8-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 8-K

CURRENT REPORT

PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

Date of Report (Date of earliest event reported): December 23, 2005

STEWART & STEVENSON SERVICES, INC.

(Exact name of Registrant as specified in charter)

Texas	0-8493	74-1051605
(State or other jurisdiction of incorporation)	(Commission File Number)	(I.R.S. Employer Identification No.)
2707 North Loop West
Houston, Texas		77008
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (713) 868-7700

Former name or former address, if changed since last report: Not Applicable

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing
obligation of the registrant under any of the following provisions:

o  Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

o  Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

o  Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

o  Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (1 7 CFR 240.13e-4(c))

Item 1.01.  Entry Into a Material Definitive Agreement

Lukens Employment Agreement

Stewart & Stevenson Services, Inc. (the “Company”) entered into an employment agreement with Max L. Lukens (“Mr. Lukens”) dated February 1, 2004 (the “Prior Employment Agreement”).  On December 23, 2005, the Company entered into an employment agreement (the “Employment Agreement”) with Mr. Lukens to remain President and Chief Executive Officer of the Company.  The Employment Agreement supersedes the Prior Employment Agreement.  The description below of the Employment Agreement does not purport to be complete and is qualified in its entirety by reference to the complete text of such agreement filed as Exhibit 10.1 to this Current Report on Form 8-K.

The term of the Employment Agreement begins December 23, 2005 (the “Commencement Date”) and ends February 1, 2010, subject to termination provisions therein (the “Term”).  From the Commencement Date until February 1, 2007, Mr. Lukens will be employed by the Company as President and Chief Executive Officer (the “Base Term”). During the last three years of the Employment Agreement, Mr. Lukens will be employed as an advisor to the senior executives of the Company and will be obligated to provide such advisory services no more than fifteen days per year (the “Ancillary Term”).

On or before December 31, 2005, Mr. Lukens will be paid $1,500,000 in consideration of the achievement of the performance goals established with respect to the contingent bonus award contemplated by the Prior Employment Agreement.

During the Base Term, Mr. Lukens will be paid an annual salary of $750,000 (the “Base Salary”).  At the end of the Base Term, Mr. Lukens will be eligible for a discretionary bonus (the “Discretionary Bonus”) of up to 100 percent (for target level performance) of his annual Base Salary during the Term (up to $750,000), which will take into account criteria specified in the Employment Agreement; provided, however, in the event there is a change of control as defined in the Severance Agreement (as defined below), the Discretionary Bonus shall be $750,000 (subject to the termination provisions of the Severance Agreement).

During the Ancillary Term, Mr. Lukens will be paid (the “Ancillary Term Compensation”) an annual salary of $35,000, and in the event Mr. Lukens and the Company agree to increase the time Mr. Lukens is obligated to provide services during such period, the Company will pay Mr. Lukens an additional $6,250 per day for such services.

If Mr. Lukens is employed by the Company on February 1, 2006, he will be granted on such date an option to purchase 5,000 shares of the Company’s Common Stock under the Company’s 1988 Nonstatutory Stock Option Plan, as amended to date (the “1988 Plan”), with the same terms specified in the option granted to Mr. Lukens pursuant to the Prior Employment Agreement, except as indicated in the first sentence of the section “2006 Option” below.

Mr. Lukens’ employment will terminate upon his death, and the Company may terminate Mr. Lukens’ employment due to a Disability (as defined in the Employment Agreement). During any period of Mr. Lukens’ Disability, prior to his termination of employment with the Company, he will continue to receive his Base Salary or Ancillary Term Compensation, as applicable, as if he were not Disabled until the term of the Employment Agreement has expired, subject to certain reductions for payments received as a result of such Disability.  Upon termination of Mr. Lukens’ employment for death or Disability, the Company will be obligated to pay a lump sum cash amount equal to the sum of (i) the Base Salary or Ancillary Term Compensation, as the case may be, through the Date of Termination (as defined in the Employment Agreement), (ii) any accrued vacation pay and (iii) any other amounts due to him as of the date of termination, in each case to the extent not yet paid (the “Accrued Obligation”), plus a pro rata portion to the Date of Termination of the aggregate value of the Discretionary Bonus based on certain specified assumptions and calculations (the “Pro-Rata Discretionary Bonus Payment”).

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If Mr. Lukens’ employment is terminated by the Company for Cause (as defined in the Employment Agreement) or by Mr. Lukens without Good Reason (as defined in the Employment Agreement), the term of the Employment Agreement will expire on the Date of Termination, the Company will pay Mr. Lukens the Accrued Obligation, and the Company will have no further obligations to Mr. Lukens other than as required by law or the terms of employee benefit plans or stock option plans of the Company.

If Mr. Lukens’ employment is terminated by the Company without Cause or by Mr. Lukens for Good Reason, then:

•the Company will pay Mr. Lukens the Accrued Obligation;

•the Company will pay to Mr. Lukens a lump sum amount equal to the Base Salary and Ancillary Term Compensation (at the rate in effect as of the Date of Termination) for the remainder of the Base Term and the Ancillary Term;

•all equity-based awards then held by Mr. Lukens will become fully vested and exercisable;

•the Company will continue to provide to Mr. Lukens benefits under the Company’s benefit plans and arrangements (other than equity compensation and bonus plans) in which he is entitled to participate, to the extent legally permitted until the end of the Term, subject to certain limitations and notifications;

•the termination of Mr. Lukens’ employment will be deemed a retirement under the 1988 Plan;

•the Company will pay to Mr. Lukens a lump sum cash amount equal to the aggregate value of the Discretionary Bonus that he would have earned as of the last day of the Base Term, assuming the achievement, at the expected value target level, of the performance goals established with respect to such award (it being understood that such amount is $750,000); and

•if Mr. Lukens’ employment is terminated before he has been granted the 2006 Option, then in lieu of granting such stock option the Company will pay to Mr. Lukens a lump sum cash payment equal to the Black-Scholes value, as reasonably determined by the Company as of February 1, 2006, of an option to purchase 5,000 shares of the Company’s Common Stock, assuming for this purpose the option was granted on February 1, 2006, the per share exercise price under the option is the fair market value of a share of the Company’s Common Stock on the date of Mr. Lukens’ termination and certain other specified terms and conditions (the “Cash Payment in Lieu of Option Grant”).

Mr. Lukens has agreed not to use or disclose confidential information obtained by him during his employment with the Company. In addition, during his employment and for a period of two years thereafter, Mr. Lukens has agreed not to solicit the Company’s employees, compete with the Company’s business or solicit the Company’s customers.

Lukens Severance Agreement

The Company entered into a Severance Agreement with Mr. Lukens dated February 1, 2004 (the “Prior Severance Agreement”).  On December 23, 2005, the Company entered into a Severance Agreement (the “Severance Agreement”), which supersedes the Prior Severance Agreement.  The Severance Agreement provides for payment of certain benefits to Mr. Lukens if his employment is terminated following a Change of Control (as defined in the Severance Agreement) of the Company.  The description below of the Severance Agreement does not purport to be complete and is qualified in its entirety by reference to the complete text of such agreement filed as Exhibit 10.2 to this Current Report on Form 8-K.

The Severance Agreement became effective December 23, 2005 and continues through February 1, 2007 (the “Severance Term”).  Pursuant to the Severance Agreement, the Company will pay severance benefits to Mr. Lukens if his employment is terminated following a Change of Control and during the Severance Term unless his employment is terminated by the Company for Cause (as defined in the Severance Agreement), by reason of death

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or Disability (as defined in the Severance Agreement), or by Mr. Lukens without Good Reason (as defined in the Severance Agreement).  If Mr. Lukens meets the criteria for payment of severance benefits due to termination of his employment following a Change of Control and during the Severance Term as described above, he will receive the following benefits:

•a lump sum cash payment equal to $2,250,000;

•continuation of life, disability, accident and health insurance benefits and all perquisites until February 1, 2010;

•notwithstanding any provision of his Employment Agreement, a lump sum cash payment equal to the aggregate value of the Discretionary Bonus that he would have earned as of the last day of the Base Term, assuming achievement, at the expected value target level, of the performance goals established with respect to such award (it being understood that amount being $750,000);

•the termination of Mr. Lukens’ employment will be deemed a retirement under the 1988 Plan; and

•if a Change in Control occurs prior to February 1, 2006, the Cash Payment in Lieu of Option Grant.

If any payment made by the Company to or for the benefit of Mr. Lukens would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended, the Company is required to pay Mr. Lukens an additional amount to cover any such taxes and any interest or penalties imposed with respect to such taxes.

Following a Change in Control and during the Severance Term: (i) during any period that Mr. Lukens fails to perform his duties as a result of incapacity due to physical or mental illness, he will continue to receive his salary, compensation and benefits payable to him during such period, until his employment is terminated by the Company for Disability (as defined in the Severance Agreement), (ii) if Mr. Lukens’ employment is terminated for any reason, Mr. Lukens will receive his salary through the Date of Termination (as defined in the Severance Agreement) and his normal post-termination compensation and benefits as such payments become due, and (iii) upon termination of Mr. Lukens’ employment due to death or Disability, Mr. Lukens shall receive the Accrued Obligation and the Pro-Rata Discretionary Bonus Payment. Upon a Change in Control, all stock options, restricted stock and all other equity incentives held by Mr. Lukens will become immediately vested, exercisable and nonforfeitable and all conditions thereof will be deemed to have been satisfied.

2006 Option

If the 2006 Option is granted, the per share exercise price of the 2006 Option will be the fair market value of a share of Company Common Stock on February 1, 2006 and the option will be fully exercisable on February 1, 2007.  The 2006 Option, if granted, would terminate upon the earliest to occur of (i) February 1, 2016, (ii) the 30th day after Mr. Lukens’ employment is terminated for any reason other than death, Disability, Retirement, or for Cause (as such terms are defined in the 1988 Plan), (iii) the first anniversary of the termination of Mr. Lukens’ employment due to death, Disability or Retirement, or (iv) the date of termination of Mr. Lukens’ employment for Cause. If Mr. Lukens’ employment is terminated for any reason other than death, Disability, Retirement or Cause, the 2006 Option would not continue to vest after such termination of employment; provided, that notwithstanding the foregoing vesting schedule, upon Mr. Lukens’ death, Disability or Retirement prior to the expiration of the 2006 Option, the 2006 Option will be exercisable in full. Further, notwithstanding the foregoing vesting schedule or any provision of the 1988 Plan, upon the occurrence of a Change in Control prior to the expiration of the 2006 Option, the 2006 Option will be exercisable in full, and upon the termination of Mr. Lukens’ employment other than for “cause” or by Mr. Lukens for “good reason” (as such terms are defined in the Employment Agreement) prior to the expiration of the 2006 Option, the 2006 Option will be exercisable in full.  Any termination of Mr. Lukens’ employment by the Company without “cause” or by Mr. Lukens for “good reason” (as such terms are defined in the Employment Agreement) prior to the expiration of the 2006 Option will be treated as a Retirement for all purposes of the 1988 Plan and the stock option agreement.

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Item 1.02.  Termination of a Material Definitive Agreement.

The Employment Agreement supersedes the Prior Employment Agreement, and the Severance Agreement supersedes the Prior Severance Agreement.  Please refer to Item 1.01 above.

Item 9.01.  Financial Statements and Exhibits.

(c)  Exhibits.

Exhibit Number	Description of Exhibit
10.1	Employment Agreement by and between Max L. Lukens and Stewart & Stevenson Services, Inc., effective as of December 23, 2005.
10.2	Severance Agreement by and between Max L. Lukens and Stewart & Stevenson Services, Inc., effective as of December 23, 2005.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

	STEWART & STEVENSON SERVICES, INC.
Dated: December 29, 2005	By:	/s/ John B. Simmons
	Name:		John B. Simmons
	Title:		Senior Vice President, Chief Financial
			Officer and Treasurer

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EXHIBIT INDEX

Exhibit Number	Description of Exhibit
10.1	Employment Agreement by and between Max L. Lukens and Stewart & Stevenson Services, Inc., effective as of December 23, 2005.
10.2	Severance Agreement by and between Max L. Lukens and Stewart & Stevenson Services, Inc., effective as of December 23, 2005.

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EX-10.1

Exhibit 10.1

EMPLOYMENT AGREEMENT

AGREEMENT, effective as of December 23, 2005 by and between Max L. Lukens (the “Executive”) and Stewart & Stevenson Services, Inc., a Texas corporation (the “Company”).

WHEREAS, the Executive and the Company are parties to that certain employment agreement, dated February 1, 2004 (the “2004 Agreement”); and

WHEREAS, the Compensation Committee of the Board (the “Compensation Committee”) has determined that the performance goals established with respect to the bonus described in Section 4(b) of the 2004 Agreement (the “Initial Bonus”) have been achieved; and

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

WHEREAS, in consideration of the Executive’s agreeing to enter into this Agreement and remain in the position of President and Chief Executive Officer of the Company through February 1, 2007, the Board has determined to accelerate the payment of the Initial Bonus;

WHEREAS, in order to effectuate the foregoing, the Company and Executive wish to enter into this Agreement on the terms and conditions set forth below; and

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

WHEREAS, the Company and the Executive have simultaneously herewith executed a Severance Agreement (the “Severance Agreement”);

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

1.Employment; Term.  The Company hereby agrees to employ the Executive, and the Executive hereby accepts such employment, on the terms and conditions hereinafter set forth.  The period of employment of the Executive by the Company hereunder (the “Employment Period”) shall commence on the date first written above (the “Effective Date”) and shall end on the Executive’s Date of Termination (as defined in Section 7(b) hereof).  The term of this Agreement (the “Term”) shall begin on the Effective Date and shall end on February 1, 2010.  The period beginning on the Effective Date and ending on February 1, 2007 is herein referred to as the “Base Term”, and the period beginning on February 1, 2007 and ending on February 1, 2010 is herein referred to as the “Ancillary Term”.

2.Position and Duties.  As of the Effective Date and for the Base Term, the Executive shall be employed by the Company as President and Chief Executive Officer of the Company, in which capacity the Executive shall perform the usual and customary duties of such

office, which shall be those normally inherent in such capacity in U.S. publicly held corporations of similar size and character.

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

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

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

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

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

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partner, consultant, employee or agent of any enterprise which is in competition with the Company or its dealers or distributors.

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

4.Compensation and Related Matters.

(a)Base Salary.  During the Base Term, the Company shall pay the Executive an annual base salary (“Base Salary”), payable in approximately equal installments in accordance with the Company’s customary payroll practices.  The Base Salary shall be $750,000.  The Base Salary may not be decreased during the Base Term.  During the Base Term, the Executive shall not be eligible for any equity compensation provided for or afforded to members of the Board of Directors as such.

(b)Bonuses.

(i)Initial Bonus.  As soon as practicable after the date hereof, but in no event later than December 31, 2005, the Company shall pay to the Executive a lump sum amount in cash equal to $1,500,000 in consideration of the achievement of the performance goals established with respect to the contingent bonus award contemplated by Section 4(b) of the 2004 Agreement.

(ii)Discretionary Bonuses.  At the end of the Base Term, the Executive shall be eligible for a discretionary bonus (the “Discretionary Bonus”) taking into account the following criteria: (A) return during the Base Term on net capital employed in the Company’s businesses on a consolidated basis; (B) the Company’s earnings per share during the Base Term; (C) the Company’s revenues during the Base Term; (D) the development of the Company’s management team so as to facilitate a succession plan to come into effect after the Base Term; (E) the successful winding down of the DES segment of the Company’s business and (F) meeting performance objectives for Automotive Technik (Holdings) Limited.

The Discretionary Bonus shall be paid as promptly as possible after the end of the Base Term, but in any event prior to April 1, 2007.   The Executive shall be eligible for a Discretionary Bonus of up to 100 (for target level performance) percent of his annual Base Salary during the Term (up to $750,000) but the actual amount thereof shall, in any event, be dependent upon the assessment of the members of the Compensation Committee and other members of the Board who are independent directors, in good faith, of his performance and contribution to the Company during the Base Term taking the above factors into account; provided, however, in the event there is a Change in Control as defined in the Severance Agreement, the Discretionary Bonus shall be $750,000, subject to the termination provisions of the Severance Agreement during the Term of the Severance Agreement.

(c)Ancillary Term Compensation.  During the Ancillary Term, the Executive, shall not be eligible for any equity compensation provided for or afforded to members of the Board of Directors as such.  During the Ancillary Term, the Company shall pay the Executive an

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annual salary of $35,000, payable in approximately equal installments in accordance with the Company’s customary payroll practices.  In the event the parties by mutual agreement increase the time the Executive shall provide services from that provided in Section 2, the Company shall pay the Executive an additional $6,250 per day for such services. The compensation to be paid to the Executive for his services during the Ancillary Term is herein referred to as the “Ancillary Term Compensation”.

(d)Stock Option.  If the Exective remains employed with the Company on February 1, 2006 (the “Grant Date”), the Executive will be granted an option to purchase 5,000 shares of the Company’s common stock under the Stewart & Stevenson Services, Inc. 1988 Nonstatutory Stock Option Plan, as amended and restated effective as of June 10, 1997 (the “1988 Option Plan”), which shall be subject to the terms and conditions thereof and of the stock option agreement with respect thereto as contemplated by the 1988 Option Plan.  The option agreement for such option shall contain the same terms as are specified in the Executive’s option agreement dated March 31, 2004; provided however that the per share exercise price applicable to such option shall be the fair market value of a share of the Company’s common stock on the Grant Date (determined in accordance with the terms of the 1988 Option Plan) and such option shall be fully exercisable on the first anniversary of the date of grant of such option.

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

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

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

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

5.Offices.  Subject to Sections 2, 3 and 4 hereof, during the Base Term the Executive agrees to serve without additional compensation, if elected or appointed thereto, as a director of any of the Company’s subsidiaries and as a member of any committees of the board of directors of any such corporations, and in one or more executive positions of any of the

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Company’s subsidiaries, provided that the Executive is indemnified for serving in any and all such capacities on a basis no less favorable than is currently, or may in the future be, provided to any other director or officer of the Company, any of its subsidiaries or in connection with any such executive position, as the case may be.

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

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

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

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

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

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

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

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

provided, that, the Executive shall have thirty (30) business days from the date on which the Executive receives the Company’s Notice of Termination for Cause under clause (ii) or (iii) above to remedy any such occurrence otherwise constituting Cause under such clause (ii) or (iii).  For purposes of clauses (ii) and (iii) of this definition, no act, or failure to act, on the Executive’s part shall be deemed to be “willful” unless done, or omitted to be done, by the Executive in bad faith and without reasonable belief that the Executive’s act, or failure to act, was in the best interest of the Company.

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

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

(i)the assignment to the Executive of any duties inconsistent with the Executive’s position (including status, office, title and reporting requirements), authorities, duties or other responsibilities as contemplated by Section 2 of this Agreement (it being understood that the Executive no longer serving as Chief Executive Officer of a publicly held United States corporation shall constitute Good Reason);

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

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

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

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

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

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7.Termination Procedure.

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

(b)Date of Termination.  “Date of Termination” shall mean (i) if the Executive’s employment is terminated pursuant to Section 6(a) above, the date of the Executive’s death, (ii) if the Executive’s employment is terminated pursuant to Section 6(b) above, thirty (30) days after the date Notice of Termination is given (provided that the Executive shall not have returned to the performance of his duties on a full-time basis during such thirty (30) day period), (iii) if the Executive’s employment is terminated pursuant to Section 6(c)(i) above, the date specified in the Notice of Termination, (iv) if the Executive’s employment is terminated pursuant to Section 6(c)(ii) or (iii) above, thirty (30) days after the date on which a Notice of Termination is given, (v) if the Executive’s employment is terminated for any other reason, the date specified in the Notice of Termination, which date shall be not earlier than thirty (30) days following the date on which Notice of Termination is given and not later than sixty (60) days following the date on which Notice of Termination is given; provided, however, that, if within ten (10) days after any Notice of Termination under Section 6(b),(c) or (d) is given the party receiving such Notice of Termination notifies the other party that a dispute exists concerning such termination, the Date of Termination shall be the date on which the dispute is finally determined, either by mutual written agreement of the parties, by a binding and final arbitration award or by a final judgment, order or decree of a court of competent jurisdiction (the time for appeal therefrom having expired and no appeal having been perfected).

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

8.Compensation upon Termination or During Disability.

(a)Accrued Obligation Defined.  For purposes of this Agreement, payment of the “Accrued Obligation” shall mean payment by the Company to the Executive (or his designated beneficiary or legal representative, as applicable), when due, of all vested benefits to which the Executive is entitled under the terms of the employee benefit plans in which the Executive is a participant as of the Date of Termination and a lump sum amount in cash equal to the sum of (i) the Executive’s Base Salary or Ancillary Term Compensation, as the case may be,

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through the Date of Termination, (ii) any accrued vacation pay and (iii) any other amounts due the Executive as of the Date of Termination, in each case to the extent not theretofore paid.

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

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

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

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

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

(ii)the Company shall pay to the Executive a lump sum amount equal to his Base Salary and Ancillary Term Compensation (at the rate in effect as of the Date of Termination) for the remainder of the Base Term and the Ancillary Term;

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

(iv)the Company shall continue to provide to the Executive the benefits described in Section 4(f), to the extent legally permitted, until the end of the Term (and the Executive shall, upon termination of health plan coverage under this Section and to the extent permitted by applicable law, have the right to elect COBRA continuation coverage under Section 4980B of the Code (“COBRA Coverage”)); provided that the benefits described in this Section 8(e)(iv) shall be reduced to the extent benefits of the same type are received by, or made available at no greater cost to, the Executive under any group plan, whether by reason of new employment, participation in

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a spouse’s plan or otherwise, during such period, and provided, further, that the Executive shall have the obligation to notify the Company that he is entitled to receive such benefits;

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

(vi)the Company shall pay to the Executive a lump sum amount, in cash, equal to the aggregate value of the Discretionary Bonus award contemplated by Section 4(b)(ii) that the Executive would have earned as of the last day of the Base Term, assuming the achievement, at the expected value target level, of the performance goals established with respect to such award (it being understood that such amount is $750,000); and

(vii)if the Executive’s employment is terminated before he has been granted the stock option contemplated by Section 4(d), then in lieu of granting such stock option the Company shall pay to the Executive a lump sum payment, in cash, equal to the Black-Scholes value, as reasonably determined by the Company as of February 1, 2006, of an option to purchase 5,000 shares of the Company’s common stock, assuming for this purpose the option was granted on February 1, 2006, the per share exercise price under the option is the fair market value of a share of the Company’s common stock on the date of Executive’s termination, the option has the same terms and conditions as applied to the option granted by the Company to the Executive on March 31, 2004 (other than the number of shares subject to the option), and the option remains outstanding for the full ten year term; and utilizing the risk free interest rate, dividend yield, and expected volatility assumptions used by the Company for purposes of valuing stock options for its 2005 fiscal year as reflected in its fiscal year 2005 Form 10-K filed with the Securities and Exchange Commission.

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

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

(a)Confidential Information.  The Executive shall hold in a fiduciary capacity for the benefit of the Company all trade secrets,  and information, knowledge or data relating to the Company and its businesses treated as confidential by the Company, which shall have been obtained by the Executive during the Executive’s employment by the Company and which shall not have been or hereafter become public knowledge (other than by acts by the Executive or

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

(b)Non-Competition.  During the Employment Period and for a period of two (2) years following the Date of Termination (such period following the Employment Period, the “Restricted Period”), the Executive shall not engage in Competition, as defined below, with the Company; provided, that it shall not be a violation of this Section 9(b) for the Executive to become the registered or beneficial owner of up to one percent (1%) of any class of the capital stock of a corporation registered under the Securities Exchange Act of 1934, as amended, provided that the Executive does not actively participate in the business of such corporation until such time as this covenant expires.

For purposes of this Agreement, Competition by the Executive shall mean the Executive’s engaging in, or otherwise directly or indirectly being employed by or acting as a consultant or lender to, or being a director, officer, employee, principal, agent, stockholder, member, owner or partner of, or permitting his name to be used in connection with the activities of any other business or organization which competes, directly or indirectly, with the business of the Company as the same shall be constituted at any time during the Employment Period.

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

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

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

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

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

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

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

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

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

11.Successors; Binding Agreement.

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

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

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

If the Executive: At the last address on the books and records of the Company

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

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

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

14.Arbitration.  Any dispute or controversy arising out of or relating to this Agreement, including without limitation, any and all disputes, claims (whether in tort, contract, statutory or otherwise), breaches or disagreements concerning the interpretation or application of the provisions of this Agreement shall be resolved by arbitration before a panel of three arbitrators and administered by the American Arbitration Association (“AAA”) under its Rules For Resolution Of Employment Disputes then in effect.   Within ten (10) business days of the initiation of an arbitration hereunder, the Company and the Executive will each separately designate an arbitrator, and within twenty (20) business days of selection, the appointed arbitrators will appoint a neutral arbitrator.  All arbitrators shall be members of the National Panel of Employment Arbitrators maintained by the AAA.  The arbitrators shall issue their written decision (including a statement of finding of facts) within thirty (30) days from the date of the close of the arbitration hearing.  The decision of the arbitrators selected hereunder will be final and binding on both parties.  This arbitration provision is expressly made pursuant to and shall be governed by the Federal Arbitration Act, 9 U.S.C. Sections 1-16 (or replacement or

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successor statute).  Pursuant to Section 9 of the Federal Arbitration Act, the Company and the Executive agree that a judgment of the United States District Court for the Southern District of Texas may be entered upon the award made pursuant to the arbitration.  The Company shall pay to the Executive all reasonable legal fees and expenses, when incurred by the Executive, in contesting or disputing any termination of employment or seeking to obtain or enforce any right, payment or benefit provided by this Agreement, regardless of outcome, unless a final decision is rendered that such claim was not brought by the Executive in good faith.

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

16.Miscellaneous.  All references to sections of any statute shall be deemed also to refer to any successor provisions to such sections.  The obligations of the parties under Sections 4, 8, 9, 10, 11, 12, 14, 15, 16, 17, 18, 19 and 20 hereof shall survive the expiration of the Term to the extent they may be applicable by their terms.  The compensation and benefits payable to the Executive or his beneficiary under Section 8 of this Agreement shall be in lieu of any other severance benefits to which the Executive may otherwise be entitled upon his termination of employment under any severance plan, program, policy, practice or arrangement of the Company other than the Severance Agreement, and the Executive shall not be entitled to receive any benefits under Section 8(e) hereof if he is eligible to receive benefits under the Severance Agreement (it being understood that upon the expiration of the Term of the Severance Agreement prior to the Executive’s termination of employment with the Company for any reason, Executive may thereafter claim benefits under this Agreement).

17.SECTION 409A OF THE CODE.  To the extent that any payment or benefit under this Agreement would be deemed to be deferred compensation subject to the requirements of Section 409A of the Code that does not comply with such requirements, the Company and the Executive shall amend this Agreement (in a manner that as closely as practicable achieves the original intent of this Agreement) so that such payment or benefit will be made in accordance with such requirements.  Without limiting the generality of the foregoing, in the event that it is determined that any payment pursuant to Sections 7 and 8 that is to otherwise be made upon or shortly following termination of employment cannot be made prior to the six-month anniversary of such termination because the Executive is a “key employee” (as defined in Section 1.409A-1(i)(1) of the regulations under Section 409A of the Code), such payment shall be paid on the first business day following such six-month anniversary.  To the extent that the benefits to be provided to the Executive under Section 8(e)(iv) are so delayed, the Company shall use its reasonable best efforts to provide that such benefits shall be reinstated as if in effect as of the date of Executive’s termination (e.g., for purposes of any pre-existing condition) immediately following the six month anniversary of Executive’s termination of employment.  The parties agree that the Executive shall be entitled to COBRA Coverage during the six month period following the date of Executive’s termination, and the Company agrees to reimburse the Executive for any Company portions of such COBRA Coverage which the Company is obligated to pay pursuant to this Agreement in the seventh month following the Date of Termination.

18.Severability.  The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect throughout the Term.  Should any one or

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more of the provisions of this Agreement be held to be excessive or unreasonable as to duration, geographical scope or activity, then that provision shall be construed by limiting and reducing it so as to be reasonable and enforceable to the extent compatible with the applicable law.

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

20.Entire Agreement.  This Agreement sets forth the entire agreement of the parties hereto in respect of the subject matter contained herein and, as of the Effective Date, supersedes all prior agreements (including, without limitation, the 2004 Agreement), promises, covenants, arrangements, communications, representations or warranties, whether oral or written, by any officer, employee or representative of any party hereto; provided, however, that the Executive’s stock option agreements and Severance Agreement shall not be superseded hereby but shall remain in full force and effect.

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

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

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EXHIBIT A

RELEASE

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

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

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

AGREED AND ACCEPTED, on this            day of                             , 20   .

EX-10.2

Exhibit 10.2

SEVERANCE AGREEMENT

THIS AGREEMENT, effective as of December 23, 2005, is made by and between Stewart & Stevenson Services, Inc., a Texas corporation (the “Company”), and Max L. Lukens (the “Executive”).

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

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

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

WHEREAS, the Executive and the Company are parties to that certain severance agreement, dated February 1, 2004 (the “2004 Agreement”);

WHEREAS, simultaneously herewith, the Company and the Executive have entered into a new Employment Agreement with the Executive (the “Employment Agreement”) that extends the term of the Executive’s employment with the Company;

WHEREAS, in order to continue to effectuate the foregoing, the Company and Executive wish to enter into this Agreement on the terms and conditions set forth below;

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 Section 14 hereof.

2.Term of Agreement.  The Term of this Agreement shall commence on the date hereof and shall continue in effect through February 1, 2007.

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 termination of the Executive’s employment due to the Executive’s death or Disability following a Change in Control and during the Term, the Company shall, within thirty (30) days pay to the Executive (or his designated beneficiary or legal representative, if applicable) (A) the Accrued Obligation (as defined in the Employment Agreement), and (B) a lump sum amount, in cash, equal to the product of (i) the Discretionary Bonus (as defined in the Employment Agreement) and (ii) the fraction obtained by dividing the number of full days during the Base Term (as defined in the Employment Agreement) through the Date of Termination by the total number of days contained in the Base Term.

4.5Upon the occurrence of a Change in Control all options to acquire shares of Company stock, all shares of restricted Company stock and all other equity incentives held by the Executive under any plan of the Company (including, but not limited to, the Company’s various stock option plans) shall become immediately vested, exercisable and nonforfeitable and all conditions thereof (including, but not limited to, any required holding periods) shall be deemed to have been satisfied.

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5.Severance.

5.1If the Executive’s employment is terminated following a Change in Control and during the Term, other than (x) by the Company for Cause, (y) by reason of death or Disability, or (z) by the Executive without Good Reason, then, the Company shall pay the Executive the amounts, and provide the Executive the benefits, described in this Section 5.1 (“Severance Payments”) and Section 5.2, in addition to any payments and benefits to which the Executive is entitled under Section 4 hereof.  Solely for purposes of determining whether termination occurred following a Change in Control pursuant to this Agreement (and without any implication that a Change in Control has in fact occurred), the Executive’s employment shall be deemed to have been terminated following a Change in Control by the Company without Cause or by the Executive with Good Reason, if (i) the Executive’s employment is terminated by the Company without Cause prior to a Change in Control and such termination was at the request, direction or suggestion, directly or indirectly, of a Person who has entered into an agreement or who 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 $2,250,000.

(B)Until February 1, 2010, the Company shall arrange to provide the Executive and his dependents life, disability, accident and health and medical 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 medical and health benefits shall be provided through the Company’s (or any successor to its business and/or assets) group health plan.  Upon the termination of health plan coverage under this Section 5.1(B) and to the extent permitted by applicable law, the Executive shall have the right to elect COBRA continuation coverage under Section 4980B of the Code (“COBRA Coverage”). 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

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plan whether by reason of the employment of the Executive or the employment of the spouse of the Executive prior to February 1, 2010 (and any such benefits received by or made available to the Executive shall be reported to the Company by the Executive); provided, however, that the Company shall reimburse the Executive for the excess, if any, of the cost of such benefits to the Executive over such cost immediately prior to the Date of Termination or, if more favorable to the Executive, the first occurrence of an event or circumstance constituting Good Reason.

(C)Notwithstanding any provision of that certain Employment Agreement between the Company and the Executive effective as of even date herewith (the “Employment Agreement”), the Company shall pay to the Executive a lump sum amount, in cash, equal to the aggregate value of the Discretionary Bonus contemplated by Section 4(b)(ii) of the Employment Agreement that the Executive would have earned as of the last day of the Base Term (as defined in the Employment Agreement), assuming the achievement, at the expected value target level ($750,000), of the performance goals established with respect to such award (it being understood that amount being $750,000).

(D)The committee (as defined by the Stewart & Stevenson Services, Inc. 1988 Nonstatutory Stock Option Plan) shall deem the Executive’s termination of employment as a retirement for purposes of the Stewart & Stevenson Services, Inc. 1988 Nonstatutory Stock Option Plan.

(E)If a Change in Control occurs prior to February 1, 2006, the Company shall pay to the Executive a lump sum payment, in cash, equal to the Black-Scholes value, as reasonably determined by the Company as of the date of the Change of Control, of an option to purchase 5,000 shares of the Company’s common stock, assuming for this purpose the option was granted on February 1, 2006, the per share exercise price under the option is the fair market value of a share of common stock on the date of the Executive’s termination of employment, the option has the same terms and conditions as applied to the option granted by the Company to the Executive on March 31, 2004 (other than the number of shares subject to the option), and the option remains outstanding for the full ten year term; and utilizing the risk free interest rate, dividend yield, and expected volatility assumptions used by the Company for purposes of valuing stock options for its 2005 fiscal year as reflected in its fiscal year 2005 Form 10-K filed with the Securities and Exchange Commission.

5.2(A)  Anything in this Agreement to the contrary notwithstanding and except as set forth below, in the event it shall be determined that any Payment would be subject to the Excise Tax, then the Executive shall be entitled to receive an additional payment (the “Gross-Up Payment”) in an amount such that, after payment by the Executive of all taxes (and any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax (and any interest and penalties with respect thereto) imposed upon the Payments.  The Company’s obligation to make Gross-Up Payments under this Section 5.2 shall not be conditioned upon the Executive’s termination of employment.

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(B)Subject to the provisions of Section 5.2(C), all determinations required to be made under this Section 5.2, including whether and when a Gross-Up Payment is required, the amount of such Gross-Up Payment and the assumptions to be utilized in arriving at such determination, shall be made by the Auditor, or such other nationally recognized certified public accounting firm as may be designated by the Executive (the “Accounting Firm”).  The Accounting Firm shall provide detailed supporting calculations both to the Company and the Executive within 15 business days of the receipt of notice from the Executive that there has been a Payment or such earlier time as is requested by the Company.  In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group effecting the Change of Control, the Executive may appoint another nationally recognized accounting firm to make the determinations required hereunder (which accounting firm shall then be referred to as the Accounting Firm hereunder).  All fees and expenses of the Accounting Firm shall be borne solely by the Company.  Any Gross-Up Payment, as determined pursuant to this Section 5.2, shall be paid by the Company to the Executive within 5 days of the receipt of the Accounting Firm’s determination.  Any determination by the Accounting Firm shall be binding upon the Company and the Executive.  As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments that will not have been made by the Company should have been made (the “Underpayment”), consistent with the calculations required to be made hereunder.  In the event the Company exhausts its remedies pursuant to Section 5.2(C) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive.

(C)The Executive shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Gross-Up Payment.  Such notification shall be given as soon as practicable, but no later than 10 business days after the Executive is informed in writing of such claim.  The Executive shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid.  The Executive shall not pay such claim prior to the expiration of the 30-day period following the date on which the Executive gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due).  If the Company notifies the Executive in writing prior to the expiration of such period that the Company desires to contest such claim, the Executive shall:

(I)give the Company any information reasonably requested by the Company relating to such claim,

(II)take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company,

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(III)cooperate with the Company in good faith in order effectively to contest such claim, and

(IV)permit the Company to participate in any proceedings relating to such claim;

provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest, and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties) imposed as a result of such representation and payment of costs and expenses.  Without limitation on the foregoing provisions of this Section 5.2(C), the Company shall control all proceedings taken in connection with such contest, and, at its sole discretion, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the applicable taxing authority in respect of such claim and may, at its sole discretion, either pay the tax claimed to the appropriate taxing authority on behalf of the Executive and direct the Executive to sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however, that, if the Company pays such claim and directs the Executive to sue for a refund, the Company shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax (including interest or penalties) imposed with respect to such payment or with respect to any imputed income in connection with such payment; and provided, further, that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount.  Furthermore, the Company’s control of the contest shall be limited to issues with respect to which the Gross-Up Payment would be payable hereunder, and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority.

(D)If, after the receipt by the Executive of a Gross-Up Payment or payment by the Company of an amount on the Executive’s behalf pursuant to Section 5.2(C), the Executive becomes entitled to receive any refund with respect to the Excise Tax to which such Gross-Up Payment relates or with respect to such claim, the Executive shall (subject to the Company’s complying with the requirements of Section 5.2(C), if applicable) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto).  If, after payment by the Company of an amount on the Executive’s behalf pursuant to Section 5.2(C), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and the Company does not notify the Executive in writing of its intent to contest such denial of refund prior to the expiration of 30 days after such determination, then the amount of such payment shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid.

(E)Notwithstanding any other provision of this Section 5.2, the Company may, in its sole discretion (but only pursuant to a good faith interpretation of

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statutes regarding an employer’s duty to withhold tax obligations and remit same directly to the taxing authority), withhold and pay over to the Internal Revenue Service or any other applicable taxing authority, for the benefit of the Executive, all or any portion of any Gross-Up Payment, and the Executive hereby consents to such withholding.

5.3If the Executive’s employment with the Company is terminated following a Change in Control and during the Term, the Company shall pay to the Executive all legal fees and expenses incurred by the Executive in disputing in good faith any issue hereunder relating to the termination of the Executive’s employment, in seeking in good faith to obtain or enforce any benefit or right provided by this Agreement or in connection with any tax audit or proceeding to the extent attributable to the application of section 4999 of the Code to any payment or benefit provided hereunder.  Such payments shall be made within five (5) business days after delivery of the Executive’s written requests for payment accompanied with such evidence of fees and expenses incurred as the Company reasonably may require.

6.Termination Procedures and Compensation During Dispute.

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

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

6.3Dispute Concerning Termination.  If within fifteen (15) days after any Notice of Termination is given following a Change in Control, or, if later, prior to the Date of Termination (as determined without regard to this Section 6.3), the party receiving such Notice of Termination notifies the other party that a dispute exists concerning the termination, the Date of Termination shall be extended until the earlier of (i) the date on which the Term ends or

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(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.

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

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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 last address on the books and records of the Company 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 (including, without limitation, the 2004 Agreement), with respect to the subject matter hereof which have been made by either party, provided, however, that this Agreement shall supersede any agreement setting forth the terms and conditions of the Executive’s employment with the Company only in the event that the Executive’s employment with the Company is terminated on or following a Change in Control, by the Company other than for Cause or by the Executive 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.  Notwithstanding the foregoing, the Executive’s covenants set forth in Section 9 of the Employment Agreement shall not be superseded by this Agreement but shall remain in full force and effect in the event that the Executive’s employment with the Company terminates on or following a Change in Control.  The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of Texas.  All references to sections of the Exchange Act or the Code shall be deemed also to refer to any successor provisions to such sections.  Any payments provided for hereunder shall be paid net of any applicable withholding required under federal, state or local law and any additional withholding to which the Executive has agreed.  The obligations of the Company and the Executive under this Agreement which by their nature may require either partial or total performance after the expiration of the Term (including, without limitation, those under Sections 5 and 6 hereof) shall survive such expiration.

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

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

13.Settlement of Disputes; Arbitration.

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

13.2Any further dispute or controversy arising out of or relating to this Agreement, including without limitation, any and all disputes, claims (whether in tort, contract, statutory or otherwise), breaches or disagreements concerning the interpretation or application of the provisions of this Agreement shall be resolved by arbitration before a panel of three arbitrators and administered by the American Arbitration Association (“AAA”) under its Rules For Resolution Of Employment Disputes 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 Employment Arbitrators maintained by the AAA.  The arbitrators shall issue their written decision (including a statement of finding of facts) within thirty (30) days from the date of the close of the arbitration hearing.  The decision of the arbitrators selected hereunder will be final and binding on both parties.  This arbitration provision is expressly made pursuant to and shall be governed by the Federal Arbitration Act, 9 U.S.C. Sections 1-16 (or replacement or successor statute).  Pursuant to Section 9 of the Federal Arbitration Act, the Company and the Executive agree that a judgment of the United States District Court for the Southern District of Texas may be entered upon the award made pursuant to the arbitration.

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

(A)“Accounting Firm” has the meaning set forth in Section 5.2(B) hereof.

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(B)“Accrued Obligation” has the meaning set forth in Section 8(a) of the Employment Agreement.

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

(D)“Auditor” shall mean the accounting firm which was, immediately prior to the Change in Control, the Company’s independent auditor.

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

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

(G)“Business Combination” has the meaning set forth in Section 14(F)(III) hereof.

(H)“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 in bad 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.

(I)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)The acquisition by any Person of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 35% or more of either (A) the then-outstanding shares of common stock of the Company (the “Outstanding Company Common Stock”) or (B) the combined voting power of the then-outstanding voting securities of the Company entitled to vote generally in the election of directors (the “Outstanding Company Voting Securities”); provided, however, that, for purposes of this Section 14(F), the following acquisitions shall not constitute a Change of Control:  (i) any

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acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any Affiliated Company or (iv) any acquisition by any corporation pursuant to a transaction that complies with Sections 14(F)(III)(A), 14(F)(III)(B) and 14(F)(III)(C);

(II)Any time at which individuals who, as of the date hereof, constitute the Board (the “Incumbent Board”) cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company’s stockholders, was approved by a vote of at least two thirds (2/3) of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or

(III)Consummation of a reorganization, merger, statutory share exchange or consolidation or similar corporate transaction involving the Company or any of its subsidiaries, a sale or other disposition of all or substantially all of the assets of the Company, or the acquisition of assets or stock of another entity by the Company or any of its subsidiaries (each, a “Business Combination”), in each case unless, following such Business Combination, (A) all or substantially all of the individuals and entities that were the beneficial owners of the Outstanding Company Common Stock and the Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 50% of the then-outstanding shares of common stock and the combined voting power of the then-outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation that, as a result of such transaction, owns the Company or all or substantially all of the Company’s assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership immediately prior to such Business Combination of the Outstanding Company Common Stock and the Outstanding Company Voting Securities, as the case may be, (B) no Person (excluding any corporation resulting from such Business Combination or any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 35% or more of, respectively, the then-outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then-outstanding voting securities of such corporation, except to the extent that such ownership existed prior to the Business Combination, and (C) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement or of the action of the Board providing for such Business Combination; or

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(IV)Approval by the stockholdersof the Company of a complete liquidation or dissolution of the Company.

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

(K)“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).

(L)“Company” shall mean Stewart & Stevenson Services, Inc. and, except in determining under Section 14(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.

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

(N)“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.

(O)“Excise Tax” shall mean the excise tax imposed by Section 4999 of the Code, together with any interest or penalties imposed with respect to such excise tax.

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

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

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

(S)“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

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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 (including, without limitation, that the Executive no longer serves as the Chief Executive Officer of a public company);

(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;

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(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.

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

(U)“Incumbent Board” has the meaning set forth in Section 14(F)(II) hereof.

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

(W)“Outstanding Company Common Stock” has the meaning set forth in Section 14(F)(I) hereof.

(X)“Outstanding Company Voting Stock” has the meaning set forth in Section 14(F)(I) hereof.

(Y)“Payment” shall mean any payment or distribution in the nature of compensation (within the meaning of Section 280G(b)(2) of the Code) to or for the benefit of the Executive, whether paid or payable pursuant to this Agreement or otherwise.

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(Z)“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.

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

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

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

15.Section 409A of the Code.  To the extent that any payment or benefit under this Agreement would be deemed to be deferred compensation subject to the requirements of Section 409A of the Code that does not comply with such requirements, the Company and the Executive shall amend this Agreement (in a manner that as closely as practicable achieves the original intent of this Agreement) so that such payment or benefit will be made in accordance with such requirements.  Without limiting the generality of the foregoing, in the event that it is determined that any payment pursuant to Sections 4 or 5 that is to otherwise be made upon or shortly following termination of employment cannot be made prior to the six-month anniversary of such termination because the Executive is a “key employee” (as defined in Section 1.409A-1(i)(1) of the Code), such payment shall be paid on the first business day following such six-month anniversary.  To the extent that the benefits to be provided to the Executive under Section 8(e)(iv) are so delayed, the Company shall use its reasonable best efforts to provide that such benefits shall be reinstated as if in effect as of the date of Executive’s termination (e.g., for purposes of any pre-existing condition) immediately following the six month anniversary of Executive’s termination of employment.  The parties agree that the Executive shall be entitled to COBRA Coverage during the six month period following the date of Executive’s termination, and the Company agrees to reimburse the Executive for any Company portions of such COBRA Coverage which the Company is obligated to pay pursuant to this Agreement in the seventh month following the Date of Termination.

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

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

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