QUANEX CORP - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

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

For the fiscal year ended October 31, 2001

OR

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

Commission file number 1-5725

QUANEX CORPORATION
(Exact name of registrant as specified in its charter)

DELAWARE 38-1872178
State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)

1900 WEST LOOP SOUTH, SUITE 1500 77027
HOUSTON, TEXAS (Zip Code)
(Address of principal executive offices)

Registrant's telephone number, including area code (713) 961-4600

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

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

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

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. [ ]

The aggregate market value of the registrant's voting stock held by
non-affiliates as of December 31, 2001, computed by reference to the closing
price for the Common Stock on the New York Stock Exchange, Inc. on that date,
was $376,508,322. Such calculation assumes only the registrant's officers and
directors were affiliates of the registrant.

At December 31, 2001, there were outstanding 13,455,580 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, 2001, for its Annual Meeting
of Stockholders to be held on February 28, 2002, are incorporated herein by
reference in Items 10, 11, 12, and 13 of Part III of this Annual Report.

TABLE OF CONTENTS

PART I

ITEM 1. BUSINESS

GENERAL

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

The Company's businesses are managed on a decentralized basis. Each
operating group has administrative, operating and marketing functions. Financial
reporting systems measure each group's return on investment, and the Company
seeks to reward superior performance with incentive compensation, which is a
significant portion of total employee compensation. 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, and human resource services to the operating divisions.

Quanex is a technological leader in the production of engineered carbon
and alloy steel bars, aluminum flat-rolled products, and precision-formed metal
products which primarily serve the vehicular products and building products
markets. The Company uses state-of-the-art manufacturing technologies, low-cost
production processes, and engineering and metallurgical expertise to provide
customers with specialized products for specific applications. Quanex believes
these capabilities also provide the Company with unique competitive advantages.
The Company's growth strategy is focused on the continued penetration of its two
core markets: vehicular products and building products.

BUSINESS DEVELOPMENTS IN FISCAL 2001

In November 2000, Quanex completed the purchase of Temroc Metals, Inc.
("Temroc"), an aluminum extrusion and fabrication company based in Hamel,
Minnesota. Temroc's products are used primarily in the outdoor recreational
vehicle market. Temroc expands the Company's offerings in its core vehicular
products market. The Company also has invested significant capital internally to
grow its technologically advanced, low-cost continuous manufacturing processes
to meet growing demand in its vehicular products and building products markets.

In the Company's MACSTEEL operations, rotary centrifugal continuous
casters are used 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 markets within its vehicular products market. Since
1992, the Company has invested approximately $257 million to enhance its steel
bar manufacturing and refining processes, to improve rolling and finishing
capability, and to expand manufacturing capacity at its MACSTEEL operations to
approximately 700,000 tons per year. Phases I through V of the MACSTEEL
expansions have been completed. In Phase V, finished in December 2000, the
Company installed additional equipment at each of the MACSTEEL plants in
Jackson, Michigan, and Ft. Smith, Arkansas to increase their capacity. This
project increased engineered steel bar shipping capacity by approximately 13% to
700,000 tons annually. Phase V also included projects at MACSTEEL Heat Treating,
based in Huntington, Indiana, where a third processing line was built, and at
Kenosha, Wisconsin-based MACSTEEL NitroSteel, where efficiency enhancing
equipment has been installed. In May 2000, the Company announced Phase VI, a
project that will boost capacity for MACPLUS cold-finished steel bars. The
project includes installation of two additional bar turning and polishing lines,
one at the plant in Jackson, which was completed in December of 2001 and the
other at the Ft. Smith plant, which is scheduled for completion by 2002
year-end. After the project is complete, MACSTEEL will have a total of six
value-added MACPLUS lines capable of producing 270,000 tons of cold finished
steel bars for its vehicular products markets.

In November 2000, Quanex completed a $4 million capital project at
AMSCO, which provides an additional 40,000 square feet of manufacturing space
and equipment to expand existing lines and produce new products for its building
products markets.

MANUFACTURING PROCESSES, MARKETS, AND PRODUCT SALES BY BUSINESS SEGMENT

Information with respect to major markets for the Company's products, expressed
as a percentage of consolidated net sales, is shown under the heading "Sales by
Major Markets" on the following table. Although Quanex has attempted to estimate
its sales by product and market categories, many products have multiple end uses
for several industries and sales are not recorded on the basis of product or

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market categories. A portion of sales is made to distributors who sell to
different industries. Net sales by principal market are based upon the total
dollar volume of customer invoices. For the years ended October 31, 2001 and
2000, no one customer accounted for 10% or more of the Company's sales. For the
year ended October 31, 1999, one customer, Autoliv Inc., accounted for 12% of
Company's sales.

SALES BY MAJOR MARKETS

Quanex operates 16 manufacturing facilities in ten states in the United
States. These facilities feature efficient plant design and flexible
manufacturing processes, enabling the Company to produce a wide variety of
engineered products and materials for the Company's vehicular products and
building products markets. The Company is generally able to maintain minimal
levels of finished goods inventories at most locations because it typically
manufactures products to customer specifications upon order.

During fiscal 2001, the Company's operations were grouped into four
business segments: (1) engineered steel bars, (2) aluminum mill sheet products,
(3) engineered products, and (4) Piper Impact. General corporate expenses are
classified as "Corporate and Other". During the latter portion of the fiscal
year ending October 31, 2001, the Company completed a strategic review of its
business, which resulted in a shift of strategy away from primarily a "process"
oriented enterprise to a more "market focused" enterprise. The review
underscored a high concentration of sales in two market segments - vehicular
products and building products. Beginning in fiscal 2002, the Company will
report operations in those two market focused segments. 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 13 to the Consolidated Financial Statements.

VEHICULAR PRODUCTS

The vehicular products segment is comprised of the former engineered steel bar
segment (MACSTEEL), Piper Impact and Temroc. The segment includes engineered
steel bar operations, impact extrusion operations, steel bar and tube
heat-treating services, steel bar and tube corrosion and wear resistant
finishing services, and aluminum extrusion and fabricated metal products.

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MACSTEEL

The Company's engineered steel bar operations are conducted through its MACSTEEL
division, consisting of two plants, one located in Ft. Smith, Arkansas, and the
other located in Jackson, Michigan. These plants can manufacture up to 700,000
tons of hot finished, precision engineered, carbon and alloy steel bars. The
Company believes that MACSTEEL has the only two plants in North America using
continuous rotary centrifugal casting technology. This casting process produces
seam-free bars, without surface defects or inclusions, thereby reducing the need
for subsequent surface conditioning. The continuous casting and automated
in-line manufacturing operations at the MACSTEEL plants substantially reduce
labor and energy costs by eliminating the intermittent steps that characterize
manufacturing operations at most larger, and particularly integrated steel
mills. The Company typically sells only complete heat lots, or batches, which
are made to specific customer requirements.

MACSTEEL produces various grades of customized, engineered steel bars
by melting steel scrap and casting it in a rotary centrifugal continuous caster.
MACSTEEL's molten steel is further processed through secondary refining
processes that include argon stirring, ladle injection, and vacuum arc degassing
prior to casting. These processes enable MACSTEEL to produce higher quality,
"cleaner" steel.

As a result of its state-of-the-art continuous manufacturing
technology, which reduces labor, energy and process yield loss, the Company
believes that MACSTEEL is one of the lowest cost producers of engineered carbon
and alloy steel bars. The Company believes that energy costs at MACSTEEL are
significantly lower than those of its competitors because its bars are moved
directly from the caster to the rolling mill before cooling, eliminating the
need for costly reheating. MACSTEEL's low unit labor costs are achieved with its
highly automated manufacturing process, enabling it to produce finished steel
bars using less than two man-hours of labor per ton compared with an estimated
average of four to five man-hours per ton for U.S. integrated steel producers.

MACSTEEL products are custom manufactured primarily for the vehicular
product markets serving the passenger car, light truck, sport utility vehicle
(SUV), heavy truck, anti-friction bearing, off-road and farm equipment, and
seamless tubular industries. These industries use engineered steel bars in
critical applications such as camshafts, crankshafts, transmission gears, wheel
spindles and hubs, bearing components, steering components, hydraulic mechanisms
and seamless tube production. Also, MACSTEEL engineered steel bars are used for
the manufacture of components for safety critical steel air bag inflators at the
Company's Piper Impact plant in New Albany, Mississippi.

Also included in the MACSTEEL division are a heat treating plant in
Huntington, Indiana ("Heat Treat") and a plant in Kenosha, Wisconsin that
improves the wear and corrosion resistance properties of steel bars and tubes
("NitroSteel").

The Heat Treat facility 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 NitroSteel plant processes steel bars and tubes using the patented
Nitrotec treatment to improve corrosion and wear resistance while providing an
environmentally friendly, non-toxic alternative to chrome plating. NitroSteel's
products are made for specific customer applications and are used for fluid
power applications in primarily the vehicular products markets.

Piper Impact

The Piper Impact division of the vehicular products segment includes two
impact-extrusion facilities in New Albany, Mississippi, dedicated to aluminum
and steel impact-extruded products.

Piper Impact is a manufacturer of custom designed, impact extruded
aluminum and steel parts primarily for vehicular and defense applications. Piper
Impact's operations use impact extrusion technology to produce highly engineered
near-net shaped components from aluminum and steel slugs. The pressure resulting
from the impact of the extrusion presses causes metal to flow into the desired
shape. This cost efficient, cold forming of the metal results in a high quality,
work hardened product with a superior finish. Products may be further processed
with heat-treating and precision machining. The parts are then delivered to
customers' assembly lines, requiring little or no additional processing. The
majority of Piper Impact's sales are to one customer, Autoliv Inc., for use in
automotive air bag systems.

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Temroc Metals

The Temroc Metals division of the vehicular products segment is located in
Hamel, Minnesota. Temroc Metals is an aluminum extruder and fabricator of metal
products. The single facility manufactures engineered products that primarily
serve the outdoor recreational vehicular products market.

BUILDING PRODUCTS

The building products segment is comprised of the former aluminum mill sheet
products segment (Nichols Aluminum) as well as the divisions comprising the
former Engineered Products segment (AMSCO, Homeshield and Imperial), excluding
Temroc. The segment includes two aluminum sheet casting and finishing operations
and fabricated metal components operations.

Nichols Aluminum

Nichols Aluminum manufactures mill finished and coated aluminum sheet for the
building products market and the food packaging market. The division comprises
five plants: a thin-slab casting and hot rolling mill ("NAC") located in
Davenport, Iowa, three cold rolling and finishing plants located in Davenport,
Iowa ("NAD"), Lincolnshire, Illinois ("NAL"), and Decatur, Alabama ("NAA"), and
Nichols Aluminum-Golden ("NAG"), an aluminum production facility located in Fort
Lupton, Colorado.

NAC's mini-mill uses an in-line casting process that can produce 400
million pounds of reroll (hot-rolled aluminum sheet) annually. The mini-mill
converts aluminum scrap to sheet through melting, continuous casting, and
in-line hot rolling processes. NAC has shredding and blending capabilities,
including two rotary barrel furnaces that broaden its sources of raw material
and allow it to melt cheaper grades of scrap. Delacquering equipment improves
the quality of the raw material before it reaches the melting furnaces by
burning off combustibles in the scrap. Scrap is blended using computerized
processes to most economically achieve the desired molten aluminum alloy
composition. The molten metal flows into a Hazelett thin-slab caster, which
casts an aluminum slab up to 52-inches wide and .75 inches thick. The slab is
fed directly to a hot mill where three in-line rolling stands reduce the slab to
gauges as thin as .045 inches. This hot rolling process substantially reduces
subsequent cold rolling requirements. NAC also has an efficient, in-house dross
recovery system to improve raw material yields.

The Company believes the combination of base capacity increases and
technological enhancements directed at producing higher quality reroll results
in a significant manufacturing advantage with savings derived from reduced raw
material costs, optimized scrap utilization, reduced unit energy cost, reduced
cold rolling requirements and lower labor costs.

Further processing of the reroll occurs at NAD, NAL or NAA, where
customers' specific product requirements can be met through cold rolling to
various gauges, annealing for additional mechanical and formability properties,
tension leveling to improve the flatness of the sheet, and slitting to specific
widths. Products at the NAD and NAA plants can also be custom painted, an
important value-added feature for the applications of certain customers in the
building products market.

Operations at NAG include melting and casting aluminum into sheet, cold
rolling to specific gauge, annealing, leveling, custom coating and slitting to
width. NAG manufactures high quality aluminum sheet from scrap, then
manufactures the sheet into engineered applications primarily for the food
packaging markets.

Engineered Products

AMSCO in Rice Lake, Wisconsin, Homeshield ("HFP"), with 2 plants in Chatsworth,
Illinois, and Imperial ("IFP") in Richmond, Indiana produce various engineered
products for the building products markets. These products include aluminum
window and patio door screens, window frames, residential exterior door
products, and a broad line of custom designed, roll formed products and stamped
shapes for manufacturers of premium wood windows and vinyl windows for the home
improvement, residential, and commercial construction markets. AMSCO combines
strong product design and development expertise with reliable, just-in-time
delivery. HFP also coats and/or paints aluminum sheet in many colors, sizes, and
finishes, and it fabricates aluminum coil into rain carrying systems, soffit,
exterior housing trim and roofing products. IFP produces sophisticated
residential exterior door thresholds, astragals, patio door systems and other
miscellaneous door components.

RAW MATERIALS AND SUPPLIES

The Company's MACSTEEL plants purchase on the open market their principal raw
material, steel scrap or substitutes such as pig iron, beach iron and hot
briquetted iron. Collection and transportation

4

of these raw materials to the Company's plants can be adversely affected by
extreme weather conditions. Prices for scrap also vary in relation to the
general business cycle, typically declining in periods of slow economic
activity.

Temroc's raw material consists primarily of aluminum billet, which it
purchases from several suppliers on the open market.

Piper Impact's raw material consists of aluminum bars and slugs that it
purchases on the open market, and steel bars that it purchases from MACSTEEL.

Nichols Aluminum's principal raw material is aluminum scrap purchased
on the open market, which can also be adversely affected by extreme weather
conditions. Nichols purchases and sells aluminum ingot futures contracts on the
London Metal Exchange to hedge against fluctuations in the price of aluminum
scrap required to manufacture products for fixed-price sales contracts.

AMSCO and HFP's primary raw material is coated and uncoated aluminum
sheet purchased primarily from Nichols Aluminum. Raw materials utilized at IFP
include aluminum, wood and vinyl that are available from a number of suppliers.
Prices for aluminum are typically set on a monthly basis based upon market
rates. In addition, IFP purchases two types of wood materials - hardwood and
softwood, which it purchases at market prices.

BACKLOG

At October 31, 2001, Quanex's backlog of orders to be shipped in the next twelve
months was approximately $185 million. This compares to approximately $158
million at October 31, 2000. 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 and
other resources. Competitive factors include product quality, price, delivery,
and the ability to manufacture to customer specifications. The amounts of
engineered steel bars, aluminum mill sheet products, engineered products and
impact extruded products manufactured by the Company generally represent a small
percentage of annual domestic production.

The Company's engineered steel bar group (MACSTEEL) competes primarily
with one large integrated steel producer and two large non-integrated steel
producers. Although these producers may be larger and have greater resources
than the Company, Quanex believes that the technology used at MACSTEEL
facilities permits it to compete effectively in the markets it serves.

The Company's aluminum mill sheet group (Nichols Aluminum) competes
with many small and large aluminum sheet manufacturers. Some of these
competitors are divisions or subsidiaries of major corporations with
substantially greater resources than the Company. The Company also competes with
major aluminum producers 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.

The Company's engineered products group (AMSCO, Homeshield, Imperial,
and Temroc) competes with many small metal fabricators and aluminum extrusion
facilities, primarily on the basis of custom engineering, quality, service, and
price.

Piper Impact competes with several other impact extrusion companies,
and companies that offer other technologies that can provide similar products,
on the basis of design, quality, price and service.

SALES AND DISTRIBUTION

The Company has sales organizations with sales representatives in many parts of
the U.S. MACSTEEL sells engineered steel bars primarily to tier one suppliers
through its sales organization and manufacturers' representatives. Nichols
Aluminum products are sold directly to original equipment manufacturers ("OEMs")
and through metal service centers. The engineered products group's products are
sold primarily to OEMs, except for some residential building products, which are
also sold through distributors. Piper Impact sells directly to OEMs.

SEASONAL NATURE OF BUSINESS

Nichols Aluminum and the Company's engineered products businesses are seasonal.
The primary markets of these businesses are in the Northeast and Midwest regions
of the United States, where winter

5

weather reduces homebuilding and home improvement activity. Historically in
these businesses, lowest sales have occurred during the Company's first fiscal
quarter. Profits for the operations in these businesses 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 fixed throughout the year. The other businesses in which the Company
competes are generally not seasonal. However, due to the holidays in the
Company's first fiscal quarter and steel plant shutdowns for vacations and
maintenance in the Company's third fiscal quarter, sales have historically been
lower in those periods. As a result of these trends, combined with the effects
of seasonality, the Company generally expects that, absent unusual activity or
changes in economic conditions, its lowest sales will occur in the first fiscal
quarter.

SERVICE MARKS, TRADEMARKS, TRADE NAMES, AND PATENTS

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

RESEARCH AND DEVELOPMENT

Expenditures for research and development of new products or services during the
last three years were not significant. Although not technically defined as
research and development, a significant amount of time, effort and expense is
devoted to custom engineering and qualifying the Company's products for specific
customer applications.

ENVIRONMENTAL MATTERS

As a manufacturer of specialized metal products, Quanex is subject to extensive
laws and regulations concerning the discharge of materials into the environment
and the remediation of chemical contamination. Quanex is required to make
capital and other expenditures on an ongoing basis in order to satisfy such
requirements. 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 or financial condition.

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
assessments or remediation at a number of those locations.

From time to time, Quanex also has been alleged to be liable for all or
part of the costs incurred to clean up third-party sites where it is alleged to
have arranged for disposal of hazardous substances. The Company's allocable
share of liability at those sites, taking into account the likelihood that other
parties will pay their shares, has not been material to its operations or
financial condition.

Total remediation reserves, at October 31, 2001, for Quanex's current
plants, former operating locations, and disposal facilities were approximately
$18 million. Of that, approximately 80% is allocated to the cleanup of
historical soil and groundwater contamination and other corrective measures at a
plant operated by the Company's Piper Impact division in New Albany,
Mississippi. Depending upon such factors as the nature and extent of
contamination, the cleanup technologies employed, and regulatory concurrences,
final remediation costs may be more or less than amounts accrued; however,
management believes it has established adequate reserves for all probable and
reasonably estimable remediation liabilities.

Environmental agencies continue to develop regulations implementing the
Federal Clean Air Act. Depending on the nature of the regulations adopted,
Quanex may be required to incur additional capital and other expenditures
sometime in the next several years for air pollution control equipment, to
maintain or obtain operating permits and approvals, and to address other air
emission-related issues. Based upon its analysis and experience to date, Quanex
does not believe that its compliance with Clean Air Act requirements will have a
material effect on its operations or financial condition. The Company plans to
have capital expenditures in fiscal 2002 for equipment upgrades in

6

order to comply with secondary aluminum production emissions standards at two of
its Nichols Aluminum facilities.

Quanex incurred approximately $3 million and $5 million during fiscal
2001 and 2000, respectively, in expenses in order to comply with existing or
proposed environmental regulations. The Company estimates expenses at various of
its facilities during fiscal 2002 will be approximately $5 million for
continuing compliance with environmental regulations. Capital expenditures for
these environmental regulations during fiscal 2001 and 2000 were immaterial.
Capital expenditures for fiscal 2002 are expected to be approximately $5 million
including upgrades related to secondary aluminum production emissions standards
at two of its Nichols Aluminum facilities. Future 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
2002, but it is not possible at this time to reasonably estimate the amount of
these expenditures.

EMPLOYEES

At October 31, 2001, the Company employed 3,321 persons. Of the total employed,
32% were covered by collective bargaining agreements. In November 2001, a
five-year agreement was ratified by the United Steel Workers representing 95
employees at Nichols Aluminum Alabama. Temroc's collective bargaining agreement
expires January 31, 2002 and negotiations will begin mid-January.

FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS

For financial information on the Company's foreign and domestic operations, see
Note 13 of the Financial Statements contained in this Annual Report on Form
10-K.

ITEM 2. PROPERTIES

The following table lists Quanex's principal plants together with their
locations, general character and the industry segment which uses the facility.
Each of the facilities identified as being owned by the Company is free of any
material encumbrance.

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ITEM 3. LEGAL PROCEEDINGS

Other than the proceedings described under Item 1, "Environmental Matters",
there are no material legal proceedings to which Quanex, its subsidiaries, or
their property is subject.

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. Quarterly stock price information and annual
dividend information for the common stock is as follows:

The terms of Quanex's revolving credit arrangements with certain banks limit the
total amount of common and preferred stock dividends and other distributions on
such stock. Under the most restrictive test under such credit facilities, the
total common stock dividends the Company may declare and pay is limited to $21
million, plus 50% of consolidated net income earned after October 31, 1989,
adjusted for other factors as set forth in the credit agreement. As of October
31, 2001, the aggregate amount available for dividends and other restricted
payments under its credit facilities was approximately $26 million.

There were 5,538 holders of Quanex common stock on record as of
December 31, 2001.

ITEM 6. SELECTED FINANCIAL DATA

GLOSSARY OF TERMS

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

Capital expenditures: Additions to property, plant and equipment.

Book value per common share: Stockholders' equity less the stated value of
preferred stock divided by the number of common shares outstanding.

Asset turnover: Net sales divided by average total assets.

Current ratio: Current assets divided by current liabilities.

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
long-term debt and stockholders' equity.

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

8

ITEM 6. SELECTED FINANCIAL DATA

Note: Several acquisitions and divestitures have been made in past years. See
Notes 2 and 3 to the financial statements for a description of these
transactions.

(1) Excludes sales from discontinued operations for the years 1997 and 1996,
respectively of $187,123 and $275,641.

(2) During fiscal 2000 and 1998, Piper Impact recorded a $56.3 million and $58.5
million, respectively, asset impairment charge as described by Statement of
Financial Accounting Standards No. 121. See Footnote 4 to the financial
statements for further information.

(3) See Note 3 to the financial statements for further information regarding the
loss on the sale of Piper Impact Europe.

(4) Working capital provided by operations is a supplemental financial
measurement used in the company's business and should not be construed as an
alternative to operating income or cash provided by operating activities
since it excludes the effects of changes in working capital. Working capital
from operations is calculated as income from continuing operations, net of
taxes, adjusted for non-cash and nonrecurring items.

(5) Includes gain on sale of discontinued operations.

(6) Includes effect of Piper Impact's asset impairment charge ($58.5 million in
FY 1998) and gain on sale of discontinued operations ($13 million in FY
1998).

(7) Includes effect of Piper Impact's asset impairment charge ($56.3 million in
FY 2000) and the loss on sale of Piper Impact Europe ($14.3 million in FY
2000).

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

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

GENERAL

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

PRIVATE SECURITIES LITIGATION REFORM ACT

Certain of the statements contained in this document and in documents
incorporated by reference herein, including those made under the caption
"Management's Discussion and Analysis of Results of Operations and Financial
Condition" are "forward-looking" statements as defined under the Private
Securities Litigation Reform Act of 1995. Generally, the words "believe,"
"expect," "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 expectations
or projections. As and when made, management believes that these forward-looking
statements are reasonable. However, caution should be taken not to place undue
reliance on any such forward-looking statements since such statements speak only
as of the date when made and there can be no assurance that such forward-looking
statements will occur. The Company undertakes no obligation to publicly update
or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.

Factors exist that could cause the Company's actual results to differ
materially from the expected results described in or underlying our Company's
forward-looking statements. Such factors include domestic and international
economic activity, prevailing prices of steel and aluminum scrap and other raw
material costs, energy costs, interest rates, construction delays, market
conditions for the Company's customers, any material changes in purchases by the
Company's principal customers, 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, 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.

RESULTS OF OPERATIONS

Overview

Summary Information as % of Sales: (Dollars in millions)

Despite a slow business environment, Quanex achieved relatively strong
earnings for the fiscal year ended October 31, 2001. The Company was able to
achieve sequentially better earnings quarter-

10

to-quarter during the year. A focus on reducing conversion and overhead costs,
coupled with the introduction of new products, were the three key drivers, which
helped the Company achieve these results.

Acquisitions / Divestitures Since October 31, 1998

In January 2000, the Company purchased from Alcoa, Inc. the Golden Aluminum
production facility based in Fort Lupton, Colorado. Quanex acquired the assets
of the facility for $9 million plus working capital valued at approximately $13
million. The newly acquired facility became part of Quanex's flat-rolled
aluminum sheet business - Nichols Aluminum (the aluminum mill sheet products
segment). It was renamed Nichols Aluminum - Golden, Inc., ("Nichols Aluminum -
Golden"), a wholly owned subsidiary of Quanex.

Operations at Nichols Aluminum-Golden include melting and casting
aluminum into sheet made from a blend of primary P1020 ingot and selected grades
of scrap metal, cold rolling it to specific gauge, annealing, leveling, custom
coating and slitting to width. Nichols Aluminum-Golden can produce more than 50
million pounds annually of high quality metal for engineered applications in
niche markets, such as end and tab stock for food and beverage packaging, metal
components for computer disks, and home accessory products.

In April 2000, the Company acquired the stock of Imperial Products,
Inc., a leading manufacturer of value-added exterior door components based in
Richmond, Indiana, for approximately $15 million. Imperial Products, Inc., now
doing business as Imperial Fabricated Products ("Imperial"), operates as a
wholly owned subsidiary of Quanex. This acquisition expands the specialized
design and manufacturing operations of Quanex's Engineered Products Group.

In July 2000, the Company sold Piper Impact Europe, an impact-extrusion
facility based in The Netherlands, to the plant's existing management group for
a nominal amount. The transaction was structured as a sale of stock. As a result
of this transaction, the Company recorded a pretax charge of $14.3 million for
the fiscal third quarter ending July 31, 2000. In connection with the sale, the
Company's range forward foreign currency agreement with a notional amount of 30
million Guilders was closed. This agreement was entered into to protect the
Company's investment in Piper Impact Europe from foreign currency fluctuations.
The settlement of this agreement resulted in a gain, which was offset against
the charge on the sale of Piper Impact Europe.

On November 30, 2000, the Company completed the purchase of all of the
Capital stock of Temroc Metals, Inc., a Minnesota corporation for approximately
$22 million in cash. Temroc, as a surviving corporation, became a wholly owned
subsidiary of the Company. Temroc has production facilities in Hamel, Minnesota,
where it manufactures customized aluminum extrusions and fabricated metal
products for recreational vehicles, architectural products, electronics and
other markets. Temroc has become part of the Company's Engineered Products Group
and will continue to operate as a manufacturer of aluminum extrusions and
fabricated metal products.

Business Segments

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

During fiscal 2001, the Company's operations were grouped into four
business segments: (1) engineered steel bars, (2) aluminum mill sheet products,
(3) engineered products, and (4) Piper Impact. General corporate expenses are
classified as "Corporate and Other". During the latter portion of the fiscal
year ending October 31, 2001, the Company completed a strategic review of its
business, which resulted in a shift of strategy away from primarily a "process"
oriented enterprise to a more "market focused" enterprise. The review
underscored a high concentration of sales in two market segments - vehicular
products and building products. Beginning in fiscal 2002, the Company will
report operations in those two market focused segments. For financial
information regarding each of Quanex's business segments as well as a
presentation under the new segments, see Note 13 to the Consolidated Financial
Statements.

The Company's engineered steel bar segment consists of manufacturing
engineered steel bars, steel bar and tube heat treating services and steel bar
and tube wear and corrosion resistant finishing services. The aluminum mill
sheet segment manufactures mill finished and coated aluminum sheet. The
engineered products segment manufactures aluminum window and patio door screens,
window frames,

11

exterior door components and other roll formed products and stamped shapes. The
Piper Impact segment manufactures impact-extruded aluminum and steel parts.

The following table sets forth selected operating data for the Company's four
business segments:

(1) Fiscal 2000 results include Nichols Aluminum-Golden operations since
the acquisition date of January 25, 2000. See Note 2 to the
consolidated financial statements.

(2) Results include Imperial operations, acquired April 2000, and Temroc
operations, acquired November 2000. See Note 2 to the consolidated
financial statements.

(3) Fiscal 2000 results include the one-time $14.3 million loss on the sale
of Piper Impact Europe and $56.3 million asset impairment charge
relating to Piper Impact facilities in New Albany, Mississippi. See
Note 3 and 4 to the consolidated financial statements.

The engineered steel bar business, MACSTEEL, had a surprisingly strong
fourth quarter finish to the year. Overall results for the year were excellent
given the difficult steel market environment. MACSTEEL's sales for the year are
off about 7% from the prior year, but the group gained market share within its
vehicular products market. MACSTEEL continues to be rated number one in customer
service and quality in the engineered bar market and remains the supplier of
choice for bar products. One of MACSTEEL's strengths is its ability to adjust to
a changing marketplace. When business activity softens in its core market, as it
did this year, MACSTEEL is able to shift into secondary markets such as energy
and defense. While these markets and products typically don't have as good of a
mix as traditional markets, these sales help improve overall results in
difficult times. For fiscal 2001, MACSTEEL maintained strict control over its
costs and the group benefited from favorable scrap pricing.

The aluminum mill sheet products business, Nichols Aluminum, operated
profitably in a very difficult business environment. The group not only reported
its highest operating income for the year in the fourth quarter, it also
improved financial results sequentially throughout the year. Estimates from the
Aluminum Association indicate that flat roll demand in our markets was down some
22% year over year, while at Nichols, output was off about 10% for the same
period. Superior customer service along with excellent, consistent quality made
the difference with customers.

The engineered products business set all-time records in net sales,
cash from operations and operating income. While somewhat softer than this time
last year, attractive interest rates continue to draw buyers into the housing
market, and remodeling spending has held up well. The combination of improved
productivity, profitable acquisitions (Imperial and Temroc), cost control and
new product development all contributed to an outstanding performance for fiscal
2001.

Piper Impact reported four consecutive quarters of profitability in
fiscal 2001 and demonstrated a substantial turnaround since 2000 for this
business. More work and improvement are needed at Piper, but they are making
progress. Focus remains on leaning-out manufacturing processes, fixed cost
reductions and new product development. As business activity continues to shift
away from

12

traditional air bag components to other vehicular product offerings, Piper has
the management team to make this transition successful. It will not happen
overnight, but the Company is confident they have the people, assets and
processes in place to make a successful transition and improve results.

Outlook

Given the current uncertainty in the economy, it remains difficult to predict
the demand level for the Company's two core markets, vehicular products and
building products, in fiscal 2002.

The Company believes that the North American automotive build rate for
fiscal 2002 will be in a range of 15 to 15.5 million units, certainly a bit
slower than 2001, but still a good level. This build rate assumes some recovery
will take place in the first half of 2002. Given this set of assumptions, taking
into account new programs and the benefit of increased "in house" value added
capacity at MACSTEEL, (a result of the Phase VI expansion at Michigan) as well
as the lean manufacturing and continuing cost reduction programs at Piper, the
Company's management is upbeat about fiscal 2002 and expects the vehicular
segment's results to exceed fiscal 2001.

Demand during 2002 in the Company's building products market is
anticipated to remain stable considering that projections for new home
construction and residential remodeling activities remain at levels similar to
2001. Nichols Aluminum, however, continues to face a very difficult market
environment as the aluminum market's capacity exceeds demand. Looking to the
first half of 2002, the extreme pricing pressures and the resulting narrow
spreads together with lower seasonal demand will continue to challenge them. The
engineered products division, with its focus on increasing market share and
reducing costs, anticipates improved results.

The Company's fiscal first quarter (November, December and January) is
historically its least profitable of the year as there are fewer production
days, the Company's vehicular and building products customers take holiday
shutdowns and customers manage year-end inventories closely. First quarter 2002
earnings per share are expected to be near this year's $0.27. For the year, we
expect to again show sequentially improving quarterly results.

2001 Compared to 2000

Net sales - Consolidated net sales for fiscal 2001 were $924.4 million,
representing a decrease of $40.2 million, or 4%, when compared to fiscal 2000.
All operating segments, with the exception of the engineered products group
experienced decreased net sales.

Net sales from the Company's engineered steel bar business for fiscal
2001 were $336.3 million, representing a decrease of $24.1 million, or 7%, when
compared to fiscal 2000. This decrease was principally due to lower volume
resulting from weaker markets in the transportation and capital goods industries
as well as lower sales prices. The business continued to experience pricing
pressures; however, due to the increased proportion of MACPLUS volume, a value
added product, the impact on overall average sales price was lessened.

Net sales for fiscal 2001 from the Company's aluminum mill sheet
products business decreased by $35.7 million, or 9%, to $380.1 million when
compared to fiscal 2000. Fiscal 2001 included a full year of Nichols Aluminum
Golden, which was acquired January 25, 2000. The decrease in net sales was due
to lower volume as well as lower sales prices. Volume was affected by more
severe winter weather during the first fiscal quarter than was experienced in
the prior year, as well as a general economic slowdown. These factors negatively
affected the building and construction and truck-trailer markets that Nichols
Aluminum serves. Sales prices were also negatively impacted by the extremely
competitive pricing environment, and the fact that other mills were aggressively
seeking available business during the economic slowdown.

Net sales from the Company's engineered products business for fiscal
2001 were $146.5 million, representing an increase of $39.6 million, or 37%,
from last year. The increase was largely due to the acquisition of Imperial in
April of 2000 and Temroc, acquired November 2000. Additionally, the group's net
sales improved at the other facilities, benefiting from the capital expansion
project at AMSCO, which was completed in November 2000, and new product
development initiatives.

Net sales for fiscal 2001 for the Company's Piper Impact business
declined by $20.9 million, or 20%, to $85.5 million when compared to fiscal
2000. Net sales for the period ending October 31, 2000 included sales from Piper
Impact Europe which was sold in July of 2000. Comparable net sales of Piper's
operations, excluding Piper Europe, decreased 3% over the same prior year
periods. These results were impacted by declining aluminum air bag product sales
and competitive pricing pressures.

Operating income - Consolidated operating income for fiscal 2001 was
$57.3 million, compared to $66.6 million in 2000, excluding the $14.3 million
loss on the sale of Piper Impact Europe and the

13

$56.3 million asset impairment charge. This represents a decrease of $9.3
million, or 14%. During fiscal 2001, the engineered steel bar business and the
aluminum mill sheet products business had decreased operating income while the
engineered products and Piper Impact businesses had higher operating income.

Operating income from the Company's engineered steel bar business was
$42.0 million for fiscal 2001, representing a decrease of $15.7 million, or 27%,
when compared to fiscal 2000. The decrease was due largely to lower net sales
resulting from the sluggish demand in the transportation and capital goods
markets as well as competitive pricing pressures. Lower material scrap prices
helped offset some of the impact of reduced volume and lower selling price. The
business experienced increased utility costs as energy prices rose and
recognized higher depreciation expense with the completion of capital projects.

Operating income for fiscal 2001 from the Company's aluminum mill sheet
products business was $5.9 million, representing a decrease of $15.6 million, or
72%, from last year. This decrease was largely due to significantly lower net
sales, lower spreads and higher energy costs.

Operating income from the Company's engineered products business was
$20.0 million for fiscal 2001, representing an increase of $5.7 million, or 40%,
from last year. This increase was due in part to the acquisition of Imperial,
acquired in April of 2000 and Temroc, acquired in November of 2000.
Additionally, operating income increased at the other facilities as a result of
new product development and higher net sales along with cost control and
improved productivity.

Operating income from the Company's Piper Impact business for fiscal
2001 was $3.3 million, compared to an operating loss of $11.9 million, excluding
the one-time loss on the sale of Piper Impact Europe of $14.3 million and the
$56.3 million asset impairment charge in the prior year. The fiscal 2000
operating loss also included operating losses from Piper Europe before its sale
in July 2000. Comparative operating income excluding Piper Europe, improved
$12.7 million from the prior year's results, despite a decline in net sales.
This improvement is a result of lower costs realized from cellular manufacturing
and cost cutting efforts as well as a $6.3 million reduction of depreciation
expense. Depreciation expense decreased due to the asset impairment charge
recorded in the fourth quarter of fiscal 2000.

In addition to the four operating segments mentioned above, operating
expenses for corporate and other for fiscal 2001 were $13.8 million,
representing a decrease of $1.2 million from the $15.0 million recorded in
fiscal 2000. Included in corporate and other are the corporate office expenses,
impact of inventory accounting using LIFO method and inter-segment eliminations.
See Notes 8 and 13 to the financial statements regarding LIFO valuation method
of inventory accounting.

Selling, general and administrative expenses - Selling, general and
administrative expenses increased by $657 thousand, or 1%, in fiscal 2001 as
compared to last year. This increase largely resulted from the following items:
1) acquisitions of Imperial in April 2000 and Temroc in November 2000 2)
write-down of assets held for disposition to estimated realizable value in the
corporate and other segment and 3) severance costs. These increases were
partially offset, however, by 1) reduced expenses due to the sale of Piper
Europe in July 2000, and 2) cost cutting initiatives throughout the Company.

Depreciation and amortization - Depreciation and amortization decreased
by $4.4 million, or 9%, in fiscal 2001 as compared to last year. The engineered
steel bar, aluminum mill sheet products and engineered products segments'
depreciation expense all increased as compared to last year due to the
completion of capital projects as well as recent acquisitions. Piper Impact's
depreciation and amortization decreased substantially from the prior year due to
the sale of Piper Europe in July of 2000, as well as the reduced asset base,
which resulted from the asset impairment charge recorded in the fourth quarter
of fiscal 2000.

Interest expense - Interest expense increased by $1.3 million, or 9%,
in fiscal 2001 as compared to the prior year. The increase was primarily due to
1) higher outstanding debt balances during fiscal 2001 (resulting largely from
the Temroc acquisition) and 2) the ineffective portion of the loss on certain
interest rate swap derivatives recognized during that period. (See Note 11 and
17 to the financial statements.)

Capitalized interest - Capitalized interest decreased by $275 thousand
in fiscal 2001 as compared to fiscal 2000 primarily due to the completion of the
Phase V capital project at MACSTEEL in December of 2000.

Other, net - "Other, net" increased by $753 thousand in fiscal 2001 as
compared to last year primarily as a result of increased investment income.

14

Income before extraordinary gain - The Company earned income before
extraordinary gain of $28.8 million in fiscal 2001 compared to $35.9 million in
the prior year, excluding the $9.3 million (net of tax) loss on the sale of
Piper Impact Europe and the $36.6 million (net of tax) asset impairment charge.
This represents a decrease of $7.0 million, or 20%, when compared to fiscal
2000. The decrease was largely due to lower operating income and increased
interest expense. Additionally, the Company's effective income tax rate was 36%
for fiscal 2001 compared to 35% in fiscal 2000.

Net income / loss - Fiscal 2001 net income was $29.2 million, compared
to a net loss of $9.7 million for fiscal 2000. Included in the net loss for
fiscal 2000 was a $9.3 million (after-tax) loss on the sale of Piper Impact
Europe and a $36.6 million (after-tax) impairment charge associated with Piper
Impact. Additionally, fiscal 2001 net loss included a $372 thousand
extraordinary gain on the early extinguishment of debt. Included in net income
for fiscal 2000 was a $358 thousand extraordinary gain on early extinguishment
of debt.

2000 Compared to 1999

Net sales - Consolidated net sales for fiscal 2000 were $964.5 million,
representing an increase of $129.6 million, or 16%, when compared to fiscal
1999. This increase reflects higher net sales at all of the business segments
except Piper Impact. The acquisitions of Nichols Aluminum-Golden in January of
2000 and Imperial in April of 2000 contributed to this increase.

Net sales from the Company's engineered steel bar business for fiscal
2000, were $360.4 million, representing an increase of $49.1 million, or 16%,
when compared to fiscal 1999. This increase was principally due to increased
sales volumes as a result of strong primary transportation markets.

Net sales for fiscal 2000 from the Company's aluminum mill sheet
products business increased by $95.5 million, or 30%, to $415.8 million when
compared to fiscal 1999. This increase was due to increased volume from the
seasonally strong construction market, increased selling prices resulting from
sales of more value-added painted product and the acquisition of Nichols
Aluminum-Golden in January 2000.

Net sales from the Company's engineered products business for fiscal
2000 were $106.9 million, representing an increase of $12.3 million, or 13%,
from last year. The increase was largely due to the acquisition of Imperial in
April of 2000.

Net sales for fiscal 2000 for the Company's Piper Impact business
declined by $28.8 million, or 21%, to $106.4 million when compared to fiscal
1999. These results were impacted by the sale of Piper Impact Europe in July of
2000 as well as declining aluminum air bag product sales and competitive pricing
pressures.

Operating income - Consolidated operating income for fiscal 2000 was
$66.6 million, excluding the $14.3 million loss on the sale of Piper Impact
Europe and the $56.3 million asset impairment charge. This represents a decrease
of $5.1 million, or 7%, when compared to the operating income of $71.8 million
in fiscal 1999. During fiscal 2000, the aluminum mill sheet products business
and the engineered products business had increased operating income while the
engineered steel bar and Piper Impact businesses had lower operating income.

Operating income from the Company's engineered steel bar business was
$57.7 million for fiscal 2000, representing a decrease of $2.7 million, or 5%,
when compared to fiscal 1999. This lower operating income resulted despite
higher net sales. The major factors in such decrease were lower realized spread
as a result of higher material costs and pricing pressures as well as higher
costs associated with outside processing. Depreciation expense for fiscal 2000
was also higher than the prior year due to the recent completion of certain
capital projects.

Operating income for fiscal 2000 from the Company's aluminum mill sheet
products business was $21.5 million, representing an increase of $6.2 million,
or 41%, from last year. This increase was largely due to significantly higher
sales attributable to increased volume and sale of more value-added products,
stable spreads and contribution from Nichols Aluminum-Golden, acquired in
January 2000.

Operating income from the Company's engineered products business was
$14.3 million for fiscal 2000, representing an increase of $1.3 million, or 10%,
from last year. The increase was due largely to increased volume and sale of
more value-added, higher margin products, as well as the acquisition of Imperial
in April 2000.

15

Operating losses from the Company's Piper Impact business for fiscal
2000 were $11.9 million, excluding the one-time loss on the sale of Piper Impact
Europe of $14.3 million and the $56.3 million asset impairment charge. See Note
4 to the financial statements. The operating loss for fiscal 1999 was $853
thousand. The declining results are largely due to reduced sales of aluminum
automotive airbag components, higher material costs and higher manufacturing
costs associated with new product development as well as cellular manufacturing
implementation.

In addition to the four operating segments mentioned above, operating
expenses for corporate and other for fiscal 2000 were $15.0 million,
representing a decrease of $1.1 million from the $16.1 million recorded in
fiscal 1999. Included in corporate and other are the corporate office expenses,
impact of inventory accounting using LIFO method and inter-segment eliminations.
See Notes 8 and 13 to the financial statements regarding LIFO valuation method
of inventory accounting.

Selling, general and administrative expenses - Selling, general and
administrative expenses increased by $441 thousand, or 1%, in fiscal 2000 as
compared to last year. This increase is largely a result of the acquisitions of
Nichols Aluminum-Golden and Imperial as well as increased sales volume at most
business segments.

Depreciation and amortization - Depreciation and amortization increased
by $2.6 million, or 6%, in fiscal 2000 as compared to last year. The increase is
principally due to increased depreciation at the engineered steel bar, aluminum
mill sheet products and engineered products businesses for recently completed
projects, partially offset by lower depreciation at the Piper Impact business.

Interest expense - Interest expense increased by $853 thousand in
fiscal 2000 primarily resulting from additional borrowings made during the
fiscal year to finance the acquisitions as well as higher interest rates.

Capitalized interest - Capitalized interest increased by $330 thousand
in fiscal 2000 as compared to fiscal 1999 primarily due to the completion of the
Phase V capital project underway at MACSTEEL during 2000.

Other, net - "Other, net" increased by $487 thousand in fiscal 2000 as
compared to last year primarily as a result of increased investment income.

Income before extraordinary gain - The Company earned income before an
extraordinary gain of $35.9 million in fiscal 2000 excluding the $9.3 million
(net of tax) loss on the sale of Piper Impact Europe and the $36.6 million (net
of tax) asset impairment charge. This represents a decrease of $3.4 million, or
9%, when compared to fiscal 1999 income before extraordinary gain of $39.3
million. The decrease (excluding the loss on the sale of Piper Impact Europe and
the Piper Impact asset impairment charge) in fiscal 2000 was principally due to
lower operating earnings at the engineered steel bar and Piper Impact business
segments partially offset by improved results in the other two business
segments.

Net income / loss - Fiscal 2000 net loss was $9.7 million, compared to
net income of $39.7 million for fiscal 1999. Included in the net loss for fiscal
2000 was a $9.3 million (after-tax) loss on the sale of Piper Impact Europe and
a $36.6 million (after-tax) impairment charge associated with Piper Impact.
Additionally, fiscal 2000 net loss included $358 thousand extraordinary gain on
the early extinguishment of debt. Included in net income for fiscal 1999 was a
$415 thousand extraordinary gain on early extinguishment of debt.

LIQUIDITY AND CAPITAL RESOURCES

Total capitalization at October 31, 2001 was $500.0 million, consisting of
$220.0 million of debt and $280.0 million of equity. The debt-to-capitalization
ratio at the end of fiscal 2001 was 44.0% compared with 41.9% at the end of
fiscal 2000. The higher debt-to-capitalization ratio results primarily from the
borrowings made to finance the Temroc acquisition and the repayment of
borrowings against life insurance policies.

The Company's principal sources of funds are cash on hand, cash flow
from operations, and borrowings under an unsecured $250 million Revolving Credit
and Term Loan Agreement ("Bank Agreement"). The Bank Agreement currently
consists of a revolving line of credit ("Revolver"). In July 1997, the term loan
provisions of the Bank Agreement expired. The Bank Agreement expires July 23,
2003 and provides for up to $25 million for standby letters of credit, limited
to the undrawn amount available under the Revolver. As of October 31, 2001,
there was $140 million outstanding under the Revolver. See footnote 11 to the
financial statements for a detailed description of all of the Company's debt
instruments, outstanding balances and aggregate maturities over each of the next
five years and beyond. The Company has started negotiations with a group of
banks to replace the existing Bank Agreement with a new one during the fiscal
year ending October 31, 2002.

16

The Bank Agreement contains customary affirmative and negative
covenants and requirements to maintain a minimum consolidated tangible net
worth, as defined. The Bank Agreement limits the payment of dividends and
certain restricted investments. At October 31, 2001, retained earnings of
approximately $26 million were available for dividends and other restricted
payments. As of October 31, 2001, the Company was in compliance with all
covenants under the Bank Agreement.

The Company accepted unsolicited block offers to buy back $4.6 and
$10.4 million principal amount of the 6.88% Convertible Subordinated Debentures
for $3.9 and $9.6 million in cash during the years ended October 31, 2001 and
2000, respectively. An after tax extraordinary gain of $372 and $358 thousand
was recorded on these transactions in those years, respectively. The outstanding
balance of these debentures as of October 31, 2001 was $58.7 million.

On June 1, 1999, the Company borrowed $3 million through unsecured
Scott County, Iowa Variable Rate Demand Industrial Waste Recycling Revenue Bonds
Series 1999.

On December 9, 1999, the Company announced that its Board of Directors
approved a program to repurchase shares of the Company's common stock. Under
terms of the program, the Company may periodically purchase up to a total of 2
million shares of its common stock in the open market or in privately negotiated
transactions. The repurchase plan does not have a time limit, and funds for the
program will be provided from the Company's available working capital and bank
credit line. During the fiscal year ended October 31, 2001, the Company
repurchased 119,000 shares for $2.2 million. During the fiscal year ended
October 31, 2000, the Company repurchased 834,300 shares for $17.2 million. See
Note 15 to the financial statements.

At October 31, 2001, the Company had commitments of $15 million for the
purchase or construction of capital assets. The most significant project
included in this total relates to the Company's continued expansion of value
added product capability at MACSTEEL. The Company plans to fund these capital
expenditures through cash flow from operations and, if necessary, additional
borrowings.

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

Operating Activities

Cash provided by operating activities during fiscal 2001 was $85.0 million,
compared to $77.9 million the prior year. This represents an increase of $7.1
million, or 9%, compared to fiscal 2000, due largely to lower working capital
requirements as a result of slowing business and a focused effort to optimize
investment in working capital. The year ended October 31, 2001 included a tax
refund of $219 thousand, compared to a $7.3 million refund in the prior year,
which resulted from an overpayment in fiscal 1999.

Investment Activities

Net cash used by investment activities in fiscal 2001 was $77.1 million compared
to a use of cash of $79.6 million in fiscal 2000. Fiscal 2001 cash from
investing activities included the acquisition of Temroc Metals, whereas fiscal
2000 cash from investing activities included the acquisitions of Nichols
Aluminum-Golden and Imperial. Net capital expenditures increased from $42.3
million in 2000 to $55.6 million in 2001. The Company estimates that fiscal 2002
capital expenditures will approximate $43 million.

Financing Activities

Net cash used by financing activities for fiscal 2001 was $692 thousand,
compared to $1.8 million in the prior year. During fiscal 2001, the Company had
net bank borrowings of $30 million, however it used $3.9 million to purchase
subordinated debentures and $2.2 million to purchase Quanex common stock.
Additionally, in fiscal 2001, Quanex repaid $17.3 million of life insurance cash
surrender value policy loans. During fiscal 2000, the Company had net bank
borrowings of $33.4 million and used $9.6 million to purchase subordinated
debentures and $17.2 million to purchase Quanex common stock. Dividend payments
amounted to $8.6 million in fiscal 2001 and $8.9 million in fiscal 2000.
Proceeds from the issuance of stock totaled $2.5 million in fiscal 2001 compared
to $1.0 million in fiscal 2000.

EFFECTS OF INFLATION

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

NEW ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities", which
establishes accounting and reporting standards

17

for derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. In June 1999, the FASB issued SFAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133" which deferred the
effective date of SFAS No. 133 until the Company's year ending October 31, 2001.
The Company adopted SFAS No. 133, as amended by SFAS No. 138 "Accounting for
Certain Derivative Instruments and Certain Hedging Activities an amendment of
FASB Statement No. 133", issued in June 2000, as of November 1, 2000. See Note
17 to the financial statements for further discussion.

In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 101. SAB No. 101 provides the staff's views in
applying Generally Accepted Accounting Principles ("GAAP") to revenue
recognition in financial statements. It does not change any of the existing
rules on revenue recognition. All registrants are expected to apply the
accounting and disclosures described in this bulletin. SAB No. 101B delayed the
implementation of SAB No. 101 until no later than the fourth quarter of fiscal
years beginning after December 15, 1999. The Company adopted SAB No. 101B in the
fourth fiscal quarter of the Company's year ending October 31, 2001. The impact
was considered immaterial.

In coordination with SAB No. 101B, the Company also adopted EITF 00-10,
"Accounting for Shipping and Handling Fees and Costs". This EITF gives specific
guidance related to recording shipping and handling fees such as freight. Prior
to adoption of this EITF, the Company reflected freight costs in the "Net sales"
item of the income statement. This EITF specifically states that freight costs
are not to be netted against revenues. In accordance with this EITF, the Company
now reflects freight costs as part of the "Cost of sales" item on the income
statement. Prior periods information has been reclassified throughout this
document.

In June 2001, the FASB issued SFAS No. 141 "Business Combinations".
SFAS No. 141 addresses financial accounting and reporting for business
combinations. The provisions of this statement apply to all business
combinations initiated after June 30, 2001. This statement also applies to all
business combinations accounted for using the purchase method for which the date
of acquisition is July 1, 2001, or later. The Company will follow the guidance
of this statement for any future acquisitions it may undertake.

In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets". This statement addresses financial accounting and reporting
for acquired goodwill and other intangible assets. It addresses how intangible
assets that are acquired individually or with a group of other assets (but not
those acquired in a business combination) should be accounted for in financial
statements upon their acquisition. This statement also addresses how goodwill
and other intangible assets should be accounted for after they have been
initially recognized in the financial statements. Under SFAS No. 142, goodwill
is no longer amortized, but reviewed for impairment annually, or more frequently
if certain indicators arise. The provisions of this statement are required to be
applied starting with fiscal years beginning after December 15, 2001 (Quanex's
fiscal year beginning November 1, 2002). Early application is permitted for
entities with fiscal years beginning after March 15, 2001 (Quanex's fiscal year
beginning November 1, 2001). The Company adopted this statement on November 1,
2001 for its fiscal year ended October 31, 2002. The Company is required to
complete the initial step of a transitional impairment test within six months of
adoption of SFAS No. 142 and to complete the final step of the transitional
impairment test by the end of the fiscal year, if necessary. Any impairment loss
resulting from the transitional impairment test would be recorded as a
cumulative effect of a change in accounting principle for the quarter ended
January 31, 2002. Subsequent impairment losses will be reflected in operating
income or loss in the consolidated statements of operations.

In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible, long-lived
assets and the associated asset retirement costs. This Statement requires that
the fair value of a liability for an asset retirement obligation be recognized
in the period in which it is incurred by capitalizing it as part of the carrying
amount of the long-lived assets. The provisions of this statement are required
to be applied starting with fiscal years beginning after June 15, 2002 (Quanex's
fiscal year beginning November 1, 2002). The Company is currently evaluating the
effects of adopting this pronouncement.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This Statement establishes a
single accounting model for the impairment or disposal of long-lived assets. The
provisions of this Statement are effective for financial statements issued for
fiscal years beginning after December 15, 2001 (Quanex's fiscal year beginning
November 1, 2002). The Company is currently evaluating the effects of adopting
this pronouncement.

18

ITEM 7A. QUANTITATIVE / QUALITATIVE DISCLOSURE

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. For a description of the Company's significant
accounting policies associated with these activities, see Notes 1 and 17 to the
Consolidated Financial Statements.

Interest Rate Risk

The Company and its subsidiaries have a Revolving Credit Facility, Convertible
Subordinated Debentures, interest rate swap agreements and other long-term debt
which subject the Company to the risk of loss associated with movements in
market interest rates.

At October 31, 2001 and 2000, the Company had fixed-rate debt totaling
$73 and $74 million, respectively. This debt is fixed-rate and, therefore, does
not expose the Company to the risk of earnings loss due to changes in market
interest rates. See Notes 11 and 17 to the Company's Consolidated Financial
Statements. The conversion feature of the Company's Subordinated Debentures
makes it impractical to estimate the effect of a hypothetical 10% change in
interest rates. This is due to the correlation between the market value of these
instruments and the market value of the Company's common stock. In general, any
changes in fair value would impact earnings and cash flows only if the Company
were to reacquire all or a portion of these instruments in the open market prior
to their maturity.

The Company and certain of its subsidiaries' floating-rate obligations
total $147.1 and $117.6 million at October 31, 2001 and 2000, respectively. See
Note 11 to the Company's Consolidated Financial Statements. The exposure of
these obligations to increases in short-term interest rates is limited for $100
million of this variable rate debt by interest rate swap agreements entered into
by the Company. These swap agreements effectively fix the interest rate, thus
limiting the potential impact that increasing interest rates would have on
earnings. Under these swap agreements, payments are made based on a fixed rate
($50 million at 7.025%, and $50 million at 6.755%) and received on a LIBOR based
variable rate (2.31% and 6.76% at October 31, 2001 and 2000, respectively). At
October 31, 2001 and 2000, the fair market value related to the interest rate
swap agreements was a loss of $7.3 million and $918 thousand, respectively. If
the floating rates were to change by 10% from October 31 levels, the fair market
value of these swaps would change by approximately $411 thousand and $1.5
million as of October 31, 2001 and 2000, respectively. However, it should be
noted that any change in value of these contracts, real or hypothetical, would
be substantially offset by an inverse change in the value of the underlying
hedged item.

As mentioned above, $100 million of the floating rate obligations are
protected by interest swap agreements. To the extent these obligations exceed
$100 million, the Company is subject to changes in the underlying interest
rates. For the years ended October 31, 2001 and 2000, the Company's floating
rate obligations exceeded the amount covered by the swap agreements by $47.1 and
$17.6 million, respectively. Increases or decreases in the underlying interest
rates of the obligations would have a direct impact on interest expense for
those uncovered balances.

Foreign Currency Exchange Rate Risk

The Company utilized a range forward zero-cost agreement to protect its initial
equity investment in its Netherlands subsidiary, Piper Impact Europe, from
fluctuations in US Dollar/Dutch Guilder exchange rates. This agreement, which
was entered into with a major financial institution, had a notional value of 30
million guilders. By establishing minimum and maximum exchange rates, this
agreement limited the potential devaluation of the Company's initial investment
in its subsidiary while also limiting any potential appreciation. During the
third quarter ended July 31, 2000, the Company sold the Piper Impact Europe
subsidiary. As such, this range forward agreement was closed, realizing a gain
of approximately $1.7 million. This gain was offset against the loss on the sale
of Piper Impact Europe, as the investment in Piper Impact Europe was the
underlying hedged item.

Commodity Price Risk

In the normal course of business, the Company enters into long-term firm price
aluminum sheet sales contracts. In order to hedge the risk of higher prices for
the anticipated aluminum purchases required to fulfill these long-term
contracts, the Company enters into long futures positions. At October 31, 2001
and 2000, the Company had open futures contracts for aluminum pounds with fair
values of $27.1 and $17.6 million, respectively. The contracts had fair value
losses of $1.8 million and $372 thousand at October 31, 2001 and 2000,
respectively, and covered a notional volume of 45,415,185 and 25,738,940 pounds
of aluminum, respectively. A hypothetical 10% change from the

19

October 31, 2001 and 2000 average London Metal Exchange ("LME") ingot price on
open contracts of $.596 and $.682, respectively, per pound would increase or
decrease the unrealized pretax gains/losses related to these contracts by
approximately $2.7 million and $1.8 million, respectively. However, it should be
noted that any change in the value of these contracts, real or hypothetical,
would be substantially offset by an inverse change in the cost of purchased
aluminum scrap. See Note 17 to the financial statements for further information.

20

Item 8. Financial Statements and Supplementary Data

INDEPENDENT AUDITORS' REPORT

Board of Directors and Stockholders
Quanex Corporation
Houston, Texas

We have audited the accompanying consolidated balance sheets of Quanex
Corporation and subsidiaries as of October 31, 2001 and 2000, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended October 31, 2001. Our audits also
included the financial statement schedule listed in the index at Item 14. These
financial statements and financial statement schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on the
financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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 Quanex Corporation and
subsidiaries as of October 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
October 31, 2001 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, presents fairly in all material respects the
information set forth therein.

/s/ Deloitte & Touche LLP

Deloitte & Touche LLP
Houston, Texas
November 27, 2001

21

RESPONSIBILITY FOR FINANCIAL REPORTING

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

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

The Audit Committee, composed solely of outside directors, determines
that management is fulfilling its financial responsibilities by meeting
periodically with management, Deloitte & Touche LLP, and Quanex's internal
auditors, to review internal accounting control and financial reporting matters.
The internal and independent auditors have free and complete access to the Audit
Committee.

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

/s/ Raymond A. Jean /s/ Terry M. Murphy
- --------------------------------------- ------------------------------------

Raymond A. Jean Terry M. Murphy
Chairman of the Board, President and Vice President - Finance and Chief
Chief Executive Officer Financial Officer

22

Quanex Corporation
CONSOLIDATED BALANCE SHEETS

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See notes to consolidated financial statements.

23

Quanex Corporation
CONSOLIDATED STATEMENTS OF INCOME

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