10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

(Mark One)

ý   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended May 1, 2004

OR

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

For the transition period from                 to                

Commission file number 0-8493

STEWART & STEVENSON SERVICES, INC.
(Exact name of registrant as specified in its charter)
Texas	74-1051605
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
2707 North Loop West, Houston, Texas	77008
(Address of principal executive offices)	(Zip Code)

(713) 868-7700

(Registrant’s telephone number, including area code)

not applicable

(Former name, former address and former fiscal year,
if changed since last report)

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

Number of shares outstanding of each of the registrant’s classes of common stock, as of May 24, 2004:

Common Stock, without Par Value:  28,728,885 Shares

PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements.

The following information required by Rule 10-01 of Regulation S-X is provided herein for Stewart & Stevenson Services, Inc. and Subsidiaries (collectively, the “Company”):

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STEWART & STEVENSON SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(In thousands)	May 1, 2004			January 31, 2004
	(Unaudited)
Assets
Current Assets:
Cash and cash equivalents	$	95,068		$	53,959
Short-term investments	11,235			7,745
Accounts receivable, net	134,162			163,324
Recoverable costs and accrued profits not yet billed	23,863			21,653
Inventories	156,164			166,315
Excess of current cost over LIFO values	(45,889		)	(45,330		)
Deferred income tax asset	23,571			23,591
Income tax receivable	25,203			25,846
Other current assets	15,432			17,310
Total assets of discontinued operations	4,725			8,059
Total Current Assets	443,534			442,472
Property, Plant and Equipment, net	129,887			136,165
Deferred Income Tax Asset	14,020			15,523
Intangibles and Other Assets, net	9,283			9,300
Total Assets	$	596,724		$	603,460
Liabilities and Shareholders’ Equity
Current Liabilities:
Notes payable	$	1,908		$	1,932
Current portion of long-term debt	250			250
Accounts payable	63,902			72,028
Accrued payrolls and incentives	18,657			18,092
Billings in excess of incurred costs	65,430			69,376
Estimated losses on uncompleted contracts	16,055			16,306
Other current liabilities	45,021			43,049
Total liabilities of discontinued operations	2,152			1,908
Total Current Liabilities	213,375			222,941
Long-Term Debt, net of current portion	26,260			26,260
Accrued Postretirement Benefits and Pension	52,611			52,056
Other Long-Term Liabilities	3,753			4,720
Total Liabilities	295,999			305,977
Shareholders’ Equity:
Common stock, without par value, 100,000,000 shares authorized; 28,718,885 and 28,644,510 shares issued, respectively	57,939			57,056
Accumulated other comprehensive loss	(26,183		)	(25,534		)
Retained earnings	268,969			265,961
Total Shareholders’ Equity	300,725			297,483
Total Liabilities and Shareholders’ Equity	$	596,724		$	603,460

See accompanying notes to consolidated condensed financial statements.

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STEWART & STEVENSON SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

	Three Months Ended
(In thousands, except per share data)	May 1, 2004			May 3, 2003
	(Unaudited)
Sales	$	304,288		$	289,772
Cost of sales	266,228			248,893
Gross profit	38,060			40,879
Selling and administrative expenses	29,779			35,309
Pension curtailment expense	—			2,400
Other (income) expense, net	(606		)	86
Operating profit	8,887			3,084
Interest expense	517			1,244
Interest and investment income	(254		)	(500		)
Earnings from continuing operations before income taxes	8,624			2,340
Income tax expense	3,118			682
Net earnings from continuing operations	5,506			1,658
Loss from discontinued operations, net of tax of ($34) and ($426)	(64		)	(823		)
Net earnings	$	5,442		$	835
Weighted average shares outstanding:
Basic	28,671			28,492
Diluted	28,934			28,643
Earnings per share:
Basic:
Continuing operations	$	0.19		$	0.06
Discontinued operations	—			(0.03		)
Net earnings per share	$	0.19		$	0.03
Diluted:
Continuing operations	$	0.19		$	0.06
Discontinued operations	—			(0.03		)
Net earnings per share	$	0.19		$	0.03
Cash dividends per share	$	0.085		$	0.085

See accompanying notes to consolidated condensed financial statements.

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STEWART & STEVENSON SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

	Three Months Ended
(In thousands)	May 1, 2004			May 3, 2003
	(Unaudited)
Operating Activities
Net earnings	$	5,442		$	835
Adjustments to reconcile net earnings to net cash provided by operating activities:
Net loss from discontinued operations	64			823
Deferred tax expense (benefit)	1,888			(1,808		)
Depreciation and amortization	7,041			7,021
Gain on sale of assets	(346		)	—
Change in operating assets and liabilities net of the effect of acquisition, divestiture and discontinued operations:
Accounts receivable, net	30,211			4,584
Recoverable costs and accrued profits not yet billed	(2,210		)	(3,634		)
Inventories	6,284			(5,441		)
Other current and noncurrent assets	5,691			174
Accounts payable	(8,126		)	(3,026		)
Accrued payrolls and incentives	565			2,517
Billings in excess of incurred costs	(3,946		)	1,630
Estimated losses on uncompleted contracts	(251		)	—
Other current liabilities	2,424			3,479
Accrued postretirement benefits and pension	555			3,823
Other, net	(1,670		)	51
Net Cash Provided by Continuing Operations	43,616			11,028
Net Cash Provided by (Used in) Discontinued Operations	(41		)	3,278
Net Cash Provided by Operating Activities	43,575			14,306
Investing Activities
Capital expenditures, excluding rental equipment	(2,138		)	(2,912		)
Additions to rental equipment	(814		)	(2,624		)
Proceeds from sale of businesses	3,168			—
Acquisition of businesses	—			(409		)
Proceeds from disposal of property, plant and equipment	2,489			770
Short-term investments	(3,490		)	(10,370		)
Net investing activities of discontinued operations	37			—
Net Cash Used in Investing Activities	(748		)	(15,545		)
Financing Activities
Change in short-term notes payable	(24		)	1,072
Dividends paid	(2,434		)	(2,422		)
Proceeds from exercise of stock options	740			41
Net Cash Used in Financing Activities	(1,718		)	(1,309		)
Increase (decrease) in cash and cash equivalents	41,109			(2,548		)
Cash and cash equivalents, beginning of period	53,959			107,994
Cash and cash equivalents, end of period	$	95,068		$	105,446
Cash Paid For:
Interest	$	137		$	168
Income taxes (excluding refunds)	135			103

See accompanying notes to consolidated condensed financial statements.

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STEWART & STEVENSON SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

Note 1 - Basis of Presentation

The accompanying unaudited consolidated condensed financial statements of Stewart & Stevenson Services, Inc. and Subsidiaries (collectively, the “Company”) have been prepared in accordance with Rule 10-01 of Regulation S-X for interim financial statements required to be filed with the Securities and Exchange Commission and do not include all information and footnotes required by generally accepted accounting principles for complete financial statements.  However, the information furnished herein reflects all normal recurring adjustments, which are, in the opinion of management, necessary for a fair statement of the results for the interim periods.  The results of operations for the three months ended May 1, 2004 are not necessarily indicative of the results that will be realized for the fiscal year ending January 31, 2005.

The Company’s fiscal year begins on February 1 of the year stated and ends on January 31 of the following year.  For example, the Company’s “Fiscal 2004” commenced on February 1, 2004 and ends on January 31, 2005.  The Company reports results on the fiscal quarter method with each quarter comprising approximately 13 weeks.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission.  These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended January 31, 2004.

The accompanying consolidated financial statements for Fiscal 2003 and related notes contain certain reclassifications to conform with the presentation used in Fiscal 2004.

Note 2 – Comprehensive Income

Total comprehensive income is as follows (in thousands):

	Three Months Ended
	May 1, 2004			May 3, 2003
Net earnings	$	5,442		$	835
Unrealized gain (loss) on forward contracts, net of tax	(199		)	34
Currency translation gain (loss), net of tax	(450		)	111
Comprehensive income	$	4,793		$	980

Note 3 - Segment Information

The Company’s operating reportable segments are organized based on the products and services offered and are aligned with the Company’s internal management structure.  Inter-segment and intra-segment revenues and costs are eliminated, and the operating profit (loss) represents the earnings (loss) from continuing operations before interest and income taxes, net of certain corporate allocations.

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The Company has identified five operating segments.  Sales and operating profit (loss) by operating segment are as follows (in thousands, except percentages):

	Three Months Ended
	May 1, 2004			May 3, 2003
Sales
Tactical Vehicle Systems	$	138,783		$	110,977
Power Products	120,719			125,834
Engineered Products	17,268			26,111
Distributed Energy Solutions	4,443			12,606
Airline Products	23,075			14,244
Total Sales	$	304,288		$	289,772
Operating profit (loss)
Tactical Vehicle Systems	$	19,490		$	17,787
Power Products	83			(3,126		)
Engineered Products	(1,787		)	(408		)
Distributed Energy Solutions	(5,140		)	(3,858		)
Airline Products	(295		)	(1,993		)
Corporate	(3,464		)	(5,318		)
Total operating profit	8,887			3,084
Interest expense	517			1,244
Interest and investment income	(254		)	(500		)
Earnings from continuing operations before income taxes	$	8,624		$	2,340
Operating profit (loss) percentage
Tactical Vehicle Systems	14.0		%	16.0		%
Power Products	0.1			(2.5		)
Engineered Products	(10.3		)	(1.6		)
Distributed Energy Solutions	(115.7		)	(30.6		)
Airline Products	(1.3		)	(14.0		)
Consolidated	2.9		%	1.1		%

Power Products

During the first quarter of Fiscal 2004, the Company exited the business activities associated with the distribution of Mercury Marine and MerCruiser products.  As a result, the distribution agreement for these products was terminated in March 2004 and the assets of this product line were sold for cash proceeds of $3.1 million, subject to adjustment.  Also in the first quarter of Fiscal 2004, the Company sold the net assets and exited the activities associated with its wheelchair lift manufacturing operation.  Consideration received for this asset sale included a receivable of $0.9 million which is due later in Fiscal 2004, along with royalty rights based on wheelchair lift sales over the next five years.  No material gain or loss was recognized on these transactions, individually or in the aggregate.

The activities above resulted in the closure of two branch locations which were primarily focused on the sale of Mercury Marine and MerCruiser products in Florida and Virginia.  Additionally during the first quarter of Fiscal 2004, the Company closed an under-performing branch location in Auburn, Washington.  Exit costs associated with these actions were $0.2 million, which was charged to selling and administrative expenses during the first quarter of Fiscal 2004, of which  $0.1 million was accrued and unpaid at May 1, 2004.

Distributed Energy Solutions

During Fiscal 2003, the Company announced the decision to exit the turnkey engineering, procurement and construction (“EPC”) activities within the Distributed Energy Solutions segment.  Under this exit plan, the Company expects that all remaining EPC contractual obligations will be substantially completed in Fiscal 2004.  The Company will, however, retain and execute obligations under certain fixed price operation and/or maintenance contracts related to EPC projects, which have terms ranging from two to ten years.  Nearly all exit costs associated with the EPC plan relate to the termination of employees.  Total estimated exit costs are $0.4 million, of which $0.1 million were expensed and paid in the first quarter of Fiscal 2004.  No liability was established for the remaining exit costs as of May 1, 2004, or January 31, 2004, as these costs do not meet the recognition criteria set forth under Statement of Financial Standards (“SFAS”) No. 146.

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Airline Products

Subsequent to the end of the first quarter of Fiscal 2004, the Company announced its intention to sell its Airline Products business located in Marietta, Georgia.  While the Company expects the sale of this business to be completed during Fiscal 2004, a buyer has not yet been identified and no assurance can be given as to when, or if, a transaction will take place.

Note 4 - Guarantees and Contingencies

Warranties:  Based on historical experience and contract terms, the Company provides for the estimated cost of product and service warranties at the time of sale or, in some cases, when specific warranty problems are identified.  Accrued warranty costs are adjusted periodically to reflect actual experience.  Certain warranty and other related claims involve matters of dispute that ultimately are resolved by negotiation, arbitration or litigation.  Occasionally, a material warranty issue can arise that is beyond the Company’s historical experience.  The Company provides for any such warranty issues as they become known and estimable.

A summary of warranty activity follows:

	Three Months Ended
(In thousands)	May 1, 2004			May 3, 2003
Accrued warranty costs - Beginning of period	$	7,816		$	6,073
Payments for completed warranty obligations	(1,621		)	(2,511		)
Warranty accrual for current period production	1,258			1,233
Adjustments to warranty accrual	14			—
Accrued warranty costs - End of period	$	7,467		$	4,795

Guarantees:  The Company is occasionally required to issue performance indemnities or to post letters of credit, generally issued by a bank, to collateralize certain insurance programs, to secure credit facilities or to ensure performance under contracts.  A letter of credit commits the issuer to remit specified amounts to the holder, if the holder demonstrates that the Company has failed to meet its obligations under the letter of credit.  If this were to occur, the Company would be obligated to reimburse the issuer for any payments the issuer was required to remit to the holder of the letter of credit.  Generally, a letter of credit is released when the Company has satisfied the obligations that the letter of credit is securing.  As of May 1, 2004 and January 31, 2004, the Company had letters of credit outstanding totaling approximately $12.8 million and $12.7 million, respectively.  Also, the Company has guaranteed the performance output levels of equipment serviced by the Company under certain operation and maintenance contracts, which have terms ranging from two to ten years.  Some of these contracts contain liquidated damages provisions.  In addition, the Company had contingent performance indemnities of approximately $6.7 million as of May 1, 2004 and January 31, 2004, which expire in Fiscal 2007.

U.S. Government Contingencies:  During Fiscal 1998, the U.S. Customs Service detained a medium tactical vehicle that was being shipped by the Company for display in a European trade show.  The Company is advised that the U.S. Customs Service and the Department of Justice have since such event carried on an investigation of potential violations by the Company of laws relating to the export of controlled military vehicles, weapons mounting systems and firearms.  Such investigation could result in the filing of civil or administrative sanctions against the Company and/or individual employees, and could result in a suspension or debarment of the Company from receiving new contracts or subcontracts with agencies of the U.S. government or the benefit of federal assistance payments.  While they are possible, the Company does not believe that criminal sanctions will be sought.  The Company believes that resolution of this matter will not have a material adverse effect on its consolidated results of operations in any period or upon its consolidated financial condition or liquidity and believes that the resolution of the matter that is possibly most adverse to the Company will involve the payment of a civil penalty that will not materially adversely affect the Company.

The Company is a defendant in a suit brought under the qui tam provision of the False Claims Act, United States of America, ex rel. Werner Stebner v. Stewart & Stevenson Services, Inc. and McLaughlin Body Co., Civil Action No. H-96-3363, in the United States District Court for the Southern District of Texas, Houston Division.  The plaintiff’s complaint seeks penalties and damages in an unspecified amount.  The suit alleges that the Company made false statements and certifications in connection with claims for payment for Family of Medium Tactical Vehicles delivered to the U.S. Army starting in 1995, and the suit alleges that the vehicles were substandard because of corrosion problems.  The suit was filed under seal in 1996, and following an investigation by the Justice Department, the United States declined to intervene in the suit, which was unsealed on August 29, 2000.  On February 2, 2004, the District Court found in favor of the Company and dismissed all of the plaintiff’s claims by summary judgment without proceeding to trial. After having all claims dismissed by the District Court, the plaintiffs then filed a notice of appeal on March 1, 2004 in the United States Court of Appeals for the Fifth Circuit, No. 04-20209. The briefing schedule has not yet been finally determined by the Court of Appeals. A decision by the Fifth Circuit is not expected until the fourth quarter of Fiscal 2004 or sometime in Fiscal 2005.  The grounds for appeal are not fully known, but the Company believes the District Court correctly dismissed all of the plaintiff’s claims as being without merit and will continue to vigorously defend the suit in the court of appeals.  While the Company does not believe that an adverse outcome is

8

reasonably likely, an unexpected adverse outcome in the suit could have a material adverse impact on the Company’s consolidated results of operations, financial position and liquidity.  The Company is presently unable to determine whether any liability has been incurred in this matter, other than legal fees and expenses, which have been provided for, or to reasonably estimate the amount or range of any loss that may result from this matter, and thus no accruals have been recorded in this matter other than estimated legal fees and expenses relating to the appeal.

Diamond Offshore Litigation:  The Company is a defendant in a suit brought by several subsidiaries of Diamond Offshore Drilling, Inc.  (collectively, “Diamond Offshore”) on May 30, 2002, arising out of claims relating to a marine riser manufactured by the Company and purchased by Diamond Offshore for use on its Ocean Baroness semi-submersible drilling rig, Cause No. 2002-27831; Diamond Offshore International Corporation, Diamond Offshore Company, Diamond Offshore Services Company, Diamond Offshore (USA), Inc., Diamond Offshore International Limited, and Diamond Offshore Drilling, Ltd. v. Stewart & Stevenson Services, Inc.; in the District Court of Harris County, Texas 125th Judicial District Court (the “Baroness Litigation”).  The suit was filed following a separation of the marine riser during deep water drilling operations.  The suit seeks to recover damages that are not specified in the petition.

In a separate transaction on or about September 13, 2001, Diamond Offshore contracted with the Company for a marine riser for use on its Ocean Rover semi-submersible drilling rig.  The Company was fulfilling this contract, when, on August 19, 2002, Diamond Offshore amended its petition in the Baroness Litigation to seek a declaration that Diamond Offshore has no further contractual obligations to the Company with respect to the Ocean Rover riser.  On August 21, 2002, before being served with Diamond Offshore’s amended petition in the Baroness Litigation, the Company filed a separate lawsuit against Diamond Offshore seeking to recover damages, including attorneys’ fees for the unilateral cancellation of the Rover contract (the “Rover Litigation”).  On August 30, 2002, the Court transferred the Rover Litigation to the 125th Judicial District Court where the Baroness Litigation is pending.  The two cases have been consolidated into one lawsuit in the 125th Judicial District Court.  The Company is vigorously prosecuting its claims against Diamond Offshore and defending the claims asserted against it by Diamond Offshore in this lawsuit.

It is presently impossible for the Company to determine the ultimate outcome of the Diamond Offshore disputes or whether their resolution will, in the future, have a material adverse effect on the Company’s consolidated results of operations, financial position or liquidity.  The Company is presently unable to determine whether a material liability has been incurred in these matters or to reasonably estimate the amount or range of any loss that may result from these matters.  Consequently, the Company has recorded no accrual for any losses related to the ultimate outcome of this litigation.  The Company has, however, recorded accruals that it believes are adequate for certain estimated legal fees that it expects to incur associated with these matters, which estimated legal fees are based on the Company’s experience to date in this litigation as to discovery activities and procedural filings with respect to the case.

Distributed Energy Solutions Contingencies:  During the third quarter of Fiscal 2003, the Company decided to exit the turnkey engineering, procurement and construction activities of the Distributed Energy Solutions business.  With respect to such turnkey activities, the Company will not be quoting any new business but will be continuing to perform under existing contracts.  In connection with certain existing contracts, the Company has received a written notice of dispute from a customer regarding equipment and services to be provided to several sites operated by the customer.  In the dispute notice, the customer alleged various contractual claims, including claims for liquidated damages.  The customer acknowledged the expectation of continuing negotiations, but indicated that if the parties were unable to resolve the dispute, it would seek relief in arbitration.  Additional issues have been raised by the customer, and issues exist with respect to the engines installed at the customer’s sites and as to engine supplier obligations.  Accordingly, the Company is actively reviewing issues regarding this situation.  In Fiscal 2003, the Company incurred substantial losses on the contracts that are in dispute based on estimated costs to complete the contracts and to otherwise address customer issues on the contracts.  The Company is continuing to work with the customer on these contracts in dispute to resolve the customer’s issues.  At present, the Company is unable to predict the outcome of this situation or even the aggregate amount of claims, if any, that may ultimately be asserted by the customer.  The Company is presently unable to determine whether any additional liability has been incurred in this matter beyond that which has been recorded or to reasonably estimate any amount or range of any further losses that may result from these contracts.  The Company intends to vigorously assert its positions in any arbitration of this matter should it not be resolved with the customer before any formal arbitration is initiated.

Environmental Contingencies:  In 2001, the Company received from the United States Environmental Protection Agency (the “EPA”) a Request for Information under Section 104(e) of the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, for information pertaining to the R&H Oil Company Site in San Antonio, Texas (the “Site”).  Information provided to the Company by the EPA indicates that the Company may have sent waste oils to the Site for recycling in the late 1980s, and that such waste oils may potentially account for between one and two percent of the volume of total wastes received by the oil recycler at the Site.  Since the Company expects to receive a claim for cleanup and other costs related to this site, it has established reserves which it believes to be adequate at this time.  As additional facts are developed and definitive remediation plans and necessary regulatory approvals for implementation of remediation are established, changes in these and other factors may result in actual costs exceeding the current environmental reserves.  While uncertainties are inherent in the final outcome of these environmental matters, and it is presently impossible to determine the actual costs that ultimately may be incurred, management currently believes that the resolution of such uncertainties should not have a material adverse effect on the Company’s consolidated results of operations, financial position or liquidity.  The Company believes that the most likely outcome in this environmental matter is the expenditure of an immaterial amount of

9

consideration as a contribution to the remediation effort.

The Company is also a defendant in a number of lawsuits relating to contractual, product liability, personal injury and warranty matters normally incident to the Company’s business.  No individual case, or group of cases presenting substantially similar issues of law or fact, is expected to have a material effect on the manner in which the Company conducts its business or on its consolidated results of operations, financial position or liquidity.  The Company maintains certain insurance policies that provide coverage for product liability and personal injury cases.  The Company has established reserves that it believes to be adequate based on current evaluations and its experience in these types of claim situations.  Nevertheless, an unexpected outcome in any such case could have a material adverse impact on the Company’s consolidated results of operations in the period it occurs.  Moreover, future adverse developments in such cases could require material changes in the recorded reserve amounts.

Note 5 - Discontinued Operations

During Fiscal 2002, the Company sold certain assets and exited the activities related to its blowout preventer and controls, valve and drilling riser business.  When the transaction was consummated, the Company retained certain contracts and related assets as well as the receivables and certain liabilities of the business, including warranty responsibility for products sold before closing as well as warranty responsibility for retained contracts to be completed.  In some cases, the Company has agreements with customers on commitments to support its products, including retained warranties and contracts.  The assets and liabilities as well as the results of operations of this business are reported as discontinued operations.

Discontinued operations also include a note receivable related to certain gas turbine equipment in Argentina.  In accordance with a financing agreement negotiated between the Company and the Argentine end user of the equipment in Fiscal 2003, the note receivable will be repaid over a nine-year term.

Discontinued operations generated the following sales and operating losses in the three month periods ended May 1, 2004 and May 3, 2003:

	Three Months Ended
(In thousands)	May 1, 2004			May 3, 2003
Sales	$	585		$	436
Operating loss	(98		)	(1,249		)
Operating loss, net of taxes	(64		)	(823		)

Note 6 – Inventories

Summarized below are the components of inventories related to continuing operations, net of customer deposits:

(In thousands)	May 1, 2004			January 31, 2004
Inventory purchased under distributor agreements	$	79,201		$	87,712
Raw materials and spare parts	43,885			35,932
Work in process	17,721			22,517
Finished goods	15,357			20,154
	156,164			166,315
Excess of current cost over LIFO values	(45,889		)	(45,330		)
Total Inventories	$	110,275		$	120,985

Raw materials and spare parts include OEM equipment and components used in the manufacturing segments.  The Company uses the last-in, first-out (“LIFO”) method of valuing the majority of its inventory.  An actual valuation of inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time.  Accordingly, interim LIFO calculations are based on management’s estimates of expected year-end inventory levels and costs and are subject to the final year-end LIFO inventory valuation.

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Note 7 – Earnings Per Share

The following table is a reconciliation of the numerators and denominators used in the calculation of basic and diluted earnings per share as presented on the consolidated condensed statements of operations.

	Three Months Ended
(In thousands, except per share data)	May 1, 2004			May 3, 2003
Numerator:
Earnings (loss) available to common shareholders
From continuing operations	$	5,506		$	1,658
From discontinued operations	(64		)	(823		)
Net earnings	$	5,442		$	835
Denominator:
Denominator for basic earnings per share
Weighted average shares outstanding	28,671			28,492
Effect of dilutive securities:
Employee and director stock options	263			151
Denominator for diluted earnings per share - Adjusted weighted average shares outstanding	28,934			28,643
Basic earnings per share:
From continuing operations	$	0.19		$	0.06
From discontinued operations	—			(0.03		)
Net earnings per share	$	0.19		$	0.03
Diluted earnings per share:
From continuing operations	$	0.19		$	0.06
From discontinued operations	—			(0.03		)
Net earnings per share	$	0.19		$	0.03
Number of shares under anti-dilutive stock options outstanding	2,031			1,435

Note 8 – Stock-Based Compensation

In December 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” which amends SFAS No. 123, “Accounting for Stock-Based Compensation,” by providing alternative methods of transition for a voluntary change to the fair value method of accounting for stock options and other stock-based employee compensation.  As permitted under SFAS No. 123, the Company continues to use the intrinsic value method of accounting prescribed by Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” to account for its stock-based compensation programs.  Accordingly, no compensation expense is recognized when the exercise price of an employee stock option is equal to or greater than the market price of the Company’s common stock on the grant date.

The following pro forma data are calculated as if compensation expense for the Company’s stock option plans was determined based on the fair value at the grant date for awards under these plans, amortized to expense on a pro rata basis over the option vesting period, in accordance with the methodology prescribed by SFAS No. 123:

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	Three Months Ended
(In thousands, except per share data)	May 1, 2004			May 3, 2003
Net earnings:
As reported	$	5,442		$	835
Pro forma compensation expense, determined under fair value method, net of tax	(468		)	(239		)
Pro forma	$	4,974		$	596
Basic earnings per share:
As reported	$	0.19		$	0.03
Pro forma	0.17			0.02
Diluted earnings per share:
As reported	$	0.19		$	0.03
Pro forma	0.17			0.02

For purposes of the pro forma disclosures, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.

Note 9 - Employee Pension and Other Benefit Plans

The Company has a noncontributory defined benefit pension plan that covered substantially all of its full-time employees and an unfunded defined benefit supplemental executive retirement plan covering certain highly compensated employees.  Effective July 1, 2003, the Company froze the benefits earned under both defined benefit pension plans, with the exception of a small transition group.

The Company also has a defined benefit postretirement medical plan, which provides for the payment of certain medical costs of eligible employees and dependents upon retirement.  The plan is currently not funded.  The Company expects to continue paying postretirement medical costs as covered claims are incurred.  Effective July 1, 2003, the Company decided that postretirement medical benefits will not be provided to future retirees, with the exception of a small transition group.

The net periodic benefit cost associated with the Company’s defined benefit pension plans and defined benefit postretirement medical plan consisted of the following components for the three months ended:

	Pension Benefits						Other Postretirement Benefits
(In thousands)	May 1, 2004			May 3, 2003			May 1, 2004			May 3, 2003
Service cost	$	183		$	649		$	—		$	138
Interest cost	1,888			1,938			164			260
Expected return on plan assets	(2,048		)	(1,909		)	—			—
Curtailment expense/(gain)	—			2,369			—			(142		)
Amortization of prior service cost	—			31			(191		)	(113		)
Amortization of net loss	365			169			73			93
Net periodic benefit cost	$	388		$	3,247		$	46		$	236

As previously disclosed in the Company’s consolidated financial statements for the year ended January 31, 2004, the Company expects to contribute at least $4.0 million to its defined benefit pension plans during Fiscal 2004.  During the three months ended May 1, 2004, no contributions were made.

On December 8, 2003, President Bush signed into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”).  The Act introduced a prescription drug benefit under Medicare (“Medicare Part D”) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D.  As allowed by FASB Staff Position 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003,” the Company has elected to defer recognizing the effects of the Act on its accumulated postretirement benefit obligation and net periodic postretirement benefit cost in the consolidated financial statements and notes thereto.  FASB Staff Position 106-2, issued in May 2004, provides guidance on the accounting for the effects of the Act.  The Company is currently evaluating the impact of such guidance, which the Company is required to adopt in the third quarter of Fiscal 2004.

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion should be read in conjunction with the attached consolidated condensed financial statements and notes thereto, and with our Annual Report on Form 10-K and notes thereto for the fiscal year ended January 31, 2004.  The following discussion contains forward-looking statements.  In connection therewith, please see “Factors That May Affect Future Results” below, which identifies important factors that could cause actual results to differ materially from those predicted or implied in the forward-looking statements.

Our fiscal year begins on February 1 of the year stated and ends on January 31 of the following year.  For example, our “Fiscal 2004” commenced on February 1, 2004 and ends on January 31, 2005.  We report results on the fiscal quarter method with each quarter comprising approximately 13 weeks.  The first quarter of Fiscal 2004 commenced on February 1, 2004 and ended on May 1, 2004, and the first quarter of Fiscal 2003 commenced on February 1, 2003 and ended on May 3, 2003.

RESULTS OF OPERATIONS

Overview

During the first quarter of Fiscal 2004, we have continued to make progress in our execution of the management action plans required to achieve acceptable financial returns throughout all of our operating segments.  The significant highlights of our progress in each operating segment are described below.

Tactical Vehicle Systems – We continue the transition efforts that will result in full rate production under the new Family of Medium Tactical Vehicles (“FMTV”) contract later this year.  Our current multi-year contract with the U.S. Army to produce the FMTV is expected to conclude during the second half of Fiscal 2004, at which time production is expected to begin under the new multi-year contract with the U.S. Army.  We expect the fourth quarter of Fiscal 2004 to be one of transition with lower sales as production commences under the new contract.

Power Products – Wecompleted numerous streamlining and cost reduction actions in the first quarter of Fiscal 2004, and we continue to look at the cost structure for additional opportunities.  Key actions taken in the first quarter include the sale of assets of the Mercury Marine MerCruiser product line, the sale of assets of the wheelchair lift manufacturing product line, the sale of certain undeveloped real estate and the closure of an under-performing branch located in Auburn, Washington.  As a result of the many actions taken during the second half of Fiscal 2003 and the first quarter of 2004, total headcount for this segment as of May 1, 2004 has been reduced by 323 personnel since September 2003, of which 126 such reductions have occurred since January 31, 2004.

Engineered Products – We are continuing to evaluate the long-term earnings potential for the primary components of this segment, including the petroleum equipment and utility equipment product lines.  Upon completing this evaluation, we plan to take the strategic actions necessary to generate acceptable returns in this segment, which may include the exit of some or all of the product lines of this segment.

Distributed Energy Solutions – Our efforts in this segment continue to be focused upon completing remaining contractual obligations and winding down the engineering, procurement and construction (“EPC”) activities of this business.

Airline Products – Subsequent to the end of the first quarter, we announced our decision to pursue the sale of our Airline Products business.  We concluded that this business is not core to the long-term direction of the Company, and therefore, it is in the best interest of our shareholders to redeploy the capital invested in this segment to other more strategic activities.

First Quarter Fiscal 2004 vs. First Quarter Fiscal 2003

Sales for the first quarter of Fiscal 2004 of $304.3 million increased $14.5 million, or 5%, from the first quarter of Fiscal 2003.  This increase in sales is primarily attributable to a $27.8 million increase in our Tactical Vehicle Systems segment along with an $8.8 million increase in our Airline Products Segment.  These increases were partially offset by lower sales in the Engineered Products, Distributed Energy Solutions and Power Products segments.  The changes within each segment are explained in greater detail in the Segment Data section below.

Gross profit decreased by $2.8 million to $38.1 million in the first quarter of Fiscal 2004 from the first quarter of Fiscal 2003.  This decrease reflects a decline in gross profit margin to 12.5% in the first quarter of Fiscal 2004 from 14.1% in the first quarter of Fiscal 2003.  The decrease in gross profit is primarily attributable to higher costs in our Distributed Energy Solutions and Tactical Vehicle Systems segments.  Within our Distributed Energy Solutions segment, the first quarter of Fiscal 2004 included $2.5 million of gross profit margin erosion primarily associated with the continued progress on existing EPC customer obligations.  Within our Tactical Vehicle Systems segment, the gross profit declined $4.4 million as a result of product mix changes associated with option truck production under the current FMTV contract and increased material costs, primarily associated with higher steel prices.  This decline

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was substantially offset by the impact of higher sales volume.  Sales volume changes in all other segments combined to generate the remaining $0.3 million of gross profit decline.

Selling and administrative expenses decreased to $29.8 million (9.8% of sales) in the first quarter of Fiscal 2004 from $35.3 million (12.2% of sales) in the first quarter of Fiscal 2003.  This $5.5 million (16%) reduction in selling and administrative expenses is primarily attributable to a $2.8 million cost savings from employee workforce reductions during Fiscal 2003, a $1.0 million reduction in fringe benefits expense associated with changes made in our employee pension, postretirement and medical benefit plans, and $1.7 million associated with reductions in other expenses.

First quarter of Fiscal 2003 operating results included a one-time non-cash write-off of $2.4 million of previously unamortized prior service costs (pension curtailment expense).  This charge was associated with our decision to freeze the benefits earned under our defined benefit pension plan, defined benefit supplemental executive retirement plan and our postretirement medical plan effective July 1, 2003, with the exception of a small transition group.

Other (income) expense, net, changed from a net expense of $0.1 million in the first quarter of Fiscal 2003 to net income of $0.6 million in the first quarter of Fiscal 2004, primarily as a result of a net gain on sales of assets and compensation earned from a supply partner during Fiscal 2004.

Net interest expense decreased $0.5 million to $0.2 million in the first quarter of Fiscal 2004.  The decrease in interest expense is primarily attributable to lower debt balances as a result of the scheduled debt payment of $30.0 million in May 2003.

The effective tax rate was 36.1% in the first quarter of Fiscal 2004 compared to 29.1% for the corresponding period in 2003.  The increase in effective tax rate is primarily a result of an expected reduction in certain state tax benefits and tax credits in Fiscal 2004 compared to the first quarter of Fiscal 2003.

Discontinued operations generated an after-tax loss of $0.1 million in the first quarter of Fiscal 2004, compared to an $0.8 million after-tax loss in the first quarter of Fiscal 2003.  These losses primarily represent costs associated with retained contracts, warranty and legal claims and obligations associated with our discontinued blowout preventer and controls, valve and drilling riser business, which was sold during Fiscal 2002.

Segment Data

Our operating reportable segments are organized based on the products and services offered and are aligned with the internal management structure.  Inter-segment and intra-segment revenues and costs are eliminated, and the operating profit (loss) represents the earnings (loss) before interest and income taxes from continuing operations, net of certain corporate allocations.

The following table represents sales and operating profit (loss) by business segment (in thousands):

	Three Months Ended
	May 1, 2004			May 3, 2003
Sales
Tactical Vehicle Systems	$	138,783		$	110,977
Power Products	120,719			125,834
Engineered Products	17,268			26,111
Distributed Energy Solutions	4,443			12,606
Airline Products	23,075			14,244
Total Sales	$	304,288		$	289,772
Operating profit (loss)
Tactical Vehicle Systems	$	19,490		$	17,787
Power Products	83			(3,126		)
Engineered Products	(1,787		)	(408		)
Distributed Energy Solutions	(5,140		)	(3,858		)
Airline Products	(295		)	(1,993		)
Corporate	(3,464		)	(5,318		)
Total operating profit	8,887			3,084
Interest expense	517			1,244
Interest and investment income	(254		)	(500		)
Earnings from continuing operations before income taxes	$	8,624		$	2,340

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Tactical Vehicle Systems

The Tactical Vehicle Systems segment manufactures tactical vehicles under contracts with the U.S. Army and provides sustaining design engineering, service and support.  Other contracts within and outside of the U.S. are also being pursued in the segment.  During the first quarter of Fiscal 2004, this segment recorded $138.8 million of sales, a $27.8 million (25%) increase from the $111.0 million of sales recorded in the first quarter of Fiscal 2003.  The sales increase is attributable to increased production volume as this segment delivered 743 trucks and 204 trailers in the first quarter of Fiscal 2004, compared to 631 trucks and 132 trailers in the same period of Fiscal 2003.  Operating profit for the first quarter of Fiscal 2004 increased to $19.5 million (14.0% operating margin) from $17.8 million (16.0% operating margin) in the first quarter of Fiscal 2003.  The increased sales volume generated a $4.4 million improvement to operating profit.  This improvement was partially offset by $1.8 million of margin deterioration associated with product mix and $0.9 million of increased material costs, primarily associated with higher steel prices.

As mentioned above, full rate production under the new multi-year FMTV contract is scheduled to begin in the fourth quarter of Fiscal 2004.  The delivery schedule at the outset of the new contract is expected to result in a decline in sales volume during the fourth quarter of Fiscal 2004.  The total sales volume for Fiscal 2004, however, is currently expected to exceed Fiscal 2003 sales levels due to higher unit volumes during the first three quarters of Fiscal 2004.  As a result of the new contract, our profit margins in this segment are expected to be lower than historical margin levels achieved with the current FMTV contract, which we believe to have been substantially higher than those typically achieved by defense contractors.  Actual future margins of this segment will, however, be dependent upon a number of factors including our ability to achieve efficiencies and other materials and labor cost control measures, the actual quantities and variations of vehicles purchased by the U.S. Army under the new contract, future prices for steel and other materials, the potential for additional contracts, bid and proposal activities and other factors.  The operating margin this segment will achieve in total may also be impacted by additional sales, if any, to other allied governments and the level of engineering and service provided.

Power Products

The Power Products segment, which is responsible for marketing and aftermarket support of a wide range of industrial equipment, recorded sales of $120.7 million in the first quarter of Fiscal 2004, down $5.1 million (4%) from $125.8 million in the first quarter of Fiscal 2003.  A breakdown of Power Products segment sales follows:

	Three Months Ended
(In thousands)	May 1, 2004		May 3, 2003
Equipment sales	$	36,259	$	37,138
Parts sales	56,098		60,778
Service and rental sales	28,362		27,918
	$	120,719	$	125,834

The decline in sales was primarily attributable to the closure of five under-performing branch locations during the fourth quarter of Fiscal 2003 and first quarter of Fiscal 2004, along with the exit of the ThermoKing product offering in Texas and Louisiana, and the wheelchair lift manufacturing and MerCruiser product offerings.  This segment reported an operating profit of $0.1 million in the first quarter of Fiscal 2004 compared to a $3.1 million operating loss in the first quarter of Fiscal 2003.  The improvement in operating profit is primarily attributable to on-going cost reduction programs.  Workforce reductions resulted in a $3.2 million decrease in employee compensation costs between the two periods.  Additionally, changes in employee benefit programs described above resulted in an additional $1.0 million decrease in operating expenses.  The earnings improvements generated by these reductions were partially offset by a $1.0 million decline resulting from the decrease in sales volume.

As mentioned above, we sold the assets of our wheelchair lift manufacturing and MerCruiser distribution product offerings during the first quarter of Fiscal 2004 for aggregate cash proceeds of $3.2 million and a receivable of $0.9 million.  No material gain or loss was recognized on these transactions, individually or in the aggregate.  We intend to continue to evaluate the many activities in this business segment in Fiscal 2004 and take the appropriate actions in order to improve the segment’s contribution to the Company’s return on invested capital.

Engineered Products

The Engineered Products segment consists of two primary product lines, petroleum equipment and utilities equipment.  The petroleum equipment business manufactures equipment primarily for the well stimulation segment of the oil service industry.  The utilities equipment products include mobile railcar movers, snowblowers and off-road seismic vehicles.  Sales in this segment decreased to $17.3 million in the first quarter of Fiscal 2004 from $26.1 million in the first quarter of Fiscal 2003, representing a 34% decline.  This net decrease included a decline in petroleum equipment sales of $11.9 million, primarily resulting from our execution of several large

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international orders during the first quarter of Fiscal 2003.  This decline was partially offset by a $3.1 million increase in utilities equipment sales, largely associated with off-road seismic vehicle sales.  Operating loss for the first quarter of Fiscal 2004 was $1.8 million, a $1.4 million change from the $0.4 million loss generated in the first quarter of Fiscal 2003.  The increased operating loss is primarily attributable to a $0.8 million decline related to the reduced sales volume along with a $0.4 million charge for potential inventory impairment associated with the recent U.S. trade sanctions against Syria, and $0.2 million associated with increased unabsorbed operating expenses.

Our order backlog in this segment has increased to $30.9 million at May 1, 2004 from $20.1 million at the end of Fiscal 2003.  The execution of the contracts currently in backlog are expected to improve sales and reduce future operating losses from the first quarter Fiscal 2004 levels.

Distributed Energy Solutions

The Distributed Energy Solutions segment packages reciprocating diesel and natural gas engine generator sets and markets power generation solutions in domestic and certain international markets.  As previously communicated, we announced the decision to exit EPC activities within this segment during the third quarter of Fiscal 2003.  With respect to such EPC activities, we are not quoting any new business but we continue to perform under existing contracts.

Sales for this segment decreased $8.2 million to $4.4 million in the first quarter of Fiscal 2004 compared to $12.6 million in the first quarter of Fiscal 2003.  The decline in sales is primarily the result of our decision to exit the EPC activities.  Sales in the first quarter of Fiscal 2004 primarily relate to our continued execution of remaining customer obligations under existing contracts.  Operating loss for the first quarter of Fiscal 2004 was $5.1 million, compared to a $3.9 million operating loss in the first quarter of Fiscal 2003.  The increased operating loss is largely attributable to continued costs incurred on existing contractual obligations, costs related to certain contract issues and disputes and the overall low volume of sales and margin that is not sufficient to cover this segment’s infrastructure costs remaining in place to service existing obligations.

The EPC contractual obligations are expected to be substantially completed by the end of Fiscal 2004.  We will, however, retain and execute obligations under certain fixed-price operation and/or maintenance contracts related to EPC projects, which have terms ranging from two to ten years.

Airline Products

The Airline Products segment, which manufactures aircraft ground support equipment, recognized sales of $23.1 million in the first quarter of Fiscal 2004, an $8.9 million (62%) increase from the $14.2 million of sales in the first quarter of Fiscal 2003.  The increased sales in Fiscal 2004 are primarily attributable to increased capital spending in the domestic commercial airline industry.  This segment delivered 571 units in the first quarter of Fiscal 2004, compared to 325 units in the first quarter of Fiscal 2003.  Operating loss for this segment was $0.3 million in the first quarter of Fiscal 2004, a $1.7 million improvement from the $2.0 million operating loss in the first quarter of Fiscal 2003.  The improvement in operating loss is primarily attributable to the increased sales volume.  Our order backlog in this segment is $14.3 million at the end of the first quarter, a $7.3 million increase from the end of Fiscal 2003.

During the first quarter of Fiscal 2004, the Airline Products business was awarded contracts by the U.S. Navy, Naval Air Warfare Center to deliver tow tractors and air conditioning units.  The initial contract awards of $2.6 million cover the design and testing of 5 pilot-production tow tractor units and 5 pilot-production air conditioning units, along with associated technical data and training and pilot-production testing.  These contracts are expected to be executed in the second and third quarters of Fiscal 2004.  Pending successful completion of the initial award, the contracts include four individual option years beginning in late Fiscal 2004 or early Fiscal 2005 which have a total contract value of approximately $72 million, if all options are fully exercised.

As mentioned above, we are currently pursuing the sale of our Airline Products business.  Until a suitable buyer is found for this business, the sale process is not expected to have a material impact to the on-going operations of this segment.  Additionally, we will continue to provide the capital and other resources needed to continue our execution in this business.

Corporate

Corporate expenses consist of costs incurred by the corporate headquarters group, which cannot be directly attributed to the activities of the business segments.  Corporate expenses incurred in the first quarter of Fiscal 2004 were $3.5 million, a $1.8 million decrease from the $5.3 million incurred in the first quarter of Fiscal 2003.  The decrease in corporate expenses is primarily attributable to a $2.4 million one-time non-cash pension curtailment expense in the first quarter of Fiscal 2003 resulting from changes made to our defined benefit pension and postretirement medical plans.  The impact of other cost reduction efforts including corporate staff reductions were offset by higher legal and professional expenses, including $0.6 million associated with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002.  While the requirements of Sarbanes-Oxley Act are expected to result in some level of increased corporate expenses, we expect the on-going expenses to be lower than the levels experienced in the first quarter of Fiscal 2004.

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UNFILLED ORDERS

The Company’s unfilled orders consist of written purchase orders and signed contracts.  Historically, cancellations are rare; however, these unfilled orders are generally subject to cancellation or modification due to customer relationships or other conditions.  Purchase options are not included in unfilled orders until exercised.  Unfilled orders relating to continuing operations were as follows:

	May 1, 2004		January 31, 2004
	(In millions)
Tactical Vehicle Systems	$	591.2	$	453.0
Power Products	29.3		26.4
Engineered Products Division	30.9		20.1
Distributed Energy Solutions	14.1		19.5
Airline Products	14.3		7.0
	$	679.8	$	526.0

Unfilled orders of the Tactical Vehicle Systems segment at May 1, 2004 consisted principally of remaining production related to the sixth program year under the U.S. Army contract awarded in October 1998, as well as the funded portion of the new multi-year FMTV contract awarded in April 2003.  Production under the October 1998 contract is expected to be complete in December 2004, and full rate production under the new FMTV contract is expected to begin in November 2004.

LIQUIDITY AND CAPITAL RESOURCES

Our sources of cash liquidity include cash and cash equivalents, short-term investments and cash from operations.  We believe that these sources will provide sufficient capital to fund our working capital requirements, capital expenditure needs, dividends and other financial commitments.

We had a $150 million unsecured revolving credit facility, which expired on January 31, 2004.  No borrowings were outstanding under the facility at any time during the past three fiscal years.  Based on non-usage of the revolving credit facility combined with the current cash and cash equivalents balance and the expected cash from operations for the foreseeable future, we elected not to renew the facility.  To provide additional financial flexibility, we intend to negotiate a smaller revolving credit facility later in Fiscal 2004.  There can be no assurance that we will be able to successfully negotiate such a facility or, if we do, that such facility will include terms and conditions similar to the expired facility.  Failure to negotiate a new facility on terms acceptable to us could restrict our future ability to make acquisitions and fund working capital, capital expenditures, common stock dividends or other financial obligations.

During Fiscal 2003, we entered into letter of credit facilities totaling $17.5 million with financial institutions, to allow us to issue letters of credit as needed to support our commercial operations.  Approximately $12.8 million of letters of credit under these facilities were outstanding as of May 1, 2004.

We have $25.0 million in unsecured senior notes outstanding, which bear interest at a rate of 7.38% and are due and payable in May 2006.  The senior notes agreement limits sales of assets and other items and contains a maximum debt-to-total capitalization covenant. Based on our financial condition as of May 1, 2004, the restrictions imposed by our senior notes do not currently restrict our ability to meet our obligations or to declare and pay dividends at historical levels.

In Fiscal 2002, we entered into an interest rate swap agreement, which expires in November 2004, with a notional amount of $15 million related to $15 million of the senior notes due in 2006.  This transaction, which is designated as a fair value hedge, effectively converts $15 million of fixed rate debt with an interest rate of 7.38% into floating rate debt with an interest rate of LIBOR plus 436 basis points.  The applicable floating interest rate as of May 1, 2004 was approximately 5.7%.  The net interest received or paid as a result of the interest rate swap is included in interest expense on the consolidated statements of operations.  The recorded value of the swap and the related fair value adjustment to the debt are carried on the consolidated balance sheets at fair value.

In addition, our international subsidiaries had foreign currency bank notes payable totaling $1.9 million at May 1, 2004 and January 31, 2004.  Such notes payable consist of renewable, secured loans for the purpose of financing our South American operations.  These loans are denominated in local currency (Colombian Pesos and Venezuelan Bolivars) and are secured by letters of credit issued by us and principally bear market-based variable rates of interest.  We use foreign denominated debt to offset the impact of foreign currency exchange rate fluctuations on our South America operations.

In the event that any acquisition of additional operations, growth in existing operations, settlements of lawsuits or disputes, changes in

17

inventory levels, accounts receivable, tax payments or other working capital items create a permanent need for working capital or capital expenditures in excess of the existing cash and cash equivalents and committed lines of credit, we may seek to borrow under other long-term financing instruments or seek additional equity capital.

Statements of Cash Flows Data

	Three Months Ended
(In thousands)	May 1, 2004			May 3, 2003
Net cash provided by (used in):
Operating activities	$	43,575		$	14,306
Investing activities	(748		)	(15,545		)
Financing activities	(1,718		)	(1,309		)
Increase (decrease) in cash and cash equivalents	$	41,109		$	(2,548	)

Selected Balance Sheet Data

(In thousands)	May 1, 2004		January 31, 2004
Cash, cash equivalents, and short-term investments	$	106,303	$	61,704
Working capital	230,159		219,531
Total debt	28,418		28,442

Total cash flow changed by $43.7 million to a $41.1 million cash increase during the first quarter of Fiscal 2004, compared to a $2.5 million cash decrease in the first quarter of Fiscal 2003.  This change in cash flow primarily relates to a $29.3 million improvement in cash provided by operating activities as accounts receivable balances were reduced by $30.2 million in the first quarter of Fiscal 2004. This decrease relates to customer receipts related to large equipment orders which were completed in our Engineered Products segment during the fourth quarter of Fiscal 2003.

Investing activities contributed an additional $14.8 million improvement in cash flow during the first quarter of Fiscal 2004 compared to the first quarter of Fiscal 2003, as capital expenditures decreased by $2.5 million and cash invested in short-term investments decreased by $6.9 million.  Additionally, during the first quarter of Fiscal 2004, we received $3.2 million of cash proceeds related to the sale of the MerCruiser product offering in our Power Products segment.

As a result of the cash provided by operating activities in the first quarter of Fiscal 2004, total cash and short-term investments has increased by $44.6 million to $106.3 million as of May 1, 2004.  We anticipate that this balance will remain relatively stable in the near-term; however, we anticipate that we will use cash during the second half of Fiscal 2004 to fund working capital related to additional orders in the Engineered Products segment.  Additionally, cash will be used to satisfy our production requirements under the expiring FMTV contract in the Tactical Vehicle Systems segment, which is expected to result in a decrease in billings in excess of costs on our consolidated condensed balance sheet.  We believe that these activities in our Engineered Products and Tactical Vehicle Systems segments could consume approximately $40-50 million of cash during the second half of Fiscal 2004.

Our working capital balance increased by $10.5 million during the first quarter of Fiscal 2004, primarily attributable to the $8.6 million of earnings before income taxes.

FACTORS THAT MAY AFFECT FUTURE RESULTS

Risks as to Rising Steel Prices.  In recent months, U.S. manufacturers and distributors of steel, which is used in many of our products, have experienced sharply increased prices and limited availability of steel and component parts containing steel. These increased steel prices have had and are expected to continue to have a negative impact on our margins in the near future, particularly on fixed-price contracts and other contracts for which we are unable to pass such cost increases on to our customers.  If these steel price conditions continue, and if we are unable to raise our prices to keep pace with the material cost increases, our sales trends, operating margins and results of operations could be adversely impacted in future periods.

Forward-Looking Statements

This filing contains forward-looking statements that are based on management’s current expectations, estimates, and projections. These statements are not guarantees of future performance and involve a number of risks, uncertainties, and assumptions and are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.  Many factors, including those discussed more fully elsewhere herein, in the Company’s latest annual report on Form 10-K, and in the Company’s quarterly reports on Form 10-Q, as well as others, could cause results to differ materially from those stated.  Specific important factors that could cause actual results, performance, or achievements to differ materially from such forward-looking statements include risks of dependence on government and failure to obtain new government contracts, inherent risks of government contracts, risks of supply interruptions to

18

Tactical Vehicle Systems segment, risks associated with Distributed Energy Solutions segment, risks of fixed-price contracts, risks as to cost controls, risks of general economic conditions, risks of oil and gas industry economic conditions, risks of airline industry economic conditions, risks as to distributorships, risks as to licenses, risk of competition, risks relating to technology, risks as to terrorist attacks on the U.S. and their impact on the U.S. economy, risks relating to personnel, risks of claims and litigation, risks of product defects, risks of no credit facility, risks as to foreign sales and global trade matters, risks as to information technology, risks as to acquisitions and restructuring activities, risks as to currency fluctuations, risks as to environmental and safety matters, and credit risks, all as more specifically outlined in the Company’s latest annual report on Form 10-K.  In addition, such forward-looking statements could be affected by general industry and market conditions and growth rates, general domestic and international conditions including interest rates, inflation and currency exchange rates and other future factors.  Actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our quantitative and qualitative disclosures about market risk for changes in interest rates and foreign exchange risk are incorporated by reference in Item 7A of our Annual Report on Form 10-K for the year ended January 31, 2004 and have not materially changed since that report was filed.

Item 4.  Controls and Procedures

The Company carried out an evaluation required by the Securities Exchange Act of 1934, as amended (the “Exchange Act”), under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act as of May 1, 2004. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company and required to be included in the Company’s periodic filings under the Exchange Act.  During the first quarter of Fiscal 2004, there have been no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II.  OTHER INFORMATION

Item 1. Legal Proceedings.

U.S. Government Contingencies:  During Fiscal 1998, the U.S. Customs Service detained a medium tactical vehicle that was being shipped by the Company for display in a European trade show.  The Company is advised that the U.S. Customs Service and the Department of Justice have since such event carried on an investigation of potential violations by the Company of laws relating to the export of controlled military vehicles, weapons mounting systems, and firearms.  Such investigation could result in the filing of civil or administrative sanctions against the Company and/or individual employees, and could result in a suspension or debarment of the Company from receiving new contracts or subcontracts with agencies of the U.S. government or the benefit of federal assistance payments.  While they are possible, the Company does not believe that criminal sanctions will be sought.  The Company believes that resolution of this matter will not have a material adverse effect on its consolidated results of operations in any period or upon its consolidated financial condition or liquidity and believes that the resolution of the matter that is possibly most adverse to the Company will involve the payment of a civil penalty that will not materially adversely affect the Company.

The Company is a defendant in a suit brought under the qui tam provision of the False Claims Act, United States of America, ex rel.  Werner Stebner v. Stewart & Stevenson Services, Inc. and McLaughlin Body Co., Civil Action No. H-96-3363, in the United States District Court for the Southern District of Texas, Houston Division.  The plaintiff’s complaint seeks penalties and damages in an unspecified amount.  The suit alleges that the Company made false statements and certifications in connection with claims for payment for Family of Medium Tactical Vehicles delivered to the U.S. Army starting in 1995, and the suit alleges that the vehicles were substandard because of corrosion problems.  The suit was filed under seal in 1996, and following an investigation by the Justice Department, the United States declined to intervene in the suit, which was unsealed on August 29, 2000.  On February 2, 2004, the District Court found in favor of the Company and dismissed all of the plaintiff’s claims by summary judgment without proceeding to trial.  After having all claims dismissed by the District Court, the plaintiffs then filed a notice of appeal on March 1, 2004 in the United States Court of Appeals for the Fifth Circuit, No. 04-20209. The briefing schedule has not yet been finally determined by the Court of Appeals.  A decision by the Fifth Circuit is not expected until the fourth quarter of Fiscal 2004 or sometime in Fiscal 2005.  The grounds for appeal are not fully known, but the Company believes the District Court correctly dismissed all of the plaintiff’s claims as being without merit and will continue to vigorously defend the suit in the court of appeals.  While the Company does not believe that an adverse outcome is reasonably likely, an unexpected adverse outcome in the suit could have a material adverse impact on the Company’s consolidated results of operations, financial position and liquidity.  The Company is presently unable to determine whether any liability has been incurred in this matter, other than legal fees and expenses, which have been provided for, or to reasonably estimate the amount or range of any loss that may result from this matter, and thus no accruals have been recorded in this matter other than estimated legal fees and expenses relating to the appeal.

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Diamond Offshore Litigation:  The Company is a defendant in a suit brought by several subsidiaries of Diamond Offshore on May 30, 2002, arising out of claims relating to a marine riser manufactured by the Company and purchased by Diamond Offshore for use on its Ocean Baroness semi-submersible drilling rig, Cause No. 2002-27831; Diamond Offshore International Corporation, Diamond Offshore Company, Diamond Offshore Services Company, Diamond Offshore (USA), Inc., Diamond Offshore International Limited, and Diamond Offshore Drilling, Ltd. v. Stewart & Stevenson Services, Inc.; in the District Court of Harris County, Texas 125^th  Judicial District Court (the “Baroness Litigation”).  The suit was filed following a parting of the marine riser during deep water drilling operations.  The suit seeks to recover damages that are not specified in the petition.

In a separate transaction on or about September 13, 2001, Diamond Offshore contracted with the Company for a marine riser for use on its Ocean Rover semi-submersible drilling rig.  The Company was fulfilling this order, when, on August 19, 2002, Diamond Offshore amended its petition in the Baroness Litigation to seek a declaration that Diamond Offshore has no further contractual obligations to the Company with respect to the Ocean Rover riser.  On August 21, 2002, before being served with Diamond Offshore’s amended petition in the Baroness Litigation, the Company filed a separate lawsuit against Diamond Offshore seeking to recover damages, including attorneys’ fees for the unilateral cancellation of the Rover contract, (the “Rover Litigation”).  On August 30, 2002, the Court transferred the Rover Litigation to the 125^th Judicial District Court where the Baroness Litigation is pending.  The two cases have been consolidated into one lawsuit in the 125^th Judicial District Court.  The Company is vigorously prosecuting its claims against Diamond Offshore and defending the claims asserted against it by Diamond Offshore in this lawsuit.

It is presently impossible for the Company to determine the ultimate outcome of the Diamond Offshore disputes or whether their resolution will, in the future, have a material adverse effect on the Company’s consolidated results of operations, financial position or liquidity.  The Company is presently unable to determine whether a material liability has been incurred in these matters or to reasonably estimate the amount or range of any loss that may result from these matters.  Consequently, the Company has recorded no accrual for any losses related to the ultimate outcome of this litigation.  The Company has, however, recorded accruals that it believes are adequate for certain estimated legal fees that it expects to incur associated with these matters, which estimated legal fees are based on the Company’s experience to date in this litigation as to discovery activities and procedural filings with respect to the case.

Environmental Contingencies:  In 2001, the Company received from the United States Environmental Protection Agency (“EPA”) a Request for Information under Section 104(e) of the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, for information pertaining to the R&H Oil Company Site in San Antonio, Texas (the “Site”).  Information provided to the Company by the EPA indicates that the Company may have sent waste oils to the Site for recycling in the late 1980s, and that such waste oils may potentially account for between one and two percent of the volume of total wastes received by the oil recycler at the Site.  Since the Company expects to receive a claim for cleanup and other costs related to this site, it has established reserves which it believes to be adequate at this time.  As additional facts are developed and definitive remediation plans and necessary regulatory approvals for implementation of remediation are established, changes in these and other factors may result in actual costs exceeding the current environmental reserves.  While uncertainties are inherent in the final outcome of these environmental matters, and it is presently impossible to determine the actual costs that ultimately may be incurred, management currently believes that the resolution of such uncertainties should not have a material adverse effect on the Company’s consolidated results of operations, financial position or liquidity.  The Company believes that the most likely outcome in this environmental matter is the expenditure of an immaterial amount of consideration as a contribution to the remediation effort.

The Company is also a defendant in a number of lawsuits relating to contractual, product liability, personal injury and warranty matters normally incident to the Company’s business.  No individual case, or group of cases presenting substantially similar issues of law or fact, is expected to have a material effect on the manner in which the Company conducts its business or on its consolidated results of operations, financial position or liquidity.  The Company maintains certain insurance policies that provide coverage for product liability and personal injury cases.  The Company has established reserves that it believes to be adequate based on current evaluations and its experience in these types of claim situations.  Nevertheless, an unexpected outcome in any such case could have a material adverse impact on the Company’s consolidated results of operations in the period it occurs.  Moreover, future adverse developments in such cases could require material changes in the recorded reserve amounts.

Item 6. Exhibits and Reports on Form 8-K.

(a)The following exhibits are filed as part of this report pursuant to Item 601 of Regulation S-K.

3.2	Sixth Restated Bylaws of Stewart & Stevenson Services, Inc., effective as of April 11, 2000, as amended.
†10.1	Employment Agreement, effective as of February 1, 2004, with Max L. Lukens.
†10.2	Severance Agreement, effective as of February 1, 2004, with Max L. Lukens.
†10.3	Nonqualified Stock Option Agreement, entered into as of March 31, 2004, with Max L. Lukens.

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31.1	Chief Executive Officer Certification
31.2	Chief Financial Officer Certification.
32.1	Statement of Max L. Lukens, Chief Executive Officer, and John B. Simmons, Chief Financial Officer, furnished pursuant to Rule 13(a)-14(b) of the Securities Exchange Act of 1934, as amended.

†  Identifies management contracts or compensation plans or arrangements required to be filed as an exhibit hereto.

(b)Form 8-K Report Date – March 2, 2004 (Stewart & Stevenson Services Announces Preliminary Fourth Quarter Results and Leadership Changes)

Items Reported -  Item 7.  Exhibits

Item 12.  Results of Operations and Financial Condition

Form 8-K Report Date – March 23, 2004 (Stewart & Stevenson Services Announces Fiscal 2003 Fourth Quarter Earnings Release and Conference Call Schedule)

Items Reported -  Item 7.  Exhibits

Item 9.  Regulation FD Disclosure

Form 8-K Report Date – March 29, 2004 (Stewart & Stevenson Reports Fourth Quarter and Fiscal 2004 Results)

Items Reported -  Item 7.  Exhibits

Item 12.  Results of Operations and Financial Condition

Form 8-K Report Date – March 31, 2004 (Transcript of Stewart & Stevenson’s Conference Call Held March 29, 2004)

Items Reported -  Item 7.  Exhibits

Item 9.  Regulation FD Disclosure

Form 8-K Report Date – April 19, 2004 (Stewart & Stevenson Announces Date of 2004 Annual Meeting of Stockholders)

Items Reported -  Item 5.  Other Events

Item 7.  Exhibits

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 25th day of May 2004.

STEWART & STEVENSON SERVICES, INC.

By:		/s/  Max L. Lukens
Max L. Lukens
President and Chief Executive Officer
(Principal Executive Officer)
By:	/s/ John B. Simmons
John B. Simmons
Vice President and Chief Financial Officer
(Principal Financial Officer)
By:		/s/ L. Scott Biar
L. Scott Biar
Controller and Chief Accounting Officer
(Principal Accounting Officer)

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EXHIBIT INDEX

Exhibit Number and Description

3.2	Sixth Restated Bylaws of Stewart & Stevenson Services, Inc., effective as of April 11, 2000, as amended.
10.1	Employment Agreement, effective as of February 1, 2004, with Max L. Lukens.
10.2	Severance Agreement, effective as of February 1, 2004, with Max L. Lukens.
10.3	Nonqualified Stock Option Agreement, entered into as of March 31, 2004, with Max L. Lukens.
31.1	Chief Executive Officer Certification.
31.2	Chief Financial Officer Certification.
32.1	Statement of Max L. Lukens, Chief Executive Officer, and John B. Simmons, Chief Financial Officer, furnished pursuant to Rule 13(a)-14(b) of the Securities Exchange Act of 1934, as amended.

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EX-3.2

Exhibit 3.2

SIXTH RESTATED
BYLAWS OF
STEWART & STEVENSON SERVICES, INC.

Effective April 11, 2000

ARTICLE I

Offices

Section 1.1.  Offices.  The principal business office of the Corporation shall be at Houston, Texas or at such other location within the State of Texas as the Board of Directors may, from time to time, establish by resolution.  The Corporation may have such other business offices within or without the State of Texas as the Board of Directors may from time to time establish or the business of the Corporation may require.

ARTICLE II

Capital Stock

Section 2.1.  Certificates Representing Shares.  Certificates representing shares of stock of the Corporation shall be consecutively numbered and in such form or forms as comply with the requirements of law and the Restated Articles of Incorporation and as the Board of Directors shall approve.  Such certificates shall be signed by the President or a Vice President, and the Secretary or an Assistant Secretary of the Corporation, and may be sealed with the seal of the Corporation or a facsimile thereof.  The signatures of the President or Vice President and the Secretary or Assistant Secretary may be facsimiles, engraved or printed, if the certificate is countersigned by a transfer agent, or registered by a registrar, other than the Corporation itself or an employee of the Corporation.  In case any officer or officers who have signed or whose facsimile signature or signatures have been placed upon such certificate shall have ceased to be such officer or officers before such certificate is issued, it may be adopted and issued by the Corporation with the same effect as if he or they had not ceased to be such officer or officers as of the date of its issuance, and the issuance and delivery thereof by the Corporation shall constitute adoption thereof by the Corporation.

Section 2.2.  Stock Certificate Register and Shareholders of Record.  The Secretary of the Corporation shall keep at the registered office of the Corporation, or cause a duly appointed transfer agent or registrar to keep at its principal office, a share register showing the names of the shareholders and their addresses, the number of shares held by each, the number and date of issue of all certificates representing shares of the Corporation, the number and date of cancellation of every certificate surrendered for cancellation and whether such certificates originated from original issue or transfer.  Such information may be kept in any medium capable of reproducing the information in clearly legible form and shall be the official list of shareholders of record of the Corporation for all purposes.  The Corporation shall be entitled to treat the holder of

record of any shares of the Corporation as the owner thereof for all purposes, and shall not be bound to recognize any equitable or other claim to, or interest in, such shares or any rights deriving from such shares on the part of any other person, including (but without limitation) a purchaser, assignee, or transferee, unless and until such other person becomes the holder of record of such shares, whether or not the Corporation shall have either actual or constructive notice of the interest of such other person.

Section 2.3.  Transfer of Stock.  The shares represented by any share certificates of the Corporation are transferable only on the stock certificate register of the Corporation by the holder of record thereof in person or by a duly authorized attorney or legal representative upon surrender of the certificate for such shares properly endorsed or assigned.

Section 2.4.  Transfer Agent and Registrar.  The Board of Directors may appoint one or more transfer agents or registrars of the shares, or both, and may require all share certificates to bear the signature of a transfer agent or registrar or both.

Section 2.5.  Lost, Stolen or Destroyed Certificates.  The Corporation may issue a new certificate for shares of stock in the place of any certificate theretofore issued and alleged to have been lost, stolen or destroyed, but the Board of Directors may require the owner of such lost, stolen or destroyed certificate, or his legal representative, to furnish an affidavit as to such loss, theft, or destruction and to give a bond in such form and substance, and with such surety or sureties, with fixed or open penalty, as it may direct, to indemnify the Corporation, and the transfer agents and registrars, if any, against any claim that may be made on account of the alleged loss, theft or destruction of such certificate.  Any such new certificate shall be plainly marked “Duplicate” on its face.

ARTICLE III

The Shareholders

Section 3.1.  Annual Meetings.  An annual meeting of the shareholders, for the election of directors to succeed those whose terms expire and for the transaction of such other business as may properly come before the meeting, shall be held at such place, within or without the State of Texas, as may be designated by the Board of Directors or officer calling the meeting at 10:00 in the morning of the second Tuesday in June, or on such other date and time as the Board of Directors or officer calling such meeting shall fix and set forth in the notice of the meeting.  At the annual meeting of the shareholders, only such business shall be conducted as shall have been properly brought before the annual meeting.  To be properly brought before the annual meeting of shareholders, business must be (i) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board of Directors, (ii) otherwise properly brought before the meeting by or at the direction of the Board of Directors, or (iii) otherwise properly brought before the meeting by a shareholder of the Corporation who is a shareholder of record at the time of giving of notice provided for in this Section 3.1, who shall be entitled to vote at such meeting and who complies with the notice procedures set forth in this Section

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3.1.  For business to be properly brought before an annual meeting by a shareholder, the shareholder, in addition to any other applicable requirements, must have given timely notice thereof in writing to the Secretary of the Corporation.  To be timely, a shareholder’s notice must be delivered to or mailed and received at the principal executive offices of the Corporation not less than ninety (90) days prior to the anniversary date of the immediately preceding annual meeting of shareholders of the Corporation.  A shareholder’s notice to the Secretary shall set forth as to each matter the shareholder proposes to bring before the annual meeting: (a) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (b) the name and address, as they appear on the Corporation’s books, of the shareholder proposing such business, (c) the class and number of shares of voting stock of the Corporation which are beneficially owned by the shareholder, (d) a representation that the shareholder intends to appear in person or by proxy at the meeting to bring the proposed business before the annual meeting, and (e) a description of any material interest of the shareholder in such business.  Notwithstanding anything in these Bylaws to the contrary, no business shall be conducted at an annual meeting except in accordance with the procedures set forth in this Section 3.1.  The presiding officer of an annual meeting shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting in accordance with the provisions of this Section 3.1, and if he should so determine, he shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted.

Notwithstanding the foregoing provisions of this Section 3.1, a shareholder shall also comply with all applicable requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder with respect to the matters set forth in this Section 3.1.

Section 3.2.  Special Meetings.  Except as otherwise provided by law or by the Restated Articles of Incorporation, special meetings of the shareholders may be called by the Chairman of the Board, the President, the Board of Directors, or the holders of not less than one-tenth of all the shares having voting power at such meeting, and shall be held at the principal office of the Corporation, at such time as is stated in the notice calling such meeting, or at such other place as the person or body calling such meeting may determine and state in such notice.

Section 3.3.  Notice of Meetings - Waiver.  Written, electronic or printed notice, stating the place, day and hour of any meeting and, in case of a special shareholders’ meeting, the purpose or purposes for which the meeting is called, shall be delivered not less than ten (10) nor more than fifty (50) days before the date of the meeting by or at the direction of the Chairman of the Board, the President, or the officer, body or person calling the meeting, to each shareholder of record entitled to vote at such meeting.  Notice shall be delivered personally, by mail or, subject to receipt by the Corporation of written authorization, electronic transmission.  If delivered personally, such notice shall be deemed delivered when actually received by the shareholder.  If delivered by mail, such notice shall be deemed delivered when deposited in the United Sates mail addressed to

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the shareholder at his address as it appears on the stock certificate register of the Corporation, with postage thereon prepaid.  If delivered by electronic transmission, such notice shall be deemed delivered when the notice or the location from which the notice can be retrieved or otherwise viewed is sent to the electronic mail address specified by each shareholder that authorized electronic transmission.  Such further or earlier notice shall be given as may be required by law.  Waiver by a shareholder of notice in writing of a shareholders’ meeting, signed by him, whether before or after the time stated therein, shall be equivalent to the giving of such notice.  No notice shall be necessary for any adjourned meeting.

Section 3.4.  Closing of Stock Certificate Register and Fixing Record Date.  For the purpose of determining shareholders entitled to notice of or to vote at any meeting of shareholders or any adjournment thereof, or entitled to receive payment of any dividend or in order to make a determination of shareholders for any other proper purpose, the Board of Directors of the Corporation may provide that the stock certificate register shall be closed for a stated period but not to exceed, in any case, fifty (50) days.  If the stock certificate register shall be closed for the purpose of determining shareholders entitled to notice of or to vote at a meeting of shareholders, such registers shall be closed for at least ten (10) days immediately preceding such meeting.  In lieu of closing the stock certificate register, the Board of Directors may fix in advance a date as the record date for any such determination of shareholders, such date in any case to be not more than fifty (50) days and, in case of a meeting of shareholders, not less than ten (10) days prior to the date on which the particular action, requiring such determination of shareholders, is to be taken.  If the stock certificate register is not closed and no record date is fixed for the determination of shareholders entitled to notice of or to vote at a meeting of shareholders, or shareholders entitled to receive payment of a dividend, the date on which notice of the meeting is mailed or the date on which the resolution of the Board of Directors declaring such dividend is adopted, as the case may be, shall be the record date for such determination of shareholders.  When a determination of shareholders entitled to vote at any meeting of shareholders has been made, as provided in this Section, such determination shall apply to any adjournment thereof except where the determination has been made through the closing of the stock certificate register and the stated period of closing has expired.

Section 3.5.  Voting List.  The officer or agent having charge of the stock certificate register for shares of the Corporation shall make, at least ten (10) days before such meeting of shareholders, a complete list of the shareholders entitled to vote at such meeting or any adjournment thereof, arranged in alphabetical order, with the address of and the number of shares held by each, which list, for a period of ten (10) days prior to such meeting, shall be kept on file at the registered office of the Corporation and shall be subject to inspection by any shareholder at any time during the usual business hours.  Such list shall also be produced and kept open at the time and place of the meeting and shall be subject to the inspection of any shareholder during the whole time of the meeting.  Failure to comply with this Section shall not effect the validity of any action taken at such meeting.

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Section 3.6.  Quorum and Officers.  Except as otherwise provided by law, by the Restated Articles of Incorporation or by these Bylaws, the holders of a majority of the shares entitled to vote, represented in person or by proxy, shall constitute a quorum at a meeting of shareholders, but the shareholders present at any meeting, although less than a quorum, may from time to time adjourn the meeting to some other day and hour, without notice other than announcement at the meeting.  The vote of the holders of a majority of the shares entitled to vote and thus represented at a meeting at which a quorum is present shall be the act of the shareholders’ meeting, unless the vote of a greater number is required by law, the Restated Articles of Incorporation or these Bylaws.  The Chairman of the Board, or in his absence, the President, shall preside at and the Secretary, or in his absence, any Assistant Secretary shall keep the records of each meeting of shareholders, and in the absence of all such officers, their respective duties shall be performed by persons appointed by the meeting.

Section 3.7.  Proxies.  A shareholder may vote either in person or by proxy executed in writing by the shareholder, or by his duly authorized attorney-in-fact.  Proxies shall be dated but need not be sealed, witnessed or acknowledged.  No proxy shall be valid after eleven (11) months from the date of its execution unless otherwise provided in the proxy.  Each proxy shall be revocable unless provided expressly therein to be irrevocable, and unless otherwise made irrevocable by law.  Proxies shall be filed with the Secretary of the Corporation before or at the time of the meeting.

Section 3.8.  Balloting.  Upon the demand of any shareholder, the vote upon any question before the meeting shall be by ballot.  At each meeting inspectors of election may be appointed by the presiding officer of the meeting, and at any meeting for the election of directors, inspectors shall be so appointed on the demand of any shareholder present or represented by proxy and entitled to vote at the election of directors.  No director or candidate for the office of directors shall be appointed as such inspector.

Section 3.9.  Voting Rights; Voting for Directors.  Each outstanding share of common stock shall be entitled to one (1) vote upon each matter submitted to a vote at a meeting of shareholders.  No shareholder shall have the right to cumulate his votes for the election of directors, but each share shall be entitled to one vote in the election of each director.

Section 3.10  Nominations for Election as a Director.  Only persons who are nominated in accordance with the procedures set forth in these Bylaws and qualify for nomination pursuant to Section 4.1 shall be eligible for election by shareholders as, and to serve as, directors.  Nominations of persons for election to the Board of Directors of the Corporation may be made at a meeting of shareholders (a) by or at the direction of the Board of Directors or a duly constituted committee thereof or (b) by any shareholder of the Corporation who is a shareholder of record at the time of giving of notice provided for in this Section 3.10, who shall be entitled to vote for the election of directors at the meeting and who complies with the notice procedures set forth in this Section 3.10.  Such nominations, other than those made by or at the direction of the Board of Directors, shall be made pursuant to timely notice in writing to the Secretary of

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the Corporation.  To be timely, a shareholder’s notice shall be delivered to or mailed and received at the principal executive offices of the Corporation (i) with respect to an election to be held at the annual meeting of the shareholders of the Corporation, not less than ninety (90) days prior to the anniversary date of the immediately preceding annual meeting of shareholders of the Corporation, and (ii) with respect to an election to be held at a special meeting of shareholders of the Corporation for the election of directors not later than the close of business on the tenth (10th) day following the day on which notice of the date of the special meeting was mailed to shareholders of the Corporation as provided in Section 3.3 or public disclosure of the date of the special meeting was made, whichever first occurs.  Such shareholder’s notice to the Secretary shall set forth (x) as to each person whom the shareholder proposes to nominate for election or re-election as a director, all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors, or is otherwise required, pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (including such person’s written consent to being named in the proxy statement as a nominee and to serve as a director if elected), and (y) as to the shareholder giving the notice (i) the name and address, as they appear on the Corporation’s books, of such shareholder and (ii) the class and number of shares of voting stock of the Corporation which are beneficially owned by such shareholder.  At the request of the Board of Directors, any person nominated by the Board of Directors for election as a director shall furnish to the Secretary of the Corporation that information required to be set forth in a shareholder’s notice of nomination which pertains to the nominee.  In the event that a person is validly designated as a nominee to the Board of Directors in accordance with the procedures set forth in this Section 3.10 and shall thereafter become unable or unwilling to stand for election to the Board of Directors, the Board of Directors or the shareholder who proposed such nominee, as the case may be, may designate a substitute nominee.  Other than directors chosen pursuant to the provisions of Section 4.3, no person shall be eligible to serve as a director of the Corporation unless nominated in accordance with the procedures set forth in this Section 3.10.  The presiding officer of the meeting of shareholders shall, if the facts warrant, determine and declare to the meeting that a nomination was not made in accordance with the procedures prescribed by these Bylaws, and if he should so determine, he shall so declare to the meeting and the defective nomination shall be disregarded.  Notwithstanding the foregoing provisions of this Section 3.10, a shareholder shall also comply with all applicable requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder with respect to the matters set forth in this Section 3.10.

ARTICLE IV

The Board of Directors

Section 4.1.  Number and Qualifications.  The business and affairs of the Corporation shall be managed and controlled by the Board of Directors, and subject to any restrictions imposed by law, by the Restated Articles of Incorporation, or by these Bylaws, the Board of Directors may exercise all the powers of the Corporation.  The

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Board of Directors shall consist of eleven (11) members.  The number thereof may be increased or decreased from time to time by amendment to these Bylaws, but no decrease shall have the effect of shortening the term of any incumbent director.  Directors need not be residents of Texas and need not be shareholders.  Directors shall retire as of the date of the annual meeting of shareholders first occurring following the Director’s 73^rd birthday; provided, that any Director who was originally elected on or before June 19, 1981 shall not be required to retire until the date of the annual meeting of shareholders first occurring following such Director’s 75^th birthday. No person shall be qualified for election or re-election as a director of the Corporation if he is an incumbent director and has attended fewer than fifty (50%) percent of the meetings of the Board of Directors held during any fiscal year commencing after January 31, 1981, which such incumbent was entitled to attend as a director.

Section 4.2.  Classification and Term.  The Board of Directors shall be divided into three classes, each class consisting as nearly as possible of one-third (1/3) of the number of directors that make up the full Board of Directors.  At each annual meeting of shareholders, the number of directors equal to the number of the class whose term expires at the time of such meeting shall be elected to hold office until the third succeeding annual meeting of shareholders.

Section 4.3.  Vacancies.  Any vacancy on the Board of Directors may be filled by the vote of a majority of the remaining directors though less than a quorum of the Board of Directors; provided, that the Board of Directors may not fill more than two (2) vacancies caused by an increase in the number of directors during any period between two (2) successive annual meetings of shareholders.  A director elected to fill a vacancy shall hold office for the unexpired portion of his predecessor’s term if such vacancy was created by the death, resignation, disqualification or removal of a director or until the next annual meeting of shareholders if such vacancy was created by an increase in the size of the Board of Directors.

Section 4.4.  Place of Meeting.  Meetings of the Board of Directors may be held either within or without the State of Texas, at whatsoever place is specified by the officer or director calling the meeting.  In the absence of other designation, the meeting shall be held at the principal business office of the Corporation.

Section 4.5.  Regular Meetings.  The Board of Directors shall hold no fewer than four (4) regular meetings in each fiscal year.  One such regular meeting (the “Annual Meeting of Directors”) shall be held immediately following the annual meeting of shareholders, at the place of such shareholder meeting, and the other regular meetings shall be held at such times and places as the Board of Directors shall establish by resolution at the regular meeting following the annual meeting of shareholders.  No notice of any kind of such regular meetings shall be necessary to either old or new members of the Board of Directors.

Section 4.6.  Special Meetings.  Special meetings of the Board of Directors shall be held at any time by call of the Chairman of the Board, the President (if a director) or by

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a majority of the directors.  The Secretary or officer performing his duties shall give notice of special meetings to each director at his usual business or residence address by mailing such notice at least five (5) days or one hundred twenty (120) hours before the meeting or by personally delivering or, subject to receipt of written authorization, electronically transmitting the same at least one (1) day or twenty-four (24) hours before the meeting.  No notice shall be necessary for any adjourned meeting.  A waiver of notice of any special meeting, in writing, signed by the person or persons entitled to such notice, whether before or after the time stated therein, shall be equivalent to the giving of such notice.  Such notice or waiver thereof need not specify the business to be transacted at, or the purpose of, such meeting.  Attendance of a director at a meeting shall constitute a waiver of notice of such meeting, except where a director attends a meeting for the express and announced purpose of objecting to the transaction of any business on the ground that the meeting is not lawfully called or convened.

Section 4.7.  Quorum.  Seven directors shall constitute a quorum for the transaction of business.  The act of a majority of the directors present at a meeting at which a quorum is in attendance shall be the act of the Board of Directors unless a larger number is required by applicable law, the Restated Articles of Incorporation or these Bylaws, but any one or more directors, although less than a quorum, may adjourn the meeting to some other day or hour.

Section 4.8.  Chairman of the Board.  At each Annual Meeting of Directors, the Board of Directors shall elect from its membership a Chairman of the Board who shall serve in such capacity until the next Annual Meeting of Directors or until his death, resignation, disqualification or removal if sooner.  The Chairman of the Board shall preside at all meetings of the Board of Directors and at all meetings of the shareholders of the Company.

Section 4.9.  Procedure at Meetings.  The Chairman of the Board shall preside at meetings of the Board of Directors.  In his absence at any meeting, the President (if a director) shall preside, and in the absence of both the Chairman of the Board and the President, a member of the Board of Directors selected by the members present shall preside.  The Secretary of the Corporation shall act as secretary at all meetings of the Board, or in his absence the presiding officer of the meeting may designate any person to act as secretary.  At meetings of the Board of Directors, business shall be transacted in such order as from time to time the Board of Directors may determine.

Section 4.10.  Presumption of Assent.  A director of the Corporation who is present at a meeting of the Board of Directors at which action on any corporate matter is taken shall be presumed to have assented to the action taken unless his dissent shall be entered in the minutes of the meeting or unless he shall file his written dissent to such action with the person acting as the secretary of the meeting before the adjournment thereof or shall forward such dissent by registered mail to the Secretary of the Corporation immediately after the adjournment of the meeting.  Such right to dissent shall not apply to a director who voted in favor of such action.

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Section 4.11.  Compensation.  Directors as such shall not receive any stated salary for their service, but by resolution of the Board of Directors (a) an annual directors fee and (b) a fixed sum and expenses for attendance, if any, may be allowed to each director who is not an officer or employee of the Corporation for attendance at each regular or special meeting of the Board of Directors or of any Committee thereof; but nothing herein shall preclude any director from serving the Corporation in any other capacity or receiving compensation therefor.

Section 4.12.  Standing Committees.The Board of Directors by resolution adopted by a majority of the number of directors fixed by the Bylaws shall designate from their number an Executive Committee and an Audit Committee.

The Executive Committee shall consist of five (5) persons.  Each member shall serve until the next annual meeting of shareholders or until such director’s retirement, removal, disqualification, or death.  The Executive Committee shall meet upon the call of the chairman of such committee or any two (2) members thereof and shall have and may exercise all of the authority of the Board of Directors in the business and affairs of the Corporation except (a) the power to authorize or approve the sale or other transfer of any real property now owned or hereafter acquired by the Corporation; (b) the power to vote, direct the vote or grant proxies relating to any stock owned by the Corporation; (c) the power to authorize or approve purchases or commitments for goods or services with an aggregate market value in any single transaction or group of related transactions exceeding $5,000,000 except for goods and services purchased in the ordinary course of business for inventory or pursuant to capital expenditure budgets approved by the Board of Directors; (d) the power to authorize or approve the incurrence or guaranty of indebtedness with an original principal amount in excess of $1,000,000 and a maturity of longer than one (1) year; (e) the power to make loans, guaranties, investments, or other commitments outside the ordinary course of business in excess of $5,000,000 at any time outstanding to any one person or group of persons; and (f) where action of the Board of Directors is specified by the Texas Business Corporation Act or by other applicable  law.

The Audit Committee shall consist of four (4) persons, all of whom shall be independent of management and free of any relationship that, in the opinion of the Board of Directors, would interfere with the exercise of independent judgment as a committee member.  Each member shall serve until the next annual meeting of shareholders or until such director’s retirement, removal, disqualification, or death.  The Audit Committee shall meet no fewer than two (2) times in each fiscal year of the Corporation upon the call of the chairman of such committee or any two (2) members thereof and shall have and may exercise such responsibilities, authority and power as the Board of Directors specifies.

The designation of Standing Committees and delegation of authority thereto shall not operate to relieve the Board of Directors, or any member thereof, of any responsibility imposed upon it or him by law.

Section 4.13.  Other Committees of the Board of Directors.  The Board of Directors, by resolution adopted by a majority of the number of directors fixed by the

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Bylaws, may designate from their number such compensation, nominating and other committees as they shall, from time to time, deem necessary and proper.  Such committees shall be composed of not less than three members and shall have and exercise such of the Board of Directors’ authority as shall by resolution, be delegated to it.  The designation of such other committees and the delegation of authority thereto shall not operate to relieve the Board of Directors, or any member thereof, of any responsibility imposed upon it or him by law.

Section 4.14.  Meetings and Reports of the Committees.  The Committees shall meet from time to time as set forth in the Bylaws and on call of the Chairman or any two or more members thereof.  Notice of each such meeting, stating the place, day and hour thereof, shall be served personally on each member of such Committee, or shall be mailed, delivered, telephoned or, subject to receipt of written authorization, electronically transmitted to his address on the books of the Corporation, at least twenty-four (24) hours before the meeting.  No such notice need state the business proposed to be transacted at the meeting.  No notice of the time or place of any meeting of such Committee need be given to any member thereof who attends in person or who, in writing executed and filed with the records of the meeting either before or after the holding thereof, waives such notice.  No notice need be given of an adjourned meeting of any Committee.  Meetings of the Committees may be held at such place or places, either within or outside of the State of Texas, as such Committee shall determine, or as may be specified or fixed in the respective notices or waivers thereof.  Each Committee may fix its own rules of procedure.  They shall keep record of their proceedings and shall report these proceedings to the Board of Directors at the regular meetings thereof held next after they have been taken.

Section 4.15.  Advisory Directors.  The Board of Directors, by resolution adopted by a majority of the number of directors fixed by the Bylaws, may appoint from those persons who have previously served as a director of the Corporation, such advisory directors as the Board of Directors may, from time to time, determine to be desirable.  Such advisory directors shall be ex-officio members of the Board of Directors, shall hold office from the date elected until the next following annual meeting of the Board of Directors unless sooner removed in the manner provided for the removal of Directors, shall be entitled to receive notice of and to attend all meetings of the Board of Directors and shall be reimbursed for all out-of-pocket expenses incurred to attend meetings of the Board of Directors.  Advisory directors shall not be a member of any committee of the Board of Directors, vote on any matter brought before the Board of Directors for action or be counted for the purposes of determining whether a quorum exists.  Failure to notify the advisory directors of any meeting shall not render any meeting or any action taken at such meeting void.

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ARTICLE V

Officers

Section 5.1.  Number.  The officers of the Corporation shall consist of the President, Secretary, Treasurer and Controller; and, in addition, such Vice Presidents, other officers and assistant officers and agents as may be deemed necessary and elected or appointed by the Board of Directors.  The Board of Directors may by resolution designate any officer as the Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer, or other title.  Any two or more offices may be held by the same person.

Section 5.2.  Election; Term; Qualification.  Officers shall be chosen by the Board of Directors at the Annual Meeting of the Directors and may be chosen at any other meeting of the Board of Directors.  Each officer shall hold office until the next following Annual Meeting of Directors, or until his death, resignation, retirement or removal.

Section 5.3.  Removal.  Any officer or agent elected or appointed by the Board of Directors may be removed by the Board of Directors at its pleasure, but such removal shall be without prejudice to other contract rights, if any, of the person so removed.  Election or appointment of an officer or agent shall not of itself create any contract rights.

Section 5.4.  Retirement.  No person may serve as an officer of the Corporation after the last day of the fiscal year in which such officer celebrates his sixty-fifth birthday or such later date as is necessary to comply with applicable laws.

Section 5.5.  Vacancies.  Any vacancy in any office for any cause may be filled by the Board of Directors at any meeting.

Section 5.6.  Duties.  The officers of the Corporation shall have such powers and duties, except as modified by the Board of Directors, as generally pertain to their offices, respectively, as well as such powers and duties as from time to time shall be conferred by the Board of Directors and by these Bylaws.

Section 5.7.  The President.  The President shall, subject to the control of the Board of Directors, have general supervision and control over all of the business, assets and affairs of the Corporation.  All other officers shall report as directed by the President.  In the absence of the Chairman of the Board, the President shall perform all of the duties of the Chairman of the Board, and when so acting shall have all of the powers of, and be subject to all restrictions upon, the Chairman of the Board.

Section 5.8.  Secretary.  The Secretary shall:  (a) keep the minutes of all meetings of the shareholders, of the Board of Directors, and of all committees of the Board of Directors, in one or more books provided for that purpose and shall distribute a copy of all such minutes to the members of the Board of Directors immediately on receipt thereof, (b) see that all notices are duly given in accordance with the provisions of these

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Bylaws or as required by law, (c) be custodian of the corporate records and of the seal of the Corporation and see that the seal of the Corporation is affixed to all documents the execution of which on behalf of the Corporation under its seal is duly authorized, (d) have general charge of the stock certificate register, transfer books and stock ledgers, and such other books and papers as the Board of Directors may direct, of the Corporation, all of which shall, at all reasonable times, be open to the examination of any director, upon application at the office of the Corporation during business hours, and (e) in general perform all duties and exercise all powers incident to the office of the Secretary and such other duties and powers as the Board of Directors or the President from time to time may assign to or confer on him.

Section 5.9.  Treasurer.  The Treasurer shall be legal custodian of all monies, notes, securities, and other valuables which may from time to time come into the possession of the Corporation and shall perform such other duties as the Bylaws may require or the Board of Directors may prescribe.  The Treasurer shall have the power and authority to incur or guaranty indebtedness on behalf of the Corporation without the prior approval of the Board of Directors provided that the original principal amount thereof is less than $1,000,000 and the original maturity is less than one year.

Section 5.10.  Controller.  The Controller shall keep complete and accurate books and records of account showing accurately at all times the financial condition of the Corporation.  He shall furnish at meetings of the Board of Directors, or whenever requested, a statement of the financial condition of the Corporation, and shall perform such other duties as the Bylaws may require or the Board of Directors may prescribe.

Section 5.11.  The Vice Presidents.  The Board of Directors may from time to time elect such Vice Presidents as the Board of Directors deems appropriate and assign thereto such general or specific powers, authority and responsibility as the Board of Directors deems appropriate.  The Board of Directors may specify the order in which the Vice Presidents may act in the absence of the President.  Any action taken by a Vice President in the performance of the duties of President shall be conclusive evidence of the absence of the President.  The Vice Presidents shall perform such other duties as may, from time to time, be assigned to them by the Board of Directors or the President.  A Vice President may also sign with the Secretary or an Assistant Secretary certificates of stock of the Corporation.

Section 5.12.  Assistant Officers.  Any Assistant Secretary, Assistant Treasurer or Assistant Controller appointed by the Board of Directors shall have power to perform, and shall perform, all duties incumbent upon the Secretary, the Treasurer or the Controller of the Corporation, respectively, subject to the general direction of such officers, and shall perform such other duties as the Bylaws may require or the Board of Directors may prescribe.

Section 5.13.  Salaries.  The salaries or other compensation of the officers shall be fixed from time to time by the Board of Directors.  No officer shall be prevented from

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receiving such salary or other compensation by reason of the fact that he is also a director of the Corporation.

Section 5.14.  Bonds of Officers.  The Board of Directors may secure the fidelity of any or all of such officers by bond or otherwise, in such terms and with such surety or sureties, conditions, penalties or securities as shall be required by the Board of Directors.

Section 5.15.  Delegation.  The Board of Directors may delegate temporarily the powers and duties of any officer of the Corporation, in case of his absence or for any other reason, to any other officer, and may authorize the delegation by any officer of the Corporation of any of his powers and duties to any agent or employee subject to the general supervision of such officer.

ARTICLE VI

Miscellaneous

Section 6.1.  Contracts.  The Board of Directors may authorize any officer or officers, agent or agents, of the Corporation to enter into any contract or execute and deliver any instrument in the name of or on behalf of the Corporation, and such authority may be general or confined to specific instances; and, unless so authorized by the Board of Directors or by these Bylaws, no officer, agent or employee shall have any power or authority to bind the Corporation by any contract or engagement, or to pledge its credit or to render it liable pecuniarily for any purpose or to any amount.

Section 6.2.  Checks, Drafts, etc.  All checks, drafts, or other orders for the payment of money, notes, or other evidences of indebtedness issued in the name of the Corporation shall be signed by such officers or employees of the Corporation as shall from time to time be authorized pursuant to these Bylaws or by resolution of the Board of Directors.

Section 6.3.  Depositories.  All funds of the Corporation shall be deposited from time to time to the credit of the Corporation in such banks, trust companies, or other depositories as the Board of Directors may from time to time designate, upon such terms and conditions as shall be fixed by the Board of Directors.  The Board of Directors may from time to time authorize the opening and keeping with any such depository as it may designate of general and special bank accounts, and may make such special rules and regulations with respect thereto, not inconsistent with the provisions of these Bylaws, as it may deem expedient.

Section 6.4.  Endorsement of Stock Certificates.  Subject to the specific directions of the Board of Directors, any share or shares of stock issued by any corporation and owned by the Corporation (including reacquired shares of the Corporation) may, for sale or transfer, be endorsed in the name of the Corporation by the President or any Vice President, and attested or witnessed by the Secretary or any Assistant Secretary either with or without affixing the corporate seal.

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Section 6.5.  Voting of Shares Owned by the Corporation.  Subject to the direction of the Board of Directors, the President, the Secretary and the Treasurer, or any of them, shall have the power and authority on behalf of the Corporation to attend and to vote and to grant proxies to be used at any meeting of shareholders of any corporation in which the Corporation may hold stock.  The Board of Directors may confer like powers upon any other person or persons.

Section 6.6.  Corporate Seal.  The corporate seal shall be in the form of a five pointed star surrounded by the words “Stewart & Stevenson Services, Inc.,” and such seal, or a facsimile thereof, may be impressed on, affixed to, or in any manner reproduced upon, instruments of any nature required to be executed by officers of the Corporation.

Section 6.7.  Fiscal Year.  The fiscal year of the Corporation shall begin on February 1 and end on January 31 of the next following year, or on such other dates as the Board of Directors at any time shall determine.

Section 6.8.  Resignations.  Any director or officer may resign at any time.  Such resignations shall be made in writing and shall take effect at the time specified therein, or, if no time be specified, at the time of its receipt by the Chairman of the Board, President or Secretary.  The acceptance of a resignation shall not be necessary to make it effective, unless expressly so provided in the resignation.

Section 6.9.  Indemnification of Officers and Directors.  The Corporation shall indemnify any person against any judgment, penalty, fine, settlement and reasonable expenses incurred by him in connection with any threatened, pending or completed action, suit or proceeding in which such person is or is threatened to be made a party because he is or was serving as an officer or director of the Corporation or at the request of the Corporation as an officer, director, partner, venturer, proprietor, trustee, employee, agent or other functionary of another entity and (i) such person is wholly successful in the defense thereof, or (ii) it is determined in the manner required by law that such person conducted himself in good faith, reasonably believed that his conduct was in the best interest of the Corporation and had no reasonable cause to believe that his conduct was unlawful; provided, however, that no person shall be indemnified if such indemnity is prohibited by applicable law.  Any such indemnification shall be reported in writing to the shareholders of the Corporation on or before the notice or waiver of notice of the next shareholders’ meeting and in any event within twelve (12) months of the indemnification.  The right of indemnification under this Section 6.9 shall be in addition to any other rights to which such persons may be entitled and is intended to provide the broadest benefits permitted by law.

Section 6.10.  Loans to and Guaranties for Officers and Directors.  The Corporation shall not lend money to or guaranty the indebtedness of any of its officers or directors unless such loan or guaranty is approved by the number of directors equal to a majority of the full Board of Directors none of whom are then or will become as a result of

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such action indebted to the Corporation and on the express finding by such directors that such loan or guaranty is reasonably expected to directly or indirectly benefit the Corporation.

ARTICLE VII

Amendments

Section 7.1.  Amendments.  The Board of Directors, by the affirmative vote of seven directors may alter, amend or repeal these Bylaws or adopt new Bylaws.  The shareholders by affirmative vote of two-thirds (2/3) of the issued and outstanding shares entitled to vote may alter, amend or repeal these Bylaws or adopt new Bylaws, without notice at any regular meeting, or if notice of the proposed amendment be contained in the notice of any special meeting.

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FIRST AMENDMENT TO THE SIXTH RESTATED BYLAWS
OF STEWART & STEVENSON SERVICES, INC.

Effective as of April 28, 2000, Section 4.1 and 4.7 of the Bylaws of Stewart & Stevenson Services, Inc. was amended to read as follows:

Section 4.1.  Number and Qualifications.  The business and affairs of the Corporation shall be managed and controlled by the Board of Directors, and subject to any restrictions imposed by law, by the Restated Articles of Incorporation, or by these Bylaws, the Board of Directors may exercise all the powers of the Corporation.  The Board of Directors shall consist of twelve (12) members.  The number thereof may be increased or decreased from time to time by amendment to these Bylaws, but no decrease shall have the effect of shortening the term of any incumbent director.  Directors need not be residents of Texas and need not be shareholders.  Directors shall retire as of the date of the annual meeting of shareholders first occurring following the Director’s 73^rd birthday; provided, that any Director who was originally elected on or before June 19, 1981 shall not be required to retire until the date of the annual meeting of shareholders first occurring following such Director’s 75^th birthday. No person shall be qualified for election or re-election as a director of the Corporation if he is an incumbent director and has attended fewer than fifty (50%) percent of the meetings of the Board of Directors held during any fiscal year commencing after January 31, 1981, which such incumbent was entitled to attend as a director.

Section 4.7.  Quorum.  Eight directors shall constitute a quorum for the transaction of business.  The act of a majority of the directors present at a meeting at which a quorum is in attendance shall be the act of the Board of Directors unless a larger number is required by applicable law, the Restated Articles of Incorporation or these Bylaws, but any one or more directors, although less than a quorum, may adjourn the meeting to some other day or hour.

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SECOND AMENDMENT TO THE SIXTH RESTATED BYLAWS
OF STEWART & STEVENSON SERVICES, INC.

Effective as of June 13, 2000, the first sentence in the third paragraph of Section 4.12 Standing Committeesof the Sixth Restated Bylaws of the Company was amended to read as follows:

“The Audit Committee shall consist of five (5) persons, all of whom shall be independent of management and free of any relationship that, in the opinion of the Board of Directors, would interfere with the exercise of independent judgment as a committee member.”

17

THIRD AMENDMENT TO THE SIXTH RESTATED BYLAWS
OF STEWART & STEVENSON SERVICES, INC.

Effective as of September 12, 2000, Section 4.1 of the Sixth Restated Bylaws of the Company is amended to read as follows in its entirety:

Section 4.1.  Number and Qualifications.  The business and affairs of the Corporation shall be managed and controlled by the Board of Directors, and subject to any restrictions imposed by law, by the Restated Articles of Incorporation, or by these Bylaws, the Board of Directors may exercise all the powers of the Corporation.  The Board of Directors shall consist of thirteen (13) members, provided, however, that such number shall be automatically reduced to twelve (12) upon the retirement, resignation, death or removal of a director on or after September 12, 2000.  The number thereof may be increased or decreased from time to time by amendment to these Bylaws, but no decrease shall have the effect of shortening the term of any incumbent director.  Directors need not be residents of Texas and need not be shareholders.  Directors shall retire as of the date of the annual meeting of shareholders first occurring following the Director’s 73^rd birthday; provided, that any Director who was originally elected on or before June 19, 1981 shall not be required to retire until the date of the annual meeting of shareholders first occurring following such Director’s 75^th birthday.  No person shall be qualified for election or re-election as a director of the Corporation if he is an incumbent director and has attended fewer than fifty percent (50%) of the meetings of the Board of Directors held during any fiscal year commencing after January 31, 1981, which such incumbent was entitled to attend as a director.

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FOURTH AMENDMENT TO THE SIXTH RESTATED BYLAWS
OF STEWART & STEVENSON SERVICES, INC.

Effective as of December 11, 2000, Section 5.4 Retirement of the Sixth Restated Bylaws of the Company is deleted.

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FIFTH AMENDMENT TO THE SIXTH RESTATED BYLAWS
OF STEWART & STEVENSON SERVICES, INC.

Effective June 12, 2001, Section 4.1 Number and Qualifications, Section 4.7 Quorum and the first sentence in the third paragraph of Section 4.12 Standing Committeesof the Sixth Restated Bylaws of the Company are amended to read as follows in their entirety:

Section 4.1.  Number and Qualifications.  The business and affairs of the Corporation shall be managed and controlled by the Board of Directors, and subject to any restrictions imposed by law, by the Restated Articles of Incorporation, or by these Bylaws, the Board of Directors may exercise all the powers of the Corporation.  The Board of Directors shall consist of ten (10) members.  The number thereof may be increased or decreased from time to time by amendment to these Bylaws, but no decrease shall have the effect of shortening the term of any incumbent director.  Directors need not be residents of Texas and need not be shareholders.  Directors shall retire as of the date of the annual meeting of shareholders first occurring following the Director’s 73^rd birthday.  No person shall be qualified for election or re-election as a director of the Corporation if he is an incumbent director and has attended fewer than fifty (50%) percent of the meetings of the Board of Directors held during any fiscal year.

Section 4.7.  Quorum.  Six directors shall constitute a quorum for the transaction of business.  The act of a majority of the directors present at a meeting at which a quorum is in attendance shall be the act of the Board of Directors unless a larger number is required by applicable law, the Restated Articles of Incorporation or these Bylaws, but any one or more directors, although less than a quorum, may adjourn the meeting to some other day or hour.

First sentence in the third paragraph of Section 4.12 Standing Committes:

The Audit Committee shall consist of not less than three (3) directors who are qualified and independent of management and free of any relationship that, in the opinion of the Board of Directors, would interfere with the exercise of independent judgment as a committee member.

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SIXTH AMENDMENT TO THE SIXTH RESTATED BYLAWS
OF STEWART & STEVENSON SERVICES, INC.

RESOLVED, that Section 4.1 Number and Qualifications of the Sixth Restated Bylaws of the Company be amended to read in its entirety as follows:

“Section 4.1.  Number and Qualifications.  The business and affairs of the Corporation shall be managed and controlled by the Board of Directors, and subject to any restrictions imposed by law, by the Restated Articles of Incorporation, or by these Bylaws, the Board of Directors may exercise all the powers of the Corporation.  The Board of Directors shall consist of ten (10) members.  The number thereof may be increased or decreased from time to time by amendment to these Bylaws, but no decrease shall have the effect of shortening the term of any incumbent director.  Directors need not be residents of Texas and need not be shareholders.  Directors who have attained the age of 73 years at the time their term expires shall resign on the expiration of their term.  No person shall be qualified for election or re-election as a director of the Corporation if he is an incumbent director and has attended fewer than fifty (50%) percent of the meetings of the Board of Directors held during any fiscal year.”

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SEVENTH AMENDMENT TO THE SIXTH RESTATED BYLAWS
OF STEWART & STEVENSON SERVICES, INC.

RESOLVED, that Section 4.1 Number and Qualifications of the Sixth Restated Bylaws of the Company be amended to read in its entirety as follows:

“Section 4.1.  Number and Qualifications.  The business and affairs of the Corporation shall be managed and controlled by the Board of Directors, and subject to any restrictions imposed by law, by the Restated Articles of Incorporation, or by these Bylaws, the Board of Directors may exercise all the powers of the Corporation.  The Board of Directors shall consist of ten (10) members.  The number thereof may be increased or decreased from time to time by amendment to these Bylaws, but no decrease shall have the effect of shortening the term of any incumbent director.  Directors need not be residents of Texas and need not be shareholders.  Directors who have attained the age of 73 years at the time their term expires shall resign on the expiration of their term.  No person shall be qualified for re-election as a director of the Corporation if he is an incumbent director and has attended fewer than fifty (50%) percent of the meetings of the Board of Directors held during any fiscal year.”

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EIGHTH AMENDMENT TO THE SIXTH RESTATED BYLAWS
OF STEWART & STEVENSON SERVICES, INC.

RESOLVED, that Section 4.1 Number and Qualifications, Section 4.7 Quorum and the third paragraph of Section 4.12 Standing Committees of the Sixth Restated Bylaws of the Company are amended to read as follows in their entirety and Section 6.10.  Loans to and Guaranties for Officers and Directors is hereby deleted.

“Section 4.1.  Number and Qualifications.  The business and affairs of the Corporation shall be managed and controlled by the Board of Directors, and subject to any restrictions imposed by law, by the Restated Articles of Incorporation, or by these Bylaws, the Board of Directors may exercise all the powers of the Corporation.  The Board of Directors shall consist of nine (9) members.  The number thereof may be increased or decreased from time to time by amendment to these Bylaws, but no decrease shall have the effect of shortening the term of any incumbent director.  Directors need not be residents of Texas and need not be shareholders.  Directors who have attained the age of 73 years at the time their term expires shall resign on the expiration of their term.  No person shall be qualified for re-election as a director of the Corporation if he is an incumbent director and has attended fewer than fifty (50%) percent of the meetings of the Board of Directors held during any fiscal year.

Section 4.7.  Quorum.  Five directors shall constitute a quorum for the transaction of business.  The act of a majority of the directors present at a meeting at which a quorum is in attendance shall be the act of the Board of Directors unless a larger number is required by applicable law, the Restated Articles of Incorporation or these Bylaws, but any one or more directors, although less than a quorum, may adjourn the meeting to some other day or hour.”

Third paragraph of Section 4.12 Standing Committes:

“The Audit Committee shall consist of not less than three (3) directors who are qualified and independent of management and free of any relationship that, in the opinion of the Board of Directors, would interfere with the exercise of independent judgment as a committee member.  Each member shall serve until the next annual meeting of shareholders or until such director’s retirement, removal, disqualification, or death.  The Audit Committee shall meet no fewer than four (4) times in each fiscal year of the Corporation upon the call of the chairman of such committee or any two (2) members thereof and shall have and may exercise such responsibilities, authority and power as the Board of Directors specifies.”

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NINTH AMENDMENT TO THE SIXTH RESTATED BYLAWS
OF STEWART & STEVENSON SERVICES, INC.

RESOLVED, that Section 4.1 Number and Qualifications and Section 4.7 Quorum of the Sixth Restated Bylaws of the Company are amended to read as follows in their entirety:

“Section 4.1.  Number and Qualifications.  The business and affairs of the Corporation shall be managed and controlled by the Board of Directors, and subject to any restrictions imposed by law, by the Restated Articles of Incorporation, or by these Bylaws, the Board of Directors may exercise all the powers of the Corporation.  The Board of Directors shall consist of eight (8) members.  The number thereof may be increased or decreased from time to time by amendment to these Bylaws, but no decrease shall have the effect of shortening the term of any incumbent director.  Directors need not be residents of Texas and need not be shareholders.  Directors who have attained the age of 73 years at the time their term expires shall resign on the expiration of their term.  No person shall be qualified for re-election as a director of the Corporation if he is an incumbent director and has attended fewer than fifty (50%) percent of the meetings of the Board of Directors held during any fiscal year.

Section 4.7.  Quorum.  Four directors shall constitute a quorum for the transaction of business.  The act of a majority of the directors present at a meeting at which a quorum is in attendance shall be the act of the Board of Directors unless a larger number is required by applicable law, the Restated Articles of Incorporation or these Bylaws, but any one or more directors, although less than a quorum, may adjourn the meeting to some other day or hour.”

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EX-10.1

Exhibit 10.1

EMPLOYMENT AGREEMENT

AGREEMENT, effective as of February 1, 2004 by and between Max L. Lukens (the “Executive”) and Stewart & Stevenson Services, Inc., a Texas corporation (the “Company”).

WHEREAS, the Board of Directors of the Company (the “Board”) desires initially to retain the Executive as the President and Chief Executive Officer of the Company and thereafter as an advisor, and  to encourage the attention and dedication to the Company of the Executive as a member of the Company’s management, in the best interests of the Company and its shareholders;

WHEREAS, the Executive is willing to commit himself to serve the Company, on the terms and conditions herein provided; and

WHEREAS, the Company and the Executive desire to set forth in this Agreement the terms and conditions of the Executive’s employment; and

WHEREAS, the Company and the Executive have simultaneously herewith executed a Severance Agreement effective as of February 1, 2004 (the “Severance Agreement”);

NOW, THEREFORE, in consideration of the premises and the respective covenants and agreements of the parties herein contained, and intending to be legally bound hereby, the parties hereto agree as follows:

1.Employment; Term.  The Company hereby agrees to employ the Executive, and the Executive hereby accepts such employment, on the terms and conditions hereinafter set forth.  The period of employment of the Executive by the Company hereunder (the “Employment Period”) shall commence on the date first written above (the “Effective Date”) and shall end on the Executive’s Date of Termination (as defined in Section 7(b) hereof).  The term of this Agreement (the “Term”) shall begin on the Effective Date and shall end on the fourth anniversary thereof.  The period beginning on the Effective Date and ending on the second anniversary thereof is herein referred to as the “Base Term”, and the period beginning on the day following such second anniversary and ending on the fourth anniversary of the Effective Date is herein referred to as the “Ancillary Term”.

2.Position and Duties.  As of the Effective Date and for the Base Term, the Executive shall be employed by the Company  as President and Chief Executive Officer of the Company, in which capacity the Executive shall perform the usual and customary duties of such office, which shall be those normally inherent in such capacity in U.S. publicly held corporations of similar size and character.

During the Ancillary Term the Executive shall serve the Company as an advisor to the senior executives of the Company with respect to strategy, management development and other matters consistent with the Executive’s experience and expertise and consistent with the Executive’s having completed the Base Term as Chief Executive Officer of the Company.

The Executive agrees and acknowledges that, in connection with his employment relationship with the Company, the Executive owes fiduciary duties to the Company and will act accordingly.

During the Base Term, the Executive agrees to devote substantially his full time, attention and energies to the Company’s business and agrees to faithfully and diligently endeavor to the best of his ability to further the best interests of the Company.  The Executive shall not engage in any other business activity, whether or not such business activity is pursued for gain, profit or other pecuniary advantage.  Subject to the covenants of Section 9 herein, this shall not be construed as preventing the Executive from investing his own assets in such form or manner as will not require his services in the daily operations of the affairs of the companies in which such investments are made.  Further, subject to Section 9 herein, the Executive may serve as a director of other companies so long as such service is not detrimental to the Company and does not interfere with his service to the Company and so long as such service does not present the Executive with a conflict of interest.

During the Ancillary Term, the Executive agrees at such times as requested (with such requests to be commercially reasonable) to advise the senior executives of the Company; provided however, the parties agree that the Executive shall not be required to provide services for more than fifteen days per year (including time in which Executive serves as a director).  The parties may, by mutual agreement, increase the time Executive shall provide such services during the Ancillary Term.

In keeping with the Executive’s fiduciary duties to the Company, the Executive agrees that he shall not knowingly, directly or indirectly, become involved in any Conflict of Interest, or upon discovery thereof, allow such a conflict to continue.  Moreover, the Executive agrees that he shall promptly disclose to the Board any facts known to him which might involve any reasonable possibility of a Conflict of Interest.  For purposes of this paragraph,  Conflict of Interest on the part of the Executive shall be defined as:  (a) ownership of a material interest in, acting in any material capacity for, or accepting directly or indirectly any material payments, services or loans from a supplier, contractor, subcontractor, customer or other entity with which the Company does business; (b) misuse of information or facilities to which the Executive has access in a manner which will be materially detrimental to the Company’s interest; (c) disclosure or other misuse of Confidential Information (as defined in Section 9); (d) acquiring or trading in, directly or indirectly, other properties or interests material to the design, manufacture or marketing of products designed, manufactured or marketed by the Company; (e) the appropriation to the Executive or the diversion to others, directly or indirectly, of any material opportunity in which it is known or could reasonably be anticipated that the Company would be interested; or (f) the ownership, directly or indirectly, of a material interest in an enterprise in competition with the Company or its dealers and distributors or acting as a director, officer, partner, consultant, employee or agent of any enterprise which is in competition with the Company or its dealers or distributors.

3.Place of Performance.  In connection with the Executive’s employment by the Company, the Executive’s principal business address shall be at the Company’s current principal executive offices in Houston, Texas (the “Principal Place of Employment”) or in such other place as the Executive and the Company may agree.

4.Compensation and Related Matters.

(a)Base Salary.  During the Base Term, the Company shall pay the Executive an annual base salary (“Base Salary”), payable in approximately equal installments in

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accordance with the Company’s customary payroll practices.  The Base Salary shall be $750,000.  The Base Salary may not be decreased during the Base Term.  During the Base Term, the Executive shall not be eligible for any equity compensation provided for or afforded to members of the Board of Directors as such.

(b)Bonuses.  At the end of the Base Term, the Executive shall be eligible for a discretionary bonus taking into account the following criteria:

(i)return during the Base Period on net capital employed in the Company’s businesses on a consolidated basis;

(ii)the Company’s earnings per share during the Base Period;

(iii)the Company’s revenues during the Base Period; and

(iv)the development of the Company’s management team so as to facilitate a succession plan to come into effect after the Base Period.

Any bonus earned pursuant to this Agreement shall be paid as promptly as possible after the end of the Base Period.   The Executive shall be eligible for a bonus of up to 100 (for target level performance) percent of his aggregate Base Salary during the Base Period (up to $1,500,000) but the actual amount thereof shall, in any event, be dependent upon the assessment of the members of the Compensation Committee and other members of the Board who are independent directors, in good faith, of his performance and contribution to the Company during the Base Period taking the above factors into account.

(c)Ancillary Term Compensation.  During the Ancillary Term, the Executive, shall not be eligible for any equity compensation provided for or afforded to members of the Board of Directors as such.  During the Ancillary Term, the Company shall pay the Executive an annual salary of $35,000, payable in approximately equal installments in accordance with the Company’s customary payroll practices.    In the event the parties by mutual agreement increase the time the Executive shall provide services from that provided in Section 2, the Company shall pay the Executive an additional $6,250 per day for such services. The compensation to be paid to the Executive for his services during the Ancillary Term is herein referred to as the “Ancillary Term Compensation”.

(d)Stock Option.  On January 3, 2005 the Executive will be granted an option to purchase 100,000 shares of the Company’s common stock under the Stewart & Stevenson Services, Inc. 1988 Nonstatutory Stock Option Plan, as amended and restated effective as of June 10, 1997 (the “1988 Option Plan”), which shall be subject to the terms and conditions thereof and of the stock option agreement with respect thereto as contemplated by the 1998 Option Plan.  The option agreement for such option shall contain the same terms as are specified in the Executive’s option agreement dated March 31, 2004; provided however that the per share exercise price applicable to such option shall be the fair market value of a share of the Company’s common stock on January 3, 2005 (determined in accordance with the terms of the 1988 Option Plan) and such option shall be fully exercisable on the first anniversary of the date of grant of such option.

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(e)Expenses.  The Company shall promptly reimburse the Executive for all reasonable (taking into account the character of the office of Chief Executive) business expenses incurred during the Employment Period by the Executive in performing services hereunder, including all expenses of travel and living expenses while away from home on business or at the request of and in the service of the Company, provided that such expenses are incurred and accounted for in accordance with the policies and procedures established by the Company.

(f)Other Benefits.  During the Employment Period, the Executive shall be entitled to participate in all of the employee benefit plans and arrangements, other than equity compensation and bonus plans, made available by the Company to its other senior executive officers, subject to and on a basis consistent with the terms, conditions and overall administration of such plans and arrangements, and shall be entitled to all perquisites and special benefits suitable to the character of the Chief Executive Officer while acting as Chief Executive Officer.  Notwithstanding the foregoing, the Company shall have the right to change, amend or discontinue any benefit plan, program, or perquisite, so long as such changes are similarly applicable to senior executive officers of the Company generally.

(g)Vacation.  During the Employment Period, the Executive shall be entitled to vacation in accordance with reasonable and customary vacation practice for chief executive offices of New York Stock Exchange listed companies of a size similar to the Company’s size.

(h)Services Furnished.  During the Employment Period, the Executive shall at all times be provided with office space, clerical assistance and such other facilities and services as are suitable to his then position.

5.Offices.  Subject to Sections 2, 3 and 4 hereof, during the Base Term the Executive agrees to serve without additional compensation, if elected or appointed thereto, as a director of any of the Company’s subsidiaries and as a member of any committees of the board of directors of any such corporations, and in one or more executive positions of any of the Company’s subsidiaries, provided that the Executive is indemnified for serving in any and all such capacities on a basis no less favorable than is currently, or may be, provided to any other director or officer of the Company, any of its subsidiaries or in connection with any such executive position, as the case may be.

6.Termination.  The Employment Period shall end in the event of a termination of the Executive’s employment in accordance with any of the provisions of Section 6 or 7, and the Term shall expire in the event of a termination of Executive’s employment by the Company for Cause or by the Executive without Good Reason, in each case, on the Executive’s Date of Termination.

(a)Death.  The Executive’s employment hereunder shall terminate upon his death.

(b)Disability.  If, as a result of the Executive’s incapacity due to physical or mental illness, the Executive shall have been absent from the full-time performance of his duties hereunder for the entire period of ninety (90) days in the aggregate during any period of twelve (12) consecutive months or it is reasonably expected that such disability will exist for more than such period of time, and within thirty (30) days after written Notice of Termination (as defined in Section 7) is given (which notice may be given during such ninety (90) day period) shall not

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have returned to the performance of his duties hereunder on a full-time basis, the Company may terminate the Executive’s employment hereunder for “Disability.”

During any period that the Executive fails to perform his duties hereunder as a result of incapacity due to physical or mental illness (“Disability Period”), the Executive shall continue to receive his Base Salary or his Ancillary Term Compensation, as the case may be, at the rate in effect at the beginning of such period as well as all other payments and benefits set forth in Section 4 hereof, reduced by any payments made to the Executive during the Disability Period under the disability benefit plans of the Company then in effect or under the Social Security disability insurance program.

(c)Cause.  The Company may terminate the Executive’s employment hereunder for Cause.  For purposes of this Agreement, the Company shall have “Cause” to terminate the Executive’s employment hereunder upon the occurrence of any of the following events:

(i)the commission by the Executive of an act of fraud, embezzlement, theft or other criminal act constituting a felony;

(ii)the willful and continued failure by the Executive to substantially perform the Executive’s duties with the Company (other than any such failure resulting from the Executive’s incapacity due to physical or mental illness or any such actual or anticipated failure after issuance of a Notice of Termination for Good Reason by the Executive) after a written demand for substantial performance is delivered to the Executive by the Board, which demand specifically identifies the manner in which the Board believes that the Executive has not substantially performed the Executive’s duties; or

(iii)the willful engaging by the Executive in conduct which is demonstrably and materially injurious to the Company or its subsidiaries, monetarily or otherwise.

provided, that, the Executive shall have thirty (30) business days from the date on which the Executive receives the Company’s Notice of Termination for Cause under clause (ii) or (iii) above to remedy any such occurrence otherwise constituting Cause under such clause (ii) or (iii).  For purposes of clauses (ii) and (iii) of this definition, no act, or failure to act, on the Executive’s part shall be deemed to be “willful” unless done, or omitted to be done, by the Executive not in good faith and without reasonable belief that the Executive’s act, or failure to act, was in the best interest of the Company.

Cause shall not exist unless and until the Company has delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of a majority of the entire membership of the Board at a meeting of the Board called and held for such purpose (after reasonable notice to the Executive and an opportunity for the Executive, together with his counsel, to be heard before the Board), finding in the good faith opinion of the Board on clear and convincing evidence there is Cause as set forth in this Section 6(c), specifying the material particulars thereof and, if applicable, determining that such Cause has not been remedied within the applicable 30-day time frame specified in Section 6(c).

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(d)Good Reason.  The Executive may terminate his employment hereunder for “Good Reason.”  Good Reason for the Executive’s termination of employment shall mean the occurrence, without the Executive’s prior written consent, of any one or more of the following;

(i)the assignment to the Executive of any duties inconsistent with the Executive’s position (including status, office, title and reporting requirements), authorities, duties or other responsibilities as contemplated by Section 2 of this Agreement;

(ii)the relocation of the Principal Place of Employment to a location more than fifty (50) miles from the Principal Place of Employment;

(iii)a material reduction in any element of the Executive’s compensation as set forth in Section 4 hereof, other than in connection with a Company-wide reduction of such benefits; or

(iv)a material breach by the Company of any provision of this Agreement;

provided, in any case, that the Company shall have thirty (30) business days from the date on which the Company receives the Executive’s Notice of Termination for Good Reason to remedy any such occurrence otherwise constituting Good Reason.

(e)Without reliance upon Section 6(b), 6(c) or 6(d), either party hereto may terminate this Agreement during the Base Term at any time by giving the other no less than thirty (30) days’ and no more than sixty (60) days’ prior written notice, in accordance with Section 7 hereof, of such party’s intent to so terminate this Agreement.

7.Termination Procedure.

(a)Notice of Termination.  Any termination of the Executive’s employment by the Company or by the Executive (other than termination pursuant to Section 6(a) hereof) shall be communicated by written Notice of Termination to the other party hereto in accordance with Section 12 hereof.  For purposes of this Agreement, a “Notice of Termination” shall mean a notice that shall indicate the specific termination provision in this Agreement relied upon and if Section 6(b), 6(c) or 6(d) is relied upon, shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive’s employment under the provision so indicated.

(b)Date of Termination.  “Date of Termination” shall mean (i) if the Executive’s employment is terminated pursuant to Section 6(a) above, the date of the Executive’s death, (ii) if the Executive’s employment is terminated pursuant to Section 6(b) above, thirty (30) days after the date Notice of Termination is given (provided that the Executive shall not have returned to the performance of his duties on a full-time basis during such thirty (30) day period), (iii) if the Executive’s employment is terminated pursuant to Section 6(c)(i) above, the date specified in the Notice of Termination, (iv) if the Executive’s employment is terminated pursuant to Section 6(c)(ii) or (iii) above, thirty (30) days after the date on which a Notice of Termination is given, (v) if the Executive’s employment is terminated for any other reason, the date specified in the Notice of Termination, which date shall be not earlier than thirty

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(30) days following the date on which Notice of Termination is given and not later than sixty (60) days following the date on which Notice of Termination is given; provided, however, that, if within ten (10) days after any Notice of Termination under Section 6(b),(c) or (d) is given the party receiving such Notice of Termination notifies the other party that a dispute exists concerning such termination, the Date of Termination shall be the date on which the dispute is finally determined, either by mutual written agreement of the parties, by a binding and final arbitration award or by a final judgment, order or decree of a court of competent jurisdiction (the time for appeal therefrom having expired and no appeal having been perfected).

(c)Compensation During Dispute.  If a purported termination occurs during the Term, and such termination is disputed in accordance with subsection (b) of this Section 7, the Company shall continue to pay the Executive the full compensation in effect when the notice giving rise to the dispute was given (including, but not limited to, Base Salary, if applicable) and continue the Executive as a participant in all compensation, benefit and insurance plans in which the Executive was participating when the notice giving rise to the dispute was given, until the Date of Termination, determined in accordance with subsection (b) of this Section 7.  Amounts paid under this Section 7(c) are in addition to all other amounts due under this Agreement and shall not be offset against or reduce any other amounts due under this Agreement.

8.Compensation upon Termination or During Disability.

(a)Accrued Obligation Defined.  For purposes of this Agreement, payment of the “Accrued Obligation” shall mean payment by the Company to the Executive (or his designated beneficiary or legal representative, as applicable), when due, of all vested benefits to which the Executive is entitled under the terms of the employee benefit plans in which the Executive is a participant as of the Date of Termination and a lump sum amount in cash equal to the sum of (i) the Executive’s Base Salary or Ancillary Term Compensation, as the case may be, through the Date of Termination, (ii) any accrued vacation pay and (iii) any other amounts due the Executive as of the Date of Termination, in each case to the extent not theretofore paid.

(b)Disability; Death.  Upon termination of the Executive’s employment pursuant to Sections 6(a) or (b) hereof, the Company shall within thirty (30) days pay to the Executive (or his designated beneficiary or legal representative, if applicable) (i) the Accrued Obligation, and (ii) a lump sum amount, in cash, in cash, equal to a pro rata portion to the Date of Termination of the aggregate value of the contingent bonus award contemplated by Section 4(b) of the Employment Agreement, calculated as to such award by multiplying the award that the Executive would have earned as of the last day of the Base Period (as defined in the Employment Agreement), assuming the achievement, at the expected value target level, of the performance goals established with respect to such award, by the fraction obtained by dividing the number of full days during the Base Period through the Date of Termination by the total number of days contained in the Base Period.

(c)By the Company for Cause.  If during the Term the Executive’s employment is terminated by the Company pursuant to Section 6(c) hereof, the Company shall pay to the Executive the Accrued Obligation within thirty (30) days following the Date of Termination.  Following such payment, the Company shall have no further obligations to the Executive other than as may be required by law or the terms of an employee benefit plan of the Company.

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(d)By the Executive Without Good Reason.  If during the Term the Executive terminates his employment for any reason other than Good Reason, the Company shall pay to the Executive the Accrued Obligation within thirty (30) days following the Date of Termination.  Following such payment, the Company shall have no further obligations to the Executive other than as may be required by law or the terms of an employee benefit plan or stock option plan of the Company.

(e)By the Company Without Cause or by the Executive for Good Reason.  If during the Term the Executive’s employment is terminated by the Company other than for Cause, death or Disability or if the Executive terminates his employment for Good Reason, then

(i)the Company shall pay the Executive the Accrued Obligation;

(ii)the Company shall continue to pay to the Executive his Base Salary or Ancillary Term Compensation (at the rate in effect as of the Date of Termination) for the remainder of the Base Term or the Ancillary Term, as the case may be, payable consistent with the Company’s normal payroll practices.

(iii)all equity-based awards then held by Executive shall become fully vested and exercisable as of the Notice of Termination;

(iv)the Company shall continue to provide to the Executive the benefits described in Section 4(f), to the extent contractually and legally permitted, provided that such benefits shall be reduced to the extent benefits of the same type are received by, or made available at no greater cost to, the Executive under any group plan, whether by reason of new employment, participation in a spouse’s plan or otherwise, during such period, and provided, further, that the Executive shall have the obligation to notify the Company that he is entitled to receive such benefits;

(v)the committee (as defined in the Stewart & Stevenson Services, Inc.1988 Nonstatutory Stock Option Plan) shall deem Executive’s termination of employment as a retirement under the Stewart & Stevenson Services, Inc. 1988 Nonstatutory Stock Option Plan;

(vi)the Company shall pay to the Executive a lump sum amount, in cash, equal to the aggregate value of the contingent bonus award contemplated by Section 4(b) that the Executive would have earned as of the last day of the Base Period, assuming the achievement, at the expected value target level, of the performance goals established with respect to such award; and

(vii)if the Executive’s employment is terminated before he has been granted the stock option contemplated by Section 4(d), then in lieu of granting such stock option the Company shall pay to the Executive a lump sum payment, in cash, equal to the Black-Scholes value, as reasonably determined by the Company as of March 31, 2004, of an option to purchase 100,000 shares of the Company’s common stock, assuming for this purpose the option was granted on March 31, 2004, the per share exercise price under the option is $ 14.62, the option has the same terms and conditions as applied to the option granted by the Company to the Executive on March 31, 2004 (other than the number of shares subject to the option), and the option remains outstanding for the full ten year

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term; and utilizing the risk free interest rate, dividend yield, and expected volatility assumptions used by the Company for purposes of valuing stock options for its 2003 fiscal year as reflected in its fiscal year 2003 Form 10-K filed with the Securities and Exchange Commission.

The Company agrees that, if the Executive’s employment with the Company terminates during the Term, the Executive is not required to seek other employment or to attempt in any way to reduce any amounts payable to the Executive by the Company pursuant to this Section 8.  Further, except with respect to the benefits provided pursuant to clause (iv) above, the amount of any payment or benefit provided for in this Agreement shall not be reduced by any compensation earned by the Executive as the result of employment by another employer, by retirement benefits, by offset against any amount claimed to be owed by the Executive to the Company, or otherwise.  Satisfaction of the obligations to the Executive under Sections 8(b) and 8(e) of this Agreement is contingent upon the Executive’s (or, if applicable, his designated beneficiary or legal representative’s) execution of a release substantially in the form of Exhibit A hereto.

9.Confidential Information; Non-Competition; Non-Solicitation.

(a)Confidential Information.  The Executive shall hold in a fiduciary capacity for the benefit of the Company all trade secrets,  and information, knowledge or data relating to the Company and its businesses treated as confidential by the Company, which shall have been obtained by the Executive during the Executive’s employment by the Company and which shall not have been or hereafter become public knowledge (other than by acts by the Executive or representatives of the Executive in violation of this Agreement) (hereinafter being collectively referred to as “Confidential Information”).  The Executive shall not, without the prior written consent of the Company or as may otherwise be required by law or legal process, communicate or divulge any such trade secrets, information, knowledge or data to anyone other than the Company and those designated by the Company.  Any termination of the Executive’s employment or of this Agreement shall have no effect on the continuing operation of this Section 9(a).  The Executive agrees to return all Confidential Information, including all photocopies, extracts and summaries thereof, and any such information stored electronically on tapes, computer disks or in any other manner to the Company at any time upon request by the Company and upon the termination of his employment hereunder for any reason.

(b)Non-Competition.  During the Employment Period and for a period of  one  (1) year following the Date of Termination (such period following the Employment Period, the “Restricted Period”), the Executive shall not engage in Competition, as defined below, with the Company; provided, that it shall not be a violation of this Section 9(b) for the Executive to become the registered or beneficial owner of up to one percent (1%) of any class of the capital stock of a corporation registered under the Securities Exchange Act of 1934, as amended, provided that the Executive does not actively participate in the business of such corporation until such time as this covenant expires.

For purposes of this Agreement, Competition by the Executive shall mean the Executive’s engaging in, or otherwise directly or indirectly being employed by or acting as a consultant or lender to, or being a director, officer, employee, principal, agent, stockholder, member, owner or partner of, or permitting his name to be used in connection with the activities

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of any other business or organization which competes, directly or indirectly, with the business of the Company as the same shall be constituted at any time during the Employment Period.

(c)Non-Solicitation.  During the Restricted Period, the Executive agrees that he will not, directly or indirectly, for his benefit or for the benefit of any other person, firm or entity, do any of the following:

(i)solicit from any customer doing business with the Company as of the Date of Termination, business of the same or of a similar nature to the business of the Company with such customer;

(ii)solicit from any known potential customer of the Company business of the same or of a similar nature to that which has been the subject of a known written or oral bid, offer or proposal by the Company, or of substantial preparation with a view to making such a bid, proposal or offer, within six (6) months prior to such Date of Termination;

(iii)solicit the employment or services of, or hire, any person who was known to be employed by or was a known consultant to the Company upon the Date of Termination, or within six (6) months prior thereto; or

(iv)otherwise knowingly interfere with the business or affairs of the Company.

The Executive and the Company agree and acknowledge that the Company has a substantial and legitimate interest in protecting the Company’s Confidential Information and goodwill.  The Executive and the Company further agree and acknowledge that the provisions of this Section 9 are reasonably necessary to protect the Company’s legitimate business interests and are designed to protect the Company’s Confidential Information and goodwill.

The Executive agrees that the scope of the restrictions as to time, geographic area, and scope of activity in this Section 9 are reasonably necessary for the protection of the Company’s legitimate business interests and are not oppressive or injurious to the public interest.  The Executive agrees that in the event of a breach or threatened breach of any of the provisions of this Section 9 the Company shall, notwithstanding Section 14 hereof, be entitled to injunctive relief against the Executive’s activities to the extent allowed by law.  The Executive further agrees that any breach or threatened breach of any of the provisions of Section 9(a) would cause irreparable injury to the Company for which it would have no adequate remedy at law.

(d)Publicity.  The Executive agrees that the Company may use, and hereby grants the Company the nonexclusive and worldwide right to use, the Executive’s name, picture, likeness, photograph, signature or any other attribute of the Executive’s persona (all of such attributes are hereafter collectively referred to as “Persona”) in any media for any advertising, publicity or other purpose at any time during the Restricted Period.  The Executive agrees that such use of his Persona will not result in any invasion or violation of any privacy or property rights the Executive may have; and the Executive agrees that he will receive no additional compensation for the use of his Persona.  The Executive further agrees that any negatives, prints or other material for printing or reproduction purposes prepared in connection with the use of his Persona by the Company shall be and are the sole property of the Company.

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10.Indemnification; Legal Fees.  The Company shall indemnify the Executive to the fullest extent permitted by the laws of the Company’s state of incorporation in effect at that time, or certificate of incorporation and by-laws of the Company, whichever affords the greater protection to the Executive, for any judgments, penalties, fines, settlements and reasonable expenses (including, without limitation, reasonable attorneys’ fees and costs) incurred by the Executive in connection with any action, suit or proceeding, threatened or pending, to which he may be made a party by reason of his being a director, officer or advisor, as contemplated hereby, whether incurred during or after the Term.  The Executive will be entitled to any insurance policies the Company may elect to maintain generally for the benefit of its officers, directors or advisors against all costs, charges and expenses incurred in connection with any action, suit or proceeding, threatened or pending,  to which he may be made a party by reason of being a director or officer of the Company.

11.Successors; Binding Agreement.

(a)Company’s Successors.  This Agreement shall be binding upon the Company and any successor thereof (whether direct or indirect, by purchase, merger, consolidation or otherwise).  As used in this Agreement, “Company” shall mean the Company as hereinbefore defined and any successor to its business and/or assets or any entity which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law or by contract.

(b)Executive’s Successors.  This Agreement and all rights of the Executive hereunder shall inure to the benefit of and be enforceable by the Executive’s personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees.  If the Executive should die while any amounts are payable to him hereunder, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive’s devisee, legatee or other designee or, if there is no such designee, to the Executive’s estate.

12.Notices.  For the purposes of this Agreement, notices, demands and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or (unless otherwise specified) mailed by United States certified or registered mail, return receipt requested, postage prepaid, addressed as follows:

If the Executive:

Max L. Lukens
3415 Albans
Houston, Texas   77005

If to the Company:

Stewart & Stevenson Services, Inc.
2707 North Loop West
Houston, TX 77008-1088
Attention:      Secretary

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or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt.

13.Amendment or Modification; Waiver.  No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the Executive and such officer of the Company as may be specifically designated by the Board or the Compensation Committee of the Board.  No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time.  No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in Agreement.

14.Arbitration.  Any dispute or controversy arising out of or relating to this Agreement, including without limitation, any and all disputes, claims (whether in tort, contract, statutory or otherwise), breaches or disagreements concerning the interpretation or application of the provisions of this Agreement shall be resolved by arbitration before a panel of three arbitrators and administered by the American Arbitration Association (“AAA”) under its Commercial Arbitration Rules then in effect.   Within ten (10) business days of the initiation of an arbitration hereunder, the Company and the Executive will each separately designate an arbitrator, and within twenty (20) business days of selection, the appointed arbitrators will appoint a neutral arbitrator.  All arbitrators shall be members of the National Panel of Commercial Arbitrators maintained by the AAA.  The arbitrators shall issue their written decision (including a statement of finding of facts) within thirty (30) days from the date of the close of the arbitration hearing.  The decision of the arbitrators selected hereunder will be final and binding on both parties.  This arbitration provision is expressly made pursuant to and shall be governed by the Federal Arbitration Act, 9 U.S.C. Sections 1-16 (or replacement or successor statute).  Pursuant to Section 9 of the Federal Arbitration Act, the Company and the Executive agree that a judgment of the United States District Court for the Southern District of Texas may be entered upon the award made pursuant to the arbitration.  The Company shall pay to the Executive all reasonable legal fees and expenses, when incurred by the Executive, in contesting or disputing any termination of employment or seeking to obtain or enforce any right, payment or benefit provided by this Agreement, regardless of outcome, unless a final decision is rendered that such claim was not brought by the Executive in good faith.

15.Governing Law.  The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of Texas without regard to its conflicts of law principles.

16.Miscellaneous.  All references to sections of any statute shall be deemed also to refer to any successor provisions to such sections.  The obligations of the parties under Sections 4, 8, 9, 10, 11, 12, 14, 15, 16, 17, 18,  and 19 hereof shall survive the expiration of the Term to the extent they may be applicable by their terms.  The compensation and benefits payable to the Executive or his beneficiary under Section 8 of this Agreement shall be in lieu of any other severance benefits to which the Executive may otherwise be entitled upon his termination of employment under any severance plan, program, policy, practice or arrangement of the Company other than the Severance Agreement, and the Executive shall not be entitled to receive any

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benefits under Section 8(e) hereof if he has become eligible to receive benefits under the Severance Agreement.

17.Severability.  The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect throughout the Term.  Should any one or more of the provisions of this Agreement be held to be excessive or unreasonable as to duration, geographical scope or activity, then that provision shall be construed by limiting and reducing it so as to be reasonable and enforceable to the extent compatible with the applicable law.

18.Counterparts.  This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument.

19.Entire Agreement.  This Agreement sets forth the entire agreement of the parties hereto in respect of the subject matter contained herein and, as of the Effective Date, supersedes all prior agreements, promises, covenants, arrangements, communications, representations or warranties, whether oral or written, by any officer, employee or representative of any party hereto; provided, however, that the Severance Agreement shall not be superseded hereby but shall remain in full force and effect.

IN WITNESS WHEREOF, the parties have executed this Agreement on the date first above written.

STEWART & STEVENSON SERVICES, INC.
By	/s/ Carl B. King
	Carl B. King
	Senior Vice President, Secretary, and General Counsel
EXECUTIVE:
/s/ Max L. Lukens
Max L. Lukens
3415 Albans Houston, Texas 77005

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EXHIBIT A

RELEASE

The Executive hereby irrevocably and unconditionally releases, acquits and forever discharges the Company and its affiliated companies and their directors, officers, employees and representatives, (collectively “Releasees”), from any and all claims, liabilities, obligations, damages, causes of action, demands, costs, losses and/or expenses (including attorneys’ fees) of any nature whatsoever, whether known or unknown, including, but not limited to, rights arising out of alleged violations of any contracts, express or implied, any covenant of good faith and fair dealing, express or implied, or any tort, or any legal restrictions on the Company’s right to terminate employees, or any federal, state or other governmental statute, regulation, or ordinance, including, without limitation, Title VII of the Civil Rights Act of 1964, and the Federal Age Discrimination in Employment Act, which the Executive claims to have against any of the Releasees.  In addition, the Executive waives all rights and benefits afforded by any state laws which provide in substance that a general release does not extend to claims which a person does not know or suspect to exist in his favor at the time of executing the release which, if known by him, must have materially affected the Executive’s settlement with the other person.  The only exception to the foregoing are claims and rights that may arise after the date of execution of this Release.

The Executive represents and acknowledges that in executing this Release he does not rely and has not relied upon any representation or statement, oral or written, not set forth herein or in the Agreement made by any of the Releasees or by any of the Releasees’ agents, representatives or attorneys with regard to the subject matter, basis or effect of this Release, the Agreement or otherwise.

The Executive represents and agrees that he fully understands his right to discuss all aspects of this Release with his private attorney, that to the extent, if any, that he desires, he has availed himself of this right, that he has carefully read and fully understands all of the provisions of this Release and that he is voluntarily entering into this Release.

AGREED AND ACCEPTED, on this           day of                               , 20   .

EX-10.2

Exhibit 10.2

SEVERANCE AGREEMENT

THIS AGREEMENT, effective as of February 1, 2004, is made by and between Stewart & Stevenson Services, Inc., a Texas corporation (the “Company”), and Max L. Lukens (the “Executive”).

WHEREAS, the Company considers it essential to the best interests of its stockholders to foster the continued employment of key management personnel; and

WHEREAS, the Board recognizes that, as is the case with many publicly held corporations, the possibility of a Change in Control exists and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of management personnel to the detriment of the Company and its stockholders; and

WHEREAS, the Board has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Company’s management, including the Executive, to their assigned duties without distraction in the face of potentially disturbing circumstances arising from the possibility of a Change in Control;

NOW, THEREFORE, in consideration of the premises and the mutual covenants herein contained, the Company and the Executive hereby agree as follows:

1.Defined Terms.  The definitions of capitalized terms used in this Agreement are provided in the last Section hereof.

2.Term of Agreement.  The Term of this Agreement shall commence on the date hereof and shall continue in effect through February 1, 2006.

3.Company’s Covenants Summarized.  In order to induce the Executive to remain in the employ of the Company and in consideration of the Executive’s covenants set forth in Section 3 hereof, the Company agrees, under the conditions described herein, to pay the Executive the Severance Payments and the other payments and benefits described herein.  Except as provided in Section 8.1 hereof, no Severance Payments shall be payable under this Agreement unless there shall have been (or, under the terms of the second sentence of Section 5.1 hereof, there shall be deemed to have been) a termination of the Executive’s employment with the Company following a Change in Control and during the Term.  This Agreement shall not be construed as creating an express or implied contract of employment and, except as otherwise agreed in writing between the Executive and the Company, the Executive shall not have any rights to be retained in the employ of the Company.

4.Compensation Other Than Severance Payments.

4.1Following a Change in Control and during the Term, during any period that the Executive fails to perform the Executive’s duties with the Company as a result of incapacity due to physical or mental illness, the Company shall pay the Executive’s full salary to the Executive at the rate in effect at the commencement of any such period, together with all compensation and benefits payable to the Executive under the terms of any compensation or

benefit plan, program or arrangement maintained by the Company during such period, until the Executive’s employment is terminated by the Company for Disability.

4.2If the Executive’s employment shall be terminated for any reason following a Change in Control and during the Term, the Company shall pay the Executive’s full salary to the Executive through the Date of Termination at the rate in effect immediately prior to the Date of Termination or, if higher, the rate in effect immediately prior to the first occurrence of an event or circumstance constituting Good Reason, together with all compensation and benefits payable to the Executive through the Date of Termination under the terms of the Company’s compensation and benefit plans, programs or arrangements as in effect immediately prior to the Date of Termination or, if more favorable to the Executive, as in effect immediately prior to the first occurrence of an event or circumstance constituting Good Reason.

4.3If the Executive’s employment shall be terminated for any reason following a Change in Control and during the Term, the Company shall pay to the Executive the Executive’s normal post-termination compensation and benefits as such payments become due in accordance with written plans.  Such post-termination compensation and benefits shall be determined under, and paid in accordance with, the Company’s retirement, insurance and other compensation or benefit plans, programs and arrangements as in effect immediately prior to the Date of Termination or, if more favorable to the Executive, as in effect immediately prior to the occurrence of the first event or circumstance constituting Good Reason.

4.4Upon the occurrence of a Change in Control all options to acquire shares of Company stock, all shares of restricted Company stock and all other equity incentives held by the Executive under any plan of the Company (including, but not limited to, the Company’s various stock option plans) shall become immediately vested, exercisable and nonforfeitable and all conditions thereof (including, but not limited to, any required holding periods) shall be deemed to have been satisfied.

5.Severance Payments.

5.1If the Executive’s employment is terminated following a Change in Control and during the Term, other than (A) by the Company for Cause, (B) by reason of death or Disability, or (C) by the Executive without Good Reason, then, the Company shall pay the Executive the amounts, and provide the Executive the benefits, described in this Section 5.1 (“Severance Payments”) and Section 5.2, in addition to any payments and benefits to which the Executive is entitled under Section 4 hereof.  Solely for purposes of determining whether termination occurred following a Change in Control pursuant to this Agreement (and without any implication that a Change in Control has in fact occurred), the Executive’s employment shall be deemed to have been terminated following a Change in Control by the Company without Cause or by the Executive with Good Reason, if (i) the Executive’s employment is terminated by the Company without Cause prior to a Change in Control and such termination was at the request, direction or suggestion, directly or indirectly, of a Person who has entered into an agreement or with whom the Company contemplates will enter into an agreement with the Company the consummation of which would constitute a Change in Control or, (ii) the Executive terminates his employment for Good Reason prior to a Change in Control and the circumstance or event which constitutes Good Reason occurs at the request, direction or suggestion of such Person

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described in clause (i).  For purposes of any determination regarding the applicability of the immediately preceding sentence, any position taken by the Executive shall be presumed to be correct unless the Company establishes to the Committee by clear and convincing evidence that such position is not correct.

(A)In lieu of any further salary payments to the Executive for periods subsequent to the Date of Termination and in lieu of any severance benefit otherwise payable to the Executive, the Company shall pay to the Executive a lump sum severance payment, in cash, equal to $2,250,000.

(B)For the thirty-six (36) month period immediately following the Date of Termination, the Company shall arrange to provide the Executive and his dependents life, disability, accident and health insurance benefits and perquisites (including, but not limited to, executive life insurance, club memberships, financial planning and tax preparation, annual physical examination and charitable contributions), in each case, substantially similar to those provided to the Executive and his dependents immediately prior to the Date of Termination or, if more favorable to the Executive, those provided to the Executive and his dependents immediately prior to the first occurrence of an event or circumstance constituting Good Reason, at no greater cost to the Executive than the cost to the Executive immediately prior to such date or occurrence; provided, however, that, unless the Executive consents to a different method (after taking into account the effect of such method on the calculation of “parachute payments” pursuant to Section 5.2 hereof), such health insurance benefits shall be provided through a third-party insurer.  Benefits otherwise receivable by the Executive pursuant to this Section 5.1(B) shall be reduced to the extent benefits of the same type are received by the Executive under any individual or group policy or program, or made available to the Executive under a group plan whether by reason of the employment of the Executive or the employment of the spouse of the Executive, during the thirty-six (36) month period following the Executive’s termination of employment (and any such benefits received by or made available to the Executive shall be reported to the Company by the Executive); provided, however, that the Company shall reimburse the Executive for the excess, if any, of the cost of such benefits to the Executive over such cost immediately prior to the Date of Termination or, if more favorable to the Executive, the first occurrence of an event or circumstance constituting Good Reason.

(C)Notwithstanding any provision of that certain Employment Agreement between the Company and the Executive effective as of February 1, 2004 (the “Employment Agreement”), the Company shall pay to the Executive a lump sum amount, in cash, equal to the aggregate value of the contingent bonus award contemplated by Section 4(b) of the Employment Agreement that the Executive would have earned as of the last day of the Base Period (as defined in the Employment Agreement), assuming the achievement, at the expected value target level, of the performance goals established with respect to such award.

(D)The committee (as defined by the Stewart & Stevenson Services, Inc. 1998 Nonstatutory Stock Option Plan) shall deem the Executive’s termination of

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employment as a retirement for purposes of the Stewart & Stevenson Services, Inc. 1998 Nonstatutory Stock Option Plan.

(E)If a Change in Control occurs prior to January 4, 2005 the Company shall pay to the Executive a lump sum payment, in cash, equal to the Black-Scholes value, as reasonably determined by the Company as of March 31, 2004, of an option to purchase 100,000 shares of the Company’s common stock, assuming for this purpose the option was granted on March 31, 2004, the per share exercise price under the option is $ 14.62, the option has the same terms and conditions as applied to the option granted by the Company to the Executive on March 31, 2004 (other than the number of shares subject to the option), and the option remains outstanding for the full ten year term; and utilizing the risk free interest rate, dividend yield, and expected volatility assumptions used by the Company for purposes of valuing stock options for its 2003 fiscal year as reflected in its fiscal year 2003 Form 10-K filed with the Securities and Exchange Commission.

5.2(A)Whether or not the Executive becomes entitled to the Severance Payments, if any of the payments or benefits received or to be received by the Executive in connection with a Change in Control or the Executive’s termination of employment (whether pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Company, any Person whose actions result in a Change in Control or any Person affiliated with the Company or such Person) (such payments or benefits, excluding the Gross-Up Payment, being hereinafter referred to as the “Total Payments”) will be subject to the Excise Tax, the Company shall pay to the Executive an additional amount (the “Gross-Up Payment”) such that the net amount retained by the Executive, after deduction of any Excise Tax on the Total Payments and any federal, state and local income and employment taxes and Excise Tax upon the Gross-Up Payment, shall be equal to the Total Payments.

(B)For purposes of determining whether any of the Total Payments will be subject to the Excise Tax and the amount of such Excise Tax, (i) all of the Total Payments shall be treated as “parachute payments” (within the meaning of section 280G(b)(2) of the Code) unless, in the opinion of tax counsel (“Tax Counsel”) reasonably acceptable to the Executive and selected by the accounting firm which was, immediately prior to the Change in Control, the Company’s independent auditor (the “Auditor”), such payments or benefits (in whole or in part) do not constitute parachute payments, including by reason of section 280G(b)(4)(A) of the Code, (ii) all “excess parachute payments” within the meaning of section 280G(b)(1) of the Code shall be treated as subject to the Excise Tax unless, in the opinion of Tax Counsel, such excess parachute payments (in whole or in part) represent reasonable compensation for services actually rendered (within the meaning of section 280G(b)(4)(B) of the Code) in excess of the Base Amount allocable to such reasonable compensation, or are otherwise not subject to the Excise Tax, and (iii) the value of any noncash benefits or any deferred payment or benefit shall be determined by the Auditor in accordance with the principles of section 280G(d)(3) and (4) of the Code.  For purposes of determining the amount of the Gross-Up Payment, the Executive shall be deemed to pay federal income tax at the highest marginal rate of federal income taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income taxes at the highest marginal rate of

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taxation in the state and locality of the Executive’s residence on the Date of Termination (or if there is no Date of Termination, then the date on which the Gross-Up Payment is calculated for purposes of this Section 5.2), net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes.

(C)In the event that the Excise Tax is finally determined to be less than the amount taken into account hereunder in calculating the Gross-Up Payment, the Executive shall repay to the Company, within five (5) business days following the time that the amount of such reduction in the Excise Tax is fully determined, the portion of the Gross-Up Payment”) attributable to such reduction (plus that portion of the Gross-Up Payment attributable to the Excise Tax and federal, state and local income and employment taxes imposed on the Gross-Up Payment being repaid by the Executive, to the extent that such repayment results in a reduction in the Excise Tax and a dollar-for-dollar reduction in the Executive’s taxable income and wages for purposes of federal, state and local income and employment taxes, plus interest on the amount of such repayment at 120% of the rate provided in section 1274(b)(2)(B) of the Code.  In the event that the Excise Tax is determined to exceed the amount taken into account hereunder in calculating the Gross-Up Payment (including by reason of any payment the existence or amount of which cannot be determined at the time of the Gross-Up Payment), the Company shall make an additional Gross-Up Payment in respect of such excess (plus any interest, penalties or additions payable by the Executive with respect to such excess) within five (5) business days following the time that the amount of such excess is finally determined.  The Executive and the Company shall each reasonably cooperate with the other in connection with any administrative or judicial proceedings concerning the existence or amount of liability for Excise Tax with respect to the Total Payments.

5.3The payments provided in subsection (A) and (C) of Section 5.1 hereof and in Section 5.2 hereof shall be made not later than the fifth day following the Date of Termination; provided, however, that if the amounts of such payments cannot be finally determined on or before such day, the Company shall pay to the Executive on such day an estimate, as determined in good faith by the Executive or, in the case of payments under Section 5.2 hereof, in accordance with Section 5.2 hereof, of the minimum amount of such payments to which the Executive is clearly entitled and shall pay the remainder of such payments (together with interest on the unpaid remainder (or on all such payments to the extent the Company fails to make such payments when due) at 120% of the rate provided in section 1274(b)(2)(B) of the Code) as soon as the amount thereof can be determined but in no event later than the thirtieth (30th) day after the Date of Termination.  In the event that the amount of the estimated payments exceeds the amount subsequently determined to have been due, such excess shall constitute a loan by the Company to the Executive, payable on the fifth (5th) business day after demand by the Company (together with interest at 120% of the rate provided in section 1274(b)(2)(B) of the Code), but only to the extent such amount has not been paid by the Executive pursuant to Section 5.2(C) above.  At the time that payments are made under this Agreement, the Company shall provide the Executive with a written statement setting forth the manner in which such payments were calculated and the basis for such calculations including, without limitation, any opinions or other advice the Company has received from Tax Counsel, the Auditor or other advisors or

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consultants (and any such opinions or advice which are in writing shall be attached to the statement).

5.4If the Executive’s employment with the Company is terminated following a Change in Control and during the Term, the Company shall pay to the Executive all legal fees and expenses incurred by the Executive in disputing in good faith any issue hereunder relating to the termination of the Executive’s employment, in seeking in good faith to obtain or enforce any benefit or right provided by this Agreement or in connection with any tax audit or proceeding to the extent attributable to the application of section 4999 of the Code to any payment or benefit provided hereunder.  Such payments shall be made within five (5) business days after delivery of the Executive’s written requests for payment accompanied with such evidence of fees and expenses incurred as the Company reasonably may require.

6.Termination Procedures and Compensation During Dispute.

6.1Notice of Termination.  After a Change in Control and during the Term, any purported termination of the Executive’s employment (other than by reason of death) shall be communicated by written Notice of Termination from one party hereto to the other party hereto in accordance with Section 9 hereof.  For purposes of this Agreement, a “Notice of Termination” shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive’s employment under the provision so indicated.  Further, a Notice of Termination for Cause is required to include a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters (3/4) of the Committee at a meeting of the Committee which was called and held for the purpose of considering such termination (after reasonable notice to the Executive and an opportunity for the Executive, together with the Executive’s counsel, to be heard before the Committee) finding on clear and convincing evidence and the good faith opinion of the Committee, the Executive’s employment was terminated for Cause, and specifying the particulars thereof in detail.

6.2Date of Termination.  “Date of Termination,” with respect to any purported termination of the Executive’s employment after a Change in Control and during the Term, shall mean (i) if the Executive’s employment is terminated for Disability, thirty (30) days after Notice of Termination is given (provided that the Executive shall not have returned to the full-time performance of the Executive’s duties during such thirty (30) day period), and (ii) if the Executive’s employment is terminated for any other reason, the date specified in the Notice of Termination (which, in the case of a termination for Cause and, in the case of a termination by the Executive, shall not be less than fifteen (15) days nor more than sixty (60) days, respectively, from the date such Notice of Termination is given).

6.3Dispute Concerning Termination.  If within fifteen (15) days after any Notice of Termination is given following a Change in Control, or, if later, prior to the Date of Termination (as determined without regard to this Section 6.3), the party receiving such Notice of Termination notifies the other party that a dispute exists concerning the termination, the Date of Termination shall be extended until the earlier of (i) the date on which the Term ends or (ii) the date on which the dispute is finally resolved, either by mutual written agreement of the parties or by a final judgment, order or decree of an arbitrator or a court of competent jurisdiction

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(which is not appealable or with respect to which the time for appeal therefrom has expired and no appeal has been perfected); provided, however, that the Date of Termination shall be extended by a notice of dispute only if such notice is given in good faith and the party giving notice pursues the resolution of such dispute with reasonable diligence.

6.4Compensation During Dispute.  If a purported termination occurs following a Change in Control and during the Term and the Date of Termination is extended in accordance with Section 6.3 hereof, the Company shall continue to pay the Executive the full compensation in effect when the notice giving rise to the dispute was given (including, but not limited to, salary) and continue the Executive as a participant in all compensation, benefit and insurance plans in which the Executive was participating when the notice giving rise to the dispute was given or those plans in which the Executive was participating immediately prior to the first occurrence of an event or circumstance giving rise to the Notice of Termination, if more favorable to the Executive, until the Date of Termination, as determined in accordance with Section 6.3 hereof.  Amounts paid under this Section 6.4 are in addition to all other amounts due under this Agreement (other than those due under Section 4.2 hereof) and shall not be offset against or reduce any other amounts due under this Agreement.

7.No Mitigation.  The Company agrees that, if the Executive’s employment with the Company terminates during the Term, the Executive is not required to seek other employment or to attempt in any way to reduce any amounts payable to the Executive by the Company pursuant to Sections 4, 5 or 6.4 hereof.  Further, the amount of any payment or benefit provided for in this Agreement (other than Section 5.1(B) hereof but including (but not limited to) Section 6.4 hereof) shall not be reduced by any compensation earned by the Executive as the result of employment by another employer, by retirement benefits, by offset against any amount claimed to be owed by the Executive to the Company, or otherwise.

8.Successors; Binding Agreement.

8.1In addition to any obligations imposed by law upon any successor to the Company, the Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place.  Failure of the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Executive to compensation from the Company in the same amount and on the same terms as the Executive would be entitled to hereunder if the Executive were to terminate the Executive’s employment for Good Reason after a Change in Control, except that, for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination.

8.2This Agreement shall inure to the benefit of and be enforceable by the Executive’s personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees.  If the Executive shall die while any amount would still be payable to the Executive hereunder (other than amounts which, by their terms, terminate upon the death of the Executive) if the Executive had continued to live, all such amounts, unless

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otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the executors, personal representatives or administrators of the Executive’s estate.

9.Notices.  For the purpose of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage prepaid, addressed, if to the Executive, to the address inserted below the Executive’s signature on the final page hereof and, if to the Company, to the address set forth below, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon actual receipt:

To the Company:

Stewart & Stevenson Services, Inc.
2707 North Loop West
Houston, Texas   77008-1088

Attention:  Secretary

10.Miscellaneous.  No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by the Executive and such officer as may be specifically designated by the Committee.  No waiver by either party hereto at any time of any breach by the other party hereto of, or of any lack of compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time.  This Agreement supersedes any other agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof which have been made by either party, provided, however, that this Agreement shall supersede any agreement setting forth the terms and conditions of the Executive’s employment with the Company only in the event that the Executive’s employment with the Company is terminated on or following a Change in Control, by the Company other than for Cause or by the Executive other than for Good Reason; and provided further that all agreements otherwise superseded by this Agreement shall be automatically reinstated with full force and effect to the extent this Agreement is terminated.  The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of Texas.  All references to sections of the Exchange Act or the Code shall be deemed also to refer to any successor provisions to such sections.  Any payments provided for hereunder shall be paid net of any applicable withholding required under federal, state or local law and any additional withholding to which the Executive has agreed.  The obligations of the Company and the Executive under this Agreement which by their nature may require either partial or total performance after the expiration of the Term (including, without limitation, those under Sections 5 and 6 hereof) shall survive such expiration.

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11.Validity.  The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect.

12.Counterparts.  This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument.

13.Settlement of Disputes; Arbitration.

13.1All claims by the Executive for benefits under this Agreement shall be directed to and determined by the Committee and shall be in writing.  Any denial by the Committee of a claim for benefits under this Agreement shall be delivered to the Executive in writing within thirty (30) days after written notice of the claim is provided to the Company in accordance with Section 10 and shall set forth the specific reasons for the denial and the specific provisions of this Agreement relied upon.  The Committee shall afford a reasonable opportunity to the Executive for a review of the decision denying a claim and shall further allow the Executive to appeal to the Committee a decision of the Committee within sixty (60) days after notification by the Committee that the Executive’s claim has been denied.

13.2Any further dispute or controversy arising out of or relating to this Agreement, including without limitation, any and all disputes, claims (whether in tort, contract, statutory or otherwise), breaches or disagreements concerning the interpretation or application of the provisions of this Agreement shall be resolved by arbitration before a panel of three arbitrators and administered by the American Arbitration Association (“AAA”) under its Commercial Arbitration Rules then in effect.  No arbitration proceeding relating to this Agreement may be initiated by either the Company or the Executive unless the claims review and appeals procedures specified in Section 13.1 have been exhausted.  Within ten (10) business days of the initiation of an arbitration hereunder, the Company and the Executive will each separately designate an arbitrator, and within twenty (20) business days of selection, the appointed arbitrators will appoint a neutral arbitrator.  All arbitrators shall be members of the National Panel of Commercial Arbitrators maintained by the AAA.  The arbitrators shall issue their written decision (including a statement of finding of facts) within thirty (30) days from the date of the close of the arbitration hearing.  The decision of the arbitrators selected hereunder will be final and binding on both parties.  This arbitration provision is expressly made pursuant to and shall be governed by the Federal Arbitration Act, 9 U.S.C. Sections 1-16 (or replacement or successor statute).  Pursuant to Section 9 of the Federal Arbitration Act, the Company and the Executive agree that a judgment of the United States District Court for the Southern District of Texas may be entered upon the award made pursuant to the arbitration.

14.Definitions.  For purposes of this Agreement, the following terms shall have the meanings indicated below:

(A)“Affiliate” shall have the meaning set forth in Rule 12b-2 promulgated under Section 12 of the Exchange Act.

(B)“Auditor” shall have the meaning set forth in Section 5.2 hereof.

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(C)“Base Amount” shall have the meaning set forth in section 280G(b)(3) of the Code.

(D)“Beneficial Owner” shall have the meaning set forth in Rule 13d-3 under the Exchange Act.

(E)“Board” shall mean the Board of Directors of the Company.

(F)“Cause” for termination by the Company of the Executive’s employment shall mean (i) the willful and continued failure by the Executive to substantially perform the Executive’s duties with the Company (other than any such failure resulting from the Executive’s incapacity due to physical or mental illness or any such actual or anticipated failure after the issuance of a Notice of Termination for Good Reason by the Executive pursuant to Section 6.1 hereof) after a written demand for substantial performance is delivered to the Executive by the Board, which demand specifically identifies the manner in which the Board believes that the Executive has not substantially performed the Executive’s duties, or (ii) the willful engaging by the Executive in conduct which is demonstrably and materially injurious to the Company or its subsidiaries, monetarily or otherwise.  For purposes of clauses (i) and (ii) of this definition, (x) no act, or failure to act, on the Executive’s part shall be deemed “willful” unless done, or omitted to be done, by the Executive not in good faith and without reasonable belief that the Executive’s act, or failure to act, was in the best interest of the Company and (y) the Executive has received written notice from the Company of the specific conduct asserted as Cause for termination and has thirty (30) business days to remedy any such occurrence otherwise constituting Cause.

(G)A “Change in Control” shall be deemed to have occurred if the event set forth in any one of the following paragraphs shall have occurred:

(I)any Person is or becomes the Beneficial Owner, directly or indirectly, of securities of the Company (not including in the securities beneficially owned by such Person any securities acquired directly from the Company or its affiliates) representing 35% or more of the combined voting power of the Company’s then outstanding securities, excluding any Person who becomes such a Beneficial Owner in connection with a transaction described in clause (i) of paragraph (III) below; or

(II)the following individuals cease for any reason to constitute a majority of the number of directors then serving: individuals who, on the date hereof, constitute the Board and any new director (other than a director whose initial assumption of office is in connection with an actual or threatened election contest relating to the election of directors of the Company) whose appointment or election by the Board or nomination for election by the Company’s stockholders was approved or recommended by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors on the date hereof or whose appointment, election or nomination for election was previously so approved or recommended; or

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(III)there is consummated a merger or consolidation of the Company or any direct or indirect subsidiary of the Company with any other corporation, other than (i) a merger or consolidation that would result in the voting securities of the Company outstanding immediately prior to such merger or consolidation continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity or any parent thereof), in combination with the ownership of any trustee or other fiduciary holding securities under an employee benefit plan of the Company or any subsidiary of the Company, at least 51% of the combined voting power of the securities of the Company or its parent outstanding immediately after such merger or consolidation, or (ii) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no Person is or becomes the Beneficial Owner, directly or indirectly, of securities of the Company (not including in the securities Beneficially Owned by such Person any securities acquired directly from the Company or its Affiliates other than in connection with the acquisition by the Company or its Affiliates of a business) representing at least 51% or more of the combined voting power of the Company’s then outstanding securities; or

(IV)the stockholders of the Company approve a plan of complete liquidation or dissolution of the Company or there is consummated an agreement for the sale or disposition by the Company of all or substantially all of the Company’s assets, other than a sale or disposition by the Company of all or substantially all of the Company’s assets to an entity, at least 51% of the combined voting power of the voting securities of which are owned by stockholders of the Company in substantially the same proportions as their ownership of the Company immediately prior to such sale.  For purposes of this Agreement, it is contemplated that a sale of substantially all of the assets of the Company shall not be deemed to occur unless at least 75% of the book value (as stated in the Company’s most recent audited financial statements) of the Company’s total assets is disposed of in a single transaction.

Notwithstanding the foregoing, a “Change in Control” shall not be deemed to have occurred by virtue of the consummation of any transaction or series of integrated transactions immediately following which the record holders of the common stock of the Company immediately prior to such transaction or series of transactions continue to have substantially the same proportionate ownership in an entity which owns all or substantially all of the assets of the Company immediately following such transaction or series of transactions.

(H)“Code” shall mean the Internal Revenue Code of 1986, as amended from time to time.

(I)“Committee” shall mean (i) the individuals (not fewer than three in number) who, on the date six months before a Change in Control, constitute the Compensation Committee of the Board, plus (ii) in the event that fewer than three individuals are available from the group specified in clause (i) above for any reason, such

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individuals as may be appointed by the individual or individuals so available (including for this purpose any individual or individuals previously so appointed under this clause (ii)); provided, however, that the maximum number of individuals constituting the Committee shall not exceed six (6).

(J)“Company” shall mean Stewart & Stevenson Services, Inc. and, except in determining under Section 15(G) hereof whether or not any Change in Control of the Company has occurred, shall include any successor to its business and/or assets which assumes and agrees to perform this Agreement by operation of law, or otherwise.

(K)“Date of Termination” shall have the meaning set forth in Section 6.2 hereof.

(L)“Disability” shall be deemed the reason for the termination by the Company of the Executive’s employment, if, as a result of the Executive’s incapacity due to physical or mental illness, the Executive shall have been absent from the full-time performance of the Executive’s duties with the Company for a period of six (6) consecutive months, the Company shall have given the Executive a Notice of Termination for Disability, and, within thirty (30) days after such Notice of Termination is given, the Executive shall not have returned to the full-time performance of the Executive’s duties.

(M)“Exchange Act” shall mean the Securities Exchange Act of 1934, as amended from time to time.

(N)“Excise Tax” shall mean any excise tax imposed under section 4999 of the Code.

(O)“Executive” shall mean the individual named in the first paragraph of this Agreement.

(P)“Extension Date” shall have the meaning set forth in Section 2 hereof.

(Q)“Good Reason” for termination by the Executive of the Executive’s employment shall mean the occurrence (without the Executive’s express written consent) after any Change in Control, or prior to a Change in Control under the circumstances described in clause (ii) of the second sentence of Section 5.1 hereof of any one of the following acts by the Company, or failures by the Company to act, unless, in the case of any act or failure to act described in paragraph (I), (V), (VI) or (VII) below, such act or failure to act is corrected prior to the Date of Termination specified in the Notice of Termination given in respect thereof:

(I)the assignment to the Executive of any duties inconsistent with the Executive’s status as a senior executive officer of the Company or a substantial adverse alteration in the nature or status of the Executive’s responsibilities from those in effect immediately prior to the Change in Control;

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(II)a reduction by the Company in the Executive’s annual base salary as in effect on the date hereof or as the same may be increased from time to time except for across-the-board salary reductions similarly affecting all senior executives of the Company and all senior executives of any Person in control of the Company;

(III)the relocation of the Executive’s principal place of employment to a location more than 50 miles from the Executive’s principal place of employment immediately prior to the Change in Control or the Company’s requiring the Executive to be based anywhere other than such principal place of employment (or permitted relocation thereof) except for required travel on the Company’s business to an extent substantially consistent with the Executive’s present business travel obligations;

(IV)the failure by the Company to pay to the Executive any portion of the Executive’s current compensation except pursuant to an across-the-board compensation deferral similarly affecting all senior executives of the Company and all senior executives of any Person in control of the Company, or to pay to the Executive any portion of an installment of deferred compensation under any deferred compensation program of the Company, within seven (7) days of the date such compensation is due;

(V)the failure by the Company to continue in effect any compensation plan in which the Executive participates immediately prior to the Change in Control which is material to the Executive’s total compensation, including but not limited to the Company’s stock option plans or any substitute plans adopted prior to the Change in Control, unless an equitable arrangement (embodied in an ongoing substitute or alternative plan) has been made with respect to such plan, or the failure by the Company to continue the Executive’s participation therein (or in such substitute or alternative plan) on a basis not materially less favorable, both in terms of the amount or timing of payment of benefits provided and the level of the Executive’s participation relative to other participants, as existed immediately prior to the Change in Control;

(VI)the failure by the Company to continue to provide the Executive with benefits substantially similar to those enjoyed by the Executive under any of the Company’s pension, savings, life insurance, medical, health and accident, or disability plans in which the Executive was participating immediately prior to the Change in Control (except for across the board changes similarly affecting all senior executives of the Company and all senior executives of any Person in control of the Company), the taking of any other action by the Company which would directly or indirectly materially reduce any of such benefits or deprive the Executive of any material fringe benefit or perquisite enjoyed by the Executive at the time of the Change in Control, or the failure by the Company to provide the Executive with the number of paid vacation days to which the Executive is entitled on the basis of years of service with the Company in

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accordance with the Company’s normal vacation policy in effect at the time of the Change in Control; or

(VII)any purported termination of the Executive’s employment which is not effected pursuant to a Notice of Termination satisfying the requirements of Section 6.1 hereof; for purposes of this Agreement, no such purported termination shall be effective.

The Executive’s right to terminate the Executive’s employment for Good Reason shall not be affected by the Executive’s incapacity due to physical or mental illness.  The Executive’s continued employment shall not constitute consent to, or a waiver of rights with respect to, any act or failure to act constituting Good Reason hereunder.

For purposes of any determination regarding the existence of Good Reason, any claim by the Executive that Good Reason exists shall be presumed to be correct unless the Company establishes to the Committee by clear and convincing evidence that Good Reason does not exist.

(R)“Gross-Up Payment” shall have the meaning set forth in Section 5.2 hereof.

(S)“Notice of Termination” shall have the meaning set forth in Section 6.1 hereof.

(T)“Person” shall have the meaning given in Section 3(a)(9) of the Exchange Act, as modified and used in Sections 13(d) and 14(d) thereof, except that such term shall not include (i) the Company or any of its subsidiaries, (ii) a trustee or other fiduciary holding securities under an employee benefit plan of the Company or any of its Affiliates, (iii) an underwriter temporarily holding securities pursuant to an offering of such securities, or (iv)a corporation owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company.

(U)“Plan” shall have the meaning set forth in Section 5.1 hereof.

(V)“Severance Payments” shall have the meaning set forth in Section 5.1 hereof.

(W)“Tax Counsel” shall have the meaning set forth in Section 5.2 hereof.

(X)“Term” shall mean the period of time described in Section 2 hereof.

(Y)“Total Payments” shall mean those payments so described in Section 5.2 hereof.

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IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date above first written.

STEWART & STEVENSON SERVICES, INC.
By:	/s/ Carl B. King
	Carl B. King
	Senior Vice President, Secretary, and General Counsel
EXECUTIVE:
/s/ Max L. Lukens
Max L. Lukens
3415 Albans Houston, Texas 77005

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EX-10.3

Exhibit 10.3

STEWART & STEVENSON SERVICES, INC.
NONQUALIFIED STOCK OPTION AGREEMENT

THIS AGREEMENT, made and entered into as of March 31, 2004 (the “Grant Date”), is between Stewart & Stevenson Services, Inc., a Texas corporation (hereinafter called the “Company”) and Max L. Lukens (hereinafter called the “Employee”).

WHEREAS, the Company has determined that its interests will be advanced by providing an incentive to the Employee to acquire a proprietary interest in the Company and, as a stockholder, to share in its success, with added incentive to work effectively for and in the Company’s interest;

NOW THEREFORE, in consideration of the mutual promises hereafter set forth and for other good and valuable consideration, the parties hereby agree as follows:

1.Grant.  Pursuant to the provisions of the Stewart & Stevenson Services, Inc. 1988 Nonstatutory Stock Option Plan (the “Plan”) the Company hereby grants to the Employee, subject to the terms and conditions of the Plan and subject further to the terms and conditions herein set forth, the right and option (the “Option”) to purchase from the Company, all or any part of 200,000 shares of Common Stock, without par value, of the Company  (the “Stock”) at the purchase price of $14.62 per share, subject to adjustment as provided in the Plan.

2.Expiration of Option.  The Option shall terminate and become null and void upon the earliest to occur of (1) the tenth anniversary of the Grant Date, (2) the 30^th day after the severance of the employment relationship between the Employee and the Company and all of its affiliates for any reason other than death, Disability, Retirement, or for Cause, (3) the first anniversary of the severance of the employment relationship between the Employee and the Company and all of its affiliates due to death, Disability or Retirement, or (4) the date of the severance of the employment relationship between the Employee and the Company and all of its affiliates for Cause.   In the event of the  severance of the employment  relationship between the Employee and the Company and all of its affiliates for any reason other than death, Disability, Retirement or Cause, the Option shall not continue to vest after such severance of employment.

3.Vesting of Option.

The Option is exercisable in accordance with the following schedule:

(i)on the first anniversary of the Grant Date, the Option may be exercised with respect to up to fifty percent (50%) of the shares subject to the Option; and

(ii)on the second anniversary of the Grant Date the Option shall be exercisable in full.

Notwithstanding the foregoing, upon the death, Disability or Retirement of the Employee prior to the expiration of the Option, the Option shall be exercisable in full.

Further, notwithstanding the foregoing or any provision of the Plan, upon the occurrence of a “change in control” (as defined in the Severance Agreement between the Company and the Employee dated effective as of February 1, 2004) prior to the expiration of the Option, the Option shall be exercisable in full.

Further, notwithstanding the foregoing or any provision of the Plan, upon the termination of the Employee’s employment by the Company other than for “cause” or by the Employee for “good reason” (as such terms are defined in the Employment Agreement between the Company and the Employee dated effective as of February 1, 2004) prior to the expiration of the Option, the Option shall be exercisable in full.

4.Certain Terminations Agreed to Constitute Retirement.  Any termination of the Employee’s employment by the Company other than for “cause” or by the Employee for “good reason” (as such terms are defined in the Employment Agreement between the Company and the Employee dated effective as of February 1, 2004) prior to the expiration of the Option shall be treated as a Retirement for all purposes of the Plan and this Agreement.

5.Manner of Exercise.  The Employee shall exercise the Option by written notice to the Company specifying the number of shares as to which the Option is being exercised.

6.Payment of Purchase Price Upon Exercise.  At the time of any exercise, the purchase price of the shares as to which the Option is exercised shall be paid to the Company in cash or with Stock already owned by the Employee for at least six months (‘Mature Shares”) having a total fair market value, as determined by the Committee appointed pursuant to paragraph 3 of the Plan, equal to the purchase price, or a combination of cash and Mature Shares having a total fair market value, as so determined, equal to the purchase price.

7.Transfer.  The Option shall not be transferable other than by will or by the laws of descent and distribution and may not be pledged, hypothecated, encumbered, garnished, attached, executed on or levied against.  During the lifetime of the Employee, the Option shall be exercisable only by the Employee.

8.Adjustments.  In the event of any change in the Stock of the Company by reason of any stock dividend, recapitalization, reorganization, merger, consolidation, split-up, combination or exchange of shares, or any rights offering to purchase Stock at a price substantially below fair market value, or of any similar change affecting the Stock, the number and kind of shares subject to the Option and their purchase price per share shall be appropriately adjusted consistent with such change in such manner as the Committee may deem equitable to prevent substantial dilution or enlargement of the rights granted to the Employee hereunder.  Any adjustment so made shall be final and binding upon the Employee.

9.No Rights as Stockholder.  The Employee shall have no rights as a stockholder with respect to any shares of Stock subject to the Option prior to the date of exercise and payment for such shares.

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10.No Right to Continued Employment.  The Option shall not confer upon the Employee any right with respect to continuance of employment by the Company, nor shall it interfere in any way with the right of his employer to terminate the Employee’s employment at any time.

11.Compliance with Laws and Regulations.  The Option, and the obligation of the Company to sell and deliver shares hereunder, shall be subject to all applicable federal and state laws, rules and regulations and to such approvals by any government or regulatory agency as may be required.  The Company shall not be required to issue or deliver any certificates for shares of Stock prior to (i) the listing of such shares on any stock exchange on which the Stock may then be listed; and (ii) the completion of any registration or qualification of such shares under any federal or state law, or any rule or regulation of any government body which the Company shall, in its sole discretion, determine to be necessary or advisable.  Moreover, the Option may not be exercised if its exercise or the receipt of shares of Stock pursuant thereto, would be contrary to applicable law.

12.Investment Representation.  The Committee may require the Employee to furnish to the Company, prior to the issuance of any shares upon the exercise of all or any part of the Option, an agreement (in such form as the Committee may specify) in which the Employee represents that the shares acquired by him upon exercise are being acquired for investment and not for resale or with a view to distribution thereof.

13.Withholding Taxes.  The Company may directly or indirectly withhold all federal, state, city or other taxes as a result of the Employee’s exercise of the Option.

In order to provide for the necessary withholding under this Agreement, the Company will deduct the additional amount of withholding required from the Employee’s salary unless the Employee makes other provision in accordance with this Agreement.  The Employee has an option to provide the Company with the necessary funds for this purpose or advising the Company that the Employee will accept a reduction in the amount of Stock due equal to the amount of withholding required.

The Company will advise the Employee at the appropriate time when the additional withholding funds are required so that the Employee can provide for the necessary funds or advise the Company that the Employee will accept a reduction in the amount of Stock due.

If a reduction in Stock is requested, the Company may deliver only the number of whole shares remaining after the withholding has been accomplished.

14.Binding Terms.  The Employee hereby acknowledges receipt of a copy of the Plan and agrees to be bound by all the terms and provisions thereof, including the terms and provisions adopted after the granting of the Option but prior to the complete exercise hereof.  This Agreement shall be binding upon, and shall inure to the benefit of, the Employee and the Company and their respective permitted successors, assigns, heirs, beneficiaries, and representatives.  All capitalized terms in this Agreement that are not specifically defined herein shall have the meanings set forth in the Plan.

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15.Notices.  All notices, requests, demands, and other communications required or permitted hereunder shall be given in writing.

16.Headings of No Effect.  The section headings contained in this Agreement are included solely for convenience of reference and shall not in any way affect the meaning or interpretation of any of the provisions of the Agreement.

17.Counterparts.  This Agreement may be executed in two (2) counterparts, each of which shall constitute one and the same instrument.

18.Governing Law.  This Agreement has been executed and delivered in the State of Texas and its validity, interpretation, performance, and enforcement shall be governed by the laws of that state.  If any provisions of this instrument shall be held by a court of competent jurisdiction to be invalid or unenforceable, the remaining provisions hereof shall continue to be fully effective.  In the event the Company determines that an adverse claim exists to payments to be made pursuant to this Agreement, the Company shall have the right, but not the obligation, to interplead the parties with claims to such payments and recover reasonable attorney fees and court costs from interplead funds.

IN WITNESS WHEREOF, this Agreement has been duly executed and delivered to be effective as of the Grant Date.

	STEWART & STEVENSON SERVICES, INC.
	By:	/s/ Carl B. King
ACCEPTED:
/s/ Max L. Lukens
Max L. Lukens

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EX-31.1

Exhibit 31.1

CHIEF EXECUTIVE OFFICER CERTIFICATION

I, Max L. Lukens, President and Chief Executive Officer, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Stewart & Stevenson Services, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and

c) disclosed in this quarterly report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:   May 25, 2004

/s/  Max L. Lukens

Max L. Lukens

President and Chief Executive Officer

(Principal Executive Officer)

EX-31.2

Exhibit 31.2

CHIEF FINANCIAL OFFICER CERTIFICATION

I, John B. Simmons, Vice President and Chief Financial Officer, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Stewart & Stevenson Services, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and

c) disclosed in this quarterly report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:   May 25, 2004

/s/ John B. Simmons

John B. Simmons

Vice President and Chief Financial Officer

(Principal Financial Officer)

EX-32.1

Exhibit 32.1

Certification Pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Solely for the purpose of Section 906 of the Sarbanes-Oxley Act of 2002, and solely to the extent this certification may be applicable to this Report on Form 10-Q, the undersigned hereby certify that this report on Form 10-Q of Stewart & Stevenson Services, Inc. fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in this report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of Stewart & Stevenson Services, Inc.

/s/  Max L. Lukens
Name:	Max L. Lukens
Title:	President and Chief Executive Officer
/s/  John B. Simmons
Name:	John B. Simmons
Title:	Vice President and Chief Financial Officer