**UNITEDSTATESSECURITIES 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 April 30, 2005**

 

**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 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.          Yes  ý    No  o

 

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

 

Numberof shares outstanding of each of the registrant’s classes of common stock, asof May 20, 2005:

 

**Common Stock, without Par Value:  29,022,914 Shares**

 

 

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# **PART** I. FINANCIAL INFORMATION

# ** **

**Item 1. Financial Statements**

 

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

 
| Consolidated  Condensed Balance Sheets – April 30, 2005 and January 31, 2005.                          |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                  |   |
| Consolidated Condensed  Statements of Operations – Three Months Ended April 30, 2005 and  May 1, 2004. |   |
|                                                                                                                  |   |
| Consolidated Condensed  Statements of Cash Flows – Three Months Ended April 30, 2005 and  May 1, 2004. |   |
|                                                                                                                  |   |
| Notes to Consolidated  Condensed Financial Statements.                                                                |   |

 

2

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**STEWART &STEVENSON SERVICES, INC. AND SUBSIDIARIESCONSOLIDATED CONDENSED BALANCE SHEETS**

*(In thousands, except share data)*

 
| ** **                                                                                                             | ** ** | **April 30, 2005** | ** ** | **January 31, 2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|---------------------------|------------|
| ** **                                                                                                             | ** ** | **(Unaudited)**         | ** ** | ** **                | ** ** |
| Assets                                                                                                                 |       |                    |       |                      |       |
| Current Assets:                                                                                                        |       |                    |       |                      |       |
| Cash and cash equivalents                                                                                              |       | $                       | 102,761    |                      | $          | 130,447 |   |
| Short-term investments                                                                                                 |       | 10,775                  |       | 2,480                     |       |
| Accounts receivable, net                                                                                               |       | 129,790                 |       | 143,600                   |       |
| Recoverable costs and accrued profits not  yet billed                                                                  |       | 24,750                  |       | 26,544                    |       |
| Inventories                                                                                                            |       | 128,809                 |       | 112,889                   |       |
| Excess of current cost over LIFO values                                                                                |       | (35,667                 | )          | (35,168                   | )          |
| Deferred income tax asset                                                                                              |       | 5,750                   |       | 5,647                     |       |
| Income tax receivable                                                                                                  |       | 6,471                   |       | 7,223                     |       |
| Other current assets                                                                                                   |       | 5,685                   |       | 4,987                     |       |
| Total assets of discontinued operations                                                                                |       | 46,636                  |       | 68,186                    |       |
| Total Current Assets                                                                                                   |       | 425,760                 |       | 466,835                   |       |
|                                                                                                                   |       |                    |       |                      |       |
| Property, Plant and Equipment, net                                                                                     |       | 113,545                 |       | 115,568                   |       |
| Deferred Income Tax Asset                                                                                              |       | 18,784                  |       | 20,874                    |       |
| Intangibles and Other Assets, net                                                                                      |       | 52,648                  |       | 10,065                    |       |
| Total Assets                                                                                                           |       | $                       | 610,737    |                      | $          | 613,342 |   |
|                                                                                                                   |       |                    |       |                      |       |
| Liabilities and Shareholders’ Equity                                                                              |       |                    |       |                      |       |
| Current Liabilities:                                                                                                   |       |                    |       |                      |       |
| Notes payable                                                                                                          |       | $                       | 3,783      |                      | $          | 1,671 |   |
| Accounts payable                                                                                                       |       | 89,782                  |       | 81,716                    |       |
| Accrued payrolls and incentives                                                                                        |       | 20,818                  |       | 22,941                    |       |
| Billings in excess of incurred costs                                                                                   |       | 45,227                  |       | 59,894                    |       |
| Other current liabilities                                                                                              |       | 43,684                  |       | 36,691                    |       |
| Total liabilities of discontinued  operations                                                                          |       | 28,268                  |       | 38,770                    |       |
| Total Current Liabilities                                                                                              |       | 231,562                 |       | 241,683                   |       |
|                                                                                                                   |       |                    |       |                      |       |
| Long-Term Debt, net of current portion                                                                                 |       | 25,069                  |       | 25,000                    |       |
| Accrued Postretirement Benefits and Pension                                                                            |       | 58,005                  |       | 57,621                    |       |
| Other Long-Term Liabilities                                                                                            |       | 3,827                   |       | 4,318                     |       |
| Total Liabilities                                                                                                      |       | 318,463                 |       | 328,622                   |       |
| Shareholders’ Equity:                                                                                             |       |                    |       |                      |       |
| Common stock, without par value,  100,000,000 shares authorized; 29,009,789 and 28,865,070 shares issued, respectively |       | 62,138                  |       | 59,616                    |       |
| Accumulated other comprehensive loss                                                                                   |       | (36,255                 | )          | (36,048                   | )          |
| Retained earnings                                                                                                      |       | 266,391                 |       | 261,152                   |       |
| Total Shareholders’ Equity                                                                                        |       | 292,274                 |       | 284,720                   |       |
| Total Liabilities and Shareholders’ Equity                                                                        |       | $                       | 610,737    |                      | $          | 613,342 |   |

 

*See accompanying notes toconsolidated condensed financial statements.*

 

3

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**STEWART &STEVENSON SERVICES, INC. AND SUBSIDIARIESCONSOLIDATED CONDENSED STATEMENTS OFOPERATIONS**

*(In thousands, except per sharedata)*

 
| ** **                                                            | ** ** | **Three Months Ended**  | ** ** |
|-----------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                            | ** ** | **April 30, 2005** | ** ** | **May 1, 2004** | ** ** |
| ** **                                                            | ** ** | **(Unaudited)**         | ** ** |
|                                                                  |       |                    |       |   |   |
| Sales                                                                 |       | $                       | 311,562    |   | $ | 262,350 |   |
| Cost of sales                                                         |       | 274,909                 |       | 225,760 |   |
|                                                                  |       |                    |       |   |   |
| Gross profit                                                          |       | 36,653                  |       | 36,590 |   |
|                                                                  |       |                    |       |   |   |
| Selling and administrative expenses                                   |       | 23,070                  |       | 23,241 |   |
| Other income, net                                                     |       | (739                    | )          | (587 | ) |
|                                                                  |       |                    |       |   |   |
| Operating profit                                                      |       | 14,322                  |       | 13,936 |   |
|                                                                  |       |                    |       |   |   |
| Interest expense                                                      |       | 525                     |       | 517 |   |
| Interest income                                                       |       | (760                    | )          | (254 | ) |
|                                                                  |       |                    |       |   |   |
| Earnings from continuing operations before  income taxes              |       | 14,557                  |       | 13,673 |   |
| Income tax expense                                                    |       | 5,224                   |       | 4,866 |   |
| Net earnings from continuing operations                               |       | 9,333                   |       | 8,807 |   |
| Loss from discontinued operations, net of  tax of ($417) and ($1,784) |       | (1,641                  | )          | (3,365 | ) |
| Net earnings                                                          |       | $                       | 7,692      |   | $ | 5,442 |   |
|                                                                  |       |                    |       |   |   |
| Weighted average shares outstanding:                                  |       |                    |       |   |   |
| Basic                                                                 |       | 28,927                  |       | 28,671 |   |
| Diluted                                                               |       | 29,433                  |       | 28,934 |   |
|                                                                  |       |                    |       |   |   |
| **Earnings (loss) per share:**                                        |       |                    |       |   |   |
| Basic:                                                                |       |                    |       |   |   |
| Continuing operations                                                 |       | $                       | 0.32       |   | $ | 0.31 |   |
| Discontinued operations                                               |       | (0.05                   | )          | (0.12 | ) |
| Net earnings per share                                                |       | $                       | 0.27       |   | $ | 0.19 |   |
|                                                                  |       |                    |       |   |   |
| Diluted:                                                              |       |                    |       |   |   |
| Continuing operations                                                 |       | $                       | 0.32       |   | $ | 0.30 |   |
| Discontinued operations                                               |       | (0.06                   | )          | (0.11 | ) |
| Net earnings per share                                                |       | $                       | 0.26       |   | $ | 0.19 |   |
|                                                                  |       |                    |       |   |   |
| Cash dividends per share                                              |       | $                       | 0.085      |   | $ | 0.085 |   |

 

*See accompanying notes to consolidatedcondensed financial statements.*

 

4

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**STEWART &STEVENSON SERVICES, INC. AND SUBSIDIARIESCONSOLIDATED CONDENSED STATEMENTS OFCASH FLOWS**

*(In thousands)*

 
| ** **                                                                                                             | ** ** | **Three Months Ended**  | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                             | ** ** | **April 30, 2005** | ** ** | **May 1, 2004** | ** ** |
| ** **                                                                                                             | ** ** | **(Unaudited)**         | ** ** |
| **Operating Activities**                                                                                               |       |                    |       |   |   |
| Net earnings                                                                                                           |       | $                       | 7,692      |   | $ | 5,442 |   |
| Adjustments to reconcile net earnings to  net cash provided by operating activities:                                   |       |                    |       |   |   |
| Net loss from discontinued operations                                                                                  |       | 1,641                   |       | 3,365 |   |
| Deferred tax expense                                                                                                   |       | 3,107                   |       | 517 |   |
| Depreciation and amortization                                                                                          |       | 5,445                   |       | 6,524 |   |
| Loss (gain) on sale of assets                                                                                          |       | 13                      |       | (346 | ) |
| Change in operating assets and liabilities  net of the effect of acquisition, divestiture and discontinued operations: |       |                    |       |   |   |
| Accounts receivable, net                                                                                               |       | 6,830                   |       | 33,598 |   |
| Recoverable costs and accrued profits not  yet billed                                                                  |       | 1,794                   |       | 1,346 |   |
| Inventories                                                                                                            |       | (8,145                  | )          | 3,620 |   |
| Other current and noncurrent assets                                                                                    |       | 2,230                   |       | 5,714 |   |
| Accounts payable                                                                                                       |       | 965                     |       | (8,454 | ) |
| Accrued payrolls and incentives                                                                                        |       | (4,202                  | )          | 339 |   |
| Billings in excess of incurred costs                                                                                   |       | (14,667                 | )          | (3,771 | ) |
| Other current liabilities                                                                                              |       | (1,899                  | )          | 1,695 |   |
| Accrued postretirement benefits and pension                                                                            |       | 384                     |       | 555 |   |
| Other, net                                                                                                             |       | (759                    | )          | (1,670 | ) |
| **Net Cash Provided by Continuing Operations**                                                                         |       | 429                     |       | 48,474 |   |
| Net Cash Provided by (Used in) Discontinued  Operations                                                                |       | 9,481                   |       | (4,857 | ) |
| **Net Cash Provided by Operating Activities**                                                                          |       | 9,910                   |       | 43,617 |   |
|                                                                                                                   |       |                    |       |   |   |
| **Investing Activities**                                                                                               |       |                    |       |   |   |
| Capital expenditures, excluding rental  equipment                                                                      |       | (1,632                  | )          | (2,008 | ) |
| Additions to rental equipment                                                                                          |       | (770                    | )          | (763 | ) |
| Proceeds from sale of businesses                                                                                       |       | 15,126                  |       | 3,168 |   |
| Acquisition of businesses, net of cash  acquired                                                                       |       | (42,308                 | )          | — |   |
| Proceeds from disposal of property, plant  and equipment                                                               |       | 588                     |       | 2,266 |   |
| Short-term investments                                                                                                 |       | (8,295                  | )          | (3,490 | ) |
| Net investing activities of discontinued  operations                                                                   |       | 39                      |       | 37 |   |
| **Net Cash Used in Investing Activities**                                                                              |       | (37,252                 | )          | (790 | ) |
|                                                                                                                   |       |                    |       |   |   |
| **Financing Activities**                                                                                               |       |                    |       |   |   |
| Loan acquisition costs                                                                                                 |       | (76                     | )          | — |   |
| Change in short-term notes payable                                                                                     |       | 69                      |       | (24 | ) |
| Dividends paid                                                                                                         |       | (2,454                  | )          | (2,434 | ) |
| Proceeds from exercise of stock options                                                                                |       | 2,065                   |       | 740 |   |
| **Net Cash Used in Financing Activities**                                                                              |       | (396                    | )          | (1,718 | ) |
|                                                                                                                   |       |                    |       |   |   |
| **Effect of exchange rate changes on cash**                                                                            |       | 52                      |       | — |   |
| Increase (decrease) in cash and cash  equivalents                                                                      |       | (27,686                 | )          | 41,109 |   |
| Cash and cash equivalents, beginning of  period                                                                        |       | 130,447                 |       | 53,959 |   |
| Cash and cash equivalents, end of period                                                                               |       | $                       | 102,761    |   | $ | 95,068 |   |
|                                                                                                                   |       |                    |       |   |   |
| Cash Paid For:                                                                                                         |       |                    |       |   |   |
| Interest                                                                                                               |       | $                       | 44         |   | $ | 137 |   |
| Income taxes (excluding refunds)                                                                                       |       | 171                     |       | 135 |   |

 

*See accompanying notes toconsolidated condensed financial statements.*

 

5

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**STEWART & STEVENSON SERVICES, INC. ANDSUBSIDIARIES****NOTES****TO CONSOLIDATED CONDENSEDFINANCIAL STATEMENTS**

(Unaudited)

 

**Note 1 – Summary of Significant Accounting Policies**

 

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-Xfor interim financial statements required to be filed with the Securities andExchange Commission and do not include all information and footnotes requiredby generally accepted accounting principles for complete financialstatements.  However, the informationfurnished herein reflects all normal recurring adjustments, which are, in theopinion of management, necessary for a fair presentation of the results for theinterim periods.  The results ofoperations for the three months ended April 30, 2005 are not necessarilyindicative of the results that will be realized for the fiscal year ending January 31,2006.

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities, the disclosure ofcontingent assets and liabilities at the date of the financial statements, andthe reported amounts of revenue and expenses during the reporting period.  Actual results may differ from theseestimates.

 

TheCompany’s fiscal year begins on February 1 of the year stated and ends on January 31of the following year.  For example, theCompany’s “Fiscal 2005” commenced on February 1, 2005 and ends on January 31,2006.  The Company reports results on thefiscal quarter method with each quarter comprising approximately 13 weeks.

 

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 theSecurities and Exchange Commission. These consolidated condensed financial statements should be read inconjunction with the consolidated financial statements and notes theretoincluded in the Company’s Annual Report on Form 10-K for the yearended January 31, 2005.

 

The accompanying consolidated condensed financial statements for Fiscal2004 and related notes contain certain reclassifications to conform with thepresentation used in Fiscal 2005.

 

Aspermitted under Statement of Financial Accounting Standards (“SFAS”) No. 123,the Company continues to use the intrinsic value method of accountingprescribed by Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees,” to account for its stock-based compensationprograms.  Accordingly, no compensation expenseis recognized when the exercise price of an employee stock option is equal toor greater than the market price of the Company’s common stock on the grantdate and all other provisions of the award are fixed.  In December 2004, the Financial AccountingStandards Board issued SFAS No. 123 (revised 2004), “Share-Based Payment,”which requires all share-based payments to employees, including grants ofemployee stock options, to be recognized as compensation expense in thestatements of operations based on their fair values.  The Company is currently evaluating theimpact of the new standard, which is required to be adopted in the firstquarter of Fiscal 2006.

 

6

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Thefollowing pro forma data are calculated as if compensation expense for theCompany’s stock option plans was determined based on the fair value at thegrant 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**  | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                      | ** ** | **April 30, 2005** | ** ** | **May 1, 2004** | ** ** |
| Net earnings:                                                                   |       |                    |       |   |   |
| As reported                                                                     |       | $                       | 7,692      |   | $ | 5,442 |   |
| Pro forma compensation expense, determined  under fair value method, net of tax |       | (578                    | )          | (468 | ) |
| Pro forma                                                                       |       | $                       | 7,114      |   | $ | 4,974 |   |
|                                                                            |       |                    |       |   |   |
| Basic earnings per share:                                                       |       |                    |       |   |   |
| As reported                                                                     |       | $                       | 0.27       |   | $ | 0.19 |   |
| Pro forma                                                                       |       | 0.25                    |       | 0.17 |   |
|                                                                            |       |                    |       |   |   |
| Diluted earnings per share:                                                     |       |                    |       |   |   |
| As reported                                                                     |       | $                       | 0.26       |   | $ | 0.19 |   |
| Pro forma                                                                       |       | 0.24                    |       | 0.17 |   |

 

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

 

**Note 2 – Comprehensive Income**

 

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

 
| ** **                                               | ** ** | **Three Months Ended**  | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|
| ** **                                               | ** ** | **April 30, 2005** | ** ** | **May 1, 2004** | ** ** |
| ** **                                               | ** ** | ** **              | ** ** | ** ** | ** ** |
| Net earnings                                             |       | $                       | 7,692      |   | $ | 5,442 |   |
| Unrealized gain (loss) on forward  contracts, net of tax |       | —                  |       | (199 | ) |
| Currency translation gain (loss), net of  tax            |       | (207                    | )          | (450 | ) |
| Comprehensive income                                     |       | $                       | 7,485      |   | $ | 4,793 |   |

 

**Note 3 – Acquisitions andDivestitures**

 

On April 8, 2005, the Company acquiredall outstanding shares of Automotive Technik (Holdings) Limited (“ATHL”), alight tactical vehicle manufacturer headquartered in the United Kingdom.  The aggregate purchase price for thetransaction was approximately $47.7 million, including cash of $45.3 million,notes of $1.9 million and transaction costs of approximately $0.5 million.  The acquisition of ATHL broadens the Company’sproduct offerings and provides additional marketing opportunities for theTactical Vehicle Systems segment.  ATHLis currently under contract to produce vehicles for the United Kingdom Ministryof Defence and the New Zealand Ministry of Defence, in addition to otherprograms worldwide.  The results ofoperations for ATHL are included in the Company’s consolidated condensedfinancial statements since the date of acquisition.  The ATHL operations contributed $3.5 millionof sales and had no material impact on operating income during the firstquarter of Fiscal 2005.

 

7

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The following table summarizes the estimatedfair value of the assets acquired and liabilities assumed at the date ofacquisition. The Company is in the process of obtaining third-party valuationsof certain long-lived and intangible assets; consequently, the allocation ofthe purchase price is subject to refinement. The Company believes that a substantial portion of the long-term assetbalance will be allocated to goodwill and other identified intangibles.

 
| **(In thousands)**                                        | ** ** | **April 8, 2005** | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|
| Cash and cash equivalents                                 |       | $                      | 3,552      |   |
| Other current assets                                      |       | 16,740                 |       |
| Total Current Assets                                      |       | 20,292                 |       |
|                                                      |       |                   |       |
| Property, Plant and Equipment and Other  Long-Term Assets |       | 45,560                 |       |
| Total Assets Acquired                                     |       | 65,852                 |       |
|                                                      |       |                   |       |
| Notes payable                                             |       | 149                    |       |
| Other current liabilities                                 |       | 17,901                 |       |
| Total Current Liabilities                                 |       | 18,050                 |       |
| Long-Term Debt, net of current portion                    |       | 68                     |       |
| Total Liabilities Assumed                                 |       | 18,118                 |       |
|                                                      |       |                   |       |
| Purchase Price Allocated                                  |       | $                      | 47,734     |   |

 

Pro forma ATHL results of operations for thefirst quarter of Fiscal 2005 and 2004 include sales of $12.0 million and $8.3million, respectively.  Pro formaoperating profit in the first quarter of Fiscal 2005 and Fiscal 2004 would not bematerial to the Company’s consolidated results of operations.

 

During the first quarter of Fiscal 2004, theCompany exited the business activities associated with the distribution ofMercury Marine and MerCruiser products within the Power Products segment.  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 the PowerProducts segment’s wheelchair lift manufacturing operation.  Consideration received for this asset saleincluded cash of $0.6 million and a receivable of $0.3 million, of which $0.2was outstanding at April 30, 2005, along with royalty rights based onwheelchair lift sales over the next five years. No material gain or loss was recognized on these transactions,individually or in the aggregate.

 

The activities above resulted in the closureof two branch locations which were primarily focused on the sale of MercuryMarine and MerCruiser products in Florida and Virginia.  Additionally during the first quarter ofFiscal 2004, the Company closed an under-performing Power Products branchlocation in Auburn, Washington.  Exitcosts associated with these actions were $0.2 million, which was charged toselling and administrative expenses during the first quarter of Fiscal2004.  As of April 30, 2005, $0.1million of these exit costs remained accrued and unpaid.

 

**Note 4 - Discontinued Operations**

 

During the first quarter of Fiscal 2005, the Company decidedto pursue the sale of substantially all of the assets, distribution rights, andoperations of four Power Products segment distribution locations inCalifornia.  The Company is currently innegotiations with a potential buyer and a sale is expected to take place duringthe second quarter of Fiscal 2005, subject to the execution of a definitiveagreement, other customary documentation and other third party consents.  Accordingly, the identified assets andliabilities held for sale and results of operations for this business are beingreported as discontinued operations for all periods presented.

 

During the fourth quarter of Fiscal 2004, the Company soldsubstantially all of the assets and business of its Airline Productssegment.  Sale proceeds were $60 millionand included $45 million of cash and a $15 million senior secured note due in April 2005,as well as the assumption of certain specified liabilities.  The $15 million note was paid in April 2005.  The total sales proceeds are subject tofurther adjustment in Fiscal 2005 based on the amount of working capitalconveyed at closing.  On May 17,2005, the Company received the buyer’s calculation of working capital atclosing, which proposes that sales proceeds should be adjusted downward byapproximately $17.0 million from that reflected in the consolidated financialstatements, which would result in a loss for the Company.  The Company does not agree with the buyer’scalculation and has requested additional supporting documentation to assist inits review.  Pursuant to the salesagreement, the Company intends to respond by June 16, 2005.  It is presently impossible for the Company todetermine the ultimate outcome of this matter.

 

8

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Additionally, the Company’s discontinuedoperations include the continued wind-down of the turnkey engineering,procurement and construction activities of the Distributed Energy Solutionssegment, which the Company decided to exit in Fiscal 2003, and the retainedwarranty and contract obligations from the Fiscal 2002 sale of the blowoutpreventer and controls, valve and drilling riser business within the EngineeredProducts segment.  Sales and operatingloss in the three months ended April 30, 2005 and May 1, 2004 fromdiscontinued operations were as follows (*in thousands):*

 
| ** **                   | ** ** | **Three Months Ended April 30, 2005** | ** ** | **Three Months Ended May 1, 2004** | ** ** |
|------------------------------|------------|--------------------------------------------|------------|-----------------------------------------|------------|
| ** **                   | ** ** | **Sales**                                  | ** ** | **Operating loss**                      | ** ** | **Operating loss,  net of taxes** | ** ** | **Sales** | ** ** | **Operating  income (loss)** | ** ** | **Operating income  (loss), net of taxes** | ** ** |
|                         |       |                                       |       |                                    |       |   |   |   |   |   |   |   |   |
| Power Products               |       | $                                          | 11,982     |                                    | $          | (154 | ) | $ | (123 | ) | $ | 14,420 |   | $ | 119 |   | $ | 78 |   |
| Airline Products             |       | —                                     |       | (901                                    | )          | (719 | ) | 23,075 |   | (102 | ) | (67 | ) |
| Distributed Energy Solutions |       | 1,478                                      |       | (871                                    | )          | (694 | ) | 4,444 |   | (5,068 | ) | (3,312 | ) |
| Engineered Products          |       | 65                                         |       | (132                                    | )          | (105 | ) | 585 |   | (98 | ) | (64 | ) |
|                         |       | $                                          | 13,525     |                                    | $          | (2,058 | ) | $ | (1,641 | ) | $ | 42,524 |   | $ | (5,149 | ) | $ | (3,365 | ) |

 

**Note 5 - 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 three operating segments.  Sales and operating profit (loss) byoperating segment are as follows (*inthousands*):

 
| ** **                                                   | ** ** | **Three Months Ended**  | ** ** |
|--------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                   | ** ** | **April 30, 2005** | ** ** | **May 1, 2004** | ** ** |
| **Sales**                                                    |       |                    |       |   |   |
| Tactical Vehicle Systems                                     |       | $                       | 165,518    |   | $ | 138,783 |   |
| Power Products                                               |       | 117,011                 |       | 106,299 |   |
| Engineered Products                                          |       | 29,033                  |       | 17,268 |   |
| Total Sales                                                  |       | $                       | 311,562    |   | $ | 262,350 |   |
|                                                         |       |                    |       |   |   |
| **Operating profit (loss)**                                  |       |                    |       |   |   |
| Tactical Vehicle Systems                                     |       | $                       | 13,175     |   | $ | 19,441 |   |
| Power Products                                               |       | 2,377                   |       | (229 | ) |
| Engineered Products                                          |       | 1,274                   |       | (1,809 | ) |
| Corporate                                                    |       | (2,504                  | )          | (3,467 | ) |
| Total operating profit                                       |       | 14,322                  |       | 13,936 |   |
|                                                         |       |                    |       |   |   |
| Interest expense                                             |       | 525                     |       | 517 |   |
| Interest income                                              |       | (760                    | )          | (254 | ) |
| **Earnings from continuing operations before  income taxes** |       | $                       | 14,557     |   | $ | 13,673 |   |

 

**Note 6 - 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.

 

9

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Asummary of warranty activity associated with continuing operations for threemonths ended April 30, 2005 and May 1, 2004 follows (*in thousands*):

 
| ** **                                                   | ** ** | **Three Months Ended**  | ** ** |
|--------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                   | ** ** | **April 30, 2005** | ** ** | **May 1, 2004** | ** ** |
| ** **                                                   | ** ** | ** **              | ** ** | ** ** | ** ** |
| Accrued warranty costs at beginning of  period               |       | $                       | 3,537      |   | $ | 3,517 |   |
| Payments for warranty obligations                            |       | (703                    | )          | (1,408 | ) |
| Warranty accrual for current period sales                    |       | 1,027                   |       | 1,064 |   |
| Changes related to pre-existing warranties  and acquisitions |       | 349                     |       | 48 |   |
| Accrued warranty costs at end of period                      |       | $                       | 4,210      |   | $ | 3,221 |   |

 

*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 April 30,2005 and January 31, 2005, the Company had letters of credit outstandingtotaling approximately $13.9 million and $13.2 million, respectively.  In addition, the Company had contingentperformance indemnities of approximately $3.5 million and $3.8 million as of April 30,2005 and January 31, 2005, respectively.

 

*U.S. Government Contingencies*:  During 1998, theU.S. Customs Service detained a medium tactical vehicle that was being shippedby the Company for display in a European trade show.  The Company is advised that the U.S. CustomsService and the Department of Justice have conducted an investigation ofpotential 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, financial condition or liquidity andbelieves that the resolution of the matter that is possibly most adverse to theCompany will involve the payment of a civil penalty that will not materiallyadversely affect the Company.

 

The Company is a defendant in a suit filed in 1996 under the *qui tam* provision of the False Claims Act, *United States of America,**ex rel.Werner Stebner v. Stewart & Stevenson Services, Inc. andMcLaughlin Body Co.*, Civil Action No. H-96-3363, inthe 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 mediumtactical vehicles delivered to the U.S. Army before 1998, and that the vehicleswere substandard because of corrosion problems. Following an investigation by the Justice Department, the United Statesdeclined to intervene in the suit.  In February 2004,the District Court found in favor of the Company and dismissed all of theplaintiff’s claims by summary judgment without proceeding to trial.  The plaintiffs filed a notice of appeal in March 2004in the United States Court of Appeals for the Fifth Circuit, No. 04-20209.  Oral argument was conducted in April 2005.  The Company expects a decision from the FifthCircuit near the end of 2005 or early 2006. The Company believes the Court of Appeals will uphold the DistrictCourts’ opinion, which dismissed all of the plaintiff’s claims as being withoutmerit.  While the Company does notbelieve that an adverse outcome is likely, an unfavorable opinion from theFifth Circuit could have a material adverse impact on the Company’sconsolidated results of operations, financial position and liquidity.  The Company is presently unable to determinewhether any liability has been incurred in this matter, other than legal feesand expenses.  Additionally, the Companycannot reasonably estimate the amount or range of any loss that may result fromthis matter, and thus no accruals have been recorded in this matter other thanestimated legal fees and expenses relating to the appeal.

 

*KlickitatLitigation:*  The Company and several of its subsidiariesin the Distributed Energy Solutions business are defendants in a suit filed bythe Klickitat County Public Utility District No. 1 on December 11,2003 arising out of claims relating to a landfill gas power generation facilityin Roosevelt, Washington, Cause No. CY-03-3175-LRS;*Klickitat County Public Utility District No. 1 v. Stewart &Stevenson Services, Inc., Stewart & Stevenson Power, Inc.,Sierra Detroit Diesel Allison, Inc., Pamco International, Inc. andWaukesha Engine Dresser, Inc.*; in the United States DistrictCourt for 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

 

10

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outcomeof this suit or whether its resolution will, in the future, have a materialadverse effect on the Company’s consolidated results of operations, financialposition or liquidity.  The Company ispresently unable to determine whether a material liability has been incurred inthis matter or to reasonably estimate the amount of any loss that may resultfrom this matter.  Consequently, theCompany has recorded no accrual for any losses related to the ultimate outcomeof this litigation.  The Company has,however, recorded accruals that it believes are adequate for estimated legalfees that it expects to incur associated 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 contracts(entered into in December 2000 and March 2001) between a subsidiaryof the Company in the Distributed Energy Solutions business and NEO, for the engineeringand construction of two natural gas fueled electricity generating facilities inCalifornia, and with respect to a related “Payment Agreement” entered into in October 2001.  The demand included the initiation ofarbitration proceedings in Minneapolis, Minnesota, under the auspices of theAmerican Arbitration Association.  Thefactual basis alleged to underlie the arbitration demand appears to be NEO’sposition that, although the power projects began operations during 2001, theplants have had operational problems, including failure to meet performancestandards for heat rate, net electrical output and, particularly,emissions.  NEO alleges claims in excessof $65 million, based on legal theories of recovery under Minnesota andCalifornia law that include intentional misrepresentation, negligentmisrepresentation, concealment, violation of contractor license requirements,unfair competition, negligence and breach of contract as well as claims on $4.7million of surety bonds as to the contract. Notwithstanding the facts that the contracts between the Companysubsidiary and NEO provided for an exclusive method of dispute resolutionwhich, under the contracts, (i) necessitated appropriate notice and aperiod of mutual efforts to resolve a dispute, which efforts (if unsuccessful)were to be followed by a mandatory non-binding mediation, and (ii) (shouldsuch 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.  During a hearing on March 2, 2005, theSuperior Court granted the Company’s Motion to Stay Litigation and the mattershould therefore proceed in arbitration in Minnesota.  The Company believes NEO’s claims are withoutmerit and is defending them vigorously. The Company further believes, in addition to its basic view that thegenerating facilities are operating satisfactorily, that NEO is incorrect invarious factual allegations, and that the Company has meritorious legaldefenses 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.

 

*AntitrustLitigation:*  The Company is a co-defendant with DetroitDiesel Corporation and other Detroit Diesel distributors in two putative classaction suits filed on February 9, 2005, Civil Action No. 05-616;*Cumberland Truck Equipment Co. et al. v. DetroitDiesel Corp., et al.* (the “Cumberland Litigation”), and Civil ActionNo. 05-625; *Diamond InternationalTrucks, Inc. et al. v. Detroit Diesel Corp., et al.* (the “DITLitigation”).  Each suit relates to thePower Products segment and has been filed**in the UnitedStates District Court for the Eastern District of Pennsylvania.  In the Cumberland Litigation, plaintiffs weredealers of Detroit Diesel parts whose agreements were terminated or not renewedon or after February 9, 2001.  TheCompany is a distributor of Detroit Diesel parts and had a dealer agreementwith one or more of the named plaintiffs. The plaintiffs are claiming antitrust violations arising out of thetermination or non-renewal of their dealer agreements.  The plaintiffs have also alleged price fixingand group boycott in violation of Section 1 of the Sherman Act.  The plaintiffs have made claims for trebledamages and injunctive and other relief.  In the DIT Litigation, plaintiffs are dealersof Detroit Diesel parts whose dealership classification was changed on or afterFebruary 9, 2001.  The Company alsohad a dealer agreement with one or more of these plaintiffs.  The plaintiffs are claiming antitrustviolations arising out of changes to the classification of theirdealerships.  The plaintiffs have allegedprice fixing and group boycott in violation of Section 1 of the ShermanAct.  The plaintiffs have made claims fortreble damages and injunctive and other relief. The Company intends to vigorously defend both suits.  It is presently impossible for the Company todetermine the ultimate outcome of either suit or whether their resolution will,in the 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 these matters or toreasonably estimate the amount of any loss that may result from thesematters.  Consequently, the Company hasrecorded no accrual for any losses related to the ultimate outcome of thislitigation.  The Company has, however,recorded accruals that it currently believes are adequate for estimated legalfees that it expects to incur associated with these matters.

 

*Environmental Contingencies*:  In 2001, theCompany received from the United States Environmental Protection Agency (the “EPA”)a Request for Information under Section 104(e) of the ComprehensiveEnvironmental Response, Compensation, and Liability Act of 1980, forinformation pertaining to the R&H Oil Company Site in San Antonio, Texas(the “Site”).  Information

 

11

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provided to the Company by the EPA indicates that the Company may havesent waste oils to the Site for recycling in the late 1980s, and that suchwaste oils may potentially account for between one and two percent of thevolume of total wastes received by the oil recycler at the Site.  Since the Company expects to receive a claimfor cleanup and other costs related to this site, it has established reserveswhich it believes to be adequate at this time. As additional facts are developed and definitive remediation plans andnecessary regulatory approvals for implementation of remediation areestablished, changes in these and other factors may result in actual costsexceeding the current environmental reserves. While uncertainties are inherent in the final outcome of theseenvironmental matters, and it is presently impossible to determine the actualcosts that ultimately may be incurred, management currently believes that theresolution of such uncertainties should not have a material adverse effect onthe Company’s consolidated results of operations, financial position orliquidity. The Company believes that the most likely outcome in thisenvironmental matter is the expenditure of an immaterial amount ofconsideration as a contribution to the remediation effort.

 

The Company is also a defendant in a number of lawsuits relating tocontractual, product liability, personal injury and warranty matters normallyincident to the Company’s business.  Noindividual case, or group of cases presenting substantially similar issues oflaw or fact, is expected to have a material effect on the manner in which theCompany conducts its business or on its consolidated results of operations,financial position or liquidity.  TheCompany maintains certain insurance policies that provide coverage for productliability and personal injury cases.  TheCompany has established reserves that it believes to be adequate based oncurrent evaluations 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 7– Inventories**

 

Summarized below arethe components of inventories related to continuing operations, net of customerdeposits *(in thousands)*:

 
| ** **                                        | ** ** | **April 30, 2005** | ** ** | **January 31, 2005** | ** ** |
|---------------------------------------------------|------------|-------------------------|------------|---------------------------|------------|
| ** **                                        | ** ** | ** **              | ** ** | ** **                | ** ** |
| Inventory purchased under distributor  agreements |       | $                       | 69,491     |                      | $          | 71,583 |   |
| Raw materials and spare parts                     |       | 32,092                  |       | 22,811                    |       |
| Work in process                                   |       | 24,742                  |       | 16,228                    |       |
| Finished goods                                    |       | 2,484                   |       | 2,267                     |       |
|                                              |       | 128,809                 |       | 112,889                   |       |
| Excess of current cost over LIFO values           |       | (35,667                 | )          | (35,168                   | )          |
| Total Inventories                                 |       | $                       | 93,142     |                      | $          | 77,721 |   |

 

Rawmaterials and spare parts include OEM equipment and components used in themanufacturing segments.  The Company usesthe last-in, first-out (“LIFO”) method of valuing the majority of its inventory.  An actual valuation of inventory under theLIFO method can be made only at the end of each fiscal year based on theinventory levels and costs at that time. Accordingly, interim LIFO calculations are based on management’sestimates of expected year-end inventory levels and costs and are subject tothe final year-end LIFO inventory valuation.

 

12

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**Note 8– Earnings (Loss) Per Share**

 

The following table is a reconciliation of the numerators and denominatorsused in the calculation of basic and diluted earnings per share as presented onthe consolidated condensed statements of operations *(inthousands, except per share data)*:

 
| ** **                                                                                 | ** ** | **Three Months Ended**  | ** ** |
|--------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                 | ** ** | **April 30, 2005** | ** ** | **May 1, 2004** | ** ** |
| Numerator:                                                                                 |       |                    |       |   |   |
| Earnings (loss) available to common  shareholders                                          |       |                    |       |   |   |
| From continuing operations                                                                 |       | $                       | 9,333      |   | $ | 8,807 |   |
| From discontinued operations                                                               |       | (1,641                  | )          | (3,365 | ) |
| Net earnings                                                                               |       | $                       | 7,692      |   | $ | 5,442 |   |
|                                                                                       |       |                    |       |   |   |
| Denominator:                                                                               |       |                    |       |   |   |
| Denominator for basic earnings per share   Weighted average shares outstanding             |       | 28,927                  |       | 28,671 |   |
| Effect of dilutive securities:                                                             |       |                    |       |   |   |
| Employee and director stock options                                                        |       | 506                     |       | 263 |   |
| Denominator for diluted earnings per share -  Adjusted weighted average shares outstanding |       | 29,433                  |       | 28,934 |   |
|                                                                                       |       |                    |       |   |   |
| Basic earnings per share:                                                                  |       |                    |       |   |   |
| From continuing operations                                                                 |       | $                       | 0.32       |   | $ | 0.31 |   |
| From discontinued operations                                                               |       | (0.05                   | )          | (0.12 | ) |
| Net earnings per share                                                                     |       | $                       | 0.27       |   | $ | 0.19 |   |
|                                                                                       |       |                    |       |   |   |
| Diluted earnings per share:                                                                |       |                    |       |   |   |
| From continuing operations                                                                 |       | $                       | 0.32       |   | $ | 0.30 |   |
| From discontinued operations                                                               |       | (0.06                   | )          | (0.11 | ) |
| Net earnings per share                                                                     |       | $                       | 0.26       |   | $ | 0.19 |   |
|                                                                                       |       |                    |       |   |   |
| Number of shares under anti-dilutive stock  options outstanding                            |       | 429                     |       | 2,031 |   |

 

**Note 9 -****Employee Pension and Other Benefit Plans**

 

Effective July 1, 2003, the Company froze the benefits earnedunder its defined benefit pension plans and its defined benefit postretirementmedical plan, with the exception of a small transition group.

 

In December 2003, the Medicare Prescription Drug, Improvement andModernization Act of 2003 (the “Act”) was signed into law. The Act introduced aprescription drug benefit under Medicare (“Medicare Part D”) as well as afederal subsidy to sponsors of retiree health care benefit plans that provide abenefit that is at least 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.  Prior to the end of Fiscal 2004, the Companyannounced that the defined benefit postretirement medical plan is being amendedeffective January 1, 2006, to discontinue prescription medication coveragefor all participants who are both eligible for prescription drug benefits underMedicare and for whom Medicare is the primary payor.  This plan change has reduced the plan’s netperiodic benefit cost beginning in the first quarter of Fiscal 2005.

 

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The net periodic benefit cost associated with the Company’s definedbenefit pension plans and defined benefit postretirement medical plan consistedof the following components for the three months ended *(inthousands)*:

 
| ** **                         | ** ** | **Pension Benefits**    | ** ** | **Other Postretirement Benefits** | ** ** |
|------------------------------------|------------|-------------------------|------------|-----------------------------------|------------|
| ** **                         | ** ** | **April 30, 2005** | ** ** | **May 1, 2004**              | ** ** | **April 30, 2005** | ** ** | **May 1, 2004** | ** ** |
| Service cost                       |       | $                       | 154        |                              | $          | 133 |   | $ | — |   | $ | — |   |
| Interest cost                      |       | 1,988                   |       | 1,939                             |       | 40 |   | 158 |   |
| Expected return on plan assets     |       | (2,241                  | )          | (2,113                            | )          | — |   | — |   |
| Amortization of prior service cost |       | —                  |       | —                            |       | (363 | ) | (207 | ) |
| Recognized actuarial loss          |       | 728                     |       | 430                               |       | 125 |   | 112 |   |
| Net periodic benefit cost (income) |       | $                       | 629        |                              | $          | 389 |   | $ | (198 | ) | $ | 63 |   |

 

As previously disclosed in the Company’s consolidated financialstatements for the year ended January 31, 2005, the Company expects tocontribute approximately $1.0 million to its defined benefit pension plansduring Fiscal 2005.  During the threemonths ended April 30, 2005, no contributions were made.

 

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

 

This discussion should be read in conjunction with theattached consolidated condensed financial statements and notes thereto, andwith our Annual Report on Form 10-K and notes thereto for the fiscalyear ended January 31, 2005.  Thefollowing discussion contains forward-looking statements.  In connection therewith, please see “FactorsThat May Affect Future Results” below, which identifies important factorsthat could cause actual results to differ materially from those predicted orimplied in the forward-looking statements.

 

Our fiscal year begins on February 1 ofthe year stated and ends on January 31 of the following year.  For example, our “Fiscal 2005” commenced on February 1,2005 and ends on January 31, 2006. We report results on the fiscal quarter method with each quartercomprising approximately 13 weeks.  Thefirst quarter of Fiscal 2005 commenced on February 1, 2005 and ended on April 30,2005, and the first quarter of Fiscal 2004 commenced on February 1, 2004and ended on May 1, 2004.

 

**RESULTS OF OPERATIONS**

 

**Strategic Overview**

 

DuringFiscal 2004, we took numerous actions aimed at generating acceptable returns inall of our core businesses.  This processbegan during the second half of Fiscal 2003, when we refocused our primaryoperating metrics and management incentive measurements to emphasize the needfor each of our businesses to achieve acceptable returns on shareholderinvested capital.  During Fiscal 2005, weare continuing to take actions to exit non-core and under-performing businessesand invest in our core operating segments in order to improve our returns onshareholder invested capital.   Thesignificant highlights of our progress during the first quarter of Fiscal 2005are described below.

 

*Tactical Vehicle Systems* – In April 2005, we acquired alloutstanding shares of Automotive Technik (Holdings) Limited (“ATHL”), themanufacturer of the Pinzgauer light tactical vehicle headquartered in theUnited Kingdom, for a total purchase price of approximately $47.7 million.  The acquisition of ATHL broadens our productofferings in our Tactical Vehicle Segment and provides additional marketingopportunities worldwide.  ATHL iscurrently under contract to produce vehicles for the United Kingdom Ministry ofDefence and the New Zealand Ministry of Defence, in addition to other programsworldwide.

 

*PowerProducts –*During thefirst quarter of Fiscal 2005, we decided to pursue the sale of substantially allof the assets, distribution rights, and operations of four Power Productssegment distribution locations in California, which is expected to reduceworking capital requirements of this segment by approximately $20 million.  We are currently in negotiations with apotential buyer and the sale of this business is expected to close during thesecond quarter of Fiscal 2005, subject to the execution of a definitiveagreement, other customary documentation and other third party consents.  This sale is another in a series of actionstaken to exit non-strategic product lines and locations and re-focus ourefforts in the Power Products segment to improve our return on invested capitalto acceptable levels.  Additionally, we have placed a renewed focuson sales efforts in this segment and have implemented intense sales trainingthroughout the organization.

 

**Fiscal 2005 vs. Fiscal 2004**

 

Sales from continuing operations for thefirst quarter of Fiscal 2005 were $311.6 million, a $49.2 million (19%)increase over the $262.4 million recorded in the first quarter of Fiscal2004.  This increase in sales isattributable to higher sales volume in all operating segments.  The Tactical Vehicle Systems segmentaccounted for the largest sales increase, contributing $26.7 million ofadditional sales, while the Power Products and Engineered Products segmentsrecorded sales increases of $10.7 million and $11.8 million, respectively, overthe first quarter of Fiscal 2004.  Thechanges within each segment are explained in greater detail in the Segment Datasection below.

 

Gross profit increased slightly to $36.7million in the first quarter of Fiscal 2005 from $36.6 million in the firstquarter of Fiscal 2004, reflecting a decline in gross profit margin from 13.9%to 11.8%.  The decrease in gross profitis primarily attributable to the transition to the current multi-year FMTVproduction contract in the fourth quarter of Fiscal 2004.  This change is explained in greater detail inthe Segment Data section below.

 

Selling and administrative expenses decreasedto $23.1 million (7.4% of sales) in the first quarter of Fiscal 2005 from $23.2million (8.9% of sales) in the first quarter of Fiscal 2004.  Fiscal 2004 included costs of $0.6 millionassociated with implementing the provisions of Section 404 of theSarbanes-Oxley Act of 2002.  While thesecosts did not recur in Fiscal 2005, they were largely replaced by selling andadministrative expenses incurred in the newly-acquired ATHL business within theTactical Vehicle Systems segment.  Sellingand administrative expenses in the other operating segments were relativelyflat compared to the first quarter of Fiscal 2004, despite increased salesvolumes.

 

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Other income, net was $0.7 million in the first quarter of Fiscal 2005, a$0.1 million increase from the first quarter of Fiscal 2004 and consistsprimarily of compensation earned from supply partners in our Power Productssegment.

 

Net interest income improved to $0.2 million in the first quarter ofFiscal 2005 from a net expense of $0.3 million in the first quarter of Fiscal2004.  This improvement is primarily theresult of higher interest income due to higher invested cash balances andhigher interest rates.

 

The effective tax rate was 35.9% in the first quarter of Fiscal 2005compared to 35.6% for the first quarter of Fiscal 2004.

 

Discontinued operations generated an after-tax loss of $1.6 million inthe first quarter of Fiscal 2005, compared to a $3.4 million after-tax loss inthe first quarter of Fiscal 2004. Discontinued operations include the resultsof our exited Distributed Energy Solutions and Airline Products segments,  as well as certain Power Products distributionlocations in California which are currently held for sale and costs associatedwith retained obligations associated with our discontinued blowout preventerand controls, valve and drilling riser business, which was sold during Fiscal2002.  The decreased losses in Fiscal2005 are primarily attributable to the continued wind down of engineering, procurement,and construction activities within the Distributed Energy Solutions business,partially offset by increased losses in the Airline Products business resultingfrom residual costs associated with this exited business.

 

**SegmentData**

 

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

 

The following table represents sales and operating profit (loss) bybusiness segment in continuing operations *(inthousands, except percentages)*:

 
| ** **                                               | ** ** | **Three Months Ended**  | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|
| ** **                                               | ** ** | **April 30, 2005** | ** ** | **May 1, 2004** | ** ** |
| **Sales**                                                |       |                    |       |   |   |
| Tactical Vehicle Systems                                 |       | $                       | 165,518    |   | $ | 138,783 |   |
| Power Products                                           |       | 117,011                 |       | 106,299 |   |
| Engineered Products                                      |       | 29,033                  |       | 17,268 |   |
| Total Sales                                              |       | $                       | 311,562    |   | $ | 262,350 |   |
|                                                     |       |                    |       |   |   |
| **Operating profit (loss)**                              |       |                    |       |   |   |
| Tactical Vehicle Systems                                 |       | $                       | 13,175     |   | $ | 19,441 |   |
| Power Products                                           |       | 2,377                   |       | (229 | ) |
| Engineered Products                                      |       | 1,274                   |       | (1,809 | ) |
| Corporate                                                |       | (2,504                  | )          | (3,467 | ) |
| Total operating profit                                   |       | 14,322                  |       | 13,936 |   |
|                                                     |       |                    |       |   |   |
| Interest expense                                         |       | 525                     |       | 517 |   |
| Interest income                                          |       | (760                    | )          | (254 | ) |
| Earnings from continuing operations before  income taxes |       | $                       | 14,557     |   | $ | 13,673 |   |
|                                                     |       |                    |       |   |   |
| **Operating profit (loss) percentage**                   |       |                    |       |   |   |
| Tactical Vehicle Systems                                 |       | 8.0                     | %          | 14.0 | % |
| Power Products                                           |       | 2.0                     |       | (0.2 | ) |
| Engineered Products                                      |       | 4.4                     |       | (10.5 | ) |
| Consolidated                                             |       | 4.6                     | %          | 5.3 | % |

 

**TacticalVehicle Systems**

 

The Tactical Vehicle Systems segment manufactures theFamily of Medium Tactical Vehicles (“FMTV”) and related armoring undercontracts with the U.S. Army and provides sustaining design engineering,service and support.  With the ATHLacquisition described above, this segment also manufactures Pinzgauer light tacticalvehicles for the United Kingdom Ministry of Defence, the

 

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New Zealand Ministry of Defence and other customers.  Other contracts within and outside of theU.S. are also being pursued in the segment. During the first quarter of Fiscal 2005, this segment recorded $165.5million of sales, a $26.7 million (19%) increase from the $138.8 million ofsales recorded in the first quarter of Fiscal 2004.  The sales increase is primarily attributableto increased production volume of Low Signature Armored Cabs (“LSAC”).  A breakdown of unit deliveries from thissegment is as follows:

 
| ** **                 | ** ** | **Three Months Ended**  | ** ** |
|----------------------------|------------|-------------------------|------------|
| ** **                 | ** ** | **April 30, 2005** | ** ** | **May 1, 2004** | ** ** |
| Trucks                     |       | 627                     |       | 743 |   |
| Trailers                   |       | 291                     |       | 204 |   |
| Low Signature Armored Cabs |       | 621                     |       | — |   |

 

This segment recorded $52.8 million of sales in the firstquarter of Fiscal 2005 associated with the LSAC production and $3.5 million ofsales attributable to Pinzgauer truck sales in our newly-acquired U.K.manufacturing operation.  These salesincreases were partially offset by a $36.5 million decline in salesattributable to the U.S. Army production contracts.  The decline in U.S. Army equipment sales isdue to lower truck volumes as well as lower pricing under the currentproduction contract.   Parts and servicesales increased by $6.9 million from the first quarter of Fiscal 2004, as thefirst quarter of Fiscal 2005 included $7.7 million of sales related to vehiclereset programs awarded during Fiscal 2004.

 

Operating profit for the first quarter of Fiscal 2005decreased to $13.2 million (8.0% operating margin) from $19.4 million (14.0%operating margin) in the first quarter of Fiscal 2004.  Lower margins on the new FMTV productioncontract were partially offset by higher operating profit generated from theLSAC production.  In addition, operatingmargins on parts and service sales declined as margins on the vehicle resetprograms and sustaining engineering services provided under the current FMTVcontract are lower than historical margin rates.

 

During the first quarter of Fiscal 2005, the third programyear of the current FMTV contract valued at $316 million was funded, extendingproduction through September 2006. Consequently, backlog in this segment at April 30, 2005 was $910million, including $54 million attributable to ATHL.  While a supplemental spending bill was signedby President Bush in May 2005, it is not currently possible to estimatethe impact that this bill may have on our operations or future results.

 

Scheduled deliveries for the remainder of Fiscal 2005currently include 2,358 trucks, 1,413 trailers and 1,145 LSAC units.  The current delivery schedule is subjectto change at the request of the customer. Expected operating margins on the components of this segment’s backlogvary considerably among the numerous contracts and variants provided.  This variability is attributable to a numberof factors including recent volatility in prices for steel and othercommodities, base versus option production, the material content within eachvariant and other factors, many of which are not within our control.  Consequently, depending on the mix ofvehicles, LSACs, parts and services delivered in each quarter, the segmentoperating margin could vary significantly from one fiscal quarter to thenext.  The operating margin that thissegment will achieve in total may also be impacted by proposal activities,additional contract awards and modifications and the level of engineeringservice and spare parts provided.

 

**Power Products**

 

The Power Products segment, which is responsible formarketing and aftermarket support of a wide range of industrial equipment,recorded sales of $117.0 million in the first quarter of Fiscal 2005, a $10.7million (10%) increase from $106.3 million in the first quarter of Fiscal 2004.A breakdown of Power Products segment sales follows *(inthousands)*:

 
| ** **               | ** ** | **Three Months Ended**  | ** ** |
|--------------------------|------------|-------------------------|------------|
| ** **               | ** ** | **April 30, 2005** | ** ** | **May 1, 2004** | ** ** |
|                     |       |                    |       |   |   |
| Equipment sales          |       | $                       | 42,875     |   | $ | 34,427 |   |
| Parts sales              |       | 50,290                  |       | 48,192 |   |
| Service and rental sales |       | 23,846                  |       | 23,680 |   |
|                     |       | $                       | 117,011    |   | $ | 106,299 |   |

 

The improved sales volume in the firstquarter of Fiscal 2005 compared to the first quarter of Fiscal 2004 isprimarily attributable to improved sales execution along with generalimprovements in the heavy equipment markets we serve.

 

This segment recorded an operating profit of$2.4 million in the first quarter of Fiscal 2005 compared to a $0.2 millionoperating loss in the first quarter of Fiscal 2004.  The $2.6 million improvement in operatingprofit is primarily attributable to

 

17

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the additional gross profit generated by thehigher sales volume while selling and administrative expenses have remainedrelatively flat compared to the first quarter of Fiscal 2004.

 

Our order backlog in this segment hasincreased to $52.6 million at April 30, 2005, compared to $39.3 million atJanuary 31, 2005.  Due to theincreasing order backlog combined with the anticipated results of the many actionstaken in the Power Products segment, we anticipate that this segment willcontinue to generate positive operating profit and cash flow and improvedreturns in the near-term.  However, dueto the many uncertainties involved with this business, including the generaleconomic conditions in the markets we serve, we cannot predict with certaintywhen this segment will consistently achieve our targeted level of financial return.

 

**EngineeredProducts**

 

The Engineered Products segment consists oftwo primary product lines, petroleum equipment and utilities equipment.  The petroleum equipment business manufacturesequipment primarily for the well stimulation segment of the oil serviceindustry.  The utilities equipmentproducts include mobile railcar movers, snowblowers and off-road seismicvehicles.  Sales in this segmentincreased to $29.0 million in the first quarter of Fiscal 2005 from $17.3million in the first quarter of Fiscal 2004, representing a 68% increase.  The sales increase resulted from theexecution of several large petroleum equipment orders that were received duringFiscal 2004.

 

Operating profit for the first quarter ofFiscal 2005 was $1.3 million, a $3.1 million improvement from the $1.8 millionoperating loss in the first quarter of Fiscal 2004.  The improvement in operating profit includes$0.7 million attributable to the increased sales volume, $2.0 millionattributable to margin improvements through pricing and manufacturing and othercost reductions on the Fiscal 2005 equipment projects, and $0.4 million due toan inventory impairment charge in the first quarter of Fiscal 2004 resultingfrom U.S. trade sanctions against Syria.

 

Our order backlog in this segment hasdecreased slightly to $89.5 million at April 30, 2005 from $91.9 millionat the end of Fiscal 2004.  As a resultof relatively high backlog and favorable economic conditions within the marketsthat we serve, sales volumes and operating profits are expected to continue tobe higher for the remainder of Fiscal 2005 compared to Fiscal 2004.  Beyond Fiscal 2005, however, sales aredifficult to predict and typically come in large volume orders and require longlead times to complete.  The sales derivedfrom customers in the United States are primarily driven by the capitalspending budgets of the oilfield service companies we serve and, to someextent, the internal capacity of some customers to package their own equipment.

 

**Corporate**

 

Corporate expenses consist of costs incurredby the corporate headquarters group that cannot be directly attributed to theactivities of the business segments. Corporate expenses incurred in the first quarter of Fiscal 2005 were $2.5million, down $1.0 million from the $3.5 million incurred in the first quarterof Fiscal 2004.  The decrease incorporate expenses is primarily attributable to costs incurred of $0.6 million inthe first quarter of Fiscal 2004 associated with the implementation of theinternal control reporting requirements of the Sarbanes-Oxley Act of 2002 whichdid not recur in Fiscal 2005.

 

In the remainder of Fiscal 2005, weanticipate that corporate expenses will continue to be lower than Fiscal 2004levels, partially due to anticipated reductions in costs associated with therequirements of Sarbanes-Oxley Act, as well as the benefits of continued costreduction programs.

 

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**UNFILLEDORDERS**

 

The Company’s unfilled orders consist of written purchase orders andsigned contracts.  Historically,cancellations are rare; however, these unfilled orders are generally subject tocancellation or modification due to customer relationships or other conditions.  Purchase options are not included in unfilledorders until exercised.  Due to theinherent uncertainties of the Congressional appropriations process, the Companyincludes only the funded portions of awarded U.S. government contracts in thetable below.  Unfilled orders relating tocontinuing operations were as follows (*in millions*):

 
| ** **               | ** ** | **April 30, 2005** | ** ** | **January  31, 2005** | ** ** |
|--------------------------|------------|-------------------------|------------|----------------------------|------------|
|                     |       |                    |       |                       |       |
| Tactical Vehicle Systems |       | $                       | 909.9      |                       | $          | 456.6 |   |
| Power Products           |       | 52.6                    |       | 39.3                       |       |
| Engineered Products      |       | 89.5                    |       | 91.9                       |       |
|                     |       | $                       | 1,052.0    |                       | $          | 587.8 |   |

 

Unfilled orders of the Tactical Vehicle Systems segment at January 31,2005 consisted primarily of vehicle production funded under the FMTV contract,production of LSAC units to be delivered in Fiscal 2005, production ofPinzgauer trucks in the newly-acquired U.K. operation and uncompleted resetcontracts for vehicles ongoing in Sealy and Ft. Hood, Texas.  During the first quarter of Fiscal 2005, thethird program year of the FMTV contract was funded, extending productionthrough September 2006 and increasing backlog by $316 million.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Our sources of cash liquidity include cash and cash equivalents,short-term investments, amounts available under credit facilities and cash fromoperations.  We believe that thesesources will provide sufficient capital to fund our working capitalrequirements, capital expenditure needs, foreseeable acquisition activity, dividendsand other financial commitments.

 

In January 2005, we entered into a $100million unsecured revolving credit facility which expires in January 2009.  No borrowings have been made under thisfacility, which in effect replaced a $150 million revolving credit facilitythat expired in January 2004.  Therevolving credit facility has a $25 million sub-facility which may be used forletters of credit.  Approximately $8.0million in letters of credit under the revolving credit facility wereoutstanding at April 30, 2005 and $92.0 million was available forborrowing.

 

This revolving credit facility was issued pursuant to agreementscontaining covenants that restrict indebtedness, guarantees, sales of assetsand other items, and require us to maintain a minimum fixed charge coverageratio and maximum leverage ratio.  Basedon our financial condition as of April 30, 2005, the restrictions imposedby the Company’s revolving credit facility do not currently restrict ourability to meet our obligations or to declare and pay dividends at historicallevels.

 

We have $25.0 million in unsecured senior notes outstanding, which bearinterest at a rate of 7.38% and are due and payable in May 2006.  The senior notes agreement limits sales ofassets and other items and contains a maximum debt-to-total capitalizationcovenant.  Based on our financialcondition as of April 30, 2005, the restrictions imposed by our seniornotes do not currently restrict our ability to meet our obligations or todeclare and pay dividends at historical levels.

 

To facilitate the purchase of new and used inventory for ourFreightliner truck dealership in the Power Products segment, we entered into afloor plan financing agreement with a commercial bank during Fiscal 2004.  The secured facility, which matures in December 2005,allows for short-term borrowings up to $3.0 million, of which $1.0 million and$0.5 million were outstanding at April 30, 2005 and January 31, 2005,respectively.  Advances under thisfacility bear interest at the prime rate.

 

Inaddition, our South American subsidiaries had foreign currency bank notespayable totaling $0.8 million and $1.1 million at April 30, 2005 and January 31,2005, respectively.  Such notes payableconsist of renewable, secured loans for the purpose of financing our SouthAmerican operations.  These loans aredenominated in local currency (Colombian Pesos and Venezuelan Bolivars) and aresecured by letters of credit issued by us and principally bear market-basedvariable rates of interest.  We useforeign denominated debt to limit our exposure to foreign currency exchangerate fluctuations on our South America operations.

 

Asa result of the ATHL acquisition in the first quarter of Fiscal 2005, our U.K.subsidiaries have $2.1 million of notes payable at April 30, 2005, whichare denominated in British pounds.  Thesenotes include $1.9 million of deferred consideration payable to ATHL’s formershareholders, bearing interest at 2% per annum, and $0.2 million of assumedcapital lease obligations.

 

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Inthe event that any acquisition of additional operations, growth in existingoperations, settlements of lawsuits or disputes, changes in inventory levels,accounts receivable, tax payments or other working capital items create apermanent need for working capital or capital expenditures in excess of theexisting cash and cash equivalents and committed lines of credit, we may seekadditional capital financing in the form of new debt or equity instruments.

 

**Statements of Cash Flows Data**

 
| ** **                                        | ** ** | **Three Months Ended**  | ** ** |
|---------------------------------------------------|------------|-------------------------|------------|
| **(In thousands)**                                | ** ** | **April 30, 2005** | ** ** | **May 1, 2004** | ** ** |
| Net cash provided by (used in):                   | ** ** | ** **              | ** ** | ** ** | ** ** |
| Operating activities                              |       | $                       | 9,910      |   | $ | 43,617 |   |
| Investing activities                              |       | (37,252                 | )          | (790 | ) |
| Financing activities                              |       | (396                    | )          | (1,718 | ) |
| Effect of exchange rate changes on cash           |       | 52                      |       | — |   |
| Increase (decrease) in cash and cash  equivalents |       | $                       | (27,686    | ) | $ | 41,109 |   |

 

**Selected Balance Sheet Data**

 
| **(In thousands)**                                  | ** ** | **April 30, 2005** | ** ** | **January 31, 2005** | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|---------------------------|------------|
| Cash, cash equivalents, and short-term  investments |       | $                       | 113,536    |                      | $          | 132,927 |   |
| Working capital                                     |       | 194,198                 |       | 225,152                   |       |
| Total debt                                          |       | 28,852                  |       | 26,671                    |       |
|                                                     |            |                         |            |                           |            |  |  |

 

Cash and cash equivalents decreased $27.7million during the first quarter of Fiscal 2005 and increased $41.1 millionduring the comparable period of Fiscal 2004. Before changes in operating accounts, net operating cash flow was $17.9million in the first quarter of Fiscal 2005 compared to $15.5 million in thefirst quarter of Fiscal 2004.  Changes inoperating account balances provided cash of $28.1 million in Fiscal 2004primarily resulting from customer receipts related to large equipment orderscompleted in late Fiscal 2003. Conversely, changes in operating accounts in the first quarter of Fiscal2005 used cash of $8.0 million, primarily as a result of increased inventoryand costs incurred on long-term contracts.

 

Investing activities contributed $36.5million to the decline in cash flows, primarily as a result of the ATHLacquisition, which used $42.3 million in the first quarter of Fiscal 2005, aswell as a $4.8 million increase in cash invested in short-terminvestments.  This cash usage waspartially offset by a $12.0 million increase in cash proceeds from the sale ofbusinesses, which included a $15.0 million receipt in the first quarter ofFiscal 2005 of a short-term note associated with sale of the Airline Productsbusiness in the fourth quarter of Fiscal 2004.

 

Financing activities generated a $1.3 milliondecline in cash used, primarily as a result of increased proceeds from theexercise of stock options.

 

Total cash andshort-term investments declined to $113.5 million at April 30, 2005 from$132.9 million at January 31, 2005. The decline in cash is primarily attributable to the investingactivities described above, partially offset by the $9.9 million net cashprovided by operating activities in the first quarter of Fiscal 2005.  Additionally, the ATHL acquisition describedabove is primarily responsible for the $31.0 million decline in working capitaland the $2.2 million increase in total debt.

 

**FACTORS THAT MAY AFFECT FUTURE RESULTS**

** **

**Forward-LookingStatements**

 

This filing contains forward-looking statements that arebased on management’s current expectations, estimates, and projections. Thesestatements are not guarantees of future performance and involve a number ofrisks, 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,and in the Company’s quarterly reports on Form 10-Q, as well asothers, could cause results to differ materially from those stated.  Specific important factors that could causeactual results, performance, or achievements to differ materially from suchforward-looking statements include risks of dependence on government andfailure to obtain new government contracts, inherent risks of

 

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government contracts, risks of supply interruptions toTactical Vehicle Systems segment, risks associated with Distributed EnergySolutions segment, risks of fixed-price contracts, risks as to rising steelprices, risks as to cost controls, risks of general economic conditions, risksof oil and gas industry economic conditions, risks as to distributorships,risks as to licenses, risk of competition, risks relating to technology, risksas to terrorist 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 as to foreign sales and global trade matters, risks as toacquisitions and restructuring activities, risks as to currency fluctuations,risks as to environmental and safety matters, and credit risks, all as morespecifically outlined 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 QualitativeDisclosures about Market Risk**

 

Our quantitative and qualitative disclosures about market risk for changesin interest rates and foreign exchange risk are incorporated by reference in Item7A of our Annual Report on Form 10-K for the year ended January 31,2005.  Our market risks have notmaterially changed since that report was filed, except as noted below.  The following changes in market risk haveoccurred during Fiscal 2005, primarily resulting from the acquisition of ATHL.

 

*Foreign Currency Risk*

 

During the first quarter of Fiscal 2005, theCompany acquired all outstanding shares of ATHL, a light tactical vehiclemanufacturer headquartered in the United Kingdom, for a total purchase price,denominated in British pounds, of approximately $47.7 million.   The functional currency for ATHL is the Britishpound.  To partially hedge itsinvestment, the Company established a British pound denominated inter-companynote in the amount of £12.5 million, which is to be repaid in annualinstallments through December 2009, and entered into a series of forwardforeign exchange contracts in order to mitigate the exposure related to theinter-company notes receivable denominated in British pounds.

 

Substantially all of the sales of ATHL aredenominated in British pounds.  Purchasesof materials and component parts are also substantially denominated in Britishpounds; however, some component purchases are denominated in Euros and otherforeign currencies.  As a result, theearnings from ATHL will be affected by fluctuation in the value of the Britishpound against the Euro, the U.S. dollar and other currencies.

 

Fluctuations in currency exchange rates may also impact the Company’sshareholders’ equity.  Amounts investedin the Company’s non-U.S. subsidiaries are translated into U.S. dollars at theexchange rates in effect at the end of the reporting period.  The resulting translation adjustments arerecorded in shareholders’ equity as cumulative translation adjustments.  With regard to the ATHL acquisition, thehedging program described above mitigates the exposure related to £12.5 million,or $23.5 million of the total investment. The remaining portion of the initial investment will be impacted byfluctuations in the U.S. dollar equivalent to British pound.

 

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

 

**Evaluation of Disclosure Controlsand Procedures**

 

At the end of the period covered by thisQuarterly Report on Form 10-Q, the Company carried out an evaluationrequired by the Securities Exchange Act of 1934, as amended (the “Exchange Act”),under the supervision and with the participation of the Company’s management,including the Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the Company’s disclosure controls and procedures pursuant to Rule 13a-15under the Exchange Act.  Based upon thatevaluation, the Company’s Chief Executive Officer and Chief Financial Officerhave concluded that the Company’s disclosure controls and procedures are effectiveas of the end of the period covered by this report in alerting them on a timelybasis to material information relating to the Company and required to beincluded in the Company’s periodic filings under the Exchange Act.

 

**Internal Controls over Financial Reporting**

** **

There have been no changes in the Company’sinternal controls over financial reporting that occurred during the firstquarter of Fiscal 2005 that have materially affected, or are reasonably likelyto materially affect, the Company’s internal controls over financial reporting.

 

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**PART II.  OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

*U.S. Government Contingencies*:  During 1998, theU.S. Customs Service detained a medium tactical vehicle that was being shippedby the Company for display in a European trade show.  The Company is advised that the U.S. CustomsService and the Department of Justice have conducted an investigation ofpotential 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, financial condition or liquidity andbelieves that the resolution of the matter that is possibly most adverse to theCompany will involve the payment of a civil penalty that will not materiallyadversely affect the Company.

 

The Company is a defendant in a suit filed in 1996 under the *qui tam* provision of the False Claims Act, *United States of America,**ex rel.Werner Stebner v. Stewart & Stevenson Services, Inc. andMcLaughlin Body Co.*, Civil Action No. H-96-3363, inthe 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 mediumtactical vehicles delivered to the U.S. Army before 1998, and that the vehicleswere substandard because of corrosion problems. Following an investigation by the Justice Department, the United Statesdeclined to intervene in the suit.  In February 2004,the District Court found in favor of the Company and dismissed all of theplaintiff’s claims by summary judgment without proceeding to trial.  The plaintiffs filed a notice of appeal in March 2004in the United States Court of Appeals for the Fifth Circuit, No. 04-20209.  Oral argument was conducted in April 2005.  The Company expects a decision from the FifthCircuit near the end of 2005 or early 2006. The Company believes the Court of Appeals will uphold the DistrictCourts’ opinion, which dismissed all of the plaintiff’s claims as being withoutmerit.  While the Company does notbelieve that an adverse outcome is likely, an unfavorable opinion from theFifth Circuit could have a material adverse impact on the Company’sconsolidated results of operations, financial position and liquidity.  The Company is presently unable to determinewhether any liability has been incurred in this matter, other than legal feesand expenses.  Additionally, the Companycannot reasonably estimate the amount or range of any loss that may result fromthis matter, and thus no accruals have been recorded in this matter other thanestimated legal fees and expenses relating to the appeal.

 

*KlickitatLitigation:*  The Company and several of its subsidiariesin the Distributed Energy Solutions business are defendants in a suit filed bythe Klickitat County Public Utility District No. 1 on December 11,2003 arising out of claims relating to a landfill gas power generation facilityin Roosevelt, Washington, Cause No. CY-03-3175-LRS;*Klickitat County Public Utility District No. 1 v. Stewart &Stevenson Services, Inc., Stewart & Stevenson Power, Inc.,Sierra Detroit Diesel Allison, Inc., Pamco International, Inc. andWaukesha Engine Dresser, Inc.*; in the United States DistrictCourt for 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 contracts(entered into in December 2000 and March 2001) between a subsidiary ofthe Company in the Distributed Energy Solutions business 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

 

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misrepresentation, concealment, violation of contractor licenserequirements, unfair competition, negligence and breach of contract as well asclaims on $4.7 million of surety bonds as to the contract.  Notwithstanding the facts that the contractsbetween the Company subsidiary and NEO provided for an exclusive method ofdispute resolution which, under the contracts, (i) necessitatedappropriate notice and a period of mutual efforts to resolve a dispute, whichefforts (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.  During a hearing on March 2,2005, the Superior Court granted the Company’s Motion to Stay Litigation andthe matter should therefore proceed in arbitration in Minnesota.  The Company believes NEO’s claims are withoutmerit and is defending them vigorously. The Company further believes, in addition to its basic view that thegenerating facilities are operating satisfactorily, that NEO is incorrect invarious factual allegations, and that the Company has meritorious legaldefenses 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.

 

*AntitrustLitigation:*  The Company is a co-defendant with DetroitDiesel Corporation and other Detroit Diesel distributors in two putative classaction suits filed on February 9, 2005, Civil Action No. 05-616;*Cumberland Truck Equipment Co. et al. v. DetroitDiesel Corp., et al.* (the “Cumberland Litigation”), and Civil ActionNo. 05-625; *Diamond InternationalTrucks, Inc. et al. v. Detroit Diesel Corp., et al.* (the “DITLitigation”).  Each suit relates to thePower Products segment and has been filed**in the UnitedStates District Court for the Eastern District of Pennsylvania.  In the Cumberland Litigation, plaintiffs weredealers of Detroit Diesel parts whose agreements were terminated or not renewedon or after February 9, 2001.  TheCompany is a distributor of Detroit Diesel parts and had a dealer agreementwith one or more of the named plaintiffs. The plaintiffs are claiming antitrust violations arising out of thetermination or non-renewal of their dealer agreements.  The plaintiffs have also alleged price fixingand group boycott in violation of Section 1 of the Sherman Act.  The plaintiffs have made claims for trebledamages and injunctive and other relief. In the DIT Litigation, plaintiffs are dealers of Detroit Diesel partswhose dealership classification was changed on or after February 9,2001.  The Company also had a dealeragreement with one or more of these plaintiffs. The plaintiffs are claiming antitrust violations arising out of changesto the classification of their dealerships. The plaintiffs have alleged price fixing and group boycott in violationof Section 1 of the Sherman Act. The plaintiffs have made claims for treble damages and injunctive andother relief.  The Company intends tovigorously defend both suits.  It ispresently impossible for the Company to determine the ultimate outcome ofeither suit or whether their resolution will, in the future, have a materialadverse effect on the Company’s consolidated results of operations, financialposition or liquidity.  The Company ispresently unable to determine whether a material liability has been incurred inthese matters or to reasonably estimate the amount of any loss that may resultfrom these matters.  Consequently, theCompany has recorded no accrual for any losses related to the ultimate outcomeof this litigation.  The Company has,however, recorded accruals that it currently believes are adequate forestimated legal fees that it expects to incur associated with these matters.

 

*Environmental Contingencies*:  In 2001, theCompany received from the United States Environmental Protection Agency (the “EPA”)a Request for Information under Section 104(e) of the ComprehensiveEnvironmental Response, Compensation, and Liability Act of 1980, forinformation pertaining to the R&H Oil Company Site in San Antonio, Texas (the“Site”).  Information provided to theCompany by the EPA indicates that the Company may have sent waste oils to theSite for recycling in the late 1980s, and that such waste oils may potentiallyaccount for between one and two percent of the volume of total wastes receivedby the oil recycler at the Site.  Sincethe Company expects to receive a claim for cleanup and other costs related tothis site, 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 otherfactors may result in actual costs exceeding the current environmentalreserves.  While uncertainties areinherent in the final outcome of these environmental matters, and it ispresently impossible to determine the actual costs that ultimately may beincurred, 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. TheCompany believes that the most likely outcome in this environmental matter isthe expenditure of an immaterial amount of consideration as a contribution tothe remediation effort.

 

The Company is also a defendant in a number of lawsuits relating tocontractual, product liability, personal injury and warranty matters normallyincident to the Company’s business.  Noindividual case, or group of cases presenting substantially similar issues oflaw or fact, is expected to have a material effect on the manner in which theCompany conducts its business or on its consolidated results of operations,financial position or liquidity.  TheCompany maintains certain insurance policies that provide coverage for productliability and personal injury cases.  TheCompany has established reserves that it believes to be adequate based oncurrent evaluations 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.

 

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**Item 6.Exhibits**

 

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

 
| *2.1   |   | Agreement  Relating to the Sale and Purchase of the Whole of the Issued Share Capital of  Automotive Technik (Holdings) Limited dated April 8, 2005 between Stewart &  Stevenson TVS UK Limited, a subsidiary of the Company, and the shareholders  of ATHL (filed April 14, 2005 as Exhibit 2.1 to the Company’s  Current Report on Form 8-K and incorporated herein by reference).  Certain portions of the Agreement have been omitted pursuant to a request for  confidential treatment. The omitted material has been filed separately with  the Securities and Exchange Commission. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| *3.1   |   | Seventh  Restated Bylaws of Stewart & Stevenson Services, Inc.,  effective July 9, 2004 (filed April 6, 2005 as Exhibit 3.1 to  the Company’s Current Report on Form 8-K and incorporated herein  by reference).                                                                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| *10.1  |   | Summary  Description of 2004 Management Incentive Compensation Plan (filed  April 6, 2005 as Exhibit 10.1 to the Company’s Current Report on  Form 8-K and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| *10.2  |   | Summary  Description of 2005 Management Incentive Compensation Plan (filed  April 6, 2005 as Exhibit 10.2 to the Company’s Current Report on  Form 8-K and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| *10.3  |   | Summary  Description of Director Compensation (filed April 6, 2005 as  Exhibit 10.3 to the Company’s Current Report on Form 8-K and  incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| *10.4  |   | Stewart &  Stevenson Supplemental Retirement Plan (filed April 6, 2005 as  Exhibit 10.4 to the Company’s Current Report on Form 8-K and  incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.5   |   | Description  of January 2005 Option Agreement with Max L. Lukens.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.6   |   | Contract  modification number P00048 dated March 23, 2005 to contract number  DAAE07-03C-S023 between Stewart & Stevenson Tactical Vehicle  Systems LP and the United States Department of Defense, U.S. Army  Tank-Automotive and Armaments Command. Certain portions of this agreement  have been omitted pursuant to a request for confidential treatment. The omitted  material has been filed separately with the Securities and Exchange  Commission.                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.7   |   | Contract  modification number P00057 dated March 29, 2005 to contract number  DAAE07-03C-S023 between Stewart & Stevenson Tactical Vehicle  Systems LP and the United States Department of Defense, U.S. Army  Tank-Automotive and Armaments Command. Certain portions of this agreement  have been omitted pursuant to a request for confidential treatment. The omitted  material has been filed separately with the Securities and Exchange  Commission.                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 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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*Incorporatedby reference

 

24

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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 26th day of May 2005.

 
| **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                                   |                 |   |
| Senior  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)                    |                 |   |
|                                                    |                      |        |  |  |  |  |

 

25

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**EXHIBIT INDEX**

 

Exhibit Numberand Description

 
| *2.1   |   | Agreement  Relating to the Sale and Purchase of the Whole of the Issued Share Capital of  Automotive Technik (Holdings) Limited dated April 8, 2005 between  Stewart & Stevenson TVS UK Limited, a subsidiary of the Company, and  the shareholders of ATHL (filed April 14, 2005 as Exhibit 2.1 to  the Company’s Current Report on Form 8-K and incorporated herein  by reference). Certain portions of the Agreement have been omitted pursuant  to a request for confidential treatment. The omitted material has been filed  separately with the Securities and Exchange Commission. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| *3.1   |   | Seventh  Restated Bylaws of Stewart & Stevenson Services, Inc.,  effective July 9, 2004 (filed April 6, 2005 as Exhibit 3.1 to  the Company’s Current Report on Form 8-K and incorporated herein  by reference).                                                                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| *10.1  |   | Summary  Description of 2004 Management Incentive Compensation Plan (filed  April 6, 2005 as Exhibit 10.1 to the Company’s Current Report on  Form 8-K and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| *10.2  |   | Summary  Description of 2005 Management Incentive Compensation Plan (filed  April 6, 2005 as Exhibit 10.2 to the Company’s Current Report on  Form 8-K and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| *10.3  |   | Summary  Description of Director Compensation (filed April 6, 2005 as  Exhibit 10.3 to the Company’s Current Report on Form 8-K and  incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| *10.4  |   | Stewart &  Stevenson Supplemental Retirement Plan (filed April 6, 2005 as  Exhibit 10.4 to the Company’s Current Report on Form 8-K and  incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.5   |   | Description  of January 2005 Option Agreement with Max L. Lukens.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.6   |   | Contract  modification number P00048 dated March 23, 2005 to contract number  DAAE07-03C-S023 between Stewart & Stevenson Tactical Vehicle  Systems LP and the United States Department of Defense, U.S. Army  Tank-Automotive and Armaments Command. Certain portions of this agreement  have been omitted pursuant to a request for confidential treatment. The  omitted material has been filed separately with the Securities and Exchange  Commission.                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.7   |   | Contract  modification number P00057 dated March 29, 2005 to contract number  DAAE07-03C-S023 between Stewart & Stevenson Tactical Vehicle  Systems LP and the United States Department of Defense, U.S. Army  Tank-Automotive and Armaments Command. Certain portions of this agreement  have been omitted pursuant to a request for confidential treatment. The  omitted material has been filed separately with the Securities and Exchange  Commission.                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 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.                                                                                                                                                                                                                                                                                                                                                                                                                  |

 

----

*Incorporatedby reference

 

26

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