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 July 31, 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 August 17, 2004:

Common Stock, without Par Value:  28,763,282 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”):

2

STEWART & STEVENSON SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(In thousands, except share data)

	July 31, 2004			January 31, 2004
	(Unaudited)
Assets
Current Assets:
Cash and cash equivalents	$	88,815		$	53,959
Short-term investments	10,935			7,745
Accounts receivable, net	144,999			163,324
Recoverable costs and accrued profits not yet billed	27,100			21,653
Inventories	159,451			166,315
Excess of current cost over LIFO values	(46,325		)	(45,330		)
Deferred income tax asset	20,699			23,591
Income tax receivable	6,985			25,846
Other current assets	12,846			17,310
Total assets of discontinued operations	4,719			8,059
Total Current Assets	430,224			442,472
Property, Plant and Equipment, net	123,875			136,165
Deferred Income Tax Asset	13,491			15,523
Intangibles and Other Assets, net	9,852			9,300
Total Assets	$	577,442		$	603,460
Liabilities and Shareholders’ Equity
Current Liabilities:
Notes payable	$	1,823		$	1,932
Current portion of long-term debt	250			250
Accounts payable	71,367			72,028
Accrued payrolls and incentives	16,159			18,092
Billings in excess of incurred costs	31,903			69,376
Estimated losses on uncompleted contracts	18,669			16,306
Other current liabilities	46,588			43,049
Total liabilities of discontinued operations	3,124			1,908
Total Current Liabilities	189,883			222,941
Long-Term Debt, net of current portion	26,125			26,260
Accrued Postretirement Benefits and Pension	52,770			52,056
Other Long-Term Liabilities	4,035			4,720
Total Liabilities	272,813			305,977
Shareholders’ Equity:
Common stock, without par value, 100,000,000 shares authorized; 28,763,282 and 28,644,510 shares issued, respectively	58,484			57,056
Accumulated other comprehensive loss	(26,259		)	(25,534		)
Retained earnings	272,404			265,961
Total Shareholders’ Equity	304,629			297,483
Total Liabilities and Shareholders’ Equity	$	577,442		$	603,460

See accompanying notes to consolidated condensed financial statements.

3

STEWART & STEVENSON SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

	Three Months Ended						Six Months Ended
	July 31, 2004			August 2, 2003			July 31, 2004			August 2, 2003
	(Unaudited)						(Unaudited)
Sales	$	316,322		$	312,851		$	620,610		$	602,623
Cost of sales	275,752			271,134			539,808			519,046
Gross profit	40,570			41,717			80,802			83,577
Selling and administrative expenses	31,045			37,571			62,996			73,860
Pension curtailment expense	—			—			—			2,400
Other income, net	(2,072		)	(564		)	(2,678		)	(476		)
Operating profit	11,597			4,710			20,484			7,793
Interest expense	436			693			953			1,936
Interest and investment income	(332		)	(559		)	(586		)	(1,059		)
Earnings from continuing operations before income taxes	11,493			4,576			20,117			6,916
Income tax expense	4,193			1,348			7,311			2,029
Net earnings from continuing operations	7,300			3,228			12,806			4,887
Loss from discontinued operations, net of tax of ($766), ($284), ($800) and ($710)	(1,423		)	(158		)	(1,487		)	(982		)
Net earnings	$	5,877		$	3,070		$	11,319		$	3,905
Weighted average shares outstanding:
Basic	28,749			28,522			28,709			28,507
Diluted	29,182			28,967			29,058			28,804
Earnings per share:
Basic:
Continuing operations	$	0.25		$	0.11		$	0.44		$	0.17
Discontinued operations	(0.05		)	—			(0.05		)	(0.03		)
Net earnings per share	$	0.20		$	0.11		$	0.39		$	0.14
Diluted:
Continuing operations	$	0.25		$	0.11		$	0.44		$	0.17
Discontinued operations	(0.05		)	—			(0.05		)	(0.03		)
Net earnings per share	$	0.20		$	0.11		$	0.39		$	0.14
Cash dividends per share	$	0.085		$	0.085		$	0.170		$	0.170

See accompanying notes to consolidated condensed financial statements.

4

STEWART & STEVENSON SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(In thousands)

	Three Months Ended						Six Months Ended
	July 31, 2004			August 2, 2003			July 31, 2004			August 2, 2003
	(Unaudited)						(Unaudited)
Operating Activities
Net earnings	$	5,877		$	3,070		$	11,319		$	3,905
Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
Net loss from discontinued operations	1,423			158			1,487			982
Depreciation and amortization	7,630			7,202			14,671			14,223
Deferred tax expense (benefit)	3,634			(145		)	5,522			(1,953		)
Gain on sale of assets	(1,498		)	—			(1,844		)	—
Change in operating assets and liabilities net of the effect of acquisition, divestiture and discontinued operations:
Accounts receivable, net	(11,322		)	(3,887		)	18,889			697
Recoverable costs and accrued profits not yet billed	(3,237		)	(29,187		)	(5,447		)	(32,821		)
Inventories	(2,851		)	13,209			3,433			7,768
Other current and noncurrent assets	15,221			(5,100		)	20,912			(4,926		)
Accounts payable	7,465			16,988			(661		)	13,962
Accrued payrolls and incentives	(2,498		)	(4,806		)	(1,933		)	(2,289		)
Billings in excess of incurred costs	(33,527		)	7,413			(37,473		)	9,043
Estimated losses on uncompleted contracts	2,614			—			2,363			—
Other current liabilities	1,567			1,465			3,991			4,944
Accrued postretirement benefits and pension	159			(540		)	714			3,283
Other, net	93			(291		)	(1,577		)	(241		)
Net Cash Provided by (Used in) Continuing Operations	(9,250		)	5,549			34,366			16,577
Net Cash Provided by (Used in) Discontinued Operations	(483		)	212			(524		)	3,490
Net Cash Provided by (Used in) Operating Activities	(9,733		)	5,761			33,842			20,067
Investing Activities
Capital expenditures, excluding rental equipment	(4,586		)	(6,642		)	(6,724		)	(9,554		)
Additions to rental equipment	(2,153		)	(3,677		)	(2,967		)	(6,301		)
Proceeds from sale of businesses	464			—			3,632			—
Acquisition of businesses	—			—			—			(409		)
Proceeds from disposal of property, plant and equipment	11,435			732			13,924			1,502
Change in short-term investments	300			(560		)	(3,190		)	(10,930		)
Net investing activities of discontinued operations	37			—			74			—
Net Cash Provided by (Used in) Investing Activities	5,497			(10,147		)	4,749			(25,692		)
Financing Activities
Change in short-term notes payable	(85		)	20			(109		)	1,092
Payments on long-term borrowings	—			(30,000		)	—			(30,000		)
Dividends paid	(2,442		)	(2,423		)	(4,876		)	(4,845		)
Proceeds from exercise of stock options	510			855			1,250			896
Net Cash Used in Financing Activities	(2,017		)	(31,548		)	(3,735		)	(32,857		)
Increase (decrease) in cash and cash equivalents	(6,253		)	(35,934		)	34,856			(38,482		)
Cash and cash equivalents, beginning of period	95,068			105,446			53,959			107,994
Cash and cash equivalents, end of period	$	88,815		$	69,512		$	88,815		$	69,512
Cash Paid For:
Interest	$	980		$	2,257		$	1,117		$	2,425
Income taxes (excluding refunds)	175			2,907			310			3,010

See accompanying notes to consolidated condensed financial statements.

5

STEWART & STEVENSON SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

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 and six months ended July 31, 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 condensed 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						Six Months Ended
	July 31, 2004			August 2, 2003			July 31, 2004			August 2, 2003
Net earnings	$	5,877		$	3,070		$	11,319		$	3,905
Unrealized loss on forward contracts, net of tax	(76		)	(132		)	(275		)	(98		)
Currency translation loss, net of tax	—			(287		)	(450		)	(178		)
Comprehensive income	$	5,801		$	2,651		$	10,594		$	3,629

Note 3 - Segment Information

The Company’s operating 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.

6

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						Six Months Ended
	July 31, 2004			August 2, 2003			July 31, 2004			August 2, 2003
Sales
Tactical Vehicle Systems	$	140,737		$	108,365		$	279,520		$	219,342
Power Products	123,680			127,886			244,399			253,720
Engineered Products	21,936			38,262			39,204			64,373
Distributed Energy Solutions	6,235			19,986			10,678			32,592
Airline Products	23,734			18,352			46,809			32,596
Total sales	$	316,322		$	312,851		$	620,610		$	602,623
Operating profit (loss)
Tactical Vehicle Systems	$	18,759		$	17,279		$	38,249		$	35,066
Power Products	1,843			(5,642		)	1,926			(8,768		)
Engineered Products	1,145			553			(642		)	145
Distributed Energy Solutions	(5,753		)	(2,788		)	(10,893		)	(6,646		)
Airline Products	(581		)	(712		)	(876		)	(2,705		)
Coporate expenses, net	(3,816		)	(3,980		)	(7,280		)	(9,299		)
Total operating profit	11,597			4,710			20,484			7,793
Interest expense	436			693			953			1,936
Interest and investment income	(332		)	(559		)	(586		)	(1,059		)
Earnings from continuing operations before income taxes	$	11,493		$	4,576		$	20,117		$	6,916
Operating profit (loss) percentage
Tactical Vehicle Systems	13.3		%	15.9		%	13.7		%	16.0		%
Power Products	1.5			(4.4		)	0.8			(3.5		)
Engineered Products	5.2			1.4			(1.6		)	0.2
Distributed Energy Solutions	(92.3		)	(13.9		)	(102.0		)	(20.4		)
Airline Products	(2.4		)	(3.9		)	(1.9		)	(8.3		)
Consolidated	3.7		%	1.5		%	3.3		%	1.3		%

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 adjusted cash proceeds of $3.3 million.  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 $0.6 million, which is due during the second half of 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.  As of July 31, 2004, $0.1 million of these exit costs remained accrued and unpaid.

During the second quarter of Fiscal 2004, the Company decided to outsource the provision of lease financing associated with certain sales-type equipment leases.  In conjunction with this decision, the Company sold assets previously classified as rental equipment within property, plant and equipment for cash proceeds of $7.3 million, with no resulting gain or loss.  Additionally during the second quarter of Fiscal 2004, the Company disposed of an idle manufacturing facility in Commerce City, Colorado for cash proceeds of $1.2 million, resulting in a net gain of $0.3 million.

7

Engineered Products

During the second quarter of Fiscal 2004, the Company disposed of an idle manufacturing facility which was previously used for the production of the Engineered Products segment’s utilities equipment and Distributed Energy Solutions products.  This facility was vacated during Fiscal 2003 following a consolidation of manufacturing operations at another Houston, Texas location.  The disposal of this facility resulted in net cash proceeds of $4.9 million.  As a result of this sale, the Company recognized a gain of $1.3 million in the second quarter of Fiscal 2004, of which $0.6 million was attributable to the Engineered Products segment and $0.7 million was attributable to the Distributed Energy Solutions segment.

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 the majority of remaining EPC projects will be completed during 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.  Total estimated exit costs, which primarily relate to the termination of employees, are $0.4 million, of which $0.1 million were expensed and paid during the six months ended July 31, 2004.  No liability was established for the remaining exit costs of approximately $0.3 million as of July 31, 2004, as these costs do not meet the recognition criteria set forth under Statement of Financial Accounting Standards (“SFAS”) No. 146.

Airline Products

During the second 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 for continuing operations for the three and six months ended July 31, 2004 and August 2, 2003 follows:

	Three Months Ended						Six Months Ended
(In thousands)	July 31, 2004			August 2, 2003			July 31, 2004			August 2, 2003
Accrued warranty costs - Beginning of period	$	7,467		$	4,795		$	7,816		$	6,073
Payments for completed warranty obligations	(888		)	(1,401		)	(2,509		)	(3,912		)
Warranty accrual for current period production	1,553			1,683			2,811			2,916
Adjustments to warranty accrual	(640		)	280			(626		)	280
Accrued warranty costs - End of period	$	7,492		$	5,357		$	7,492		$	5,357

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 July 31, 2004 and January 31, 2004, the Company had letters of credit outstanding totaling $13.6 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 July 31, 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 conducted 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

8

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 sometime in Fiscal 2005.  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.

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, including direct damages, attorney’s fees and expenses and punitive damages.  Discovery in the case indicates that the direct damage claim is for approximately $36 million.

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 consolidated 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 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 it expects to incur associated with these matters.  Such accruals are included in liabilities of discontinued operations, as the business that manufactured drilling risers was sold in Fiscal 2002 (see Note 5).

Klickitat Litigation:  The Company and several of its subsidiaries are named as defendants in a suit filed by the Klickitat County Public Utility District No. 1 on December 11, 2003 arising out of claims relating to a landfill gas power generation facility in Roosevelt, Washington, Cause No. CY-03-3175-LRS; Klickitat County Public Utility District No. 1 v. Stewart & Stevenson Services, Inc., Stewart & Stevenson Power, Inc., Sierra Detroit Diesel Allison, Inc., Pamco International, Inc. and Waukesha Engine Dresser, Inc.; in the United States District Court for the Eastern District of Washington.  The plaintiff has asserted claims with respect to equipment installed and used since 1999 for breach of contract; promissory estoppel; violations of the Washington Products Liability Act; breach of warranties; intentional or negligent misrepresentation; and violations of the Washington Consumer Protection Act and seeks recovery of damages in excess of $13 million.  The Company is vigorously defending this suit and is taking procedural steps to seek its dismissal.  It is presently impossible for the Company to determine the ultimate outcome of this suit or whether its

9

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 this matter or to reasonably estimate the amount of any loss that may result from this matter.  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 this matter.

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 is not quoting any new business but continues 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 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.  During the second quarter of Fiscal 2004, the Company recognized $2.1 million of additional estimated losses ($1.4 million after-tax) related to certain obligations associated with this business based on recent developments.  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 is being repaid over a nine-year term.

10

Discontinued operations generated the following sales and operating losses in the three month and six month periods ended July 31, 2004 and August 2, 2003:

	Three Months Ended						Six Months Ended
(In thousands)	July 31, 2004			August 2, 2003			July 31, 2004			August 2, 2003
Sales	$	402		$	942		$	987		$	1,380
Operating loss	(2,189		)	(442		)	(2,287		)	(1,692		)
Operating loss, net of taxes	(1,423		)	(158		)	(1,487		)	(982		)

Note 6 – Inventories

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

(In thousands)	July 31, 2004			January 31, 2004
Inventory purchased under distributor agreements	$	78,721		$	87,712
Raw materials and spare parts	41,731			35,932
Work in process	21,173			22,517
Finished goods	17,826			20,154
	159,451			166,315
Excess of current cost over LIFO values	(46,325		)	(45,330		)
Total Inventories	$	113,126		$	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 fiscal 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.

11

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						Six Months Ended
(In thousands, except per share data)	July 31, 2004			August 2, 2003			July 31, 2004			August 2, 2003
Numerator:
Earnings (loss) available to common shareholders
From continuing operations	$	7,300		$	3,228		$	12,806		$	4,887
From discontinued operations	(1,423		)	(158		)	(1,487		)	(982		)
Net earnings	$	5,877		$	3,070		$	11,319		$	3,905
Denominator:
Denominator for basic earnings per share
Weighted average shares outstanding	28,749			28,522			28,709			28,507
Effect of dilutive securities:
Employee and director stock options	433			445			349			297
Denominator for diluted earnings per share -
Adjusted weighted average shares outstanding	29,182			28,967			29,058			28,804
Basic earnings per share:
From continuing operations	$	0.25		$	0.11		$	0.44		$	0.17
From discontinued operations	(0.05		)	—			(0.05		)	(0.03		)
Net earnings per share	$	0.20		$	0.11		$	0.39		0.14
Diluted earnings per share:
From continuing operations	$	0.25		$	0.11		$	0.44		$	0.17
From discontinued operations	(0.05		)	—			(0.05		)	(0.03		)
Net earnings per share	$	0.20		$	0.11		$	0.39		$	0.14
Number of shares under anti-dilutive stock options outstanding	1,000			1,255			1,009			1,255

Note 8 – Stock-Based Compensation

The Company uses the intrinsic value method of accounting 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:

	Three Months Ended						Six Months Ended
(In thousands, except per share data)	July 31, 2004			August 2, 2003			July 31, 2004			August 2, 2003
Net earnings:
As reported	$	5,877		$	3,070		$	11,319		$	3,905
Pro forma compensation expense, determined under fair value method, net of tax	(591		)	(443		)	(1,059		)	(682		)
Pro forma	$	5,286		$	2,627		$	10,260		$	3,223
Basic earnings per share:
As reported	$	0.20		$	0.11		$	0.39		$	0.14
Pro forma	0.18			0.09			0.36			0.11
Diluted earnings per share:
As reported	$	0.20		$	0.11		$	0.39		$	0.14
Pro forma	0.18			0.09			0.35			0.11

12

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 that covered 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 not funded, and 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:

	Pension Benefits
	Three Months Ended						Six Months Ended
(In thousands)	July 31, 2004			August 2, 2003			July 31, 2004			August 2, 2003
Service cost	$	183		$	649		$	366		$	1,298
Interest cost	1,888			1,938			3,776			3,876
Expected return on plan assets	(2,048		)	(1,909		)	(4,096		)	(3,818		)
Curtailment expense	—			—			—			2,369
Amortization of prior service cost	—			31			—			62
Recognized actuarial loss	365			169			730			338
Net periodic benefit cost	$	388		$	878		$	776		$	4,125

	Other Postretirement Benefits
	Three Months Ended						Six Months Ended
(In thousands)	July 31, 2004			August 2, 2003			July 31, 2004			August 2, 2003
Service cost	$	—		$	138		$	—		$	276
Interest cost	164			260			328			520
Curtailment gain	—			—			—			(142		)
Amortization of prior service cost	(191		)	(113		)	(382		)	(226		)
Recognized actuarial loss	73			93			146			186
Net periodic benefit cost	$	46		$	378		$	92		$	614

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 six months ended July 31, 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.

13

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 second quarter of Fiscal 2004 commenced on May 2, 2004 and ended on July 31, 2004, and the second quarter of Fiscal 2003 commenced on May 4, 2003 and ended on August 2, 2003.

RESULTS OF OPERATIONS

Strategic Overview

As previously announced, we initiated a comprehensive strategic review of our primary businesses during the second half of Fiscal 2003.  As part of this review, we refocused our primary operating metrics and management incentive measurement to emphasize the need for each of our businesses to achieve acceptable returns on shareholder invested capital.  We are taking actions in each of our business segments that we believe will help us achieve and sustain an acceptable return on invested capital.  During the first half of Fiscal 2004, we have continued to make progress in our execution of management action plans required to meet these objectives.  The significant highlights of our progress in each operating segment are described below.

Tactical Vehicle Systems – As we transition from the current Family of Medium Tactical Vehicles (“FMTV”) contract with the U.S. Army to the new multi-year FMTV contract, which is expected to begin in November 2004, we continue to pursue opportunities to supplement the new FMTV contract.  We were recently awarded two contracts from Lear Siegler totaling $19.3 million to provide on-site service support at a U.S. Army base where approximately 1,000 FMTVs and 400 Heavy Expanded Mobility Tactical Trucks will be reset to their full operational standards.  In addition, we were awarded a separate contract directly with the U.S. Army, which is expected to generate approximately $17 million of sales, to reset 200 FMTVs to their full operational standards.  These reset contracts are expected to generate relatively low margins and to be substantially completed over the next six months.  We have also received an award for long lead material for 385 low signature armored cabs for the FMTV, valued at $23 million.  We also continue to anticipate the United Kingdom’s Ministry of Defence announcement of a preferred bidder related to their multi-year production contract for over 8,000 trucks.  We currently expect this announcement to be made during the second half of Fiscal 2004.

Power Products – Wecompleted numerous streamlining and cost reduction actions in the first half of Fiscal 2004, and we continue to evaluate additional opportunities.  Key actions taken during Fiscal 2004  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 an idle manufacturing facility, the closure of an under-performing branch located in Auburn, Washington and the sale of certain assets within our rental equipment fleet.  As a result of the many actions taken during the second half of Fiscal 2003 and the first half of 2004, total headcount for this segment as of July 31, 2004 has been reduced by 341 personnel (or 17%) since September 2003, of which 144 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.  We anticipate that the majority of remaining EPC projects will be completed during Fiscal 2004.  Additionally, we are currently transitioning the responsibility for the marketing and production of custom generator sets to our Power Products segment.

Airline Products – As we announced during the second quarter of Fiscal 2004, we are pursuing 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.  While we expect 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.

14

Fiscal 2004 vs. Fiscal 2003

Sales for the second quarter of Fiscal 2004 were $316.3 million, a $3.4 million increase over the $312.9 million recorded in the second quarter of Fiscal 2003.  This increase in sales is primarily attributable to a $32.4 million increase in our Tactical Vehicle Systems segment along with a $5.4 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.  For the first half of Fiscal 2004, sales were $620.6 million, which represented an increase of $18.0 million, or 3%, from the corresponding period in Fiscal 2003.  The increased sales volume for this period was also largely attributable to increases in our Tactical Vehicle Systems and Airline Products segments, which were partially offset by lower sales in all other segments.  The changes within each segment are explained in greater detail in the Segment Data section below.

Gross profit decreased by $1.1 million to $40.6 million in the second quarter of Fiscal 2004 from the second quarter of Fiscal 2003, reflecting a decline in gross profit margin from 13.3% to 12.8%.  The decrease in gross profit is primarily attributable to losses in our Distributed Energy Solutions segment primarily associated with additional costs to complete existing EPC projects and fulfill customer obligations.  This decline was partially offset by a $1.7 million gross profit improvement in our Tactical Vehicle Systems segment driven primarily by higher sales volume, along with a $2.6 million improvement in our Power Products Segment resulting from a variety of strategic actions and cost reduction programs.

For the first half of Fiscal 2004, gross profit decreased by $2.8 million to $80.8 million from the corresponding period of Fiscal 2003, reflecting a decline in gross profit margin from 13.9% to 13.0%.  The gross profit in the Distributed Energy Solutions segment declined $7.6 million in the first half of Fiscal 2004 due to the ongoing execution of existing EPC projects and satisfaction of customer obligations.  Gross profit improved in our Tactical Vehicle Systems segment by $2.6 million and in our Airline Products segment by $2.0 million, primarily driven by increased sales volume, while the Engineered Products gross profit declined $2.2 million on lower sales volume.  The Power Products segment generated a $2.4 million gross profit improvement resulting from numerous strategic actions and cost reduction programs.

Selling and administrative expenses decreased to $31.0 million (9.8% of sales) in the second quarter of Fiscal 2004 from $37.6 million (12.0% of sales) in the second quarter of Fiscal 2003.  This $6.6 million (17%) reduction in selling and administrative expenses is primarily attributable to a $2.3 million cost savings from employee workforce reductions during Fiscal 2003 and Fiscal 2004, a $1.6 million reduction in fringe benefits expense associated with changes made in our employee pension, postretirement and medical benefit plans, a $1.9 million reduction in employee separation costs and restructuring activities in Fiscal 2003, and $0.8 million associated with reductions in other expenses.

For the first half of Fiscal 2004, selling and administrative expenses decreased to $63.0 million (10.2% of sales) compared to $73.9 million (12.3% of sales) in the first six months of Fiscal 2003.  This $10.9 million (15%) reduction in selling and administrative expenses is primarily attributable to a $5.1 million cost savings from employee workforce reductions during Fiscal 2003, a $2.5 million reduction in fringe benefits expense associated with changes made in our employee pension, postretirement and medical benefit plans, and a $3.5 million reduction in employee separation costs and restructuring activities from Fiscal 2003.

Operating results for the first half of Fiscal 2003 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 postretirement medical plan effective July 1, 2003, with the exception of a small transition group.

Other income, net, increased by $1.5 million in the second quarter of Fiscal 2004 and by $2.2 million in the first half of Fiscal 2004, compared to the corresponding periods of Fiscal 2003, primarily as a result of a $1.6 million gain on sales of assets resulting from the disposal of two idle manufacturing facilities during the second quarter of Fiscal 2004.

Net interest expense was unchanged at $0.1 million in the second quarter of Fiscal 2004, and decreased by $0.5 million to $0.4 million for the first half of Fiscal 2004 compared to the corresponding periods of Fiscal 2003.  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 36.3% in the first half of Fiscal 2004 compared to 29.3% for the corresponding period in Fiscal 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 Fiscal 2003.

Discontinued operations generated an after-tax loss of $1.4 million in the second quarter and $1.5 million in the first half of Fiscal 2004, compared to a $0.2 million after-tax loss in the second quarter and a $1.0 million after-tax loss in the first half of Fiscal 2003.  These losses primarily represent costs associated with retained obligations associated with our discontinued blowout preventer and controls, valve and drilling riser business, which was sold during Fiscal 2002.

15

Segment Data

Our operating 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						Six Months Ended
	July 31, 2004			August 2, 2003			July 31, 2004			August 2, 2003
Sales
Tactical Vehicle Systems	$	140,737		$	108,365		$	279,520		$	219,342
Power Products	123,680			127,886			244,399			253,720
Engineered Products	21,936			38,262			39,204			64,373
Distributed Energy Solutions	6,235			19,986			10,678			32,592
Airline Products	23,734			18,352			46,809			32,596
Total sales	$	316,322		$	312,851		$	620,610		$	602,623
Operating profit (loss)
Tactical Vehicle Systems	$	18,759		$	17,279		$	38,249		$	35,066
Power Products	1,843			(5,642		)	1,926			(8,768		)
Engineered Products	1,145			553			(642		)	145
Distributed Energy Solutions	(5,753		)	(2,788		)	(10,893		)	(6,646		)
Airline Products	(581		)	(712		)	(876		)	(2,705		)
Coporate expenses, net	(3,816		)	(3,980		)	(7,280		)	(9,299		)
Total operating profit	11,597			4,710			20,484			7,793
Interest expense	436			693			953			1,936
Interest and investment income	(332		)	(559		)	(586		)	(1,059		)
Earnings from continuing operations before income taxes	$	11,493		$	4,576		$	20,117		$	6,916

During 2004, manufacturers and distributors of steel have experienced sharply increased prices and limited availability of steel and component parts containing steel.  These higher material costs have negatively impacted our results, particularly in our Tactical Vehicle Systems and Airline Products segments where increased material costs have impacted our operating profit by $3.3 million and $1.0 million, respectively, during the first six months of Fiscal 2004.  We are continuing to work with our supply chain and pursuing all avenues to minimize the impact.  In addition, we have implemented product price increases where market conditions and contracts have allowed.  However, we anticipate continued negative impact to our material costs into Fiscal 2005.  We are unable to predict how long these conditions are likely to persist, or whether further price increases will occur in the future.

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 second quarter of Fiscal 2004, this segment recorded $140.7 million of sales, a $32.3 million (30%) increase from the $108.4 million of sales recorded in the second quarter of Fiscal 2003.  Sales for the first half of Fiscal 2004 were $279.5 million, a $60.2 million (27%) increase from the $219.3 million of sales recorded in the corresponding period of Fiscal 2003.  The sales increase is primarily attributable to increased production volume.  A breakdown of this segment’s unit deliveries is as follows:

	Three Months Ended		Six Months Ended
	July 31, 2004	August 2, 2003	July 31, 2004	August 2, 2003
Trucks	751	644	1,494	1,275
Trailers	201	126	405	258
Total Unit Deliveries	952	770	1,899	1,533

The increased unit deliveries above generated equipment sales increases of $24.5 million and $48.7 million for the second quarter and first half of Fiscal 2004, respectively, compared to same periods in Fiscal 2003.  Additionally, this segment recorded parts and service

16

sales increases of $7.8 million and $11.5 million in the second quarter and first half of Fiscal 2004, respectively, compared to the same periods of Fiscal 2003.  The increased parts and service sales are primarily due to increased requirements for U.S. Army vehicles deployed in Iraq.

Operating profit for the second quarter of Fiscal 2004 increased to $18.8 million (13.3% operating margin) from $17.3 million (15.9% operating margin) in the second quarter of Fiscal 2003.  The increased sales volume generated a $5.1 million improvement to operating profit.  This improvement was partially offset by a $2.5 million increase in material costs, primarily associated with higher steel prices, along with a $1.1 million decrease associated with product mix and new product development costs.

For the first half of Fiscal 2004, operating profit increased to $38.3 million (13.7% operating margin) from $35.1 million (16.0% operating margin) in the corresponding period of Fiscal 2003.  The increased sales volume generated a $9.6 million improvement to operating profit, partially offset by a $3.3 million increase in material costs, primarily associated with higher steel prices, along with a $3.2 million decrease primarily associated with sales mix.

As we transition to the new multi-year FMTV contract, for which production is scheduled to begin in November 2004, unit deliveries are expected to decline to 661 trucks and 146 trailers in the third quarter and 644 trucks and 179 trailers in the fourth quarter of Fiscal 2004.  Our profit margins in this segment are also expected to be lower in the near future than margin levels historically achieved under the current FMTV contract.  Actual future margins of this segment will be dependent upon a number of factors including our ability to achieve operational efficiencies, 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 commodities, the potential for additional contracts, other product introductions, bid and proposal activities and other factors.  The operating margin that this segment will achieve in total may also be impacted by additional sales, if any, to other allied governments and the level of engineering service and spare parts 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 $123.7 million in the second quarter of Fiscal 2004, down $4.2 million (3%) from $127.9 million in the second quarter of Fiscal 2003.  For the first half of Fiscal 2004, the segment recorded sales of $244.4 million, down $9.3 million (4%) from $253.7 million in the first half of Fiscal 2003.  A breakdown of Power Products segment sales follows:

	Three Months Ended				Six Months Ended
(In thousands)	July 31, 2004		August 2, 2003		July 31, 2004		August 2, 2003
Equipment sales	$	39,140	$	39,244	$	75,400	$	76,382
Parts sales	55,373		59,908		111,471		120,686
Service and rental sales	29,167		28,734		57,528		56,652
	$	123,680	$	127,886	$	244,399	$	253,720

For the second quarter and first six months of Fiscal 2004, respectively, the decline in sales from the comparable period of Fiscal 2003 includes approximately $16 million and $29 million attributable to the exit of the ThermoKing product offering in Texas and Louisiana, the wheelchair lift manufacturing and MerCruiser product offerings, along with the closure of certain under-performing branch locations.  Additionally, parts sales are $4.5 million and $9.2 million lower, respectively, in the second quarter and first half of Fiscal 2004, largely as a result of changes to our distribution contracts with Detroit Diesel Corporation (“Detroit Diesel”), as discussed more fully below.  These sales declines were largely offset by higher equipment sales in continuing locations, which were largely attributable to general improvements in the heavy equipment markets we serve.

Effective January 2004, we entered into new contracts with Detroit Diesel for the distribution and servicing of its diesel engine products.  One set of contracts, which expires in December 2010, is with Detroit Diesel Corporation and covers the “on-highway” products and services.  Under the terms of the new on-highway agreements with all of its distributors, Detroit Diesel allows its affiliated Freightliner, Sterling and Western Star dealers (collectively, the “Freightliner dealers”) to purchase their on-highway Detroit Diesel parts directly from the Freightliner Parts Distribution Centers, rather than purchasing them from a Detroit Diesel distributor such as the Company, as was previously required.  Consequently, our parts sales to Freightliner dealers have declined in the first six months of Fiscal 2004, compared to the same period in Fiscal 2003.  Additionally, under the terms of the new contract, we have received direct compensation from Detroit Diesel totaling $0.6 million for the first six months of Fiscal 2004 related to Freightliner dealer purchases made directly from the Freightliner Parts Distribution Centers.

The second set of Detroit Diesel agreements is with DaimlerChrysler Off-Highway Holding Gmbh, and covers “off-highway” products and services.  This contract expires in December 2004 and includes terms similar to the previous distribution agreement.  At

17

present, we are unable to predict the effect of these “off-highway” contract arrangements on future operations or whether they will be renewed and, if so, on what terms upon their expiration.

This segment recorded an operating profit of $1.8 million in the second quarter of Fiscal 2004 compared to a $5.6 million operating loss in the second quarter of Fiscal 2003.  The improvement in operating profit is primarily attributable to on-going cost reduction programs.  Workforce reductions resulted in a $4.8 million decrease in employee compensation costs between the two periods.  Additionally, changes in employee benefit programs previously described resulted in an additional $1.5 million decrease in operating expenses.  This segment also recognized a $0.3 million gain in the second quarter of Fiscal 2004 associated with the sale of an idle manufacturing facility.  Reductions in other operating expenses provided an additional $0.8 million improvement.

Operating profit for the first half of Fiscal 2004 was $1.9 million, representing a $10.7 million improvement over the $8.8 million operating loss recognized in the corresponding period of Fiscal 2003.  This improvement was driven primarily by the cost reduction programs, including $7.8 million from workforce reductions, $2.7 million from employee benefit program changes, the $0.3 million gain on the sale of an idle manufacturing facility and $0.7 million from other operating expense reductions.  These improvements were partially offset by a $0.8 million decline from lower sales volume and changes in sales mix.

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.  During the second quarter of Fiscal 2004, we sold a vacant manufacturing facility and certain rental equipment assets for aggregate proceeds of $8.6 million, resulting in a gain of $0.3 million to the segment. We continue to evaluate the various product and service offerings, distribution channels and cost structure in this business segment and intend to take further action, as necessary, 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 $21.9 million in the second quarter of Fiscal 2004 from $38.3 million in the second quarter of Fiscal 2003, representing a 42% decline. For the first half of Fiscal 2004, sales decreased $25.2 million (39%) to $39.2 million from $64.4 million in the corresponding period of Fiscal 2003. The decreases experienced in Fiscal 2004 are largely due to the timing of execution on several large petroleum equipment orders which were largely completed during the first half of Fiscal 2003.  Compared to the corresponding periods in Fiscal 2003, petroleum equipment sales represented $24.1 million and $36.7 million of this segment’s sales decline in the second quarter and first half, respectively.  The declines in petroleum equipment sales were partially offset by increases in utilities equipment sales, largely associated with the sales of off-road seismic vehicles.

Operating profit for the second quarter of Fiscal 2004 was $1.1 million, a $0.5 million increase from the $0.6 million operating profit in the second quarter of Fiscal 2003, despite the decline in sales volume.  The second quarter of Fiscal 2004 included a $0.6 million gain resulting from the sale of an idle manufacturing facility, which was vacated as a result of the consolidation of manufacturing operations in Houston, Texas during Fiscal 2003.  Additionally, the second quarter of Fiscal 2003 included $0.5 million of non-recurring project costs associated with the consolidation effort.  The remainder of the change in operating profit is attributable to sales volume and mix changes as the decline in profit associated with the large international equipment orders in Fiscal 2003 was largely offset by the improved profitability of the utilities equipment and domestic petroleum equipment sales.

For the first half of Fiscal 2004, this segment generated a $0.6 million operating loss, which reflected a $0.7 million decrease from the $0.1 million operating profit in the corresponding period of Fiscal 2003.  Included in the Fiscal 2004 loss was a $0.4 million charge for potential inventory impairment associated with the recent U.S. trade sanctions against Syria.  Other issues contributing to the increased loss in the first half of Fiscal 2004 were $2.2 million associated with declining sales volume, partially offset by $1.0 million of non-recurring costs in Fiscal 2003 associated with the consolidation of manufacturing operations and the $0.6 million gain from the manufacturing facility sale in Fiscal 2004.  Additionally, sales mix improvements generated an additional $0.3 million improvement.

Our order backlog in this segment has increased to $26.6 million at July 31, 2004 from $20.1 million at the end of Fiscal 2003.  Additionally, this segment obtained an order for petroleum equipment subsequent to the end of the second quarter of Fiscal 2004 totaling $17.5 million.  The execution of these contracts currently in backlog is expected to improve sales and operating profits in future quarters.

Distributed Energy Solutions

The Distributed Energy Solutions segment packages and markets reciprocating diesel and natural gas engine generator sets and markets power generation solutions primarily in domestic and certain international markets.  As previously communicated, we

18

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.  We are currently transitioning the responsibility for the marketing and production of custom generator sets to our Power Products segment.

Sales for this segment decreased $13.8 million to $6.2 million in the second quarter of Fiscal 2004 compared to $20.0 million in the second quarter of Fiscal 2003.  For the first half of Fiscal 2004, this segment generated sales of $10.7 million, compared to $32.6 million in the corresponding period in Fiscal 2003.  The decline in sales is primarily the result of our decision to exit the EPC activities.  Sales in the first half of Fiscal 2004 primarily relate to our continued execution of remaining customer obligations under existing contracts.

Operating loss for the second quarter of Fiscal 2004 was $5.8 million, compared to a $2.8 million operating loss in the second quarter of Fiscal 2003.  For the first half of Fiscal 2004, this segment’s operating loss was $10.9 million, compared to $6.6 million in the corresponding period 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.

As mentioned above, we are continuing to perform our remaining obligations associated with the EPC activities of this segment.  We expect that the majority of these remaining obligations will be completed during the second half of Fiscal 2004.  While we have recognized all known estimated losses on these uncompleted contracts, continued uncertainty remains related to the execution of the remaining obligations.  These uncertainties may result in additional unexpected losses until all remaining EPC projects are completed.  Additionally, upon completing our remaining EPC projects, we will 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

As previously mentioned, we are currently pursuing the sale of our Airline Products business, which designs, manufactures and sells ground support equipment.  Until a suitable buyer is found for this business, the sale process is not expected to have a material impact on the operations of this segment.  Additionally, we will continue to provide the capital and other resources needed to continue our improvement and growth of this business.

The Airline Products segment recorded sales of $23.7 million in the second quarter of Fiscal 2004, a $5.3 million or 29% increase from the $18.4 million of sales recorded in the second quarter of Fiscal 2003.  For the first half of Fiscal 2004, this segment recorded sales of $46.8 million, which reflected a $14.2 million or 44% increase over the same period in Fiscal 2003.  The increased sales reflect a growing demand for equipment resulting from the continued recovery of the airline industry and the lack of replacement purchases over the past three years.

This sales improvement resulted from the following increase in unit deliveries, which reflect an 80% increase in the second quarter of Fiscal 2004 and a 78% increase in the first half of Fiscal 2004, compared to the same periods of Fiscal 2003:

	Three Months Ended		Six Months Ended
	July 31, 2004	August 2, 2003	July 31, 2004	August 2, 2003
Total Unit Deliveries	653	363	1,224	688

Unit volumes have increased at a higher rate than sales dollars, primarily as a result of our Fiscal 2002 acquisition of the DAVCO product line, which has expanded this segment’s market into the rapidly growing regional airline sector.  The DAVCO equipment tends to be of smaller size, and therefore has a lower selling price per unit.

This segment produced an operating loss of $0.6 million in the second quarter of Fiscal 2004 compared to a $0.7 million operating loss in the second quarter Fiscal 2003.  The reduced operating loss for the second quarter of Fiscal 2004 is attributable to the increase in sales volume, which contributed a $1.0 million improvement.  This improvement was offset by higher material costs, including a $0.6 million increase attributable to steel prices along with other operating cost increases and sales mix changes.

For the first half of Fiscal 2004, this segment reduced its operating loss by $1.8 million from the prior year, recording an operating loss of $0.9 million as compared to a $2.7 million operating loss in the comparable period for Fiscal 2003.  A $2.5 million improvement was generated by higher sales volume along with $0.3 million of improvement associated with favorable sales mix and operating expenses, partially offset by higher material costs including $1.0 million due to steel price increases.

Ground support equipment purchases by the airline industry have increased in the first half of Fiscal 2004, as reflected by our increased sales volume and increased backlog to $12.8 million at the end of the second quarter of Fiscal 2004, compared to $7.0 million at January 31, 2004 and $2.5 million at the end of the second quarter of Fiscal 2003.  We anticipate that the continued

19

recovery of the airline industry, as well as regulatory requirements for reduced emission ground support vehicles, will have a positive impact on the Airline Products segment.  While we expect the recent increases in steel prices to affect our product costs in the near future, we expect to offset this impact significantly through product price increases.

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 $2.5 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 currently being executed and are expected to be completed in the third quarter of Fiscal 2004.  Assuming successful completion of the initial awards, 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.

Corporate

Corporate expenses consist of costs incurred by the corporate headquarters group that cannot be directly attributed to the activities of the business segments.  Corporate expenses incurred in the second quarter of Fiscal 2004 were $3.8 million, down $0.2 million from the $4.0 million incurred in the second quarter of Fiscal 2003.  The decrease in corporate expenses is primarily attributable to a $0.9 million reduction in employee separation costs related to corporate office workforce reductions.  The second quarter of Fiscal 2004 included $0.4 million of employee separation costs, compared to $1.3 million in the second quarter of Fiscal 2003.  This reduction was partially offset by higher legal and professional expenses, including costs associated with the implementation of the internal control reporting requirements of the Sarbanes-Oxley Act of 2002.

For the first half of Fiscal 2004, corporate expenses were $7.3 million, compared to $9.3 million in the comparable period of Fiscal 2003.  Fiscal 2003 included a $2.4 million one-time non-cash pension curtailment expense 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 $0.9 million associated with the implementation of the internal control reporting requirements of the Sarbanes-Oxley Act of 2002.  While the requirements of the Sarbanes-Oxley Act are expected to result in some level of increased ongoing corporate expenses, we expect such ongoing costs to be significantly lower than the levels experienced in the first half of Fiscal 2004.

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:

	July 31, 2004		January 31, 2004
	(In millions)
Tactical Vehicle Systems	$	496.7	$	453.0
Power Products	44.2		26.4
Engineered Products	26.6		20.1
Distributed Energy Solutions	10.6		19.5
Airline Products	12.8		7.0
	$	590.9	$	526.0

Additionally, subsequent to July 31, 2004, the Engineered Products segment obtained an order for petroleum equipment totaling $17.5 million.  Unfilled orders of the Tactical Vehicle Systems segment at July 31, 2004 included $121.2 million associated with the 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 completed in December 2004, and scheduled 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

20

the facility.  To provide additional financial flexibility, we intend to negotiate a smaller revolving credit facility during the second half of 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 $13.6 million of letters of credit under these facilities were outstanding as of July 31, 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 July 31, 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 July 31, 2004 was approximately 6.29%.  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 $1.8 million at July 31, 2004 and $1.9 million at 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 inventory levels, accounts receivable, tax payments or other working capital items create a 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						Six Months Ended
(In thousands)	July 31, 2004			August 2, 2003			July 31, 2004			August 2, 2003
Net cash provided by (used in):
Operating activities	$	(9,733	)	$	5,761		$	33,842		$	20,067
Investing activities	5,497			(10,147		)	4,749			(25,692		)
Financing activities	(2,017		)	(31,548		)	(3,735		)	(32,857		)
Increase (decrease) in cash and cash equivalents	$	(6,253	)	$	(35,934	)	$	34,856		$	(38,482	)

Selected Balance Sheet Data

(In thousands)	July 31, 2004		January 31, 2004
Cash, cash equivalents, and short-term investments	$	99,750	$	61,704
Working capital	240,341		219,531
Total debt	28,198		28,442

Total cash flows improved by $29.7 million in the second quarter of Fiscal 2004 compared to the second quarter of Fiscal 2003.  Net cash provided by operating activities decreased by $15.5 million primarily as a result of a $31.1 million cash outflow in the second quarter of Fiscal 2004 attributable to a reduction in billings in excess of incurred costs associated with the Tactical Vehicle Systems segment payment and production schedule under the existing FMTV contract and transition to the new multi-year FMTV contract.  The impact of this cash outflow was partially offset by other changes in operating assets and liabilities, including a $17.8 million receipt of a federal income tax refund receivable.

Investing activities contributed a $15.6 million improvement in cash flow during the second quarter of Fiscal 2004 compared to the second quarter of Fiscal 2003.  This improvement is primarily attributable to $11.4 million of cash proceeds associated with the sale of rental equipment assets and related customer leases and two idle manufacturing facilities.  Additionally, capital expenditures in the

21

second quarter of Fiscal 2004 were $3.6 million lower than the comparative period of the previous year due to capital spending in Fiscal 2003 related to the consolidation of two manufacturing facilities.

Financing activities contributed a $29.5 million improvement in cash flow during the second quarter of Fiscal 2004 compared to the second quarter of Fiscal 2003.  This improvement related primarily to a scheduled debt payment of $30.0 million in May of 2003.

Total cash flows for the first half of 2004 improved by $73.3 compared to the same period of Fiscal 2003.  Net cash provided by operating activities increased $13.7 million as a $35.0 million cash usage in Fiscal 2004 related to the payment and production schedule under the existing FMTV contract and transition to the new multi-year FMTV contract was more than offset by a $43.4 million cash flow improvement related to customer receipts on large Engineered Products equipment orders completed during the fourth quarter of Fiscal 2003, as well as the $17.8 million collection of the income tax refund.

Investing activities contributed a $30.4 million improvement in cash flow during the first half of Fiscal 2004 compared to the first half of Fiscal 2003.  This improvement is primarily attributable to $17.5 million of cash proceeds associated with the sale of businesses and property, plant and equipment.  Additionally, cash invested in short-term investments decreased by $7.7 million and capital expenditures were $6.2 million lower due to the manufacturing facility consolidation project in Fiscal 2003.

Financing activities contributed a $29.2 million improvement in cash flow during the first half of Fiscal 2004 compared to the first half of Fiscal 2003, resulting from the scheduled debt payment of $30.0 million in May of 2003.

As a result of the cash provided by operating activities in the first half of Fiscal 2004, total cash and short-term investments has increased since January 31, 2004 by $38.0 million to $99.8 million as of July 31, 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 primarily to fund working capital related to additional orders in the Engineered Products segment.

Our working capital balance increased by $20.8 million during the first half of Fiscal 2004, primarily attributable to the $20.1 million of earnings before income taxes along with $9.9 million of plant, property and equipment disposals, partially offset by $4.9 million of dividend payments and other reductions of working capital.

FACTORS THAT MAY AFFECT FUTURE RESULTS

Risks as to Rising Steel Prices.  During 2004, 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 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 as to rising steel prices, 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.

22

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

We 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 management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act as of July 31, 2004.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our 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 our periodic filings under the Exchange Act.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, management will be required to report on the adequacy of our internal control structure in our annual report on Form 10-K for this fiscal year.  In preparation for this report, we have been actively engaged in a process that includes documentation and testing of all significant financial reporting processes and related internal controls.  During this process, we have taken actions to improve controls and processes in a number of areas.  While the concepts under Section 404 and the rules thereunder are new and developing, we do not consider any of the changes made to date to have materially affected, or to be reasonably likely to materially affect, our 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 conducted 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 sometime in Fiscal 2005.  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.

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

23

drilling operations.  The suit seeks to recover damages that are not specified in the petition, including direct damages, attorney’s fees and expenses and punitive damages.  Discovery in the case indicates that the direct damage claim is for approximately $36 million.

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 consolidated 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 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 it expects to incur associated with these matters.  Such accruals are included in liabilities of discontinued operations, as the business that manufactured drilling risers was sold in Fiscal 2002.

Klickitat Litigation:  The Company and several of its subsidiaries are named as defendants in a suit filed by the Klickitat County Public Utility District No. 1 on December 11, 2003 arising out of claims relating to a landfill gas power generation facility in Roosevelt, Washington, Cause No. CY-03-3175-LRS; Klickitat County Public Utility District No. 1 v. Stewart & Stevenson Services, Inc., Stewart & Stevenson Power, Inc., Sierra Detroit Diesel Allison, Inc., Pamco International, Inc. and Waukesha Engine Dresser, Inc.; in the United States District Court for the Eastern District of Washington.  The plaintiff has asserted claims with respect to equipment installed and used since 1999 for breach of contract; promissory estoppel; violations of the Washington Products Liability Act; breach of warranties; intentional or negligent misrepresentation; and violations of the Washington Consumer Protection Act and seeks recovery of damages in excess of $13 million.  The Company is vigorously defending this suit and is taking procedural steps to seek its dismissal.  It is presently impossible for the Company to determine the ultimate outcome of this suit or whether its 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 this matter or to reasonably estimate the amount of any loss that may result from this matter.  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 this matter.

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.

24

Item 4. Submission of Matters to a Vote of Security Holders

On July 9, 2004 the Company’s Annual Meeting of Shareholders was held.  Set forth below is a brief description of each matter acted upon at the meeting and the number of votes cast for, against or withheld, abstaining or not voting as to each matter.

	For	Withheld
1. Election of Directors:
Max L. Lukens	26,315,474	1,378,872
Robert S. Sullivan	25,934,460	1,759,886
James M. Tidwell	26,311,539	1,382,807

The following directors’ terms of office continued after the meeting:  Monroe M. Luther, Charles R. Ofner, Khleber V. Attwell, Darvin M. Winick, and Howard Wolf.

	For	Against	Abstain	Broker Non-votes
2. Ratification of Ernst & Young LLP as to the Company’s auditor:	27,456,009	225,862	12,475	—
3. Approval of Amendment No. 1 to the Stewart & Stevenson Services, Inc. Amended and Restated 1996 Director Stock Plan:	17,006,187	5,849,912	1,529,946	3,308,301
4. Approval of the Stewart & Stevenson Services, Inc. Amended and Restated 1993 Nonofficer Employee Stock Option Plan:	21,687,611	4,480,386	1,526,349	—
5. Approval of Any Proposal to Postpone or Adjorn the Meeting:	17,730,911	9,907,937	55,498	—

Item 6. Exhibits

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

3.2	Seventh Restated Bylaws of Stewart & Stevenson Services, Inc. effective July 9, 2004, as amended.
†10.1	Form of Severance Agreement, dated as of July 19, 2004, by and between Stewart & Stevenson Services, Inc. and Carl B.  King, John B. Simmons, Stephen A. Hines, Dennis M. Dellinger, Don Kyle and Mark Whitman.
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.

25

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 26th day of August 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)

26

EXHIBIT INDEX

 Exhibit Number and Description

3.2	Seventh Restated Bylaws of Stewart & Stevenson Services, Inc. effective July 9, 2004, as amended.
10.1	Form of Severance Agreement, dated as of July 19, 2004, by and between Stewart & Stevenson Services, Inc. and Carl B.King, John B. Simmons, Stephen A. Hines, Dennis M. Dellinger, Don Kyle and Mark Whitman.
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.

27

EX-3.2

Exhibit 3.2

SEVENTH RESTATED
BYLAWS OF
STEWART & STEVENSON SERVICES, INC.

Effective July 9, 2004

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

2

at such meeting and who complies with the notice procedures set forth in this Section 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

3

notice shall be deemed delivered when deposited in the United Sates mail addressed to 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.

4

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

5

Board of Directors, shall be made pursuant to timely notice in writing to the Secretary of 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.

6

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 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 4.2.  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

7

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 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.  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.

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

8

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.

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 not less than three (3) 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 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.

9

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 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.

10

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

Section 5.5.  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 5.6.  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 5.7.  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 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

11

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 5.8.  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 5.9.  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 5.10.  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 5.11.  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 5.12.  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 receiving such salary or other compensation by reason of the fact that he is also a director of the Corporation.

12

Section 5.13.  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 5.14.  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.

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

13

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.

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.

14

EX-10.1

Exhibit 10.1

SEVERANCE AGREEMENT

THIS AGREEMENT, dated as of July 19, 2004, is made by and between Stewart & Stevenson Services, Inc., a Texas corporation (the “Company”), and                    (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 December 31, 2006; provided, however, that commencing on January 1, 2005 and each January 1 thereafter (an “Extension Date”), the Term shall automatically be extended for one additional year (i.e., resulting in a two-year Term on the Extension Date) unless, not later than September 30 of the year preceding the Extension Date, the Company or the Executive shall have given notice not to extend the Term; and further provided, however, that if a Change in Control shall have occurred during the Term, the Term shall expire no earlier than twenty-four (24) months beyond the month in which such Change in Control occurred.

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 or phantom 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

2

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 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 two times the sum of (i) the Executive’s base salary as in effect immediately prior to the Date of Termination or, if higher, in effect immediately prior to the first occurrence of an event or circumstance constituting Good Reason, and (ii) the average cash value of annual bonus (whether paid in cash or stock) earned by the Executive pursuant to any annual bonus or incentive plan maintained by the Company in respect of the three fiscal years ending immediately prior to the fiscal year in which occurs the Date of Termination or, if higher, immediately prior to the fiscal year in which occurs the first event or circumstance constituting Good Reason; provided, that if the Executive has not participated in an annual bonus or incentive plan maintained by the Company for the entirety of such three-year period, the amount referred to in this clause (ii) shall be calculated using such lesser number of bonuses as have been actually earned by the Executive in respect of such lesser period.

(B)For the twenty-four (24) 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

3

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 the Company’s management incentive compensation plan (the “Annual Incentive Plan”), the Company shall pay to the Executive a lump sum amount, in cash, equal to the sum of (i) any unpaid incentive compensation which has been allocated or awarded to the Executive for a completed fiscal year or other measuring period preceding the Date of Termination under the Annual Incentive Plan and which, as of the Date of Termination, is contingent only upon the continued employment of the Executive to a subsequent date, and (ii) a pro rata portion to the Date of Termination of the aggregate value of all contingent incentive compensation awards to the Executive for all then uncompleted periods under the Annual Incentive Plan, calculated as to each such award by multiplying the award that the Executive would have earned as of the last day of the performance award period, assuming the achievement, at the expected value target level, of the individual and corporate performance goals established with respect to such award, by the fraction obtained by dividing the number of full months and any fractional portion of a month during such performance award period through the Date of Termination by the total number of months contained in such performance award period; provided, however, that if such termination of employment occurs during the same year in which the Change in Control occurs, the pro-rata bonus payment referred to in clause (ii) above shall be offset by any payments received under the Annual Incentive Plan in connection with such Change in Control.

(D)The Company shall provide the Executive with outplacement services suitable to the Executive’s position for a period of one year or, if earlier, until the first acceptance by the Executive of an offer of employment.

(E)The Executive shall have a fully nonforfeitable interest in the Executive’s benefits accrued, if any, under the Stewart & Stevenson Supplemental Retirement Plan and the Stewart & Stevenson Supplemental Executive Retirement Plan.

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.

4

(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 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

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 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

6

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 (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.

7

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 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

8

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.

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 (the “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

9

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.

(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

10

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

(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.

11

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 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.

12

(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;

(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;

13

(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 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.

14

(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 (including any extension, continuation or termination described therein).

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

15

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

STEWART & STEVENSON SERVICES, INC.

By:

Carl B. King

Senior Vice President, Secretary and

General Counsel

EXECUTIVE:

By:

Address:

16

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:   August 26, 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:   August 26, 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