UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

              (MARK ONE)
              [X]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
                       OF THE SECURITIES EXCHANGE ACT OF 1934

               FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 1998

                                         OR

              [ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
                       OF THE SECURITIES EXCHANGE ACT OF 1934


              FOR THE TRANSITION PERIOD FROM __________ TO _________


                            COMMISSION FILE NUMBER 0-8493

                          STEWART & STEVENSON SERVICES, INC.
                (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


               Texas                                 74-1051605
   (State or other jurisdiction of                (I.R.S. Employer
    incorporation or organization)                Identification No.)


  2707 North Loop West, Houston, Texas                  77008
(Address of principal executive offices)              (Zip Code)



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


                                 not applicable
              (Former name, former address and former fiscal year,
                          if changed since last report)


      Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]


      Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.


Common Stock, Without Par Value                        27,984,035 Shares
            (Class)                           (Outstanding at December 1, 1998)


<PAGE>
PART I. FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS.

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

Consolidated Condensed Statement of Financial Position - October 31, 1998 and
  January 31, 1998.

Consolidated Condensed Statement of Earnings -- Nine Months and Three Months
  Ended October 31, 1998 and 1997.

Consolidated Condensed Statement of Cash Flows -- Nine Months Ended October 31,
  1998 and 1997.


Notes to Consolidated Condensed Financial Statements.


                                       2
<PAGE>
STEWART & STEVENSON SERVICES, INC.
CONSOLIDATED CONDENSED STATEMENT OF FINANCIAL POSITION
(Dollars in thousands)

                                                       OCTOBER 31     JANUARY 31
                                                          1998           1998
                                                      -------------  -----------
                                                       (UNAUDITED)
ASSETS
CURRENT ASSETS
   Cash and equivalents ..........................   $     5,737    $    18,987
   Accounts and notes receivable, net ............       200,266        185,033
   Receivable from sale of Gas Turbine Operations           --          600,000
   Recoverable costs and accrued profits
      not yet billed .............................       178,354        138,208
   Inventories:
      Engineered Power Systems ...................        59,099         46,551
      Power Products .............................       185,813        166,918
      Excess of current cost over LIFO values ....       (48,003)       (45,892)
                                                     -----------    -----------
                                                         196,909        167,577
                                                     -----------    -----------
      TOTAL CURRENT ASSETS .......................       581,266      1,109,805
PROPERTY, PLANT AND EQUIPMENT ....................       256,478        227,152
   Allowances for depreciation and
       amortization ..............................      (143,352)      (129,408)
                                                     -----------    -----------
                                                         113,126         97,744
INVESTMENTS AND OTHER ASSETS .....................        30,370         45,098
                                                     -----------    -----------
                                                     $   724,762    $ 1,252,647
                                                     ===========    ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
   Notes payable .................................   $     5,234    $    35,000
   Accounts payable ..............................        96,199         92,728
   Current income taxes ..........................        15,849         88,862
   Current portion of long-term debt .............        60,000        226,000
   Other current liabilities .....................        35,283        119,512
                                                     -----------    -----------
      TOTAL CURRENT LIABILITIES ..................       212,565        562,102
                                                     -----------    -----------

COMMITMENTS AND CONTINGENCIES (SEE NOTE B)

LONG-TERM DEBT ...................................       109,339        147,166
DEFERRED INCOME TAXES ............................          --            2,899
ACCRUED POSTRETIREMENT BENEFITS ..................        13,350         13,256
DEFERRED COMPENSATION ............................         3,737          5,517
SHAREHOLDERS' EQUITY
   Common Stock, without par value, 100,000,000
      shares authorized; 27,984,035 and 33,205,688
      shares issued at October 31, 1998 and
      January 31, 1998, respectively, including
      0 and 11,820 shares held in treasury .......        47,180        166,454
   Retained earnings .............................       338,591        355,286
                                                     -----------    -----------
                                                         385,771        521,740
   Less cost of treasury stock ...................          --              (33)
                                                     -----------    -----------
      TOTAL SHAREHOLDERS' EQUITY .................       385,771        521,707
                                                     -----------    -----------
                                                     $   724,762    $ 1,252,647
                                                     ===========    ===========


See accompanying notes to consolidated condensed financial statements.


                                       3
<PAGE>
STEWART & STEVENSON SERVICES, INC.
CONSOLIDATED CONDENSED STATEMENT OF EARNINGS
(In thousands, except per share data)

<TABLE>
<CAPTION>
                                            NINE MONTHS ENDED       THREE MONTHS ENDED
                                               OCTOBER 31                OCTOBER 31
                                        ------------------------------------------------
                                           1998         1997        1998          1997
                                        ---------    ---------    ---------    ---------
                                              (UNAUDITED)                (UNAUDITED)
<S>                                     <C>          <C>          <C>          <C>      
Sales ...............................   $ 949,670    $ 780,737    $ 321,121    $ 298,998
Cost of sales .......................     875,054      689,029      309,279      265,305
                                        ---------    ---------    ---------    ---------

Gross profit ........................      74,616       91,708       11,842       33,693

Selling and administrative
 expenses ...........................      62,011       53,836       23,316       18,546
Interest expense ....................       8,868       10,545        2,912        3,399
Settlement of litigation ............        --         10,000         --         10,000
Other income, net ...................     (13,097)      (8,213)      (2,867)      (6,023)
                                        ---------    ---------    ---------    ---------

                                           57,782       66,168       23,361       25,922
                                        ---------    ---------    ---------    ---------

Earnings (loss) from continuing
 operations before income taxes .....      16,834       25,540      (11,519)       7,771
Income tax provision (benefit) ......       5,960       10,150       (4,335)       4,063
                                        ---------    ---------    ---------    ---------

Earnings (loss) from continuing
 operations of consolidated
 companies ..........................      10,874       15,390       (7,184)       3,708
Equity in net earnings (loss) of
 unconsolidated affiliates ..........        (189)        (206)         267         (184)
                                        ---------    ---------    ---------    ---------

Net earnings (loss) from
 continuing operations ..............      10,685       15,184       (6,917)       3,524
Net earnings (loss) from discontinued
 operations net of tax provision
 (benefit) of ($11,750), $1,920,
 ($11,750), and ($1,198) ............     (20,000)       5,068      (20,000)      (1,382)
                                        ---------    ---------    ---------    ---------
Net earnings (loss)..................   $  (9,315)   $  20,252    $ (26,917)   $   2,142
                                        =========    =========    =========    =========


Weighted average number of shares  of
Common Stock outstanding -
   Basic ............................      29,351       33,181       27,984       33,194
   Diluted ..........................      29,351       33,236       27,984       33,264
Net earnings (loss) per share:
 Basic and Diluted
   Continuing operations ............   $     .36    $     .46    $    (.25)   $     .11
   Discontinued operations ..........        (.68)         .15         (.71)        (.04)
                                        ---------    ---------    ---------    ---------

                                        $    (.32)   $     .61    $    (.96)   $     .07
                                        =========    =========    =========    =========
Cash dividends per share ............   $    .255    $    .255    $    .085    $    .085
                                        =========    =========    =========    =========
</TABLE>

See accompanying notes to consolidated condensed financial statements.

                                       4
<PAGE>
STEWART & STEVENSON SERVICES, INC.
CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS
(Dollars in thousands)

<TABLE>
<CAPTION>
                                                             NINE MONTHS ENDED
                                                                 OCTOBER 31
                                                          ----------------------

                                                             1998         1997
                                                          ---------    ---------
                                                               (UNAUDITED)
<S>                                                       <C>          <C>      
OPERATING ACTIVITIES
   Net earnings from continuing operations ............   $  10,685    $  15,184
   Adjustments to reconcile net earnings to net cash
     provided by (used in) operating activities:
       Depreciation and amortization ..................      14,046       17,416
       Deferred income taxes, net .....................      (2,899)      (1,528)
       Loss (Gain) on sale of business ................         243       (4,317)
       Change in operating assets and liabilities
         net of the effect of acquisition:
          Accounts and notes receivable, net ..........     (14,095)      (4,757)
          Recoverable costs and accrued profits not
           yet billed .................................     (40,146)      (2,741)
          Inventories .................................     (24,252)     (51,514)
          Accounts payable ............................          41      (38,701)
          Current income taxes ........................     (61,301)       5,802
          Other current liabilities ...................     (20,969)         841
          Accrued litigation settlement ...............        --          9,206
          Other--principally long-term assets and
           liabilities ................................       2,546       (3,108)
                                                          ---------    ---------

   NET CASH PROVIDED BY (USED IN) CONTINUING OPERATIONS    (136,101)     (58,217)
   NET CASH PROVIDED BY DISCONTINUED OPERATIONS .......     516,000        5,457
                                                          ---------    ---------

   NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES      379,899      (52,760)

INVESTING ACTIVITIES
   Expenditures for property, plant and equipment .....     (23,612)     (24,794)
   Acquisition of businesses ..........................     (19,951)      (5,029)
   Proceeds from sale of business .....................       4,600       22,773
   Disposal of property, plant and equipment, net .....       1,931        3,279
                                                          ---------    ---------

   NET CASH USED IN INVESTING ACTIVITIES ..............     (37,032)      (3,771)

FINANCING ACTIVITIES
   Additions to long-term borrowings ..................      25,000       78,885
   Payments on long-term borrowings ...................    (226,459)     (27,532)
   Net short-term borrowings (payments) ...............     (28,037)      21,000
   Dividends paid .....................................      (7,380)      (8,465)
   Repurchase of common stock .........................    (120,000)        --
   Exercise of stock options ..........................         759        1,495
                                                          ---------    ---------

   NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES     (356,117)      65,383
                                                          ---------    ---------

Increase (decrease) in cash and equivalents ...........     (13,250)       8,852
Cash and equivalents, February 1 ......................      18,987        9,132
                                                          ---------    ---------

Cash and equivalents, October 31 ......................   $   5,737    $  17,984
                                                          =========    =========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
   Net cash paid during the period for:
     Interest payments ................................   $   7,308    $  18,475
     Income tax payments ..............................   $  75,483    $   9,816

NON-CASH ACTIVITIES:
   Transfer of inventory to fixed assets -
     Discontinued operations ..........................   $    --      $  (8,727)

</TABLE>
See accompanying notes to consolidated condensed financial statements.

                                       5

<PAGE>
STEWART & STEVENSON SERVICES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

NOTE A--BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
-----------------------------------------------------------------

The accompanying consolidated condensed financial statements have been prepared
in accordance with Rule 10-01 of Regulation S-X for interim financial statements
required to be filed with the Securities and Exchange Commission and do not
include all information and footnotes required by generally accepted accounting
principles for complete financial statements. However, the information furnished
reflects all normal recurring adjustments which are, in the opinion of
management, necessary for a fair statement of the results for the interim
periods. The results of operations for the nine months ended October 31, 1998
are not necessarily indicative of the results that will be realized for the
fiscal year ending January 31, 1999.

The accounting policies followed by the Company in preparing interim
consolidated financial statements are similar to those described in the "Notes
to Consolidated Financial Statements" in the Company's January 31, 1998 Form
10-K.

The Company's fiscal year begins on February 1 of the year stated and ends on
January 31 of the following year. For example, "Fiscal 1998" commenced on
February 1, 1998 and ends on January 31, 1999.

In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
128 Earnings Per Share ("SFAS 128"), which specifies the computation,
presentation, and disclosure requirements for earnings per share ("EPS"). It
replaces the presentation of primary and fully diluted EPS with basic and
diluted EPS. Basic EPS excludes all dilution. It is based upon the weighted
average number of common shares outstanding during the period. Diluted EPS
reflects the potential dilution that would occur if all securities or other
contracts to issue common stock were exercised or converted into common stock.
During the third quarter of Fiscal 1998 and 1997, 0 and 70,000 unexercised stock
options, respectively, were deemed to be dilutive. For the nine months ended
October 31, 1998 and 1997, 0 and 55,000 unexercised stock options, respectively,
were deemed to be dilutive. The Company adopted SFAS 128 as of January 31, 1998.
Accordingly, all periods presented have been restated to disclose basic and
diluted EPS. There is no material difference between SFAS 128 presentation of
EPS and the EPS presented in prior reporting periods. The Company repurchased
5,265,120 shares of its outstanding Common Stock during the nine months ended
October 31, 1998, which has been considered in the computation of the weighted
average number of shares outstanding. These 5,265,120 shares, as well as the
11,820 shares held as treasury stock, were cancelled during the nine months
ended October 31, 1998.

The accompanying consolidated financial statements for Fiscal 1997 contain
certain reclassifications to conform with the presentation used in Fiscal 1998.
The consolidated financial statements have been restated to reflect the
Company's Gas Turbine Operations as a discontinued operation.

NOTE B--COMMITMENTS AND CONTINGENCIES
-------------------------------------

During the quarter the Company reached an agreement with General Electric
Company (GE) regarding certain adjustments to the purchase price and the matters
relating to the sale of the Company's Gas Turbine Operations to GE. The
agreement required the Company to pay GE $84 million resulting in an after tax
charge, net of accruals, of $20 million, or $.71 per share to earnings from
discontinued operations.

The U.S. Army has alleged that a latent defect exists in the drive-train of all
vehicles produced by the Company under the 1991 contract to supply the Family of
Medium Tactical Vehicles ("FMTV"), and has directed the Company to make certain
changes in the drive-train of all 11,197 vehicles produced without cost to the
Army. The Company, supported by outside counsel, believes that there is a legal
basis to require its vendors to perform 


                                       6
<PAGE>
the necessary work at no cost to the Company. The Company has notified the
vendors of the affected parts and directed the vendors to perform the necessary
work without cost to the Company. The Company and its vendors deny that a latent
defect exists and the Company has notified the Army that it intends to submit a
substantial claim for all cost incurred by it or its vendors to perform the
specified changes. Under the applicable subcontracts, the Company's vendors are
required to perform the specified changes and recover their costs, if such costs
are recoverable under the subcontracts, by submission of a claim through the
Company to the U.S. Army. One of the Company's vendors, Caterpillar, Inc.
("Caterpillar"), has indicated that it will not make the specified change
without additional compensation from the Company. If Caterpillar or other
vendors refuse to perform under their subcontracts, the Company may be required
to fund all or part of the work specified by the Army and recover such cost
either from the Army via the claims process or from the vendors. The aggregate
expected cost of the change to all the parties could be substantial. Because of
the uncertainties inherent in the claims process, the Company cannot predict
whether all or any part of costs arising from the directed work will be borne by
the Company or its vendors. In the event that such costs are borne by the
Company, they could adversely affect liquidity unless they are recovered from
the customer or the vendor and could have a material adverse effect on the
results of operations and financial condition of the Company in the period in
which such determination is made. See additional discussion of the FMTV contract
in Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations--Government Contract Status.

The Company was a party to an arbitration proceeding before the American
Arbitration Association in San Francisco, California in which Noell, Inc.
asserted claims of approximately $6 million in damages arising from the sale of
turbine-driven equipment for installation in power plants located in Ceres,
California and Lodi, California. On September 1, 1998, all claims by Noell were
resolved in a settlement agreement under which the Company was not required to
contribute any funds.

The Company is involved in a number of other lawsuits and disputes relating to
contractual, product liability, personal injury and warranty matters and
otherwise of the type normally incident to the Company's business. Management is
of the opinion that such lawsuits and disputes are either fully reserved or will
not result in any material liability to the Company.

The Company has provided certain guarantees in support of its customer's
financing of purchases from the Company in the form of both residual value
guarantees and debt guarantees. The maximum exposure of the Company related to
guarantees at October 31, 1998 is $66.4 million.


                                       7
<PAGE>
ITEM 2.       MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
              AND RESULTS OF OPERATIONS

The following discussion contains forward-looking statements which are based on
assumptions such as timing, volume and pricing of customers' orders. These
forward-looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. These forward-looking
statements are subject to risks and uncertainties that could cause actual
results to differ materially from those outlined in the forward-looking
statements, including the risk of cancellation or adjustment of specific orders,
termination of significant government programs, decrease in demand in the
markets served, the outcome of pending and future litigation and governmental
proceedings, increasing product/service competition, risk associated with newly
acquired businesses, or lower-than-anticipated penetration of markets served.

This discussion should be read in conjunction with the attached condensed
consolidated financial statements and notes thereto, and with the Company's Form
10-K and notes thereto for the fiscal year ended January 31, 1998.

RESULTS OF OPERATIONS

The following table sets forth for the periods indicated the percentage of sales
represented by certain items reflected in the Company's Consolidated Condensed
Statement of Earnings.

                                      NINE MONTHS ENDED      THREE MONTHS ENDED
                                           OCTOBER 31            OCTOBER 31

                                         1998       1997      1998        1997
                                        ------     ------    ------      ------
Sales ..............................    100.0%     100.0%     100.0%     100.0%
Cost of sales ......................     92.1       88.3       96.3       88.7
                                        -----      -----      -----      -----
Gross profit .......................      7.9       11.7        3.7       11.3

Selling and administrative
 Expenses ..........................      6.5        6.9        7.3        6.2
Interest expense ...................      0.9        1.3        0.9        1.1
Settlement of litigation ...........     --          1.3       --          3.4
Other income, net ..................     (1.3)      (1.1)      (0.9)      (2.0)
                                        -----      -----      -----      -----
                                          6.1        8.4        7.3        8.7
                                        -----      -----      -----      -----
Earnings (loss)from
 Continuing Operations
 before income taxes ...............      1.8        3.3       (3.6)       2.6
Income tax provision
 (benefit) .........................       .7        1.3       (1.3)       1.4
                                        -----      -----      -----      -----
Earnings (loss)from
 Continuing Operations of
 consolidated companies ............      1.1        2.0       (2.3)       1.2
Equity in net earnings
 Of unconsolidated
 Affiliates ........................      --        --          0.1       --
                                        -----      -----      -----      -----
Net earnings (loss)from
 Continuing Operations .............      1.1%       2.0%      (2.2)%      1.2%
                                        =====      =====      =====      =====


                                       8
<PAGE>
Sales for the third quarter of the year ending January 31, 1999 ("Fiscal 1998")
increased 7% to $321 million compared to sales of $299 million for the same
period of the year ended January 31, 1998 ("Fiscal 1997"). Sales for the nine
months ended October 31, 1998 increased 22% to $950 million, compared to sales
of $781 million for the same period of
Fiscal 1997.

The Power Products segment sales decreased $1 million (1%) in the third quarter
of Fiscal 1998 compared to the same period in Fiscal 1997, but increased $13
million (3%) for the nine months ended October 31, 1998 over the same period of
Fiscal 1997. The quarter and nine month periods ended October 31, 1997 included
$6 million and $25 million, respectively, of sales from the Company's John Deere
dealership, which was sold during the third quarter of Fiscal 1997. The Power
Products segment experienced some softness in petroleum related markets in the
third quarter of Fiscal 1998 due to depressed oil price levels, and management
expects this trend to continue in the near future.

The Tactical Vehicle Systems (TVS) segment sales increased $19 million (19%) for
the third quarter of Fiscal 1998 compared to the same period in Fiscal 1997. TVS
segment sales for the nine months ended October 31, 1998 increased $141 million
(58%) over the same period in Fiscal 1997. The sales increase was primarily due
to higher production of trucks under the Family of Medium Tactical Vehicles
("FMTV") contract. See "Note B -- Commitments and Contingencies" for discussion
of contract issues. Also, see "Government Contract Status" for discussion of the
second multi-year contract.

The Engineered Power Systems (EPS) segment sales decreased $1 million (2%) in
the third quarter of Fiscal 1998 compared to the same period in Fiscal 1997. EPS
segment sales for the nine months ended October 31, 1998 decreased $1 million
(1%) over the same period in Fiscal 1997. Sales for the Petroleum Equipment
Division increased 32% and 37% for the quarter and nine months ended October 31,
1998, respectively, reflecting the strong demand for new equipment by the
oilfield drilling and services industries. In particular, demand increased in
the overseas markets and in the market for marine riser systems. These increases
were partially offset by a 28% and 29% decline in sales in the Aircraft Ground
Support Division for the quarter and year-to-date period ended October 31, 1998,
respectively. The Aircraft Ground Support Division continues to be adversely
affected by the Asian financial crisis. Gas compression sales decreased $1
million (22%) from last year's comparable quarter, and $5 million for the nine
months ended October 31, 1998 compared with the same period in Fiscal 1997,
largely due to timing of shipments.

The gross profit margin rate of 3.7% for the third quarter of Fiscal 1998
decreased compared to the 11.3% gross profit margin rate for the same period in
Fiscal 1997. The gross profit margin rate of 7.9% for the nine months ended
October 31, 1998 decreased compared to the 11.7% gross profit margin rate for
the same period of Fiscal 1997. These decreases were largely due to (1) a $19.7
million provision for cost overruns, superseded materials, and efforts to
resolve truck performance issues on the initial FMTV truck contract, and (2) a
greater percentage of sales represented by the TVS segment, which carry a lower
gross profit margin rate than the other segments.

Increases in selling and administrative expenses for the third quarter and first
three quarters of Fiscal 1998, over comparable periods for Fiscal 1997 primarily
resulted from recent business acquisitions.

The sale of the Gas Turbine Operations enabled the Company to reduce its debt.
As a result, interest expense for the third quarter of Fiscal 1998 decreased to
$2.9 million, down from $3.4 million for the same period in Fiscal 1997.
Interest expense decreased $1.7 million (16%) for the nine months ended October
31, 1998, as compared to the same period of Fiscal 1997.


                                       9
<PAGE>
Other income decreased to $2.9 million in the third quarter of Fiscal 1998
compared to $6.0 million for the same period in Fiscal 1997, which included a
$4.3 million gain on the sale of a construction equipment dealership. Other
income increased to $13.1 million for the nine months ended October 31, 1998, as
compared to $8.2 million for the same period of Fiscal 1997, due to increased
interest income from short-term investment of the proceeds from the sale of the
Company's Gas Turbine Operations.

A net loss from continuing operations of $6.9 million ($.25 per share) was
recorded for the three months ended October 31, 1998 as compared to net earnings
from continuing operations of $3.5 million ($.11 per share) for the three months
ended October 31, 1997. Net earnings from continuing operations of $10.7 million
($.36 per share) were recorded for the nine months ended October 31, 1998, as
compared to net earnings from continuing operations of $15.2 million ($.46 per
share) for the same period of Fiscal 1997. This decrease was largely due to
$12.7 million (net of a $7 million tax benefit) of 1998 write-offs in the TVS
segment, compared to approximately $6.5 (net of tax) million in 1997 litigation
settlements.

Net loss for the quarter including discontinued operations was $26.9 million, or
$.96 per share. During the quarter the Company reached an agreement with General
Electric Company (GE) regarding certain adjustments to the purchase price and
the matters relating to the sale of the Company's Gas Turbine Operations to GE.
The agreement required the Company to pay GE $84 million resulting in an after
tax charge, net of accruals, of $20 million, or $.71 per share to earnings from
discontinued operations.

GOVERNMENT CONTRACT STATUS

The FMTV contract is a firm fixed-price multi-year contract. The price paid to
the Company is not subject to adjustment to reflect the Company's actual costs,
except costs incurred as a result of actions or inactions of the government.

As of October 31, 1998, the Company has completed approximately 10,954 of the
11,197 vehicles covered by the original contract plus options and additional
requirements to date. Revenues and profits realized on the FMTV contract are
based on the Company's estimates of total contract sales value and costs at
completion. The Company has incurred significant cost overruns and delivery
schedule delays on the FMTV contract which the Company believes are primarily
due to the government's decision to delay the testing of trucks and other
government directed changes to the contract. In addition, the Company has been
directed to change certain drive-train components of the vehicles produced. The
Company has and will continue to submit a series of Requests for Equitable
Adjustments (REAs) under the FMTV contract, seeking increases in the FMTV
contract price for those additional costs that relate to government caused
delays and changes. Amounts in excess of agreed upon contract price for
government caused delays, disruptions, unpriced change orders and government
caused additional contract costs are recognized in contract value when the
Company believes it is probable that the claim for such amounts will result in
additional contract revenue and the amount can be reasonably estimated.

At October 31, 1998, the Company's FMTV contract accounting position reflected
the expected recovery of substantial amounts in excess of the contract price for
government caused delays, disruptions, unpriced change orders and other
government caused additional contract costs. Although management believes that
the contract provides a legal basis for the claims and its estimates are based
on reasonable assumptions and on a reasonable analysis of contract costs, due to
uncertainties inherent in the estimation and claims negotiations process, no
assurances can be given that its estimates will be accurate, and variances
between such estimates and actual results could be material. In the event that
the Company is unable to recover a substantial portion of the additional costs,
or is required to absorb costs relating to the drive-train changes, the Company
may suffer a material adverse effect on its earnings, financial condition and
liquidity during the accounting period in which such contract issues are
resolved.


                                       10

<PAGE>
The Company has received a second contract with the United States Army that
provides for continued production of the FMTV through 2002, with a one year
option that would extend the contract through 2003. Production of vehicles under
the second contract is expected to begin in the second quarter of Fiscal 1999.
If all options are exercised, the second contract will have a total value of
$1.36 billion with projected gross profit margins in excess of the current
contract.

The funding of the contracts is subject to the inherent uncertainties of
congressional appropriations. As is typical of multi-year defense contracts, the
FMTV contracts must be funded annually by the Department of the Army and may be
terminated at any time for the convenience of the government. The government has
approved full funding for the initial 5 year program and the first two (2) years
of the subsequent contract. If the FMTV contracts are terminated other than for
default, they provide for termination charges that will reimburse the Company
for allowable costs, but not necessarily all costs.

EFFECT OF ADMINISTRATIVE AGREEMENT

The Company is subject to an Administrative Agreement with the U.S. Air Force
that imposes certain requirements on the Company intended to assure the U.S. Air
Force that the Company is a responsible government contractor. A default by the
Company of the requirements under the Administrative Agreement could result in
the suspension or debarment of the Company from receiving new government
contracts or modifications to existing government contracts unless the
contracting agency finds a compelling need to enter into such agreement. The
Company would also be unable to sell equipment and services to customers that
depend on loans or financial commitments from the Export Import Bank ("EXIM
Bank"), Overseas Private Investment Corporation ("OPIC") and similar government
agencies during a suspension or debarment. Any such suspension or debarment
could have a material adverse impact on the Company's financial condition and
results of operations.

UNFILLED ORDERS

The Company's unfilled orders consist of written purchase orders, letters of
intent, and oral commitments. These unfilled orders are generally subject to
cancellation or modification due to customer relationships or other conditions.
Purchase options are not included in unfilled orders until exercised. Unfilled
orders at October 31, 1998 and at the close of Fiscal 1997 were as follow:

-------------------------------------------------------------------------------
                                                  OCTOBER 31        JANUARY 31
                                                     1998              1998
-------------------------------------------------------------------------------
                                                      (DOLLARS IN MILLIONS)

Tactical Vehicle Systems ...................       $1,091.3           $  487.0
Power Products .............................           87.5               69.6
Engineered Power Systems ...................           69.7               57.5
                                                   --------           --------
                                                   $1,248.5           $  614.1
                                                   ========           ========


Unfilled orders of the Tactical Vehicle Systems segment at October 31, 1998
consisted principally of the four year follow-on contract awarded in October
1998 by the United States Department of the Army to manufacture medium tactical
vehicles.

CAPITAL EXPENDITURES AND COMMITMENTS

Capital spending for property, plant and equipment of $23.6 million for the nine
months ended October 31, 1998 decreased as compared to $24.8 million for the
same period in Fiscal 1997. These amounts are consistent with the historical
capital expenditure levels of the Company.


                                       11

<PAGE>
LIQUIDITY AND SOURCES OF CAPITAL

The Company has $150 million in committed credit facilities, of which $125
million was available for the Company's use at October 31, 1998. The Company has
additional banking relationships which provide uncommitted borrowing
arrangements.

In the event that any acquisition of additional operations, growth in existing
operations, settlement of other lawsuits and disputes, changes in inventory
levels, new capital investments, accounts receivable or other working capital
items create a permanent need for working capital or capital expenditures in
excess of existing cash and equivalents and committed lines of credit, the
Company may seek to convert additional uncommitted borrowing arrangements to
committed credit facilities or to issue additional equity securities. Management
believes that the Company's cash and equivalents and current credit facilities
and available options for external sources of funds are adequate to meet its
foreseeable cash requirements.

YEAR 2000 COMPLIANCE

In the past, many computer software programs were written using two digits
rather than four to define the applicable year. As a result, date-sensitive
computer software may recognize a date using "00" as the year 1900 rather than
the year 2000. This is generally referred to as the Year 2000 issue. If this
situation occurs, the potential exists for computer system failures or
miscalculations by computer programs, which could disrupt operations.

The Company has established a team to address the potential impacts of the year
2000 on each of its critical business functions. The team is continuing its
assessment of the Company's critical information technology and embedded
technology, including its information system, computer equipment and other
systems used in its various operations, and is now in the process of making the
required modifications to or replacing these systems to be year 2000 compliant.
The modification costs are expected to be approximately $2 million. The majority
of these costs are attributable to the purchase of new computer equipment. The
required modifications are expected to be completed March 31, 1999 and in most
cases testing of the modifications will also be completed by such time. The
Company's contingency plan for any non-compliant systems will be developed for
each particular system if, and as, they are identified. Systems modification
costs are being expensed as incurred. Costs associated with new equipment are
being capitalized and will be amortized over the life of the product.

In addition to addressing the Company's internal systems, the team has
identified key vendors that could be impacted by year 2000 issues, and
communication has been made. The Company has evaluated the responses to this
correspondence and has not identified any critical vendor systems whose timely
remediation poses a material threat to the Company.

While the Company believes that its program is sufficient to identify the
critical issues and associated costs necessary to address possible year 2000
problems in a timely manner, there can be no assurances that the program or
underlying steps implemented, will be successful in resolving all such issues
prior to the year 2000. If the steps taken by the Company (or critical third
parties) are not made in a timely manner, or are not successful in identifying
and remedying all significant year 2000 issues, business interruptions or delays
could occur. However, based on the information the Company has gathered to date
and its expectations of its ability to remedy problems encountered, the Company
believes that it will not experience significant business interruptions that
would have a material adverse impact on its results of operations or financial
condition.

                                       12
<PAGE>
ACQUISITIONS

On October 27, 1998, the Company announced that it has reached an agreement to
acquire the assets of Tug Manufacturing Corporation, a leading manufacturer of
airline ground service equipment. Tug is a privately held corporation based in
Kennesaw, Georgia. The acquisition is expected to be completed before the end of
1998.

The Company intends to continue looking for acquisition opportunities in its
core businesses and for synergistic opportunities in niche businesses.


                                       13
<PAGE>
PART II.  OTHER INFORMATION

Item 1. Legal Proceedings.

See Note B to the Consolidated Condensed Financial Statements and Management's
Discussion and Analysis of Financial Condition and Results of Operations.

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

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


          3.1    Third Restated Articles of Incorporation of Stewart & Stevenson
                 Services, Inc., effective as of September 13, 1995
                 (incorporated by reference to Exhibit 3(a) of the Form 10-Q of
                 Stewart & Stevenson for the quarterly period ended October 31,
                 1995 under the Commission File No. 001-11443).

          3.2    Fifth Restated Bylaws of Stewart & Stevenson Services, Inc.,
                 effective as of April 14, 1998 (incorporated by reference to
                 Exhibit 3.2 of the Form 10-K of Stewart & Stevenson for the
                 Fiscal year ended January 31, 1998 under the Commission File 
                 No. 0-8493).

          4.1    Note Purchase Agreement effective May 30, 1996, between Stewart
                 & Stevenson Services, Inc. and the Purchasers named therein
                 (incorporated by reference to Exhibit 4 of the Form 10-Q of
                 Stewart & Stevenson for the quarterly period ended July 31,
                 1997 under the Commission File No. 0-8493).

          4.2    Rights Agreement effective March 13, 1995, between Stewart &
                 Stevenson Services, Inc. and The Bank of New York (incorporated
                 by reference to Exhibit 1 of the Form 8-A Registration
                 Statement of Stewart & Stevenson under the Commission File 
                 No. 001-11443).

         10.1    Lease Agreement effective April 15, 1997, between Miles
                 McInnes and Faye Manning Tosch, as Lessors, and the Company,
                 as Lessee (incorporated by reference to Exhibit 10.1 of the
                 Form 10-K of Stewart & Stevenson for the Fiscal year ended
                 January 31, 1997 under Commission File No. 0-8493).

         10.2    Distributor Sales and Service Agreement effective January 1,
                 1996, between the Company and Detroit Diesel Corporation
                 (incorporated by reference to Exhibit 10.2 of the Form 10-K of
                 Stewart & Stevenson for the Fiscal year ended January 31, 1996
                 under Commission File No. 0-8493).

         10.3    Contract Number DAAE07-92-R001 dated October 11, 1991 between
                 Stewart & Stevenson Services, Inc. and the United States
                 Department of Defense, U.S. Army Tank-Automotive Command, as
                 modified (incorporated by reference to Exhibit 28.1 of the Form
                 S-3 Registration Statement of Stewart & Stevenson under the
                 Commission File No. 33-44149).


                                       14

<PAGE>
         10.4    Contract Number DAAE07-92-R002 dated October 15, 1991 between
                 Stewart & Stevenson Services, Inc. and the United States
                 Department of Defense, U.S. Army Tank-Automotive Command, as
                 modified (incorporated by reference to Exhibit 28.2 of the Form
                 S-3 Registration Statement of Stewart & Stevenson under the
                 Commission File No. 33-44149).

         10.5    Stewart & Stevenson Services, Inc. Deferred Compensation Plan
                 dated as of December 31, 1979 (incorporated by reference to
                 Exhibit 10.8 of the Form 10-K of Stewart & Stevenson for the
                 Fiscal year ended January 31, 1994 under the Commission File 
                 No. 0-8493).

         10.6    Stewart & Stevenson Services, Inc. 1988 Nonstatutory Stock
                 Option Plan (as amended and restated effective as of June 10,
                 1997) (incorporated by reference to Exhibit B of the Proxy
                 Statement of Stewart & Stevenson filed
                 with the Commission on May 9, 1997).

         10.7    Stewart & Stevenson Services, Inc. Supplemental Executive
                 Retirement Plan (incorporated by reference to Exhibit 10.11 of
                 the Form 10-K of Stewart & Stevenson for the Fiscal year ended
                 January 31, 1994 under the Commission File No. 0-8493).

         10.8    Stewart & Stevenson Services, Inc. 1996 Director Stock Plan
                 (incorporated by reference to Exhibit A of the Proxy Statement
                 of Stewart & Stevenson filed with the Commission on May 9,
                 1997).

       **10.9    Contract Number DAAE07-98-C-M005 dated October 14, 1998 between
                 Stewart & Stevenson Services, Inc. and the United States
                 Department of Defense, U.S. Army Tank-Automotive and Armaments
                 Command.

         23.1    Consent of Arthur Andersen LLP, Independent Public Accountants
                 (incorporated by reference to Exhibit 23.1 of the Form 10-K of
                 Stewart & Stevenson for the Fiscal year ended January 31, 1998
                 under Commission File No. 0-8493).

        *27.1    Financial Data Schedule.


        ----------
       *Filed with this report.

      **Filed with this report.  Portions of this exhibit have been
        omitted pursuant to a request for confidential treatment filed
        separately with the Commission.

(b)   Form 8-K Report Date
      October 19, 1998 (Agreement with GE)
      Item reported - Item 5.  Other Events
                      Item 7.  Exhibits

      October 20, 1998 (Government Contract)
      Item reported - Item 5.  Other Events
                      Item 7  Exhibits


                                       15
<PAGE>
                                   SIGNATURES



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




                              STEWART & STEVENSON SERVICES, INC.



Date: December 15, 1998       By: /s/ ROBERT L. HARGRAVE
                                      Robert L. Hargrave
                                      President and Chief Executive Officer
                                      (as authorized officer)

Date: December 15, 1998.      By: /s/ PATRICK G. O'ROURKE
                                      Patrick G. O'Rourke
                                      Controller (as chief accounting officer)



                                       16
<PAGE>
EXHIBIT INDEX

 EXHIBIT NUMBER AND DESCRIPTION


            3.1   Third Restated Articles of Incorporation of Stewart &
                  Stevenson Services, Inc.

            3.2   Fifth Restated Bylaws of Stewart & Stevenson Services, Inc.

            4.1   Note Purchase Agreement.

            4.2   Rights Agreement.

           10.1   Lease Agreement.

           10.2   Distributor Sales and Services Agreement. 

           10.3   Contract Number DAAE07-92-R001.

           10.4   Contract Number DAAE07-92-R002.


           10.5   Stewart & Stevenson Services, Inc. Deferred Compensation Plan.

           10.6   Stewart & Stevenson Services, Inc. 1988 Nonstatutory Stock
                  Option Plan (as amended and restated effective as of June 10,
                  1997).

           10.7   Stewart & Stevenson Services, Inc. Supplemental Executive
                  Retirement Plan.

           10.8   Stewart & Stevenson Services, Inc. 1996 Director Stock Plan.

           10.9   Contract Number DAAE07-98-C-M005 (portions of this exhibit
                  have been omitted pursuant to a request for confidential
                  treatment filed separately with the Commission).

           23.1   Consent of Arthur Andersen LLP, Independent Public
                  Accountants.

           27.1   Financial data schedule.