is made up of a 69.8 % increase as a result of the Macsteel Monroe acquisition coupled with an 8.2% increase in volume and a 21.5% increase in average prices (including surcharges).

•                  Fiscal 2005 volumes dropped from the strong levels that had persisted for several years primarily as a result of reduced end-use demand and inventory drawdowns.  Over time, end-use demand is expected to increase, influenced, in part, to overall driver aged population growth.  The Company continues to focus on consistently improving productivity as well as enhancing its value-added offerings in an effort to meet the anticipated higher demand over time.  Future volume increases will also be based upon the Company’s ability to increase content per vehicle as well as continued sales growth with the New American Manufacturers (NAMs) which continue to take share from the Big 3 manufacturers.

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•                  The average price increases realized over the last three years are primarily the result of three items.  First, the Company is focused on continuing to increase sales of the segment’s value-added products.  As the mix of value-added sales increases, so does the average sales price.  The second contributing factor to the average price increases are underlying base price increases that were realized in 2005.  The largest contributing factor for the increase from fiscal 2003 to 2004 and from fiscal 2004 to 2005 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 steel scrap price increases, surcharges began on January 1, 2004 and have been adjusted quarterly since then (see further discussion of surcharge lag in “Commodity Price Risk” of Item 7A).  Steel scrap price surcharges have been a component of the Company’s MACSTEEL sales contracts for many years and will remain in effect as long as steel scrap prices remain at current levels.

The 40.7% and 157.7% increases in operating income from fiscal 2003 to 2004 and fiscal 2004 to 2005, respectively, resulted from the increases in average selling prices offset by higher raw material costs.  At MACSTEEL, average selling prices increased as raw material costs fell during fiscal 2005, whereas in fiscal 2004 raw material costs increased more than average selling prices.  Volume increases in fiscal 2004 were able to offset the higher raw material price increases.  Raw material costs increased significantly during fiscal 2004.  During fiscal 2005 raw material costs steadily declined for the first three fiscal quarters followed by an increase during the fiscal fourth quarter.  Fiscal 2005 selling, general and administrative expenses were higher primarily due to increased incentives resulting from the improved return on net assets (RONA) level achieved for the year coupled with a $3.1 million increase in the reserve for doubtful accounts receivable due to Jernberg Industries, Inc. and Delphi, which filed for bankruptcy during the year. During fiscal 2004, selling, general and administrative expenses increased primarily related to the addition of Macsteel Monroe.

Operating income margin variation from fiscal 2003 to 2004 and 2005 was greatly impacted by the dramatic rise and fall of raw material prices and the timing and magnitude of scrap surcharges.  Raw material prices increased sharply throughout fiscal 2004 which compressed the segment’s margins, while in fiscal 2005 raw material prices declined during the first three quarters of the year.  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 surcharge reductions lag behind.  Based upon the inherent lag of surcharge pricing, the Company’s margins were compressed during fiscal 2004 and expanded during fiscal 2005.  The operating income margins realized during fiscal 2005 are not sustainable over the long-term.  In fact, margins experienced compression during the latter months of the Company’s fiscal 2005.

Building Products – Three Years Ended October 31, 2005

The Building Products segment reported record net sales and operating income in fiscal 2005.  The segment’s primary market drivers are North American new housing starts and remodeling activity, and both drivers continue to perform at high levels.  For example, new housing starts are expected to exceed 2 million for calendar year 2005, a best ever year.  The Building Products segment’s process business, Nichols Aluminum, benefited from higher selling prices and very robust demand, particularly in the first half of the year, when customer demand for the segment’s mill finished and painted sheet outstripped our ability to supply.  The segment’s window and door components business benefited from both healthy demand through the year and the addition of Mikron Industries, a leading supplier of vinyl window profiles, which was acquired in December 2004.  The business was negatively impacted late in the fiscal year from a sharp rise in the cost of raw materials at its Mikron and TruSeal businesses, the result of Hurricane Katrina and its impact on major suppliers located along the Gulf coast.

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

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

(2)                                  Fiscal 2005 includes Mikron’s operations as of December 10, 2004.

(3)                                  Fiscal 2005 and 2004 include TruSeal’s operations as of January 1, 2004.

The fiscal 2005 net sales increase resulted from a 34.8% increase from the acquisition of Mikron and a 13.4% increase at the other businesses within the segment.  The increase in net sales from fiscal 2003 to fiscal 2004 was comprised of a 16.6% increase from the acquisition of TruSeal and a 15.9% increase at the other businesses within the segment.  The increase in net sales over the three year period was a result of increased volumes across the entire segment during fiscal 2004 combined with a 13.8% and 17.9% increase in aluminum sheet selling prices for 2004 and 2005, respectively.

•                  The volume increase in fiscal 2004 was driven by strong demand in the building products market and new programs with fenestration customers.  Volume in fiscal 2005 declined slightly due to inventory drawdowns of aluminum sheet that resulted from prebuying that occurred early in the year. Fenestration component sales remained robust as a result of increased housing starts as well as strong remodeling and renovation activity.  Fiscal 2005 housing starts were also fueled by relatively low mortgage rates.  Mortgage rates are increasing and expected to rise further during fiscal 2006, which could slow the pace of housing starts.  The segment is expected to benefit from continued steady demand from remodeling and renovation activity which comprises an estimated 50% of the segment’s sales.  The Company is focused on working closely with customers to be a part of their new product development which is an important component to increasing revenue.  Generally, demographics for long-term housing demand are favorable when factoring the population increase, immigration and an increase in vacation homes.  These coupled with an increase in the average-sized home should benefit the segment over the long-term.  Furthermore, the Company’s presence in the vinyl and composite window market, which represents the fastest growing window segment, should continue to fuel growth.

•                  The increased aluminum sheet selling prices during fiscal 2004 and 2005 was a result of reduced industry capacity which combined with strong demand during fiscal 2004 and the first half of 2005 to put upward pressure on pricing.  The Company continues to increase the mix of value-added products across the segment which should mitigate the expected margin pressure due to moderation in demand.

Excluding Mikron, net sales increased 13.4% in fiscal 2005 compared to a 7.4% increase in cost of sales.  The spread between the Company’s selling price and raw material price expanded in fiscal 2005 over fiscal 2004 even with the rise in raw material costs.  This increase in spread was the primary contributor to the increase in operating income from 9.8% in fiscal 2004 to 13.8% in fiscal 2005.  The increased spread was partially offset by more incentives from higher RONA levels.

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Operating income for fiscal 2004 increased 47.9% from the acquisition of TruSeal and 47.2% primarily due to margin expansion.  During fiscal 2004 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 volume increases resulted in further expansion of the operating income margin.

While the spreads realized during fiscal 2005 are not expected to continue, the spreads are anticipated to remain at more favorable levels than had been realized historically.

Corporate and Other – Three Years Ended October 31, 2005

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) and corporate office expenses.  As a result of raw material cost increases during fiscal 2003 and fiscal 2004, the Company incurred expense of $6.1 million and $20.4 million in the form of a LIFO inventory adjustment.  The pool of average raw material costs was only slightly lower at the end of fiscal 2005 compared to the end of fiscal 2004 and as a result the Company recognized $0.1 million of income due to the reduction of the LIFO inventory adjustment.  Fluctuations associated with the LIFO inventory adjustment tend to comprise a majority of the change from year to year in corporate and other expenses.  For the year ended October 31, 2005, the Company incurred $8.2 million of external consulting fees and external audit fees associated with the Sarbanes-Oxley Act.

Other Items – Three Years Ended October 31, 2005

Interest expense for fiscal 2005 was $9.3 million compared to $6.0 million in fiscal 2004 and $2.7 million in fiscal 2003.  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.  During the first quarter of fiscal 2005 the Company borrowed against the revolving credit facility to fund the acquisition of Mikron.  The borrowings and subsequent debt repayment followed a similar pattern to what occurred in 2004.  The difference in interest expense is related to a full year of interest on the Company’s 2.5% Convertible Senior Debentures combined with higher interest rates incurred during fiscal 2005.

Other, net (on the income statement) for fiscal 2005 was income of $0.1 million compared to income of $0.3 million in fiscal 2004 and $2.7 million in fiscal 2003.  The change from 2003 to 2004 is due to a $1.7 million reduction associated with the cash surrender value of life insurance, net of the change for the supplemental retirement liability, combined with $0.5 million of additional expenses recognized in fiscal 2004 for deferred compensation.

Income (loss) from discontinued operations, net of taxes for fiscal 2005 was a loss of $22.1 million compared to a loss of $3.0 million for fiscal 2004 and a loss of $0.8 million for fiscal 2003.  The increased loss from

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fiscal 2003 to fiscal 2004 is related to the $0.6 million loss on the sale of Nichols Aluminum – Golden, combined with the net $3.5 million write down of Piper Impact.  During fiscal 2005, the Company recorded a goodwill impairment charge for Temroc of $13.1 million.  The Temroc impairment combined with an additional loss on the sale of Piper Impact comprised the difference between fiscal 2004 and fiscal 2005.  See Note 19 for further information regarding the composition of discontinued operations.

Outlook

For 2006, North American light vehicle builds for the calendar year are expected to be about 15.5 million units, down slightly from 2005’s estimated 15.7 million units.  “Big 3” light vehicle builds are expected to be down, roughly offset by an increase in builds at the transplant companies.  The Company’s market response to a fall-off in builds is to continue to increase our content per vehicle with both the “Big 3” and the transplants.  One major area of content growth lies within the conversion of automotive crankshafts from a cast iron product to a steel application, which represents a 200,000 ton opportunity.  In 2005, the Company produced approximately 10,000 tons of bars for crankshaft applications, and for 2006, the Company expects that tonnage to reach 35,000 tons.  The production of heavy duty trucks is expected to remain quite strong in 2006, with builds topping 325,000, as manufacturers attempt to beat the 2007 deadline for new EPA emission mandates for Class 8 engines.

For fiscal 2006, the Company believes that the bulk of the industry-wide steel inventory drawdowns are behind us.  The significant production cutbacks the Company experienced over the last couple of quarters of fiscal 2005 seem to be over, which should result in our bar production being more in line with normalized demand.  Looking at the first quarter, MACSTEEL has seen a recent up-tick in customer activity and the plants today are collectively running at about 90% capacity.  In addition, the pace is expected to pick up after the holidays based on the current backlog.

In the Building Products segment, both housing starts and remodeling activity are expected to remain at historically high levels.  For 2005, housing starts hovered around 2 million units, which will make it the best year ever.  For 2006, the Company is expecting a modest slowdown, but is looking for starts to stay around 1.8 million while remodeling activity is expected to remain at high levels.  The segment will also benefit this year from both lower costs and higher sales associated with our relatively new Hood River and Dubuque fenestration facilities.  Expectations for the Mikron business and the vinyl window market they serve appear excellent.  The Company expects the vinyl window market to experience growth approaching 5% for the new construction market and closer to 10% for the remodeling market.  The Company believes that the outlook for Nichols Aluminum remains favorable as well.  Supply and demand fundamentals have shifted considerably over the last year as the industry experienced mergers, downsizing and price increases, and we will continue to benefit from that transition.  Near term, the Company does expect shipments to trail year ago figures as customers continue to work off high inventories.

Given these sound fundamentals, an end to the sharp spike in raw material costs experienced this year, some catch up in pricing, and the growth the Company expects to see from its vinyl window profile sales, the Company believes 2006 will be a better year for our fenestration business.  In fact, Quanex expects to substantially outperform the market with growth exceeding 15%.

Combining the anticipated operating results of the two operating segments, Quanex expects to report diluted earnings per share from continuing operations for the first quarter of fiscal 2006 in a range of $0.70 to $0.80. The Company cautions that its combination of short cycle businesses and volatile raw material costs, particularly for scrap, makes forecasting problematic.

For the first quarter of 2005, both MACSTEEL and Nichols Aluminum were running at unsustainably high operating rates, they were aggressively raising prices, their customers were on allocation and their backlogs were at

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record levels.  Adding to these positive factors was that MACSTEEL was experiencing a significant over recovery on their actual scrap costs in the first quarter of 2005 as well.  These factors combined to give the Company a huge first quarter in 2005, with earnings over 4 times higher than the first quarter of 2004, along with record net sales and record income from continuing operations.  Unfortunately, these earnings cannot reasonably be duplicated in what looks to be a much more normal first quarter of 2006.

At this time, Quanex is not providing annual guidance for 2006.  The Company is still finalizing contract talks with its customers at MACSTEEL; the volatility of steel scrap continues; and the Company wants to experience the volume rebound for aluminum sheet it expects to see after the holiday.  For these reasons, the Company expects to give 2006 guidance when it announces first quarter results in February 2006.  In the meantime, the Company’s first quarter guidance cannot be multiplied by four to estimate the full fiscal year 2006 as there is considerable seasonality to the Company’s earnings.  In recent years, first quarter earnings have typically been approximately 15% of the Company’s annual earnings per share.

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).  On December 19, 2003, the Company executed an agreement with our credit facility banks to increase the Bank Agreement from $200.0 million to $310.0 million to provide the funds necessary for acquisitions.  On April 9, 2004, the Company requested and received consent from its credit facility bank group to extend the maturity date of the Bank Agreement from November 15, 2005, to February 28, 2007.

In December 2004, the Company borrowed $200.0 million under the Bank Agreement to fund the acquisition of Mikron.  Since then, the Company has paid off all $200.0 million of the borrowings.  At October 31, 2005, the Company had no borrowings under the Bank Agreement and $125.0 million outstanding 2.50% Senior Convertible Debentures due May 15, 2034 (the Debentures).  This represents no change from October 31, 2004, borrowing levels.  The aggregate availability under the Bank Agreement was $296.3 million at October 31, 2005, which is net of $13.7 million of outstanding letters of credit.

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

The Company’s working capital was $133.9 million on October 31, 2005 compared to $140.1 million on October 31, 2004, a $6.2 million reduction.  Excluding the impact of the acquisitions and the impact of discontinued operations, working capital increased $6.7 million from October 31, 2004, to October 31, 2005.  The most significant changes were a $34.6 million reduction in accounts receivable and a $43.7 million reduction in accounts payable.  Accounts receivable declined because of two items.  The accounts receivable balance as of October 31, 2005 represented fewer days of sales outstanding than the balance as of October 31, 2004, which accounts for $29.0 million of the reduction, with $18.7 million attributable to the Vehicular Products segment.  The remaining difference is a result of the fact that net sales for the fourth quarter of 2005 were lower than net sales in the fourth quarter of 2004, excluding the acquisitions.  The reduction in accounts payable is directly related to lower raw material prices coupled with lower purchase volumes across both segments.  The cash and equivalents balance increased $6.5 million to $49.7 million as the Company ended fiscal 2005 with nothing outstanding under the Bank Agreement.

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Operating Activities

Cash provided by operating activities during the year ended October 31, 2005 was $249.1 million compared to $124.2 million and $102.8 million for 2004 and 2003, respectively. The $124.9 million increase in operating cash flows from fiscal 2004 to 2005 is primarily attributable to the $119.8 million increase in income from continuing operations.  Similarly, the increase of $21.4 million from fiscal 2003 to fiscal 2004 is primarily attributable to the $13.8 million increase in income from continuing operations.  Accounts receivable and accounts payable decreased in fiscal 2005 as a result of the weaker demand experienced during the year.  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.  The Company continues to focus on working capital consistent with improving its business processes.

Investment Activities

Net cash used for investment activities during the year ended October 31, 2005 was $240.7 million compared to $213.1 million and $22.5 million for fiscal 2004 and 2003, respectively.  Investment activities for the year ended October 31, 2005 included the acquisition of Mikron and Besten for $200.6 million. The cost of the acquisitions was partially offset by the $11.7 million received from the sale of Piper Impact as well as proceeds received as a working capital adjustment from the sale of Nichols Aluminum - Golden.  The Company expects to receive proceeds from the sale of Temroc in fiscal 2006 (see Note 19 for further explanation).

Capital expenditures increased $32.1 million in fiscal 2005 compared to fiscal 2004.  Of this increase, $15.1 million is attributable to the expansion of value added capabilities and caster upgrades within the Company’s Vehicular Products segment (Phase VIII and Phase IX expansions at MACSTEEL).  In addition, Mikron’s capital spending totaled $13.1 million for capacity expansion.  Capital expenditures had been relatively steady in previous years at $24.4 million in fiscal 2003 and $18.7 million in fiscal 2004. The Company expects 2006 capital expenditures to increase to range from approximately $75 million to $85 million as both MACSTEEL and Mikron continue with their respective expansions.  At October 31, 2005, the Company had commitments of approximately $36.2 million for the purchase or construction of capital assets. The Company plans to fund these capital expenditures through cash flow from operations.

Financing Activities

Cash from financing activities was a $0.5 million use of cash, a $108.5 million source of cash and a $76.5 million use of cash for the years ended October 31, 2005, 2004 and 2003, respectively.  During fiscal 2005, the Company borrowed approximately $200.0 million to fund the acquisition of Mikron.  By the end of fiscal 2005, all $200.0 million had been repaid.  The amount of dividends paid was offset by the amount of cash received associated with the issuance of stock upon exercise of stock options.  During fiscal 2004, the primary reason for the source was the issuance of the Debentures.  Fiscal 2003 resulted in a use of cash as the Company repaid bank borrowings and repurchased some of the Company’s common stock.

Debt Structure and Activity

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

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Stock Purchase Program

On August 26, 2004, the Board of Directors authorized the Company to reload its stock buy back program, increasing the existing authorization up to 1.5 million shares.  During fiscal 2006, the Company may purchase shares, from time to time, on the open market or in negotiated transactions, as circumstances warrant, depending upon market conditions and other factors.

Contractual Obligations and Commercial Commitments

Contractual Cash Obligations

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

(1)   The long-term debt is primarily comprised of the $125.0 million of Debentures due in 2034 and $10.6 million of various revenue bonds.  The Debenture obligation is based on the stated maturity, and the debt interest amounts are based on rates as of October 31, 2005.

(2)   Operating leases cover a range of items from facilities, fork trucks and cars to fax machines and other miscellaneous equipment.

(3)   The unconditional purchase obligations are made up of $6.9 million of natural gas contracts and $13.5 million of aluminum scrap contracts along with other miscellaneous repair and maintenance items.

Other Commercial Commitments

The following table reflects other commercial commitments or potential cash outflows that may result from a contingent event, such as a need to borrow short-term funds for liquidity purposes.

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 the Company’s 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 Estimates

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. Inventories are valued using both the first-in first-out (FIFO) and last in, first out (LIFO) methods.  The Company adopted the link chain LIFO method in fiscal 1973. Since then, acquisitions were integrated into the Company’s operations with some valuing inventories on a LIFO basis and others on a FIFO basis.  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.

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

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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 in circumstances and/or legal requirements 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 and Intangibles

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.

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.

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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.

The effects of the decrease in selected assumptions, assuming no changes in benefit levels and no amortization of gains or losses for the pension plans in fiscal 2005, is shown below:

Accounting guidance applicable to pensions does not require immediate recognition of the effects of a deviation between actual and assumed experience and the revision of an estimate. This approach allows the favorable and unfavorable effects that fall within an acceptable range to be netted and disclosed as an unrecognized gain or loss in the footnotes. At October 31, 2005 and 2004, there were unrecognized losses of $18.8 million and $20.1 million, respectively. A portion of the loss will be amortized in fiscal year 2006. The effect on fiscal years after 2006 will depend on the actual experience of the plans.

Postretirement plan assumptions reflect our historical experience and our best judgments regarding future expectations.  Assumed health care cost trend rates could have an effect on the amounts reported for post retirement benefit plans.  A one-percentage point change in assumed health care cost trend rates would have the following effects:

Mortality assumptions used to determine the obligations for our pension and other postretirement benefit plans are related to the experience of the plans and to our third-party actuary’s best estimate of expected plan mortality. The mortality assumptions for fiscal 2006 valuation purposes will be based on different mortality tables.  The selected mortality tables for fiscal 2006 are among the most recent tables available.  The effect of the change is expected to increase the projected benefit obligation and pension expense for fiscal 2006 by approximately $2.9 million and $0.6 million, respectively.

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Discontinued Operations

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (SFAS 144) 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.

New Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R). SFAS 123R requires companies to measure all employee stock-based compensation awards using a fair value method and record such expense in the Company’s consolidated financial statements.  The provisions of SFAS 123R are effective for the first annual reporting period that begins after June 15, 2005. The Company will adopt this standard at the beginning of fiscal 2006 and will elect the modified-prospective transition method. Under the modified-prospective method, awards that are granted, modified, repurchased or cancelled after the date of adoption should be measured and accounted for in accordance with SFAS 123R. Awards that are granted prior to the effective date should continue to be accounted for in accordance with SFAS 123 except that stock option expense for unvested options must be recognized in the income statement. The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on, among other things, levels of share-based payments granted in the future, the market value of the Company’s common stock as well as assumptions regarding a number of complex variables. These variables include, but are not limited to, the Company’s stock price, volatility, and employee stock option exercise behaviors and the related tax impact. However, had the Company adopted SFAS 123R in prior periods, the Company believes the impact of that standard would have approximated the impact of SFAS 123 as described in the “Stock Based Employee Compensation” disclosure of pro forma net income and earnings per share in Note 1 of Item 8 of this Form 10-K.

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 Note 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, 2005 and 2004, the Company had fixed-rate debt totaling $126.9 million. 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.

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The Company and certain of its subsidiaries’ floating-rate obligations totaled $9.0 million and $2.0 million at October 31, 2005 and 2004, respectively.  Based on the floating-rate obligations outstanding at October 31, 2005, a one percent increase or decrease in the average interest rate would result in a change to pre-tax interest expense of approximately $90 thousand.

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 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 prevailing in three cities.  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, to the extent not covered by 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 2005, 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, 2005.

Within the Building Products segment, polyvinyl resin (PVC) is the significant raw material consumed during the manufacture of vinyl extrusions.  The Company has a monthly resin adjustor in place with its customers that is adjusted

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based upon published industry resin prices.  The adjuster effectively shares Mikron’s base pass-through price changes of PVC with its customers commensurate with the market at large.  The Company’s long-term exposure to changes in PVC prices is thus significantly reduced due to the contractual component of the resin adjustor program.

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Item 8.           Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

Quanex Corporation

Houston, TX

We have audited the accompanying consolidated balance sheets of Quanex Corporation and subsidiaries (the “Company”) as of October 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended October 31, 2005.  Our audits also included the financial statement schedule listed in the Index at 15(a)2. These financial statements and financial statement schedule 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, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended October 31, 2005, in conformity with accounting principles generally accepted in the United States of America.  Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of October 31, 2005, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated December 20, 2005 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

DELOITTE & TOUCHE LLP

Houston, TX

December 20, 2005

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QUANEX CORPORATION
CONSOLIDATED BALANCE SHEETS