**UNITED STATES********SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

** **

**FORM 10-Q**

** **

**(Mark One)**

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

** **

**For the quarterly period ended October 30, 2004**

 

**OR**

 

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

 

**For the transition period from                to                **

 

**Commission file number 0-8493**

 

**STEWART & STEVENSON SERVICES, INC.**

(Exact name of registrant as specified in itscharter)

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

 

**(713) 868-7700**

(Registrant’s telephone number, including area code)

 

**not applicable**

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months(or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.    Yes ý    Noo

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).    Yes ý    Noo

 

Numberof shares outstanding of each of the registrant’s classes of common stock, asof November 29, 2004:

 

**Common Stock, without Par Value:  28,786,398 Shares**

 

 

----

 

# **PARTI. FINANCIAL INFORMATION**

# ** **

**Item 1.  FinancialStatements**

 

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

 
| Consolidated  Condensed Balance Sheets – October 30, 2004 and January 31, 2004.                                        |   |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                  |   |
| Consolidated  Condensed Statements of Operations – Three and Nine Months Ended October 30,  2004 and November 1, 2003. |   |
|                                                                                                                                  |   |
| Consolidated  Condensed Statements of Cash Flows – Three and Nine Months Ended October 30,  2004 and November 1, 2003. |   |
|                                                                                                                                  |   |
| Notes  to Consolidated Condensed Financial Statements.                                                                                |   |

 

2

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**STEWART & STEVENSON SERVICES, INC. ANDSUBSIDIARIES**

**CONSOLIDATED CONDENSED BALANCE SHEETS**

*(In thousands, except share data)*

 
| ** **                                                                                                              | ** ** | **October 30, 2004** | ** ** | **January 31, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                                                              | ** ** | **(Unaudited)**           | ** ** | ** **                | ** ** |
| Assets                                                                                                                  |       |                      |       |                      |       |
| Current Assets:                                                                                                         |       |                      |       |                      |       |
| Cash and cash equivalents                                                                                               |       | $                         | 75,599     |                      | $          | 53,959 |   |
| Short-term investments                                                                                                  |       | 7,430                     |       | 7,745                     |       |
| Accounts receivable, net                                                                                                |       | 130,086                   |       | 150,102                   |       |
| Recoverable costs and accrued profits not  yet billed                                                                   |       | 25,863                    |       | 21,653                    |       |
| Inventories                                                                                                             |       | 140,185                   |       | 146,277                   |       |
| Excess of current cost over LIFO values                                                                                 |       | (42,546                   | )          | (41,311                   | )          |
| Deferred income tax asset                                                                                               |       | 23,548                    |       | 20,349                    |       |
| Income tax receivable                                                                                                   |       | 8,594                     |       | 25,846                    |       |
| Other current assets                                                                                                    |       | 6,250                     |       | 17,240                    |       |
| Total assets of discontinued operations                                                                                 |       | 69,373                    |       | 44,715                    |       |
| Total Current Assets                                                                                                    |       | 444,382                   |       | 446,575                   |       |
|                                                                                                                    |       |                      |       |                      |       |
| Property, Plant and Equipment, net                                                                                      |       | 124,382                   |       | 135,417                   |       |
| Deferred Income Tax Asset                                                                                               |       | 5,533                     |       | 12,205                    |       |
| Intangibles and Other Assets, net                                                                                       |       | 9,411                     |       | 9,263                     |       |
| Total Assets                                                                                                            |       | $                         | 583,708    |                      | $          | 603,460 |   |
|                                                                                                                    |       |                      |       |                      |       |
| Liabilities and Shareholders’ Equity                                                                               |       |                      |       |                      |       |
| Current Liabilities:                                                                                                    |       |                      |       |                      |       |
| Notes payable                                                                                                           |       | $                         | 1,512      |                      | $          | 1,932 |   |
| Current portion of long-term debt                                                                                       |       | 250                       |       | 250                       |       |
| Accounts payable                                                                                                        |       | 66,337                    |       | 67,996                    |       |
| Accrued payrolls and incentives                                                                                         |       | 21,791                    |       | 17,445                    |       |
| Billings in excess of incurred costs                                                                                    |       | 35,173                    |       | 69,376                    |       |
| Estimated losses on uncompleted contracts                                                                               |       | 6,611                     |       | 16,306                    |       |
| Other current liabilities                                                                                               |       | 47,645                    |       | 41,164                    |       |
| Total liabilities of discontinued  operations                                                                           |       | 27,578                    |       | 8,472                     |       |
| Total Current Liabilities                                                                                               |       | 206,897                   |       | 222,941                   |       |
|                                                                                                                    |       |                      |       |                      |       |
| Long-Term Debt, net of current portion                                                                                  |       | 25,883                    |       | 26,260                    |       |
| Accrued Postretirement Benefits and Pension                                                                             |       | 42,622                    |       | 52,056                    |       |
| Other Long-Term Liabilities                                                                                             |       | 3,724                     |       | 4,720                     |       |
| Total Liabilities                                                                                                       |       | 279,126                   |       | 305,977                   |       |
| Shareholders’ Equity:                                                                                              |       |                      |       |                      |       |
| Common stock, without par value,  100,000,000 shares authorized; 28,780,273 and 28,644,510 shares issued,  respectively |       | 58,733                    |       | 57,056                    |       |
| Accumulated other comprehensive loss                                                                                    |       | (26,173                   | )          | (25,534                   | )          |
| Retained earnings                                                                                                       |       | 272,022                   |       | 265,961                   |       |
| Total Shareholders’ Equity                                                                                         |       | 304,582                   |       | 297,483                   |       |
| Total Liabilities and Shareholders’ Equity                                                                         |       | $                         | 583,708    |                      | $          | 603,460 |   |

 

*See accompanying notes to consolidated condensedfinancial statements.*

 

3

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**STEWART & STEVENSON SERVICES, INC. ANDSUBSIDIARIES**

**CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS**

*(In thousands, except per share data)*

 
| ** **                                                                                          | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                                          | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
| ** **                                                                                          | ** ** | **(Unaudited)**           | ** ** | **(Unaudited)**           | ** ** |
|                                                                                                |       |                      |       |                      |       |   |   |   |   |
| Sales                                                                                               |       | $                         | 291,160    |                      | $          | 275,660 |   | $ | 864,961 |   | $ | 845,687 |   |
| Cost of sales                                                                                       |       | 254,686                   |       | 255,625                   |       | 755,349 |   | 747,717 |   |
|                                                                                                |       |                      |       |                      |       |   |   |   |   |
| Gross profit                                                                                        |       | 36,474                    |       | 20,035                    |       | 109,612 |   | 97,970 |   |
|                                                                                                |       |                      |       |                      |       |   |   |   |   |
| Selling and administrative expenses                                                                 |       | 25,966                    |       | 38,072                    |       | 80,813 |   | 103,809 |   |
| Pension curtailment expense                                                                         |       | —                    |       | —                    |       | — |   | 2,400 |   |
| Other income, net                                                                                   |       | (1,270                    | )          | (51                       | )          | (3,944 | ) | (530 | ) |
|                                                                                                |       |                      |       |                      |       |   |   |   |   |
| Operating profit (loss)                                                                             |       | 11,778                    |       | (17,986                   | )          | 32,743 |   | (7,709 | ) |
|                                                                                                |       |                      |       |                      |       |   |   |   |   |
| Interest expense                                                                                    |       | 534                       |       | 640                       |       | 1,487 |   | 2,576 |   |
| Interest income                                                                                     |       | (411                      | )          | (142                      | )          | (997 | ) | (1,201 | ) |
|                                                                                                |       |                      |       |                      |       |   |   |   |   |
| Earnings (loss) from continuing operations  before income taxes                                     |       | 11,655                    |       | (18,484                   | )          | 32,253 |   | (9,084 | ) |
| Income tax expense (benefit)                                                                        |       | 3,280                     |       | (7,205                    | )          | 10,766 |   | (4,320 | ) |
| Net earnings (loss) from continuing  operations                                                     |       | 8,375                     |       | (11,279                   | )          | 21,487 |   | (4,764 | ) |
| Loss from discontinued operations, net of  tax benefit of ($5,207), ($2,712), ($6,182) and ($4,278) |       | (6,292                    | )          | (4,162                    | )          | (8,085 | ) | (6,772 | ) |
| Net earnings (loss)                                                                                 |       | $                         | 2,083      |                      | $          | (15,441 | ) | $ | 13,402 |   | $ | (11,536 | ) |
|                                                                                                |       |                      |       |                      |       |   |   |   |   |
| Weighted average shares outstanding:                                                                |       |                      |       |                      |       |   |   |   |   |
| Basic                                                                                               |       | 28,768                    |       | 28,600                    |       | 28,729 |   | 28,538 |   |
| Diluted                                                                                             |       | 29,186                    |       | 28,600                    |       | 29,100 |   | 28,538 |   |
|                                                                                                |       |                      |       |                      |       |   |   |   |   |
| **Earnings  (loss) per share:**                                                                     |       |                      |       |                      |       |   |   |   |   |
| Basic:                                                                                              |       |                      |       |                      |       |   |   |   |   |
| Continuing operations                                                                               |       | $                         | 0.29       |                      | $          | (0.39 | ) | $ | 0.75 |   | $ | (0.17 | ) |
| Discontinued operations                                                                             |       | (0.22                     | )          | (0.15                     | )          | (0.28 | ) | (0.23 | ) |
| Net earnings (loss) per share                                                                       |       | $                         | 0.07       |                      | $          | (0.54 | ) | $ | 0.47 |   | $ | (0.40 | ) |
|                                                                                                |       |                      |       |                      |       |   |   |   |   |
| Diluted:                                                                                            |       |                      |       |                      |       |   |   |   |   |
| Continuing operations                                                                               |       | $                         | 0.29       |                      | $          | (0.39 | ) | $ | 0.74 |   | $ | (0.17 | ) |
| Discontinued operations                                                                             |       | (0.22                     | )          | (0.15                     | )          | (0.28 | ) | (0.23 | ) |
| Net earnings (loss) per share                                                                       |       | $                         | 0.07       |                      | $          | (0.54 | ) | $ | 0.46 |   | $ | (0.40 | ) |
|                                                                                                |       |                      |       |                      |       |   |   |   |   |
| Cash dividends per share                                                                            |       | $                         | 0.085      |                      | $          | 0.085 |   | $ | 0.255 |   | $ | 0.255 |   |

 

*See accompanying notes to consolidatedcondensed financial statements.*

 

4

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**STEWART & STEVENSON SERVICES, INC. ANDSUBSIDIARIES**

**CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS**

*(In thousands)*

 
| ** **                                                                                                             | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                                                             | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
| ** **                                                                                                             | ** ** | **(Unaudited)**           | ** ** | **(Unaudited)**           | ** ** |
| **Operating  Activities**                                                                                              |       |                      |       |                      |       |   |   |   |   |
| Net earnings (loss)                                                                                                    |       | $                         | 2,083      |                      | $          | (15,441 | ) | $ | 13,402 |   | $ | (11,536 | ) |
| Adjustments to reconcile net earnings  (loss) to net cash provided by operating activities:                            |       |                      |       |                      |       |   |   |   |   |
| Net loss from discontinued operations                                                                                  |       | 6,292                     |       | 4,162                     |       | 8,085 |   | 6,772 |   |
| Deferred tax expense (benefit)                                                                                         |       | (2,471                    | )          | 2,513                     |       | 3,734 |   | 82 |   |
| Provision for excess and obsolete inventory                                                                            |       | —                    |       | 4,700                     |       | — |   | 4,700 |   |
| Depreciation and amortization                                                                                          |       | 7,679                     |       | 7,403                     |       | 22,268 |   | 21,609 |   |
| Gain on sale of assets, net                                                                                            |       | (760                      | )          | —                    |       | (2,604 | ) | — |   |
| Change in operating assets and liabilities  net of the effect of acquisition, divestiture and discontinued operations: |       |                      |       |                      |       |   |   |   |   |
| Accounts receivable, net                                                                                               |       | (3,767                    | )          | 2,474                     |       | 22,337 |   | 8,300 |   |
| Recoverable costs and accrued profits not  yet billed                                                                  |       | 1,237                     |       | (4,134                    | )          | (4,210 | ) | (36,955 | ) |
| Inventories                                                                                                            |       | (4,906                    | )          | 2,010                     |       | 1,899 |   | 7,288 |   |
| Other current and noncurrent assets                                                                                    |       | (857                      | )          | (5,052                    | )          | 20,080 |   | (10,000 | ) |
| Accounts payable                                                                                                       |       | 2,635                     |       | (8,127                    | )          | (1,659 | ) | 4,321 |   |
| Accrued payrolls and incentives                                                                                        |       | 6,441                     |       | 4,902                     |       | 4,346 |   | 2,463 |   |
| Billings in excess of incurred costs                                                                                   |       | 3,269                     |       | (3,405                    | )          | (34,204 | ) | 5,638 |   |
| Estimated losses on uncompleted contracts                                                                              |       | (12,058                   | )          | —                    |       | (9,695 | ) | — |   |
| Other current liabilities                                                                                              |       | 2,323                     |       | 6,423                     |       | 6,391 |   | 11,052 |   |
| Accrued postretirement benefits and pension                                                                            |       | (10,148                   | )          | (10,421                   | )          | (9,434 | ) | (7,138 | ) |
| Other, net                                                                                                             |       | 166                       |       | (22                       | )          | (1,412 | ) | (263 | ) |
| **Net Cash  Provided by (Used in) Continuing Operations**                                                              |       | (2,842                    | )          | (12,015                   | )          | 39,324 |   | 6,333 |   |
| Net Cash Used in Discontinued Operations                                                                               |       | (8,301                    | )          | (4,660                    | )          | (17,268 | ) | (3,496 | ) |
| **Net Cash  Provided by (Used in) Operating Activities**                                                               |       | (11,143                   | )          | (16,675                   | )          | 22,056 |   | 2,837 |   |
|                                                                                                                   |       |                      |       |                      |       |   |   |   |   |
| **Investing  Activities**                                                                                              |       |                      |       |                      |       |   |   |   |   |
| Capital expenditures, excluding rental  equipment                                                                      |       | (4,828                    | )          | (7,123                    | )          | (10,910 | ) | (16,119 | ) |
| Additions to rental equipment                                                                                          |       | (2,038                    | )          | (3,053                    | )          | (5,004 | ) | (9,357 | ) |
| Proceeds from sale of businesses                                                                                       |       | 891                       |       | —                    |       | 4,523 |   | — |   |
| Acquisition of businesses                                                                                              |       | —                    |       | (965                      | )          | — |   | (1,374 | ) |
| Proceeds from disposal of property, plant  and equipment                                                               |       | 3,296                     |       | 3,405                     |       | 17,220 |   | 4,907 |   |
| Change in short-term investments                                                                                       |       | 3,505                     |       | 3,115                     |       | 315 |   | (7,815 | ) |
| Net investing activities of discontinued  operations                                                                   |       | 38                        |       | 550                       |       | 112 |   | 550 |   |
| **Net Cash  Provided by (Used in) Investing Activities**                                                               |       | 864                       |       | (4,071                    | )          | 6,256 |   | (29,208 | ) |
|                                                                                                                   |       |                      |       |                      |       |   |   |   |   |
| **Financing  Activities**                                                                                              |       |                      |       |                      |       |   |   |   |   |
| Change in short-term notes payable                                                                                     |       | (311                      | )          | (226                      | )          | (420 | ) | 866 |   |
| Payments on long-term borrowings                                                                                       |       | (250                      | )          | (250                      | )          | (250 | ) | (30,250 | ) |
| Dividends paid                                                                                                         |       | (2,465                    | )          | (2,428                    | )          | (7,341 | ) | (7,273 | ) |
| Proceeds from exercise of stock options                                                                                |       | 89                        |       | 622                       |       | 1,339 |   | 1,518 |   |
| **Net Cash  Used in Financing Activities**                                                                             |       | (2,937                    | )          | (2,282                    | )          | (6,672 | ) | (35,139 | ) |
|                                                                                                                   |       |                      |       |                      |       |   |   |   |   |
| Increase (decrease) in cash and cash  equivalents                                                                      |       | (13,216                   | )          | (23,028                   | )          | 21,640 |   | (61,510 | ) |
| Cash and cash equivalents, beginning of  period                                                                        |       | 88,815                    |       | 69,512                    |       | 53,959 |   | 107,994 |   |
| Cash and cash equivalents, end of period                                                                               |       | $                         | 75,599     |                      | $          | 46,484 |   | $ | 75,599 |   | $ | 46,484 |   |
|                                                                                                                   |       |                      |       |                      |       |   |   |   |   |
| Cash Paid For:                                                                                                         |       |                      |       |                      |       |   |   |   |   |
| Interest                                                                                                               |       | $                         | 50         |                      | $          | 83 |   | $ | 1,167 |   | $ | 2,508 |   |
| Income taxes (excluding refunds)                                                                                       |       | 768                       |       | 517                       |       | 1,078 |   | 3,528 |   |

 

*See accompanying notes to consolidated condensedfinancial statements.*

 

5

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**STEWART & STEVENSON SERVICES, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED CONDENSEDFINANCIAL STATEMENTS**

(Unaudited)

 

**Note 1 - Basis of Presentation**

 

Theaccompanying unaudited consolidated condensed financial statements of Stewart& Stevenson Services, Inc. and Subsidiaries (collectively, the “Company”)have been prepared in accordance with Rule 10-01 of Regulation S-X for interimfinancial statements required to be filed with the Securities and ExchangeCommission and do not include all information and footnotes required bygenerally accepted accounting principles for complete financial statements.  However, the information furnished hereinreflects all normal recurring adjustments, which are, in the opinion of management,necessary for a fair presentation of the results for the interim periods.  The results of operations for the three and ninemonths ended October 30, 2004 are not necessarily indicative of theresults that will be realized for the fiscal year ending January 31, 2005.

 

The Company’s fiscal year begins on February 1 of the year statedand ends on January 31 of the following year.  For example, the Company’s “Fiscal 2004”commenced on February 1, 2004 and ends on January 31, 2005.  The Company reports results on the fiscalquarter method with each quarter comprising approximately 13 weeks.  The third quarter of Fiscal 2004 commenced onAugust 1, 2004 and ended on October 30, 2004, and the third quarterof Fiscal 2003 commenced on August 3, 2003 and ended on November 1,2003.

 

Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with generally accepted accounting principles have beencondensed or omitted pursuant to the rules and regulations of the Securitiesand Exchange Commission.  Theseconsolidated condensed financial statements should be read in conjunction withthe consolidated financial statements and notes thereto included in the Company’sAnnual Report on Form 10-K for the year ended January 31, 2004.

 

The accompanyingconsolidated condensed financial statements for Fiscal 2003 and related notescontain certain reclassifications to conform with the presentation used inFiscal 2004.

 

**Note 2 – Comprehensive Income**

 

Totalcomprehensive income (loss) is as follows *(inthousands*):

 
| ** **                                                 | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                 | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
|                                                       |       |                      |       |                      |       |   |   |   |   |
| Net earnings (loss)                                        |       | $                         | 2,083      |                      | $          | (15,441 | ) | $ | 13,402 |   | $ | (11,536 | ) |
| Unrealized income (loss) on forward  contracts, net of tax |       | (34                       | )          | 91                        |       | (310 | ) | (7 | ) |
| Currency translation gain (loss), net of  tax              |       | 120                       |       | (53                       | )          | (330 | ) | (230 | ) |
| Comprehensive income (loss)                                |       | $                         | 2,169      |                      | $          | (15,403 | ) | $ | 12,762 |   | $ | (11,773 | ) |

 

**Note 3 - Discontinued Operations**

 

OnDecember 6, 2004, the Company entered into an agreement to sellsubstantially all of the assets and business of its Airline Products segmentfor cash of $60 million and other consideration, subject to adjustment.  The sale is expected to close by the end ofFiscal 2004, and is subject to customary regulatory approvals and certain otherconditions to closing.  Accordingly, the identified assets andliabilities held for sale and results of operations for this business are beingreported as discontinued operations for all periods presented.  Sales and operating loss in the three andnine months ended October 30, 2004 and November 1, 2003 from theAirline Products business were as follows *(in thousands)*:

 
| ** **                   | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                   | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
|                         |       |                      |       |                      |       |   |   |   |   |
| Sales                        |       | $                         | 26,749     |                      | $          | 14,379 |   | $ | 73,558 |   | $ | 46,975 |   |
| Operating loss               |       | (196                      | )          | (6,479                    | )          | (677 | ) | (8,963 | ) |
| Operating loss, net of taxes |       | (107                      | )          | (4,219                    | )          | (384 | ) | (5,847 | ) |
|                              |            |                           |            |                           |            |  |  |  |  |  |  |  |  |

 

During Fiscal 2002, the Company sold certain assets and exited theactivities related to its blowout preventer and controls, valve and drillingriser business.  When the transaction wasconsummated, the Company retained certain contracts and related assets as wellas the receivables and certain liabilities of the business, including warrantyresponsibility for products sold before closing as well as

 

6

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warranty responsibility for retained contracts to be completed.  In some cases, the Company has agreementswith customers on commitments to support its products, including retainedwarranties and contracts.  During thesecond quarter of Fiscal 2004, the Company recognized $2.1 million ofadditional estimated losses ($1.4 million after-tax) related to certainobligations associated with this business based on developments during theperiod.  During the third quarter ofFiscal 2004, the Company recorded a $6.0 million charge, net of tax, to reflectthe November 2004 settlement of a customer lawsuit that was filed on May30, 2002 (see Note 5).  The assets,liabilities and results of operations of this business are reported asdiscontinued operations.

 

Discontinued operations from this business generated the followingsales and operating losses in the three and nine months ended October 30,2004 and November 1, 2003 *(in thousands)*:

 
| ** **                   | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                   | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
|                         |       |                      |       |                      |       |   |   |   |   |
| Sales                        |       | $                         | 443        |                      | $          | 122 |   | $ | 1,430 |   | $ | 1,502 |   |
| Operating loss               |       | (11,303                   | )          | (394                      | )          | (13,590 | ) | (2,087 | ) |
| Operating loss, net of taxes |       | (6,185                    | )          | 57                        |       | (7,701 | ) | (925 | ) |
|                              |            |                           |            |                           |            |  |  |  |  |  |  |  |  |

 

During the third quarter of Fiscal 2004, the Companyreceived an assessment from the Mexican taxing authority totaling approximately$6 million, including penalties and interest. This assessment relates to a 1995 equipment sale from the Company’s gasturbine division, which division was sold by the Company in 1998.  The Company believes it has valid defenses tothis assessment, and has filed an appeal in the Mexican Tax Court.  Based on its analysis, the Company hasprovided accruals in prior years that it believes to be adequate for estimatedlosses related to the ultimate outcome of this matter.

 

**Note 4 - Segment Information**

 

TheCompany’s operating segments are organized based on the products and servicesoffered and are aligned with the Company’s internal management structure.  Inter-segment and intra-segment revenues andcosts are eliminated, and the operating profit (loss) represents the earnings(loss) from continuing operations before interest and income taxes, net ofcertain corporate allocations.

 

TheCompany has identified four operating segments. Sales and operating profit (loss) by operating segment are as follows (*in thousands, except percentages*):

 
| ** **                                                          | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|---------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                          | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
| **Sales**                                                           |       |                      |       |                      |       |   |   |   |   |
| Tactical Vehicle Systems                                            |       | $                         | 133,431    |                      | $          | 110,036 |   | $ | 412,951 |   | $ | 329,378 |   |
| Power Products                                                      |       | 129,813                   |       | 128,901                   |       | 374,212 |   | 382,621 |   |
| Engineered Products                                                 |       | 25,356                    |       | 29,231                    |       | 64,560 |   | 93,604 |   |
| Distributed Energy Solutions                                        |       | 2,560                     |       | 7,492                     |       | 13,238 |   | 40,084 |   |
| Total sales                                                         |       | $                         | 291,160    |                      | $          | 275,660 |   | $ | 864,961 |   | $ | 845,687 |   |
|                                                                |       |                      |       |                      |       |   |   |   |   |
| **Operating  profit (loss)**                                        |       |                      |       |                      |       |   |   |   |   |
| Tactical Vehicle Systems                                            |       | $                         | 15,972     |                      | $          | 16,770 |   | $ | 54,152 |   | $ | 51,811 |   |
| Power Products                                                      |       | 3,243                     |       | (6,627                    | )          | 4,902 |   | (15,565 | ) |
| Engineered Products                                                 |       | 815                       |       | (1,532                    | )          | 133 |   | (1,405 | ) |
| Distributed Energy Solutions                                        |       | (5,163                    | )          | (20,720                   | )          | (16,075 | ) | (27,374 | ) |
| Corporate expenses, net                                             |       | (3,089                    | )          | (5,877                    | )          | (10,369 | ) | (15,176 | ) |
| Total operating profit (loss)                                       |       | 11,778                    |       | (17,986                   | )          | 32,743 |   | (7,709 | ) |
|                                                                |       |                      |       |                      |       |   |   |   |   |
| Interest expense                                                    |       | 534                       |       | 640                       |       | 1,487 |   | 2,576 |   |
| Interest income                                                     |       | (411                      | )          | (142                      | )          | (997 | ) | (1,201 | ) |
| **Earnings  (loss) from continuing operations before income taxes** |       | $                         | 11,655     |                      | $          | (18,484 | ) | $ | 32,253 |   | $ | (9,084 | ) |
|                                                                |       |                      |       |                      |       |   |   |   |   |
| **Operating  profit (loss) percentage**                             |       |                      |       |                      |       |   |   |   |   |
| Tactical Vehicle Systems                                            |       | 12.0                      | %          | 15.2                      | %          | 13.1 | % | 15.7 | % |
| Power Products                                                      |       | 2.5                       |       | (5.1                      | )          | 1.3 |   | (4.1 | ) |
| Engineered Products                                                 |       | 3.2                       |       | (5.2                      | )          | 0.2 |   | (1.5 | ) |
| Distributed Energy Solutions                                        |       | (201.7                    | )          | (276.6                    | )          | (121.4 | ) | (68.3 | ) |
| Consolidated                                                        |       | 4.0                       | %          | (6.5                      | )%         | 3.8 | % | (0.9 | )% |

 

7

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*Power Products*

 

Duringthe first quarter of Fiscal 2004, the Company exited the business activitiesassociated with the distribution of Mercury Marine and MerCruiser products.  As a result, the distribution agreement forthese products was terminated in March 2004 and the assets of this productline were sold for adjusted cash proceeds of $3.3 million.  Also in the first quarter of Fiscal 2004, theCompany sold the net assets and exited the activities associated with itswheelchair lift manufacturing operation. Consideration received for this asset sale included a receivable of $0.3million, which is due during the fourth quarter of Fiscal 2004, along withroyalty rights based on wheelchair lift sales over the next five years.  No material gain or loss was recognized onthese transactions, individually or in the aggregate.

 

Theactivities above resulted in the closure of two branch locations which were primarilyfocused on the sale of Mercury Marine and MerCruiser products in Florida andVirginia.  Additionally during the firstquarter of Fiscal 2004, the Company closed an under-performing branch locationin Auburn, Washington.  Exit costsassociated with these actions were $0.2 million, which was charged to sellingand administrative expenses during the first quarter of Fiscal 2004.  As of October 30, 2004, $0.1 million ofthese exit costs remained accrued and unpaid.

 

During the second quarter of Fiscal 2004, the Company decided to outsourcethe provision of lease financing associated with certain sales-type equipmentleases.  In conjunction with thisdecision, the Company sold assets previously classified as rental equipmentwithin property, plant and equipment for cash proceeds of $7.3 million, with noresulting gain or loss.  Additionallyduring the second quarter of Fiscal 2004, the Company disposed of an idlemanufacturing facility in Commerce City, Colorado for cash proceeds of $1.2million, resulting in a net gain of $0.3 million.

 

Effective October 30, 2004, the Company sold the assetsassociated with the distribution of the Thermo King product line for total cashconsideration of $2.1 million, which was received subsequent to the end of thethird quarter.  Also in the third quarterof Fiscal 2004, the Company sold assets associated with equipmenttransportation activities for total cash proceeds of $0.6 million.  A net gain of $0.9 million was recognized inthe third quarter as a result of these transactions.

 

*Engineered Products*

 

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

 

*DistributedEnergy Solutions*

 

During the third quarter of Fiscal 2003, theCompany announced its decision to exit the turnkey engineering, procurement andconstruction (“EPC”) activities within the Distributed Energy Solutionssegment.  With respect to suchturnkey activities, the Company is not quoting any new business but continuesto perform under existing contracts.  TheCompany has completed the majority of EPC obligations that were entered intoprior to its decision to exit; however, a number of EPC projects are notexpected to be completed until Fiscal 2005. In addition, the Company will retain and execute obligations under certain fixed priceoperation and/or maintenance contracts related to EPC projects, which haveterms ranging from two to ten years. Total estimated exit costs, which primarily relate to the termination ofemployees, are $0.4 million, of which $0.1 million were expensed and paid duringthe nine months ended October 30, 2004. No liability was established for the remaining exit costs ofapproximately $0.2 million as of October 30, 2004, as these costs do notmeet the recognition criteria set forth under Statement of Financial AccountingStandards (“SFAS”) No. 146.

 

**Note 5 - Guarantees and Contingencies**

 

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

 

Asummary of warranty activity for continuing operations for the three and ninemonths ended October 30, 2004 and November 1, 2003 follows *(in thousands)*:

 

8

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| ** **                                    | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|-----------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                    | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
|                                          |       |                      |       |                      |       |   |   |   |   |
| Accrued warranty costs - Beginning of  period |       | $                         | 6,369      |                      | $          | 4,688 |   | $ | 6,719 |   | $ | 5,296 |   |
| Payments for warranty obligations             |       | (1,638                    | )          | (1,177                    | )          | (3,528 | ) | (3,177 | ) |
| Warranty accrual for current period sales     |       | 2,095                     |       | 2,110                     |       | 4,110 |   | 3,411 |   |
| Changes related to pre-existing warranties    |       | (359                      | )          | (11                       | )          | (834 | ) | 80 |   |
| Accrued warranty costs - End of period        |       | $                         | 6,467      |                      | $          | 5,610 |   | $ | 6,467 |   | $ | 5,610 |   |

 

*Guarantees:*  The Company is occasionally required to issueperformance indemnities or to post letters of credit, generally issued by abank, to collateralize certain insurance programs, to secure credit facilitiesor to ensure performance under contracts. A letter of credit commits the issuer to remit specified amounts to theholder, if the holder demonstrates that the Company has failed to meet itsobligations under the letter of credit. If this were to occur, the Company would be obligated to reimburse theissuer for any payments the issuer was required to remit to the holder of theletter of credit.  Generally, a letter ofcredit is released when the Company has satisfied the obligations that theletter of credit is securing.  As of October 30,2004 and January 31, 2004, the Company had letters of credit outstandingtotaling $12.5 million and $12.7 million, respectively.  Also, the Company has guaranteed theperformance output levels of equipment serviced by the Company under certain operationand maintenance contracts, which have terms ranging from two to ten years.  Some of these contracts contain liquidateddamages provisions.  In addition, theCompany had contingent performance indemnities of approximately $6.7 million asof October 30, 2004 and January 31, 2004, which expire in Fiscal 2007.

 

*U.S.Government Contingencies*:  During Fiscal 1998, the U.S. Customs Servicedetained a medium tactical vehicle that was being shipped by the Company fordisplay in a European trade show.  The Companyis advised that the U.S. Customs Service and the Department of Justice have conductedan investigation of potential violations by the Company of laws relating to theexport of controlled military vehicles, weapons mounting systems andfirearms.  Such investigation couldresult in the filing of civil or administrative sanctions against the Companyand/or individual employees, and could result in a suspension or debarment ofthe Company from receiving new contracts or subcontracts with agencies of the U.S.government or the benefit of federal assistance payments.  While they are possible, the Company does notbelieve that criminal sanctions will be sought. The Company believes that resolution of this matter will not have amaterial adverse effect on its consolidated results of operations or upon itsconsolidated financial condition or liquidity and believes that the resolutionof the matter that is possibly most adverse to the Company will involve thepayment of a civil penalty that will not materially adversely affect theCompany.

 

The Company is adefendant in a suit brought under the *qui tam*provision of the False Claims Act, *United States of America,**ex rel. Werner Stebner v. Stewart & StevensonServices, Inc. and McLaughlin Body Co.*, Civil Action No. H-96-3363,in the United States District Court for the Southern District of Texas, HoustonDivision.  The plaintiff’s complaintseeks penalties and damages in an unspecified amount.  The suit alleges that the Company made falsestatements and certifications in connection with claims for payment for Familyof Medium Tactical Vehicles delivered to the U.S. Army starting in 1995, andthe suit alleges that the vehicles were substandard because of corrosionproblems.  The suit was filed under sealin 1996, and following an investigation by the Justice Department, the UnitedStates declined to intervene in the suit, which was unsealed on August 29,2000.  On February 2, 2004, theDistrict Court found in favor of the Company and dismissed all of the plaintiff’sclaims by summary judgment without proceeding to trial. After having all claimsdismissed by the District Court, the plaintiffs then filed a notice of appealon March 1, 2004 in the United States Court of Appeals for the FifthCircuit, No. 04-20209.  The appeal hasbeen fully briefed but oral argument has not yet been scheduled by the Court ofAppeals.  A decision by the Fifth Circuitis not expected until sometime in Fiscal 2005. The Company believes the District Court correctly dismissed all of theplaintiff’s claims as being without merit and will continue to vigorouslydefend the suit in the court of appeals. While the Company does not believe that an adverse outcome is reasonablylikely, an unexpected adverse outcome in the suit could have a material adverseimpact on the Company’s consolidated results of operations, financial positionand liquidity.  The Company is presentlyunable to determine whether any liability has been incurred in this matter,other than legal fees and expenses, which have been provided for, or toreasonably estimate the amount or range of any loss that may result from thismatter, and thus no accruals have been recorded in this matter other thanestimated legal fees and expenses relating to the appeal.

 

*DiamondOffshore Litigation*:  In November 2004, the Company reached anagreement to settle certain previously reported litigation brought by severalsubsidiaries of Diamond Offshore Drilling, Inc. (collectively, “Diamond Offshore”) on May 30, 2002, arising out ofclaims relating to a marine riser manufactured by the Company and purchased byDiamond Offshore, Cause No. 2002-27831; *Diamond OffshoreInternational Corporation, Diamond Offshore Company, Diamond Offshore ServicesCompany, Diamond Offshore (USA), Inc., Diamond Offshore International Limited,and Diamond Offshore Drilling, Ltd. v. Stewart & Stevenson Services, Inc.*;in the District Court of Harris County, Texas 125th Judicial DistrictCourt.  The parties have agreed to settlethe litigation, pursuant to which the Company expects to contribute $11.8million, net of insurance proceeds.  Thesettlement is subject to the execution of definitive agreements. The Companyrecorded its expected settlement contribution, net of related income tax benefit,to loss from discontinued operations during the third quarter of Fiscal 2004.

 

*Klickitat Litigation:*  The Company and several of its subsidiariesare defendants in a suit filed by the Klickitat County Public Utility DistrictNo. 1 on December 11, 2003 arising out of claims relating to a landfillgas power generation facility in Roosevelt,

 

9

----

 

Washington, Cause No. CY-03-3175-LRS;*Klickitat County Public Utility District No. 1 v. Stewart &Stevenson Services, Inc., Stewart & Stevenson Power, Inc., Sierra DetroitDiesel Allison, Inc., Pamco International, Inc. and Waukesha Engine Dresser,Inc.*; in the United States District Court for the Eastern Districtof Washington.  The plaintiff hasasserted claims with respect to equipment installed and used since 1999 forbreach of contract; promissory estoppel; violations of the Washington ProductsLiability Act; breach of warranties; intentional or negligentmisrepresentation; and violations of the Washington Consumer Protection Act andseeks recovery of damages in excess of $13 million.  The Company is vigorously defending this suit.  It is presently impossible for the Company todetermine the ultimate outcome of this suit or whether its resolution will, inthe future, have a material adverse effect on the Company’s consolidatedresults of operations, financial position or liquidity.  The Company is presently unable to determinewhether a material liability has been incurred in this matter or to reasonablyestimate the amount of any loss that may result from this matter.  Consequently, the Company has recorded noaccrual for any losses related to the ultimate outcome of this litigation.  The Company has, however, recorded accrualsthat it believes are adequate for estimated legal fees that it expects to incurassociated with this matter.

 

*DistributedEnergy Solutions Contingencies*:  As discussed in Note 4, during the thirdquarter of Fiscal 2003, the Company decided to exit the turnkey EPC activitiesof the Distributed Energy Solutions business. In connection with certain contracts, the Company received a writtennotice of dispute in late 2003 from a customer regarding equipment and servicesto be provided to several sites operated by the customer.  In the dispute notice, the customer allegedvarious contractual claims, including claims for liquidated damages.  The Company responded to the dispute andengaged in settlement discussions.  InFiscal 2003, the Company recorded substantial losses on the contracts based onestimated costs to complete the contracts and to otherwise address customerissues on the contracts.  In September 2004,the Company and the customer reached a settlement in this dispute, pursuant towhich the Company is required to perform certain obligations to complete thecustomer sites, pay a cash settlement and provide operations and maintenanceservices at the customer sites through August 2007.  The Company recorded no significant gain orloss in Fiscal 2004 as a result of this settlement.

 

*NEO Dispute:*  On November 3, 2004, theCompany was served with a demand for arbitration by NEO California Power, LLCand NEO Corporation (collectively “NEO”) with respect to two EPC contracts(entered into in December 2000 and March 2001) between a subsidiaryof the Company in the Distributed Energy Solutions segment and NEO, for theengineering and construction of two natural gas fueled electricity generatingfacilities in California, and with respect to a related “Payment Agreement”entered into in October 2001.  Thedemand included the initiation of arbitration proceedings in Minneapolis,Minnesota, under the auspices of the American Arbitration Association.  The factual basis alleged to underlie thearbitration demand appears to be NEO’s position that, although the powerprojects began operations during 2001, the plants have had operationalproblems, including failure to meet performance standards for heat rate, netelectrical output and, particularly, emissions. NEO alleges claims in excess of $65 million, based on legal theories ofrecovery under Minnesota and California law that include intentionalmisrepresentation, negligent misrepresentation, concealment, violation ofcontractor license requirements, unfair competition, negligence and breach ofcontract as well as claims on $4.7 million of surety bonds as to thecontract.  Notwithstanding the facts thatthe contracts between the Company subsidiary and NEO provided for an exclusivemethod of dispute resolution which, under the contracts, (i) necessitated appropriatenotice and a period of mutual efforts to resolve a dispute, which efforts (ifunsuccessful) were to be followed by a mandatory non-binding mediation, and(ii) (should such mediation fail) resolution by binding arbitration, on November 2,2004, NEO filed a lawsuit against the Company and the surety bond company inthe Superior Court of California for the County of Madera, alleging essentiallythe same claims that it makes in the arbitration demand.  While these claims by NEO against the Companyare new and unexpected, the Company believes they are without merit and intendsto defend them vigorously, whether in court or arbitration or both.  The Company further believes, in addition toits basic view that the generating facilities are operating satisfactorily andthat NEO is incorrect in various factual allegations, that it has meritoriouslegal defenses to the claims.  It is not,however, possible at present for the Company to determine the ultimate outcomeof these claims or whether their resolution will, in the future, have amaterial adverse effect on the Company’s consolidated results of operations,financial position or liquidity.  TheCompany is presently unable to determine whether a material liability has beenincurred in these matters or to reasonably estimate the amount of any loss thatmay result from these matters. Consequently, the Company has recorded no accrual for any losses relatedto the ultimate outcome of these claims. The Company has, however, recorded accruals that it believes areadequate for certain estimated legal fees it expects to incur associated withthese claims.

 

*EnvironmentalContingencies*:  In 2001, the Company received from the UnitedStates Environmental Protection Agency (the “EPA”) a Request for Informationunder Section 104(e) of the Comprehensive Environmental Response,Compensation, and Liability Act of 1980, for information pertaining to theR&H Oil Company Site in San Antonio, Texas (the “Site”).  Information provided to the Company by theEPA indicates that the Company may have sent waste oils to the Site forrecycling in the late 1980s, and that such waste oils may potentially accountfor between one and two percent of the volume of total wastes received by theoil recycler at the Site.  Since theCompany expects to receive a claim for cleanup and other costs related to thissite, it has established reserves which it believes to be adequate at thistime.  As additional facts are developedand definitive remediation plans and necessary regulatory approvals for implementationof remediation are established, changes in these and other factors may resultin actual costs exceeding the current environmental reserves.  While uncertainties are inherent in the finaloutcome of these environmental matters, and it is presently impossible todetermine the actual costs that ultimately may be incurred, managementcurrently believes that the resolution of such uncertainties should not have amaterial adverse effect on the Company’s consolidated results of operations, financialposition or liquidity. The Company believes that the most likely outcome inthis environmental matter is the expenditure of an immaterial amount ofconsideration as a contribution to the remediation effort.

 

10

----

 

The Company is also adefendant in a number of lawsuits relating to contractual, product liability,personal injury and warranty matters normally incident to the Company’sbusiness.  No individual case, or groupof cases presenting substantially similar issues of law or fact, is expected tohave a material effect on the manner in which the Company conducts its businessor on its consolidated results of operations, financial position orliquidity.  The Company maintains certaininsurance policies that provide coverage for product liability and personalinjury cases.  The Company hasestablished reserves that it believes to be adequate based on currentevaluations and its experience in these types of claim situations.  Nevertheless, an unexpected outcome oradverse development in any such case could have a material adverse impact onthe Company’s consolidated results of operations in the period it occurs.

 

**Note 6 – Inventories**

 

Summarized below are the components of inventories relatedto continuing operations, net of customer deposits *(in thousands)*:

 

| ** **                                        | ** ** | **October 30, 2004** | ** ** | **January 31, 2004** | ** ** |
|---------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                        | ** ** | ** **                | ** ** | ** **                | ** ** |
| Inventory purchased under distributor  agreements |       | $                         | 76,843     |                      | $          | 87,712 |   |
| Raw materials and spare parts                     |       | 23,312                    |       | 18,651                    |       |
| Work in process                                   |       | 27,320                    |       | 21,842                    |       |
| Finished goods                                    |       | 12,710                    |       | 18,072                    |       |
|                                              |       | 140,185                   |       | 146,277                   |       |
| Excess of current cost over LIFO values           |       | (42,546                   | )          | (41,311                   | )          |
| Total Inventories                                 |       | $                         | 97,639     |                      | $          | 104,966 |   |

 

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

 

**Note 7 – Earnings (Loss) Per Share**

 

The following table isa reconciliation of the numerators and denominators used in the calculation ofbasic and diluted earnings (loss) per share as presented on the consolidated condensedstatements of operations *(in thousands, except pershare data)*:

 
| ** **                                                                                  | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|---------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                                  | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
| Numerator:                                                                                  |       |                      |       |                      |       |   |   |   |   |
| Earnings (loss) available to common  shareholders                                           |       |                      |       |                      |       |   |   |   |   |
| From continuing operations                                                                  |       | $                         | 8,375      |                      | $          | (11,279 | ) | $ | 21,487 |   | $ | (4,764 | ) |
| From discontinued operations                                                                |       | (6,292                    | )          | (4,162                    | )          | (8,085 | ) | (6,772 | ) |
| Net earnings (loss)                                                                         |       | $                         | 2,083      |                      | $          | (15,441 | ) | $ | 13,402 |   | $ | (11,536 | ) |
|                                                                                        |       |                      |       |                      |       |   |   |   |   |
| Denominator:                                                                                |       |                      |       |                      |       |   |   |   |   |
| Denominator for basic earnings per share -  Weighted average shares outstanding             |       | 28,768                    |       | 28,600                    |       | 28,729 |   | 28,538 |   |
| Effect of dilutive securities:                                                              |       |                      |       |                      |       |   |   |   |   |
| Employee and director stock options                                                         |       | 418                       |       | —                    |       | 371 |   | — |   |
| Denominator for diluted earnings per share  -  Adjusted weighted average shares outstanding |       | 29,186                    |       | 28,600                    |       | 29,100 |   | 28,538 |   |
|                                                                                        |       |                      |       |                      |       |   |   |   |   |
| Basic earnings (loss) per share:                                                            |       |                      |       |                      |       |   |   |   |   |
| From continuing operations                                                                  |       | $                         | 0.29       |                      | $          | (0.39 | ) | $ | 0.75 |   | $ | (0.17 | ) |
| From discontinued operations                                                                |       | (0.22                     | )          | (0.15                     | )          | (0.28 | ) | (0.23 | ) |
| Net earnings (loss) per share                                                               |       | $                         | 0.07       |                      | $          | (0.54 | ) | $ | 0.47 |   | (0.40 | ) |
|                                                                                        |       |                      |       |                      |       |   |   |   |   |
| Diluted earnings (loss) per share:                                                          |       |                      |       |                      |       |   |   |   |   |
| From continuing operations                                                                  |       | $                         | 0.29       |                      | $          | (0.39 | ) | $ | 0.74 |   | $ | (0.17 | ) |
| From discontinued operations                                                                |       | (0.22                     | )          | (0.15                     | )          | (0.28 | ) | (0.23 | ) |
| Net earnings (loss) per share                                                               |       | $                         | 0.07       |                      | $          | (0.54 | ) | $ | 0.46 |   | $ | (0.40 | ) |
|                                                                                        |       |                      |       |                      |       |   |   |   |   |
| Number of shares under anti-dilutive stock  options outstanding                             |       | 984                       |       | 2,216                     |       | 985 |   | 2,216 |   |

 

11

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**Note 8 – Stock-BasedCompensation**

 

The Company usesthe intrinsic value method of accounting to account for its stock-basedcompensation programs.  Accordingly, nocompensation expense is recognized when the exercise price of an employee stockoption is equal to or greater than the market price of the Company’s commonstock on the grant date.

 

The following pro forma data are calculated as if compensation expensefor the Company’s stock option plans was determined based on the fair value atthe grant date for awards under these plans, amortized to expense on a pro ratabasis over the option vesting period *(in thousands, except pershare data)*:

 
| ** **                                                                      | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                      | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
|                                                                            |       |                      |       |                      |       |   |   |   |   |
| Net earnings (loss):                                                            |       |                      |       |                      |       |   |   |   |   |
| As reported                                                                     |       | $                         | 2,083      |                      | $          | (15,441 | ) | $ | 13,402 |   | $ | (11,536 | ) |
| Pro forma compensation expense, determined  under fair value method, net of tax |       | (601                      | )          | (467                      | )          | (1,661 | ) | (1,149 | ) |
| Pro forma                                                                       |       | $                         | 1,482      |                      | $          | (15,908 | ) | $ | 11,741 |   | $ | (12,685 | ) |
|                                                                            |       |                      |       |                      |       |   |   |   |   |
| Basic earnings (loss) per share:                                                |       |                      |       |                      |       |   |   |   |   |
| As reported                                                                     |       | $                         | 0.07       |                      | $          | (0.54 | ) | $ | 0.47 |   | $ | (0.40 | ) |
| Pro forma                                                                       |       | 0.05                      |       | (0.56                     | )          | 0.41 |   | (0.44 | ) |
|                                                                            |       |                      |       |                      |       |   |   |   |   |
| Diluted earnings (loss) per share:                                              |       |                      |       |                      |       |   |   |   |   |
| As reported                                                                     |       | $                         | 0.07       |                      | $          | (0.54 | ) | $ | 0.46 |   | $ | (0.40 | ) |
| Pro forma                                                                       |       | 0.05                      |       | (0.56                     | )          | 0.40 |   | (0.44 | ) |

 

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

 

**Note9 -****Employee Pension and OtherBenefit Plans**

 

The Company has anoncontributory defined benefit pension plan that covered substantially all ofits full-time employees and an unfunded defined benefit supplemental executiveretirement plan that covered certain highly compensated employees.  Effective July 1, 2003, the Companyfroze the benefits earned under both defined benefit pension plans, with theexception of a small transition group.

 

The Company alsohas a defined benefit postretirement medical plan, which provides for thepayment of certain medical costs of eligible employees and dependents uponretirement.  The plan is not funded, andthe Company expects to continue paying postretirement medical costs as coveredclaims are incurred.  Effective July 1,2003, the Company decided that postretirement medical benefits will not beprovided to future retirees, with the exception of a small transition group.

 

The net periodic benefitcost associated with the Company’s defined benefit pension plans and definedbenefit postretirement medical plan consisted of the following components *(in thousands)*:

 
| ** **                         | ** ** | **Pension Benefits**      | ** ** |
|------------------------------------|------------|---------------------------|------------|
| ** **                         | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended** | ** ** |
| ** **                         | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
| Service cost                       |       | $                         | 183        |   | $ | 649 |   | $ | 549 |   | $ | 1,947 |   |
| Interest cost                      |       | 1,888                     |       | 1,938 |   | 5,664 |   | 5,814 |   |
| Expected return on plan assets     |       | (2,048                    | )          | (1,909 | ) | (6,144 | ) | (5,727 | ) |
| Curtailment expense                |       | —                    |       | — |   | — |   | 2,369 |   |
| Amortization of prior service cost |       | —                    |       | 31 |   | — |   | 93 |   |
| Recognized actuarial loss          |       | 365                       |       | 169 |   | 1,095 |   | 507 |   |
| Net periodic benefit cost          |       | $                         | 388        |   | $ | 878 |   | $ | 1,164 |   | $ | 5,003 |   |

 

12

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| ** **                         | ** ** | **Other Postretirement Benefits** | ** ** |
|------------------------------------|------------|-----------------------------------|------------|
| ** **                         | ** ** | **Three Months Ended**            | ** ** | **Nine Months Ended** | ** ** |
| ** **                         | ** ** | **October 30, 2004**         | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
| Service cost                       |       | $                                 | —     |   | $ | 138 |   | $ | — |   | $ | 414 |   |
| Interest cost                      |       | 164                               |       | 260 |   | 492 |   | 780 |   |
| Curtailment gain                   |       | —                            |       | — |   | — |   | (142 | ) |
| Amortization of prior service cost |       | (191                              | )          | (113 | ) | (573 | ) | (339 | ) |
| Recognized actuarial loss          |       | 73                                |       | 93 |   | 219 |   | 279 |   |
| Net periodic benefit cost          |       | $                                 | 46         |   | $ | 378 |   | $ | 138 |   | $ | 992 |   |

 

Duringthe first nine months of Fiscal 2004 and Fiscal 2003, the Company contributed$10.5 million and $13.1 million, respectively, to its defined benefit pensionplans.  The Company does not intend tomake any additional contributions during Fiscal 2004.

 

OnDecember 8, 2003, President Bush signed into law the Medicare PrescriptionDrug, Improvement and Modernization Act of 2003 (the “Act”).  The Act introduced a prescription drugbenefit under Medicare (“Medicare Part D”) as well as a federal subsidy tosponsors of retiree health care benefit plans that provide a benefit that is atleast actuarially equivalent to Medicare Part D.  FASB Staff Position 106-2, issued in May 2004,provides guidance on the accounting for the effects of the Act, and was adoptedby the Company in the third quarter of Fiscal 2004.  The financial impact of this change was notmaterial to the Company’s consolidated financial statements.

 

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

 

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

 

Our fiscal year begins on February 1 of the year stated and endson January 31 of the following year. For example, our “Fiscal 2004” commenced on February 1, 2004 andends on January 31, 2005.  We reportresults on the fiscal quarter method with each quarter comprising approximately13 weeks.  The third quarter of Fiscal2004 commenced on August 1, 2004 and ended on October 30, 2004, andthe third quarter of Fiscal 2003 commenced on August 3, 2003 and ended on November 1,2003.

 

**RESULTS OF OPERATIONS**

 

**Strategic Overview**

 

As previously announced, we initiated a comprehensive strategic reviewof our primary businesses during the second half of Fiscal 2003.  As part of this review, we refocused ourprimary operating metrics and management incentive measurement to emphasize theneed for each of our businesses to achieve acceptable returns on shareholderinvested capital.  We are taking actionsin each of our business segments that we believe will help us achieve andsustain an acceptable return on invested capital.  During the first nine months of Fiscal2004, we have continued to make progress in our execution of management actionplans required to meet these objectives. The significant highlights of our progress in each operating segment aredescribed below.

 

*Tactical Vehicle Systems* – As we transition tothe new multi-year Family of Medium Tactical Vehicles (“FMTV”) contract withthe U.S. Army during the fourth quarter of 2004, we continue to pursueopportunities to supplement this contract. As previously announced, we were awarded two contracts from Lear Sieglertotaling $19.8 million to provide on-site service support at a U.S. Army basewhere approximately 1,000 FMTVs and 400 Heavy Expanded Mobility Tactical Truckswill be reset to their full operational standards.  In addition, we were awarded a separatecontract directly with the U.S. Army, which is expected to generateapproximately $17 million of sales, to reset 200 FMTVs to their fulloperational standards.  We also receiveda contract award valued at $32.8 million for the production of 385 LowSignature Armored Cabs (“LSAC”) for the FMTV, with deliveries scheduled throughFebruary 28, 2005.  The contract hasrecently been modified to add 813 additional LSACs, for which the delivery schedule andpricing are expected to be finalized in the fourth quarter.

 

*PowerProducts –*We**completed numerousstreamlining and cost reduction actions in the first nine months of Fiscal2004, and we continue to evaluate additional opportunities.  Key actions taken during Fiscal 2004 includethe sale of assets and distribution rights of the Thermo King and MercuryMarine MerCruiser product lines, the sale of assets of the wheelchair liftmanufacturing product line, the sale of certain undeveloped real estate and anidle manufacturing facility, the closure of an under-performing branch locatedin Auburn, Washington and the sale of certain assets within our rental equipmentfleet.  These product and facility exitsrepresent approximately $60 million in annual sales, which have largely beenreplaced by a higher quality revenue stream as a result of improved economicconditions and focused sales efforts in our primary markets.  As a result of the many actions taken duringthe second half of Fiscal 2003 and the first nine months of Fiscal 2004, totalheadcount for this segment as of October 30, 2004 has been reduced by 349personnel (or 17%) since September 2003, of which 152 such reductions haveoccurred since January 31, 2004.

 

*EngineeredProducts* – We are continuing to evaluate the long-termearnings potential for the primary components of this segment, including thepetroleum equipment and utility equipment product lines.  Upon completing this evaluation, we plan totake the strategic actions necessary to generate acceptable returns in thissegment, which may include the exit of some or all of the product lines of thissegment.

 

***DistributedEnergy Solutions*** – Our efforts in this segment continue to befocused upon completing remaining contractual obligations and winding down theengineering, procurement and construction (“EPC”) activities of thisbusiness.  We have completed the majorityof EPC obligations that were entered into prior to our decision to exit;however, a number of EPC projects are not expected to be completed until Fiscal2005.

** **

*AirlineProducts* – On December 6,2004, we entered into an agreement to sell substantially all of the assets andbusiness of our Airline Products segment for cash of $60 million and otherconsideration, subject to adjustment. The sale is expected to close by the end of Fiscal 2004, and is subjectto customary regulatory approvals and certain other conditions to closing.  We concluded in the second quarter of Fiscal2004 that this business was not core to the long-term direction of the Company,and therefore, it was in the best interest of our shareholders to redeploy thecapital invested in this segment to other more strategic activities.

 

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**Fiscal 2004 vs. Fiscal 2003**

 

Sales for the third quarter of Fiscal 2004 were $291.2 million, a $15.5million (6.1%) increase over the $275.7 million recorded in the third quarterof Fiscal 2003.  This increase in salesis primarily attributable to a $23.4 million increase in our Tactical VehicleSystems segment, which was partially offset by lower sales in the EngineeredProducts and Distributed Energy Solutions segments.  For the first nine months of Fiscal 2004,sales were $865.0 million, which represented an increase of $19.3 million, or2%, from the corresponding period in Fiscal 2003.  The increased sales volume for this periodwas also largely attributable to increases in our Tactical Vehicle Systemssegment, partially offset by lower sales in all other segments.  The changes within each segment are explainedin greater detail in the Segment Data section below.

 

Gross profit increased by $16.4 million to $36.5 million in the thirdquarter of Fiscal 2004 from the third quarter of Fiscal 2003, reflecting animprovement in gross profit margin from 7.3% to 12.5%.  The increase in gross profit is primarilyattributable to $12.0 million of reduced losses in our Distributed EnergySolutions segment as we continue to complete existing EPC projects and fulfillcustomer obligations.  Additionally, thePower Products segment contributed an additional $3.3 million gross profitimprovement resulting from a variety of strategic actions and cost reductionprograms. The remainder of the gross profit improvement was generated by theEngineered Products and Tactical Vehicle Systems segments.

 

For the first nine months of Fiscal 2004, gross profit increased by $11.6million to $109.6 million from the corresponding period of Fiscal 2003,reflecting an improvement in gross profit margin from 11.6% to 12.7%.  The gross profit in the Distributed EnergySolutions segment improved by $4.4 million in the first nine months of Fiscal2004 due to the continued wind down of EPC activities and satisfaction ofremaining customer obligations. Increased sales volume in our Tactical Vehicle Systems segmentcontributed to a gross profit improvement of $2.4 million, while the EngineeredProducts gross profit declined $0.9 million on lower sales volume.  The Power Products segment generated a $5.7million gross profit improvement resulting from numerous strategic actions andcost reduction programs.

 

Selling and administrative expenses decreased to $26.0 million (8.9% ofsales) in the third quarter of Fiscal 2004 from $38.1 million (13.8% of sales)in the third quarter of Fiscal 2003. This $12.1 million (32%) reduction in selling and administrativeexpenses is primarily attributable to $2.3 million cost savings from employeeworkforce reductions, a $1.6 million reduction in fringe benefits expenseassociated with changes made in our employee pension, postretirement andmedical benefit plans, a $3.1 million reduction in employee separation costsand other restructuring activities, $2.8 million associated with wind down ofEPC activities in the Distributed Energy Solutions segment and $2.3 millionassociated with reductions in other expenses.

 

For the first nine months of Fiscal 2004,selling and administrative expenses decreased to $80.8 million(9.3% of sales) compared to $103.8 million (12.3% of sales) in the first ninemonths of Fiscal 2003.  This $23.0million (22%) reduction in selling and administrative expenses is primarilyattributable to a $7.7 million cost savings from employee workforce reductions,a $3.9 million reduction in fringe benefits expense associated with changesmade in our employee pension, postretirement and medical benefit plans, a $4.9million reduction in employee separation costs and restructuring activitiesfrom Fiscal 2003, $4.0 million associated with wind down of EPC activities inthe Distributed Energy Solutions segment and $2.5 million associated withreductions in other expenses.

 

Operating results for the firstnine months of Fiscal 2003 included a one-time non-cash write-off of $2.4million of previously unamortized prior service costs (pension curtailmentexpense).  This charge was associatedwith our decision to freeze the benefits earned under our defined benefitpension plan, defined benefit supplemental executive retirement plan andpostretirement medical plan effective July 1, 2003, with the exception ofa small transition group.

 

Other income, net was $1.3million in the third quarter of Fiscal 2004, which included $0.9 million ofgains in the Power Products segment related to the exit of the Thermo Kingproduct line and sale of other assets. For the first nine months of Fiscal 2004, other income, net was $3.9million, which included $2.5 million of gains recognized in conjunction withthe sale of assets during the second quarter of Fiscal 2004.

 

Net interest expense decreased by$0.4 million to $0.1 million in the third quarter of Fiscal 2004 compared toFiscal 2003, primarily as a result of higher interest income due to higherinvested cash balances and higher interest rates.  Net interest expense decreased by $0.9million to $0.5 million for the first nine months of Fiscal 2004 compared tothe corresponding period of Fiscal 2003, primarily as a result of lower debtbalances due to the scheduled debt payment of $30.0 million in May 2003.

 

The effective tax rate was 33.4%in the first nine months of Fiscal 2004 compared to 47.6% for the correspondingperiod in Fiscal 2003.  The unusuallyhigh effective tax rate in Fiscal 2003 is primarily the result of the Companygenerating a significant loss from continuing operations during the thirdquarter of Fiscal 2003.

 

Discontinued operations generatedan after-tax loss of $6.3 million in the third quarter and $8.1 million in thefirst nine months of Fiscal 2004, compared to a $4.2 million after-tax loss inthe third quarter and a $6.8 million after-tax loss in the first nine months ofFiscal 2003. Discontinued operations include the results of our AirlineProducts segment as well as costs associated with retained obligations

 

15

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associated with our discontinuedblowout preventer and controls, valve and drilling riser business, which wassold during Fiscal 2002.  The increasedlosses in Fiscal 2004 are primarily attributable to a $6.0 million after-taxcharge for the settlement of a customer lawsuit related to the drilling riserbusiness, partially offset by reduced operating losses in the Airline Productsbusiness.

 

**Segment Data**

 

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

 

The following tablerepresents sales and operating profit (loss) by business segment *(in thousands, except percentages)*:

 
| ** **                                                          | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|---------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                          | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
| **Sales**                                                           |       |                      |       |                      |       |   |   |   |   |
| Tactical Vehicle Systems                                            |       | $                         | 133,431    |                      | $          | 110,036 |   | $ | 412,951 |   | $ | 329,378 |   |
| Power Products                                                      |       | 129,813                   |       | 128,901                   |       | 374,212 |   | 382,621 |   |
| Engineered Products                                                 |       | 25,356                    |       | 29,231                    |       | 64,560 |   | 93,604 |   |
| Distributed Energy Solutions                                        |       | 2,560                     |       | 7,492                     |       | 13,238 |   | 40,084 |   |
| Total sales                                                         |       | $                         | 291,160    |                      | $          | 275,660 |   | $ | 864,961 |   | $ | 845,687 |   |
|                                                                |       |                      |       |                      |       |   |   |   |   |
| **Operating  profit (loss)**                                        |       |                      |       |                      |       |   |   |   |   |
| Tactical Vehicle Systems                                            |       | $                         | 15,972     |                      | $          | 16,770 |   | $ | 54,152 |   | $ | 51,811 |   |
| Power Products                                                      |       | 3,243                     |       | (6,627                    | )          | 4,902 |   | (15,565 | ) |
| Engineered Products                                                 |       | 815                       |       | (1,532                    | )          | 133 |   | (1,405 | ) |
| Distributed Energy Solutions                                        |       | (5,163                    | )          | (20,720                   | )          | (16,075 | ) | (27,374 | ) |
| Corporate expenses, net                                             |       | (3,089                    | )          | (5,877                    | )          | (10,369 | ) | (15,176 | ) |
| Total operating profit (loss)                                       |       | 11,778                    |       | (17,986                   | )          | 32,743 |   | (7,709 | ) |
|                                                                |       |                      |       |                      |       |   |   |   |   |
| Interest expense                                                    |       | 534                       |       | 640                       |       | 1,487 |   | 2,576 |   |
| Interest income                                                     |       | (411                      | )          | (142                      | )          | (997 | ) | (1,201 | ) |
| **Earnings  (loss) from continuing operations before income taxes** |       | $                         | 11,655     |                      | $          | (18,484 | ) | $ | 32,253 |   | $ | (9,084 | ) |
|                                                                |       |                      |       |                      |       |   |   |   |   |
| **Operating  profit (loss) percentage**                             |       |                      |       |                      |       |   |   |   |   |
| Tactical Vehicle Systems                                            |       | 12.0                      | %          | 15.2                      | %          | 13.1 | % | 15.7 | % |
| Power Products                                                      |       | 2.5                       |       | (5.1                      | )          | 1.3 |   | (4.1 | ) |
| Engineered Products                                                 |       | 3.2                       |       | (5.2                      | )          | 0.2 |   | (1.5 | ) |
| Distributed Energy Solutions                                        |       | (201.7                    | )          | (276.6                    | )          | (121.4 | ) | (68.3 | ) |
| Consolidated                                                        |       | 4.0                       | %          | (6.5                      | )%         | 3.8 | % | (0.9 | )% |

 

During 2004, manufacturers anddistributors of steel have experienced sharply increased prices and limitedavailability of steel and component parts containing steel.  These higher material costs have negativelyimpacted our results, particularly in our Tactical Vehicle Systems segmentwhere increased material costs have impacted our operating profit by $6.1million during the first nine months of Fiscal 2004.  We are continuing to work with our supplychain and pursuing all avenues to minimize this impact.  In addition, we have implemented productprice increases where market conditions and contracts have allowed.  However, we anticipate continued negativeimpact to our material costs into Fiscal 2005. We are unable to predict how long these conditions are likely topersist, or whether further price increases will occur in the future.

 

**Tactical Vehicle Systems**

 

The Tactical Vehicle Systems segment manufactures tactical vehicles under contracts with the U.S. Army andprovides sustaining design engineering, service and support.  Other contracts within and outside of theU.S. are also being pursued in the segment. During the third quarter of Fiscal 2004, this segment recorded $133.4million of sales, a $23.4 million (21%) increase from the $110.0 million ofsales recorded in the third quarter of Fiscal 2003.  Sales for the firstnine months of Fiscal 2004 were $413.0 million, a $83.6 million (25%) increasefrom the $329.4 million of sales recorded in the corresponding period of Fiscal2003.  The sales increase is primarilyattributable to increased production volume. A breakdown of this segment’s unit deliveries is as follows:

 

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| ** **            | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|-----------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **            | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
| Trucks                |       | 683                       |       | 585                       |       | 2,177 |   | 1,860 |   |
| Trailers              |       | 146                       |       | 121                       |       | 551 |   | 379 |   |
|                  |       |                      |       |                      |       |   |   |   |   |
| Total Unit Deliveries |       | 829                       |       | 706                       |       | 2,728 |   | 2,239 |   |

 

The increased unitdeliveries above generated equipment sales increases of $17.6 million and $66.3million for the third quarter and first nine months of Fiscal 2004,respectively, compared to same periods in Fiscal 2003.  Additionally, this segment recorded parts andservice sales increases of $5.8 million and $17.3 million in the third quarterand first nine months of Fiscal 2004, respectively, compared to the sameperiods of Fiscal 2003.  The increased parts and service sales are primarily due toincreased requirements for U.S. Army vehicles deployed in Iraq as well as $8.5million of sales recorded in the second and third quarters of Fiscal 2004related to the vehicle reset programs awarded earlier this year.

 

Operating profit for the third quarter of Fiscal 2004 decreased to $16.0million (12.0% operating margin) from $16.8 million (15.2% operating margin) inthe third quarter of Fiscal 2003.  Theincreased sales volume generated a $3.6 million improvement to operatingprofit.  This improvement was partiallyoffset by a $2.8 million increase in material costs, primarily associated withhigher steel prices, along with a $1.6 million decrease associated with salesmix and operating expenses partially due to the lower margin reset programs.

 

For the first nine months of Fiscal 2004, operating profit increased to $54.2million (13.1% operating margin) from $51.8 million (15.7% operating margin) inthe corresponding period of Fiscal 2003. The increased sales volume generated a $13.1 million improvement tooperating profit, partially offset by a $6.1 million increase in materialcosts, primarily associated with higher steel prices, along with a $4.6 milliondecrease primarily associated with the mix of unit deliveries under the FMTVcontract.

 

As we transition tothe new multi-year FMTV contract in fourth quarter of Fiscal 2004, we expectunit deliveries to decline to 627 trucks and 179 trailers in the fourth quarterof Fiscal 2004, supplemented by the reset contracts and armored cab deliveriesresulting from the recently awarded LSAC contract.  Our profit margins in this segment areexpected to be lower in the near future than margin levels historicallyachieved under the prior FMTV contract. Actual future margins of the Tactical Vehicle Systems segment will bedependent upon a number of factors including our ability to achieve operationalefficiencies, materials and labor cost control measures, the actual quantitiesand variations of vehicles purchased by the U.S. Army under the new contract,future prices for steel and other commodities, the potential for additionalcontracts, other product introductions, bid and proposal activities and otherfactors.  The operating margin that thissegment will achieve in total may also be impacted by additional sales, if any,to other allied governments and the level of engineering service and spareparts provided.

 

**Power Products**

 

The Power Products segment, which is responsible for marketing andaftermarket support of a wide range of industrial equipment, recorded sales of$129.8 million in the third quarter of Fiscal 2004, up slightly from $128.9million in the third quarter of Fiscal 2003. For the first nine months ofFiscal 2004, the segment recorded sales of $374.2 million, down $8.4 million(2%) from $382.6 million in the first nine months of Fiscal 2003.  A breakdown of Power Products segment salesfollows *(in thousands)*:

 
| ** **               | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|--------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **               | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
|                     |       |                      |       |                      |       |   |   |   |   |
| Equipment sales          |       | $                         | 43,543     |                      | $          | 39,631 |   | $ | 118,943 |   | $ | 116,013 |   |
| Parts sales              |       | 57,137                    |       | 59,474                    |       | 168,608 |   | 180,160 |   |
| Service and rental sales |       | 29,133                    |       | 29,796                    |       | 86,661 |   | 86,448 |   |
|                     |       | $                         | 129,813    |                      | $          | 128,901 |   | $ | 374,212 |   | $ | 382,621 |   |

 

For the third quarter and first nine months of Fiscal 2004,respectively, the change in sales from the comparable period of Fiscal 2003includes approximately $15 million and $44 million of sales declines,respectively, attributable to the exit of the Thermo King product offering inTexas and Louisiana, the wheelchair lift manufacturing and MerCruiser productofferings, along with the closure of certain under-performing branchlocations.  Additionally, parts sales are$2.3 million and $11.6 million lower, respectively, in the third quarter and firstnine months of Fiscal 2004, largely as a result of changes to our distributioncontracts with Detroit Diesel Corporation (“Detroit Diesel”), as discussed morefully below.  These sales declines werelargely offset by higher equipment sales in continuing locations, which werelargely attributable to more focused sales efforts and general economic improvementsin the heavy equipment markets we serve.

 

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Effective January 2004, we entered intonew contracts with Detroit Diesel for the distribution and servicing of itsdiesel engine products.  One set ofcontracts, which expires in December 2010, is with Detroit DieselCorporation and covers the “on-highway” products and services.  Under the terms of the new on-highwayagreements with all of its distributors, Detroit Diesel allows its affiliatedFreightliner, Sterling and Western Star dealers (collectively, the “FLLCdealers”) to purchase their on-highway Detroit Diesel parts directly from theFreightliner Parts Distribution Centers, rather than purchasing them from aDetroit Diesel distributor such as the Company, as was previouslyrequired.  Consequently, our parts salesto FLLC dealers have declined in the first nine months of Fiscal 2004, comparedto the same period in Fiscal 2003. Additionally, under the terms of the new contract, we have receiveddirect compensation from Detroit Diesel totaling $1.0 million for the firstnine months of Fiscal 2004 related to FLLC dealer purchases made directly fromthe Freightliner Parts Distribution Centers.

 

The second set of Detroit Diesel agreements is with DaimlerChryslerOff-Highway Holding Gmbh, and covers “off-highway” products and services.  This contract expires in December 2004and includes terms similar to the previous distribution agreement.  We are currently negotiating a three yearextension to this agreement. We expectto have this negotiation completed in the fourth quarter of Fiscal 2004 onterms similar to previous agreements.

 

This segment recorded an operating profit of $3.2 million in the thirdquarter of Fiscal 2004 compared to a $6.6 million operating loss in the thirdquarter of Fiscal 2003.  The improvementin operating profit is primarily attributable to on-going cost reductionprograms. Workforce reductions resulted in a $5.2 million decrease in employeecompensation costs between the two periods. Additionally, changes in employee benefit programs previously describedresulted in an additional $1.9 million decrease in operating expenses.  This segment also recognized a $0.9 milliongain in the third quarter of Fiscal 2004 associated with the sale of assets andexit of the Thermo King product line. Reductions in other operating expenses provided an additional $1.8million improvement.

 

Operating profit for the first nine months of Fiscal 2004 was $4.9million, representing a $20.5 million improvement over the $15.6 millionoperating loss recognized in the corresponding period of Fiscal 2003.  This improvement was driven primarily by thecost reduction programs, including $13.1 million from workforce reductions,$4.5 million from employee benefit program changes, $1.2 million of gainsrecognized on the sale of assets, $1.0 million of direct compensation fromDetroit Diesel, and $1.8 million from other operating expense reductions.  These improvements were partially offset by a$1.1 million decline from lower sales volume and changes in sales mix.

 

As mentioned above, we sold the assets of our wheelchair liftmanufacturing and MerCruiser distribution product offerings during thefirst quarter of Fiscal 2004 foraggregate cash proceeds of $3.2 million and a receivable of $0.9 million.  No material gain or loss was recognized onthese transactions, individually or in the aggregate.  During the second quarter of Fiscal 2004, wesold a vacant manufacturing facility and certain rental equipment assets foraggregate proceeds of $8.6 million, resulting in a gain of $0.3 million to thesegment. During the third quarter of Fiscal 2004, we sold the assets of our ThermoKing distribution product offering and other assets for net cash proceeds of$2.6 million, resulting in a gain of $0.9 million to the segment.  We continue to evaluate the various productand service offerings, distribution channels and cost structure in thisbusiness segment and intend to take further action, as necessary, to improvethe segment’s contribution to the Company’s overall return on invested capital.

 

**Engineered Products**

 

TheEngineered Products segment consists of two primary product lines, petroleumequipment and utilities equipment.  Thepetroleum equipment business manufactures equipment primarily for the wellstimulation segment of the oil service industry.  The utilities equipment products includemobile railcar movers, snowblowers and off-road seismic vehicles.  Sales in this segment decreased to $25.4million in the third quarter of Fiscal 2004 from $29.2 million in the thirdquarter of Fiscal 2003, representing a 13% decline. For the first nine monthsof Fiscal 2004, sales decreased $29.0 million (31%) to $64.6 million from $93.6million in the corresponding period of Fiscal 2003. The decreases experiencedin Fiscal 2004 are largely due to the timing of execution on several largepetroleum equipment orders which were largely completed during the first halfof Fiscal 2003.  Compared to thecorresponding periods in Fiscal 2003, petroleum equipment sales represented$7.1 million and $41.5 million of this segment’s sales decline in the thirdquarter and first nine months, respectively. The declines in petroleum equipment sales were partially offset byincreases in utilities equipment sales, primarily associated with the sales ofoff-road seismic vehicles.

 

Operating profit for the third quarter of Fiscal 2004 was $0.8 million,a $2.3 million improvement from the $1.5 million operating loss in the thirdquarter of Fiscal 2003, despite the decline in sales volume.  The improvement in operating profit islargely attributable to sales mix changes as the decline in profit associatedwith the large international equipment orders in Fiscal 2003 was offset by theimproved profitability of the utilities equipment and domestic petroleumequipment sales, generating a $1.4 million improvement to gross profit.  Additionally, the third quarter of Fiscal 2003included $0.5 million of non-recurring project costs associated with theconsolidation of manufacturing operations. Other operating expense improvements generated an additional $0.4million of operating profit improvement.

 

For the first nine months of Fiscal 2004, this segment generated a $0.1million operating profit, reflecting a $1.5 million improvement from the $1.4million operating loss in the corresponding period of Fiscal 2003.  This improvement was largely attributable to$1.4 

 

18

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million of non-recurring costs in Fiscal 2003 associated with theconsolidation of manufacturing operations and the $0.6 million gain from themanufacturing facility sale in Fiscal 2004. Sales mix, improved execution of sales contracts and other operatingexpense improvement largely offset the impact of the sales decline.

 

Our order backlog in this segment has increased to $47.1 million at October 30,2004 from $20.1 million at the end of Fiscal 2003.  Additionally, subsequent to October 30,2004, this segment obtained an international petroleum equipment order totaling$43.7 million, increasing the backlog in this segment to its highest levelsince inception.  The execution of thesecontracts currently in backlog is expected to improve sales and operatingprofits in future quarters.

 

**Distributed Energy Solutions**

 

The DistributedEnergy Solutions segment packages and markets reciprocating diesel and naturalgas engine generator sets and markets power generation solutions primarily indomestic and certain international markets. As previously reported, we announced the decision to exit EPC activitieswithin this segment during the third quarter of Fiscal 2003.  With respect to such EPC activities, we arenot quoting any new business but we continue to perform under existingcontracts.

 

Sales for this segment decreased $4.9 million to $2.6 million in thethird quarter of Fiscal 2004 compared to $7.5 million in the third quarter ofFiscal 2003.  For the first nine monthsof Fiscal 2004, this segment generated sales of $13.2 million, compared to$40.1 million in the corresponding period in Fiscal 2003.  The decline in sales is primarily the resultof our decision to exit the EPC activities. Sales in the first nine months of Fiscal 2004 primarily relate to ourcontinued execution of remaining customer obligations under existing contracts.

 

Operating loss for the third quarter of Fiscal 2004 was $5.2 million,compared to a $20.7 million operating loss in the third quarter of Fiscal 2003.  For the first nine months of Fiscal 2004,this segment’s operating loss was $16.1 million, compared to $27.4 million inthe corresponding period of Fiscal 2003. The decreased operating loss is largely attributable to the wind down ofEPC activities as we continue to complete existing EPC projects andfulfill customer obligations. Additionally, this segment incurred $0.5 million and $1.5 million ofnon-recurring project costs in the third quarter and first nine months ofFiscal 2003, respectively, related to the consolidation of manufacturingoperations.

 

As reportedpreviously, in connection with certain contracts, the Company received awritten notice of dispute in late 2003 from a customer regarding equipment andservices to be provided to several sites operated by the customer.  In the dispute notice, the customer allegedvarious contractual claims, including claims for liquidated damages.  The Company responded to the dispute andengaged in settlement discussions.  InFiscal 2003, the Company recorded substantial losses on the contracts based onestimated costs to complete the contracts and to otherwise address customerissues on the contracts.  In September 2004,the Company and the customer reached a settlement in this dispute, pursuant to whichthe Company is required to perform certain obligations to complete the customersites, pay a cash settlement and provide operations and maintenance services atthe customer sites through August 2007. The Company recorded no significant gain or loss in Fiscal 2004 as aresult of this settlement.

 

As we continue to perform our remaining obligations associated with theEPC activities of this segment, we have encountered a number of customernotices or disputes, including the item mentioned above and other mattersdiscussed in Note 5 to the consolidated condensed financial statements.  In these and other cases, we are taking everyreasonable effort to avoid further claims by working with our customers andsupply partners to address customer issues related to our EPC contractperformance.  Although we have completedthe majority of EPC obligations that were entered into prior to our decision toexit the business, a number of EPC projects are not expected to be completeduntil Fiscal 2005.  Until all of theseprojects are completed, we believe we will continue to recognize operatinglosses in this segment as the overall low volume of sales and margins isnot sufficient to cover this segment’s infrastructure costs.Additionally, while we have recognized all known estimated losses on theseuncompleted contracts, warranty obligations and other customer disputes, continueduncertainty remains related to the execution of the remaining obligationsrelated to our EPC activities.  Theseuncertainties may result in additional unexpected losses until all remainingEPC projects are completed, our customers are satisfied with our performanceand related warranty periods have expired. Upon completing our remaining EPCprojects, we will also retain and execute obligations under certain fixed-priceoperation and/or maintenance contracts related to EPC projects, which haveterms ranging from two to ten years. Upon completing all significant activities remaining with this business,we expect this segment will be reclassified to discontinued operations.

 

**Corporate**

 

Corporateexpenses consist of costs incurred by the corporate headquarters group thatcannot be directly attributed to the activities of the business segments.  Corporate expenses incurred in the thirdquarter of Fiscal 2004 were $3.1 million, down $2.8 million from the $5.9million incurred in the third quarter of Fiscal 2003.  The decrease in corporate expenses isprimarily attributable to a non-recurring $2.9 million charge in Fiscal 2003for employee separation costs resulting from the resignation of our thenPresident and Chief Executive Officer. This reduction was partially offset by higher legal and professionalexpenses, including costs associated with the implementation of the internalcontrol reporting requirements of the Sarbanes-Oxley Act of 2002.

 

19

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Forthe first nine months of Fiscal 2004, corporate expenses were $10.4 million,compared to $15.2 million in the comparable period of Fiscal 2003.  Fiscal 2003 included a $2.4 million one-timenon-cash pension curtailment expense resulting from changes made to our definedbenefit pension and postretirement medical plans.  Employee separation costs declined $4.1million due to the various corporate office workforce reductions in Fiscal 2003as well as those costs described above. The impact of other cost reduction efforts including corporate staffreductions were offset by higher legal and professional expenses, including $1.4million associated with the implementation of the internal control reportingrequirements of the Sarbanes-Oxley Act of 2002. While the requirements of the Sarbanes-Oxley Act are expected to resultin increased ongoing corporate expenses, we expect such ongoing costs to belower than the levels experienced in the first nine months of Fiscal 2004.

 

**UNFILLED ORDERS**

 

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

 

| ** **                   | ** ** | **October 30, 2004** | ** ** | **January 31, 2004** | ** ** |
|------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                   | ** ** | **(In millions)**         | ** ** |
|                         |       |                      |       |                      |       |
| Tactical Vehicle Systems     |       | $                         | 450.9      |                      | $          | 453.0 |   |
| Power Products               |       | 31.3                      |       | 26.4                      |       |
| Engineered Products          |       | 47.1                      |       | 20.1                      |       |
| Distributed Energy Solutions |       | 9.4                       |       | 19.5                      |       |
|                         |       | $                         | 538.7      |                      | $          | 519.0 |   |

 

Unfilled orders in theTactical Vehicle Systems segment at October 30, 2004 included $357.5million representing the funded portion of the new multi-year FMTV contractawarded in April 2003, as well as $5.7 million associated with theremaining production related to the sixth program year under the U.S. Armycontract awarded in October 1998, $32.8 million of LSAC armored cabproduction and $15.7 million under the reset programs mentionedpreviously.  Additionally, subsequent to October 30,2004, the Engineered Products segment obtained an international petroleumequipment order totaling $43.7 million and the Tactical Vehicle Systems segmentobtained a modification to the LSAC contract, adding 813 LSAC armored cabs tothe contract, with delivery schedule and pricing expected to be finalizedin the fourth quarter.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Our sources ofcash liquidity include cash and cash equivalents, short-term investments andcash from operations.  We believe thatthese sources will provide sufficient capital to fund our working capitalrequirements, capital expenditure needs, dividends and other financialcommitments.

 

We had a $150million unsecured revolving credit facility, which expired on January 31,2004.  Based on our lack of borrowingsunder the revolving credit facility, our available cash and cash equivalentsbalance and the expected cash from operations for the foreseeable future, weelected at the time not to renew the facility. To provide additional financial flexibility, we are currently negotiatinga $100 million unsecured revolving credit facility with potential lenders.  We currently expect that we will enter into anew facility during the fourth quarter of Fiscal 2004 on terms that arereasonable and competitive with the current market environment.  There can be no assurance, however, that wewill be able to successfully negotiate such a facility. Failure to negotiate anew facility on terms acceptable to us could restrict our future ability tomake acquisitions and fund working capital, capital expenditures, common stockdividends or other financial obligations.

 

During Fiscal 2003, we entered into letter of credit facilitiestotaling $17.5 million with financial institutions, to allow us to issueletters of credit as needed to support our commercial operations.  Approximately $12.5 million of letters ofcredit under these facilities were outstanding as of October 30, 2004.

 

We have $25.0million in unsecured senior notes outstanding, which bear interest at a rate of7.38% and are due and payable in May 2006. The senior notes agreement limits sales of assets and other items andcontains a maximum debt-to-total capitalization covenant. Based on ourfinancial condition as of October 30, 2004, the restrictions imposed byour senior notes do not currently restrict our ability to meet our obligationsor to declare and pay dividends at historical levels.

 

In Fiscal 2002, we entered into an interest rate swap agreement, whichexpired in November 2004, with a notional amount of $15 million related to$15 million of the senior notes due in 2006. This transaction, which is designated as a fair value hedge, effectivelyconverts $15 million of fixed rate debt with an interest rate of 7.38% intofloating rate debt with an interest rate of LIBOR plus 436

 

20

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basis points.  The applicablefloating interest rate as of October 30, 2004 was approximately 6.32%.  The net interest received or paid as a resultof the interest rate swap is included in interest expense on the consolidatedstatements of operations.  The recordedvalue of the swap and the related fair value adjustment to the debt are carriedon the consolidated balance sheets at fair value.

 

In addition, our international subsidiaries had foreign currency banknotes payable totaling $1.5 million at October 30, 2004 and $1.9 millionat January 31, 2004.  Such notespayable consist of renewable, secured loans for the purpose of financing ourSouth American operations.  These loansare denominated in local currency (Colombian Pesos and Venezuelan Bolivars) andare secured by letters of credit issued by us and principally bear market-basedvariable rates of interest.  We useforeign denominated debt to offset the impact of foreign currency exchange ratefluctuations on our South America operations.

 

In the event that anyacquisition of additional operations, growth in existing operations,settlements of lawsuits or disputes, changes in inventory levels, accountsreceivable, tax payments or other working capital items create a need forworking capital or capital expenditures in excess of the existing cash and cashequivalents and committed lines of credit, we may seek to borrow under otherlong-term financing instruments or seek additional equity capital.

 

**Statementsof Cash Flows Data**

 
| ** **                                        | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|---------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| **(In  thousands)**                               | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
| Net cash provided by (used in):                   |       |                      |       |                      |       |   |   |   |   |
| Operating activities                              |       | $                         | (11,143    | )                         | $          | (16,675 | ) | $ | 22,056 |   | $ | 2,837 |   |
| Investing activities                              |       | 864                       |       | (4,071                    | )          | 6,256 |   | (29,208 | ) |
| Financing activities                              |       | (2,937                    | )          | (2,282                    | )          | (6,672 | ) | (35,139 | ) |
| Increase (decrease) in cash and cash  equivalents |       | $                         | (13,216    | )                         | $          | (23,028 | ) | $ | 21,640 |   | $ | (61,510 | ) |

 

**SelectedBalance Sheet Data**

 
| **(In  thousands)**                                 | ** ** | **October 30, 2004** | ** ** | **January 31, 2004** | ** ** |
|-----------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| Cash, cash equivalents, and short-term  investments |       | $                         | 83,029     |                      | $          | 61,704 |   |
| Working capital                                     |       | 237,485                   |       | 223,634                   |       |
| Total debt                                          |       | 27,645                    |       | 28,442                    |       |
|                                                     |            |                           |            |                           |            |  |  |

 

Total cash flows improved by $9.8 million in the third quarter ofFiscal 2004 compared to the third quarter of Fiscal 2003.  Net cash used in operating activities improvedby $5.5 million primarily as a result of increased net earnings, which improvedby $17.5 million, partially offset by changes in operating assets including a$12.1 million reduction in estimated losses on uncompleted contracts and $3.6million of increased cash outflows associated with discontinued operations,largely due to increased inventory levels in the Airline Products business.  During the third quarters of Fiscal 2004 and2003, we also contributed $10.6 million and $11.7 million, respectively, to ourdefined benefit pension plan.

 

Investing activities contributed a $4.9 million improvement in cashflow during the third quarter of Fiscal 2004 compared to the third quarter ofFiscal 2003.  This improvement isprimarily attributable to a $3.3 million decrease in capital expenditures asFiscal 2003 included expenditures related to the consolidation of twomanufacturing facilities.

 

Cash outflows for financing activities increased by $0.7 million duringthe third quarter of Fiscal 2004 compared to the third quarter of Fiscal 2003due primarily to changes in proceeds from the exercise of stock options.

 

Total cash flows for the first nine months of 2004 improved by $83.2million compared to the same period of Fiscal 2003.  Net cash provided by operating activitiesincreased $19.2 million, including a $33.0 million increase in cash provided bycontinuing operations.  Significantdecreases in operating cash flows include a $13.8 increase in cash usage fordiscontinued operations, primarily due to increases in Airline Products inventory,as well as a $34.2 million cash usage in Fiscal 2004 related to the payment andproduction schedule under the existing FMTV contract and transition to thenew multi-year FMTV contract.  These cashoutflows were more than offset by a $22.3 million cash flow improvement inaccounts receivable primarily due to customer receipts on large EngineeredProducts equipment orders completed during the fourth quarter of Fiscal 2003, a$24.9 million improvement in net earnings, and $21.8 million in income tax refundsreceived.

 

Investing activities contributed a $35.4 million improvement in cashflow during the first nine months of Fiscal 2004 compared to the first ninemonths of Fiscal 2003.  This improvementis primarily attributable to $21.7 million of cash proceeds associated with thesale of businesses and property, plant and equipment.  Additionally, cash invested in short-terminvestments decreased by $8.1 million and capital expenditures were $9.6million lower due to the manufacturing facility consolidation project in Fiscal2003 and lower purchases of rental equipment in Fiscal 2004.

 

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Financing activities contributed a $28.5 million improvement in cashflow during the first nine months of Fiscal 2004 compared to the first ninemonths of Fiscal 2003, resulting from the scheduled debt payment of $30.0million in May 2003.

 

Asa result of the cash provided by operating activities in the first nine months ofFiscal 2004, total cash and short-term investments has increased since January 31,2004 by $21.3 million to $83.0 million as of October 30, 2004.  Our working capital balance increased by $13.9million during the first nine months of Fiscal 2004, primarily attributable tothe $13.4 million of net earnings along with $17.2 million of plant, propertyand equipment disposals, partially offset by $7.3 million of dividend paymentsand other reductions of working capital.

 

**FACTORS THAT MAY AFFECT FUTURE RESULTS**

** **

*Risksas to Rising Steel Prices.*  During 2004, manufacturers anddistributors of steel, which is used in many of our products, have experiencedsharply increased prices and limited availability of steel and component partscontaining steel. These increased steel prices have had and are expected tocontinue to have a negative impact on our margins in the near future,particularly on fixed-price contracts and other contracts for which we areunable to pass such cost increases on to our customers.  If these steel price conditions continue, andif we are unable to raise our prices to keep pace with the material costincreases, our sales trends, operating margins and results of operations couldbe adversely impacted in future periods.

 

**Forward-Looking Statements**

 

This filing contains forward-looking statements that are based onmanagement’s current expectations, estimates, and projections. These statementsare not guarantees of future performance and involve a number of risks,uncertainties, and assumptions and are made pursuant to the Safe HarborProvisions of the Private Securities Litigation Reform Act of 1995.  Many factors, including those discussed morefully elsewhere herein, in the Company’s latest annual report on Form 10-K, andin the Company’s quarterly reports on Form 10-Q, as well as others, could causeresults to differ materially from those stated. Specific important factors that could cause actual results, performance,or achievements to differ materially from such forward-looking statementsinclude risks of dependence on government and failure to obtain new governmentcontracts, inherent risks of government contracts, risks of supplyinterruptions to Tactical Vehicle Systems segment, risks associated withDistributed Energy Solutions segment, risks of fixed-price contracts, risks asto cost controls, risks of general economic conditions, risks as to risingsteel prices, risks of oil and gas industry economic conditions, risks ofairline industry economic conditions, risks as to distributorships, risks as tolicenses, risk of competition, risks relating to technology, risks as toterrorist attacks on the U.S. and their impact on the U.S. economy, risksrelating to personnel, risks of claims and litigation, risks of productdefects, risks of no credit facility, risks as to foreign sales and globaltrade matters, risks as to information technology, risks as to acquisitions andrestructuring activities, risks as to currency fluctuations, risks as toenvironmental and safety matters, and credit risks, all as more specificallyoutlined in the Company’s latest annual report on Form 10-K.  In addition, such forward-looking statementscould be affected by general industry and market conditions and growth rates,general domestic and international conditions including interest rates,inflation and currency exchange rates and other future factors.  Actual outcomes and results may differmaterially from what is expressed or forecasted in such forward-lookingstatements.

 

**Item 3. Quantitative and Qualitative Disclosures about MarketRisk**

 

Our quantitative andqualitative disclosures about market risk for changes in interest rates andforeign exchange risk are incorporated by reference in Item 7A of our AnnualReport on Form 10-K for the year ended January 31, 2004 and have notmaterially changed since that report was filed.

 

## **Item 4.  Controls and Procedures**

 

Wecarried out an evaluation required by the Securities Exchange Act of 1934, asamended (the “Exchange Act”), under the supervision and with the participationof management, including the Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures pursuant to Rule 13a-15 under the Exchange Act as of theend of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures areeffective in alerting them on a timely basis to material information relatingto the Company and required to be included in our periodic filings under theExchange Act.

 

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002,management will be required to report on the adequacy of our internal controlstructure in our annual report on Form 10-K for this fiscal year.  In preparation for this report, we have beenactively engaged in a process that includes documentation and testing of allsignificant financial reporting processes and related internal controls.  During this process, we have taken actions toimprove controls and processes in a number of areas.  While the concepts under Section 404 andthe rules thereunder are new and developing, we do not consider any of thechanges made to date to have materially affected, or to be reasonablylikely to materially affect, our internal control over financialreporting.

 

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**PART II.  OTHERINFORMATION**

 

**Item 1. Legal Proceedings**

 

*U.S.Government Contingencies:* During Fiscal 1998, the U.S. Customs Service detained a medium tacticalvehicle that was being shipped by the Company for display in a European tradeshow.  The Company is advised that theU.S. Customs Service and the Department of Justice have conducted an investigationof potential violations by the Company of laws relating to the export ofcontrolled military vehicles, weapons mounting systems, and firearms.  Such investigation could result in the filingof civil or administrative sanctions against the Company and/or individualemployees, and could result in a suspension or debarment of the Company fromreceiving new contracts or subcontracts with agencies of the U.S. government orthe benefit of federal assistance payments. While they are possible, the Company does not believe that criminalsanctions will be sought.  The Companybelieves that resolution of this matter will not have a material adverse effecton its consolidated results of operations or upon its consolidated financialcondition or liquidity and believes that the resolution of the matter that ispossibly most adverse to the Company will involve the payment of a civilpenalty that will not materially adversely affect the Company.

 

The Company is adefendant in a suit brought under the *quitam* provision of the False Claims Act, *UnitedStates of America,**ex rel.  Werner Stebner v. Stewart & StevensonServices, Inc. and McLaughlin Body Co*., Civil Action No. H-96-3363,in the United States District Court for the Southern District of Texas, HoustonDivision.  The plaintiff’s complaintseeks penalties and damages in an unspecified amount.  The suit alleges that the Company made falsestatements and certifications in connection with claims for payment for Familyof Medium Tactical Vehicles delivered to the U.S. Army starting in 1995, andthe suit alleges that the vehicles were substandard because of corrosionproblems.  The suit was filed under sealin 1996, and following an investigation by the Justice Department, the UnitedStates declined to intervene in the suit, which was unsealed on August 29,2000.  On February 2, 2004, theDistrict Court found in favor of the Company and dismissed all of the plaintiff’sclaims by summary judgment without proceeding to trial.  After having all claims dismissed by the DistrictCourt, the plaintiffs then filed a notice of appeal on March 1, 2004 inthe United States Court of Appeals for the Fifth Circuit, No. 04-20209.  The appeal has been fully briefed but oralargument has not yet been scheduled by the Court of Appeals.  A decision by the Fifth Circuit is notexpected until sometime in Fiscal 2005. The Company believes the District Court correctly dismissed all of theplaintiff’s claims as being without merit and will continue to vigorouslydefend the suit in the court of appeals. While the Company does not believe that an adverse outcome is reasonablylikely, an unexpected adverse outcome in the suit could have a material adverseimpact on the Company’s consolidated results of operations, financial positionand liquidity.  The Company is presentlyunable to determine whether any liability has been incurred in this matter,other than legal fees and expenses, which have been provided for, or toreasonably estimate the amount or range of any loss that may result from thismatter, and thus no accruals have been recorded in this matter other thanestimated legal fees and expenses relating to the appeal.

 

*DiamondOffshore Litigation:*  In November 2004, the Company reached anagreement to settle certain previously reported litigation brought by severalsubsidiaries of Diamond Offshore on May 30, 2002, arising out of claimsrelating to a marine riser manufactured by the Company and purchased by DiamondOffshore, Cause No. 2002-27831; *DiamondOffshore International Corporation, Diamond Offshore Company, Diamond OffshoreServices Company, Diamond Offshore (USA), Inc., Diamond Offshore InternationalLimited, and Diamond Offshore Drilling, Ltd. v. Stewart & StevensonServices, Inc.*; in the District Court of Harris County, Texas 125thJudicial District Court.  The partieshave agreed to settle the litigation, pursuant to which the Company expects tocontribute $11.8 million, net of insurance proceeds.  The settlement is subject to the execution ofdefinitive agreements. The Company recorded its expected settlementcontribution, net of related tax benefit, to loss from discontinued operationsduring the third quarter of Fiscal 2004.

 

*Klickitat Litigation:*  The Company and several of its subsidiariesare defendants in a suit filed by the Klickitat County Public Utility DistrictNo. 1 on December 11, 2003 arising out of claims relating to a landfillgas power generation facility in Roosevelt, Washington, Cause No.CY-03-3175-LRS;*Klickitat County Public Utility DistrictNo. 1 v. Stewart & Stevenson Services, Inc., Stewart & Stevenson Power,Inc., Sierra Detroit Diesel Allison, Inc., Pamco International, Inc. andWaukesha Engine Dresser, Inc.*; in the United States District Courtfor the Eastern District of Washington. The plaintiff has asserted claims with respect to equipment installedand used since 1999 for breach of contract; promissory estoppel; violations ofthe Washington Products Liability Act; breach of warranties; intentional ornegligent misrepresentation; and violations of the Washington ConsumerProtection Act and seeks recovery of damages in excess of $13 million.  The Company is vigorously defending thissuit.  It is presently impossible for theCompany to determine the ultimate outcome of this suit or whether itsresolution will, in the future, have a material adverse effect on the Company’sconsolidated results of operations, financial position or liquidity.  The Company is presently unable to determinewhether a material liability has been incurred in this matter or to reasonablyestimate the amount of any loss that may result from this matter.  Consequently, the Company has recorded noaccrual for any losses related to the ultimate outcome of this litigation.  The Company has, however, recorded accrualsthat it believes are adequate for estimated legal fees that it expects to incurassociated with this matter.

 

*NEO Dispute:*  On November 3, 2004, theCompany was served with a demand for arbitration by NEO California Power, LLCand NEO Corporation (collectively “NEO”) with respect to two EPC contracts(entered into in December 2000 and March 2001) between a subsidiaryof the Company in the Distributed Energy Solutions segment and NEO, for theengineering and construction of two natural gas

 

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fueled electricitygenerating facilities in California, and with respect to a related “PaymentAgreement” entered into in October 2001. The demand included the initiation of arbitration proceedings inMinneapolis, Minnesota, under the auspices of the American ArbitrationAssociation.  The factual basis allegedto underlie the arbitration demand appears to be NEO’s position that, althoughthe power projects began operations during 2001, the plants have hadoperational problems, including failure to meet performance standards for heatrate, net electrical output and, particularly, emissions.  NEO alleges claims in excess of $65 million,based on legal theories of recovery under Minnesota and California law thatinclude intentional misrepresentation, negligent misrepresentation,concealment, violation of contractor license requirements, unfair competition,negligence and breach of contract as well as claims on $4.7 million of suretybonds as to the contract.  Notwithstandingthe facts that the contracts between the Company subsidiary and NEO providedfor an exclusive method of dispute resolution which, under the contracts, (i)necessitated appropriate notice and a period of mutual efforts to resolve adispute, which efforts (if unsuccessful) were to be followed by a mandatory non-bindingmediation, and (ii) (should such mediation fail) resolution by bindingarbitration, on November 2, 2004, NEO filed a lawsuit against the Companyand the surety bond company in the Superior Court of California for the Countyof Madera, alleging essentially the same claims that it makes in thearbitration demand.  While these claimsby NEO against the Company are new and unexpected, the Company believes theyare without merit and intends to defend them vigorously, whether in court orarbitration or both.  The Company furtherbelieves, in addition to its basic view that the generating facilities areoperating satisfactorily and that NEO is incorrect in various factualallegations, that it has meritorious legal defenses to the claims.  It is not, however, possible at present forthe Company to determine the ultimate outcome of these claims or whether theirresolution will, in the future, have a material adverse effect on the Company’sconsolidated results of operations, financial position or liquidity.  The Company is presently unable to determinewhether a material liability has been incurred in these matters or toreasonably estimate the amount of any loss that may result from these matters.  Consequently, the Company has recorded noaccrual for any losses related to the ultimate outcome of these claims.  The Company has, however, recorded accrualsthat it believes are adequate for certain estimated legal fees it expects toincur associated with these claims.

 

*Environmental Contingencies:*  In 2001,the Company received from the United States Environmental Protection Agency (“EPA”)a Request for Information under Section 104(e) of the ComprehensiveEnvironmental Response, Compensation, and Liability Act of 1980, for informationpertaining to the R&H Oil Company Site in San Antonio, Texas (the “Site”).  Information provided to the Company bythe EPA indicates that the Company may have sent waste oils to the Site forrecycling in the late 1980s, and that such waste oils may potentially accountfor between one and two percent of the volume of total wastes received by theoil recycler at the Site.  Since theCompany expects to receive a claim for cleanup and other costs related to thissite, it has established reserves which it believes to be adequate at thistime.  As additional facts are developedand definitive remediation plans and necessary regulatory approvals forimplementation of remediation are established, changes in these and other factorsmay result in actual costs exceeding the current environmental reserves.  Whileuncertainties are inherent in the final outcome of these environmental matters,and it is presently impossible to determine the actual costs that ultimatelymay be incurred, management currently believes that the resolution of suchuncertainties should not have a material adverse effect on the Company’sconsolidated results of operations, financial position or liquidity.  The Company believes that the most likelyoutcome in this environmental matter is the expenditure of an immaterial amountof consideration as a contribution to the remediation effort.

 

The Company isalso a defendant in a number of lawsuits relating to contractual, productliability, personal injury and warranty matters normally incident to theCompany’s business.  No individual case,or group of cases presenting substantially similar issues of law or fact, isexpected to have a material effect on the manner in which the Company conductsits business or on its consolidated results of operations, financial positionor liquidity.  The Company maintainscertain insurance policies that provide coverage for product liability andpersonal injury cases.  The Company hasestablished reserves that it believes to be adequate based on currentevaluations and its experience in these types of claim situations.  Nevertheless, an unexpected outcome oradverse development in any such case could have a material adverse impact onthe Company’s consolidated results of operations in the period it occurs.

 

**Item 6. Exhibits**

 

Thefollowing exhibits are filed as part of this report pursuant to Item 601 ofRegulation S-K.

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

 

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**SIGNATURES**

** **

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized on the 7th day of December 2004.

 
| **STEWART & STEVENSON SERVICES, INC**. |
|--------------------------------------------|
|                                       |
|                                       |
|                                       | By: | /s/  Max L. Lukens |   |
|                                       | Max  L. Lukens |
|                                       | President  and Chief Executive Officer |
|                                       | (Principal  Executive Officer) |
|                                       |   |
|                                       |   |
|                                       | By: | /s/  John B. Simmons |   |
|                                       | John  B. Simmons |
|                                       | Vice  President and Chief Financial Officer |
|                                       | (Principal  Financial Officer) |
|                                       |   |
|                                       |   |
|                                       | By: | /s/  L. Scott Biar |   |
|                                       | L.  Scott Biar |
|                                       | Controller  and Chief Accounting Officer |
|                                       | (Principal  Accounting Officer) |
|                                            |  |  |  |  |  |

 

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**EXHIBIT INDEX**

 

ExhibitNumber and Description

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

 

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