**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

** **

**FORM 10-Q**

** **

**(Mark One)**

**ý****   QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended October 29, 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          |       | (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 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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).    Yes o   No ý

 

Numberof shares outstanding of each of the registrant’s classes of common stock, asof November 21, 2005:

 

**Common Stock, without Par Value:  29,277,710 Shares**

 

 

----

 

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

# ** **

# **INDEX**

 
| ** **                                                                                                | **Page**                                                                                                                              |
|-----------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                |                                                                                                                                  |
| **PART I. FINANCIAL INFORMATION**                                                                    |                                                                                                                                  |
|                                                                                                      |                                                                                                                                  |
| Item  1.                                                                                                  | Financial  Statements                                                                                                            |   |
|                                                                                                      |                                                                                                                                  |   |
|                                                                                                      | Consolidated Condensed  Balance Sheets – October 29, 2005 and January 31, 2005.                                        | 3 |
|                                                                                                      |                                                                                                                                  |   |
|                                                                                                      | Consolidated Condensed  Statements of Operations –  Three and Nine Months Ended October 29, 2005 and October 30, 2004. | 4 |
|                                                                                                      |                                                                                                                                  |   |
|                                                                                                      | Consolidated Condensed  Statements of Cash Flows –  Three and Nine Months Ended October 29, 2005 and October 30, 2004. | 5 |
|                                                                                                      |                                                                                                                                  |   |
|                                                                                                      | Notes to Consolidated  Condensed Financial Statements.                                                                                | 6 |
|                                                                                                      |                                                                                                                                  |
| Item 2.  Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 14                                                                                                                                    |
|                                                                                                      |                                                                                                                                  |
| Item 3.  Quantitative and Qualitative Disclosures  about Market Risk                                 | 20                                                                                                                                    |
|                                                                                                      |                                                                                                                                  |
| Item 4.  Controls and Procedures                                                                     | 21                                                                                                                                    |
|                                                                                                      |                                                                                                                                  |
| PART II. OTHER INFORMATION                                                                           |                                                                                                                                  |
|                                                                                                      |                                                                                                                                  |
| Item 1.   Legal Proceedings                                                                          | 21                                                                                                                                    |
|                                                                                                      |                                                                                                                                  |
| Item 6.   Exhibits                                                                                   | 23                                                                                                                                    |
|                                                                                                      |                                                                                                                                  |
| SIGNATURES                                                                                                | 24                                                                                                                                    |

 

2

----

 

**Item1.  Financial Statements**

 

**STEWART & STEVENSON SERVICES, INC. AND SUBSIDIARIES**

**CONSOLIDATED CONDENSED BALANCE SHEETS**

*(In thousands, except share data)*

 
| ** **                                                                                                             | ** ** | **October 29, 2005** | ** ** | **January 31, 2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                                                             | ** ** | **(Unaudited)**           | ** ** | ** **                | ** ** |
| Assets                                                                                                                 |       |                      |       |                      |       |
| Current Assets:                                                                                                        |       |                      |       |                      |       |
| Cash and cash equivalents                                                                                              |       | $                         | 50,093     |                      | $          | 128,515 |   |
| Short-term investments                                                                                                 |       | 10,790                    |       | 2,480                     |       |
| Accounts receivable, net                                                                                               |       | 63,221                    |       | 62,136                    |       |
| Inventories                                                                                                            |       | 21,460                    |       | 17,803                    |       |
| Deferred income tax asset                                                                                              |       | 6,406                     |       | 5,872                     |       |
| Income tax receivable                                                                                                  |       | 4,551                     |       | 7,223                     |       |
| Other current assets                                                                                                   |       | 3,957                     |       | 1,655                     |       |
| Total assets of discontinued operations                                                                                |       | 344,738                   |       | 321,949                   |       |
| Total Current Assets                                                                                                   |       | 505,216                   |       | 547,633                   |       |
|                                                                                                                   |       |                      |       |                      |       |
| Property, Plant and Equipment, net                                                                                     |       | 40,993                    |       | 34,660                    |       |
| Deferred Income Tax Asset                                                                                              |       | 23,998                    |       | 26,438                    |       |
| Intangibles and Other Assets, net                                                                                      |       | 45,972                    |       | 4,611                     |       |
| Total Assets                                                                                                           |       | $                         | 616,179    |                      | $          | 613,342 |   |
|                                                                                                                   |       |                      |       |                      |       |
| Liabilities and Shareholders’ Equity                                                                              |       |                      |       |                      |       |
| Current Liabilities:                                                                                                   |       |                      |       |                      |       |
| Notes payable                                                                                                          |       | $                         | 1,874      |                      | $          | — |   |
| Current portion of long-term debt                                                                                      |       | 25,000                    |       | —                    |       |
| Accounts payable                                                                                                       |       | 53,897                    |       | 43,441                    |       |
| Accrued payrolls and incentives                                                                                        |       | 13,308                    |       | 13,178                    |       |
| Billings in excess of incurred costs                                                                                   |       | 18,162                    |       | 59,894                    |       |
| Other current liabilities                                                                                              |       | 26,358                    |       | 26,154                    |       |
| Total liabilities of discontinued  operations                                                                          |       | 112,005                   |       | 99,193                    |       |
| Total Current Liabilities                                                                                              |       | 250,604                   |       | 241,860                   |       |
|                                                                                                                   |       |                      |       |                      |       |
| Long-Term Debt, net of current portion                                                                                 |       | 76                        |       | 25,000                    |       |
| Accrued Postretirement Benefits and Pension                                                                            |       | 58,684                    |       | 57,621                    |       |
| Other Long-Term Liabilities                                                                                            |       | 3,715                     |       | 4,141                     |       |
| Total Liabilities                                                                                                      |       | 313,079                   |       | 328,622                   |       |
| Shareholders’ Equity:                                                                                             |       |                      |       |                      |       |
| Common stock, without par value,  100,000,000 shares authorized; 29,270,741 and 28,865,070 shares issued, respectively |       | 66,978                    |       | 59,616                    |       |
| Accumulated other comprehensive loss                                                                                   |       | (37,968                   | )          | (36,048                   | )          |
| Retained earnings                                                                                                      |       | 274,090                   |       | 261,152                   |       |
| Total Shareholders’ Equity                                                                                        |       | 303,100                   |       | 284,720                   |       |
| Total Liabilities and Shareholders’ Equity                                                                        |       | $                         | 616,179    |                      | $          | 613,342 |   |

 

*See accompanying notes to consolidated condensed financialstatements.*

 

3

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**STEWART & STEVENSONSERVICES, INC. AND SUBSIDIARIES**

**CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS**

*(Inthousands, except per share data)*

 
| ** **                                                                                                            | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                                                            | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** |
| ** **                                                                                                            | ** ** | **(Unaudited)**           | ** ** | **(Unaudited)**           | ** ** |
|                                                                                                                  |       |                      |       |                      |       |   |   |   |   |
| Sales                                                                                                                 |       | $                         | 161,821    |                      | $          | 133,431 |   | $ | 531,513 |   | $ | 412,951 |   |
| Cost of sales                                                                                                         |       | 155,421                   |       | 114,961                   |       | 489,349 |   | 351,752 |   |
|                                                                                                                  |       |                      |       |                      |       |   |   |   |   |
| Gross profit                                                                                                          |       | 6,400                     |       | 18,470                    |       | 42,164 |   | 61,199 |   |
|                                                                                                                  |       |                      |       |                      |       |   |   |   |   |
| Selling and administrative expenses                                                                                   |       | 4,720                     |       | 6,199                     |       | 14,869 |   | 19,281 |   |
| Other expense (income), net                                                                                           |       | 85                        |       | 29                        |       | (138 | ) | 29 |   |
|                                                                                                                  |       |                      |       |                      |       |   |   |   |   |
| Operating profit                                                                                                      |       | 1,595                     |       | 12,242                    |       | 27,433 |   | 41,889 |   |
|                                                                                                                  |       |                      |       |                      |       |   |   |   |   |
| Interest expense                                                                                                      |       | 563                       |       | 534                       |       | 1,636 |   | 1,487 |   |
| Interest income                                                                                                       |       | (525                      | )          | (411                      | )          | (2,082 | ) | (997 | ) |
|                                                                                                                  |       |                      |       |                      |       |   |   |   |   |
| Earnings from continuing operations before  income taxes                                                              |       | 1,557                     |       | 12,119                    |       | 27,879 |   | 41,399 |   |
| Income tax expense                                                                                                    |       | 918                       |       | 3,630                     |       | 10,411 |   | 14,038 |   |
| Net earnings from continuing operations                                                                               |       | 639                       |       | 8,489                     |       | 17,468 |   | 27,361 |   |
| Earnings (loss) from discontinued  operations, net of tax expense (benefit) of $2,574, ($5,557), $4,656 and  ($9,454) |       | 4,660                     |       | (6,406                    | )          | 9,656 |   | (13,959 | ) |
| Loss from disposal of discontinued operations,  net of tax of ($1,077) and ($3,269)                                   |       | (1,949                    | )          | —                    |       | (6,780 | ) | — |   |
| Net earnings                                                                                                          |       | $                         | 3,350      |                      | $          | 2,083 |   | $ | 20,344 |   | $ | 13,402 |   |
|                                                                                                                  |       |                      |       |                      |       |   |   |   |   |
| Weighted average shares outstanding:                                                                                  |       |                      |       |                      |       |   |   |   |   |
| Basic                                                                                                                 |       | 29,194                    |       | 28,768                    |       | 29,060 |   | 28,729 |   |
| Diluted                                                                                                               |       | 29,674                    |       | 29,186                    |       | 29,555 |   | 29,100 |   |
|                                                                                                                  |       |                      |       |                      |       |   |   |   |   |
| **Earnings  (loss) per share:**                                                                                       |       |                      |       |                      |       |   |   |   |   |
| Basic:                                                                                                                |       |                      |       |                      |       |   |   |   |   |
| Continuing operations                                                                                                 |       | $                         | 0.02       |                      | $          | 0.30 |   | $ | 0.60 |   | $ | 0.95 |   |
| Discontinued operations                                                                                               |       | 0.09                      |       | (0.23                     | )          | 0.10 |   | (0.48 | ) |
| Net earnings per share                                                                                                |       | $                         | 0.11       |                      | $          | 0.07 |   | $ | 0.70 |   | $ | 0.47 |   |
|                                                                                                                  |       |                      |       |                      |       |   |   |   |   |
| Diluted:                                                                                                              |       |                      |       |                      |       |   |   |   |   |
| Continuing operations                                                                                                 |       | $                         | 0.02       |                      | $          | 0.29 |   | $ | 0.59 |   | $ | 0.94 |   |
| Discontinued operations                                                                                               |       | 0.09                      |       | (0.22                     | )          | 0.10 |   | (0.48 | ) |
| Net earnings per share                                                                                                |       | $                         | 0.11       |                      | $          | 0.07 |   | $ | 0.69 |   | $ | 0.46 |   |
|                                                                                                                  |       |                      |       |                      |       |   |   |   |   |
| Cash dividends per share                                                                                              |       | $                         | 0.085      |                      | $          | 0.085 |   | $ | 0.255 |   | $ | 0.255 |   |

 

*See accompanying notes toconsolidated condensed financial statements.*

 

4

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**STEWART &STEVENSON SERVICES, INC. AND SUBSIDIARIES**

**CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS**

*(Inthousands)*

 
| ** **                                                                                                             | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                                                             | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** |
| ** **                                                                                                             | ** ** | **(Unaudited)**           | ** ** | **(Unaudited)**           | ** ** |
| **Operating  Activities**                                                                                              |       |                      |       |                      |       |   |   |   |   |
| Net earnings                                                                                                           |       | $                         | 3,350      |                      | $          | 2,083 |   | $ | 20,344 |   | $ | 13,402 |   |
| Adjustments to reconcile net earnings to  net cash provided by operating activities:                                   |       |                      |       |                      |       |   |   |   |   |
| Net (earnings) loss from discontinued  operations                                                                      |       | (2,711                    | )          | 6,406                     |       | (2,876 | ) | 13,959 |   |
| Deferred tax (benefit) expense                                                                                         |       | (2,393                    | )          | 2,634                     |       | 1,378 |   | (427 | ) |
| Depreciation and amortization                                                                                          |       | 2,738                     |       | 2,233                     |       | 5,988 |   | 6,200 |   |
| Unrealized foreign exchange (gains) losses                                                                             |       | (198                      | )          | —                    |       | 1,216 |   | — |   |
| Change in operating assets and liabilities  net of the effect of acquisition, divestiture and discontinued operations: |       |                      |       |                      |       |   |   |   |   |
| Accounts receivable, net                                                                                               |       | (7,826                    | )          | (6,627                    | )          | (8,576 | ) | (9,716 | ) |
| Recoverable costs and accrued profits not  yet billed                                                                  |       | 5,044                     |       | —                    |       | — |   | — |   |
| Inventories                                                                                                            |       | 1,877                     |       | (6,527                    | )          | 3,066 |   | (7,072 | ) |
| Other current and noncurrent assets                                                                                    |       | 619                       |       | (7,373                    | )          | 1,771 |   | 8,935 |   |
| Accounts payable                                                                                                       |       | (10,440                   | )          | 3,077                     |       | 3,918 |   | (663 | ) |
| Accrued payrolls and incentives                                                                                        |       | 4,385                     |       | 4,690                     |       | (1,929 | ) | 3,308 |   |
| Billings in excess of incurred costs                                                                                   |       | 18,179                    |       | 3,635                     |       | (41,715 | ) | (33,094 | ) |
| Other current liabilities                                                                                              |       | (2,065                    | )          | (2,452                    | )          | (8,153 | ) | 2,884 |   |
| Accrued postretirement benefits and pension                                                                            |       | 348                       |       | (10,148                   | )          | 1,063 |   | (9,434 | ) |
| Other, net                                                                                                             |       | 59                        |       | 163                       |       | (304 | ) | (1,413 | ) |
| **Net Cash  Provided by (Used in) Continuing Operations**                                                              |       | 10,966                    |       | (8,206                    | )          | (24,809 | ) | (13,131 | ) |
| Net Cash Provided by (Used in) Discontinued  Operations                                                                |       | (24,231                   | )          | (3,152                    | )          | (16,606 | ) | 47,218 |   |
| **Net Cash  Provided by (Used in) Operating Activities**                                                               |       | (13,265                   | )          | (11,358                   | )          | (41,415 | ) | 34,087 |   |
|                                                                                                                   |       |                      |       |                      |       |   |   |   |   |
| **Investing  Activities**                                                                                              |       |                      |       |                      |       |   |   |   |   |
| Capital expenditures                                                                                                   |       | (7,125                    | )          | (3,021                    | )          | (8,960 | ) | (6,567 | ) |
| Proceeds from sale of businesses                                                                                       |       | 9,438                     |       | —                    |       | 24,438 |   | — |   |
| Acquisition of businesses, net of cash  acquired                                                                       |       | —                    |       | —                    |       | (42,778 | ) | — |   |
| Proceeds from disposal of property, plant  and equipment                                                               |       | 147                       |       | 163                       |       | 147 |   | 342 |   |
| Short-term investment activity, net                                                                                    |       | 250                       |       | 3,505                     |       | (8,310 | ) | 315 |   |
| Net investing activities of discontinued  operations                                                                   |       | —                    |       | 38                        |       | 66 |   | 112 |   |
| **Net Cash  Provided by (Used in) Investing Activities**                                                               |       | 2,710                     |       | 685                       |       | (35,397 | ) | (5,798 | ) |
|                                                                                                                   |       |                      |       |                      |       |   |   |   |   |
| **Financing  Activities**                                                                                              |       |                      |       |                      |       |   |   |   |   |
| Loan acquisition costs                                                                                                 |       | —                    |       | —                    |       | (76 | ) | — |   |
| Change in short-term notes payable                                                                                     |       | (19                       | )          | —                    |       | (19 | ) | — |   |
| Dividends paid                                                                                                         |       | (2,474                    | )          | (2,465                    | )          | (7,407 | ) | (7,341 | ) |
| Proceeds from exercise of stock options                                                                                |       | 2,302                     |       | 89                        |       | 5,949 |   | 1,339 |   |
| **Net Cash  Used in Financing Activities**                                                                             |       | (191                      | )          | (2,376                    | )          | (1,553 | ) | (6,002 | ) |
|                                                                                                                   |       |                      |       |                      |       |   |   |   |   |
| **Effect  of exchange rate changes on cash**                                                                           |       | 348                       |       | —                    |       | (57 | ) | — |   |
|                                                                                                                   |       |                      |       |                      |       |   |   |   |   |
| Increase (decrease) in cash and cash  equivalents                                                                      |       | (10,398                   | )          | (13,049                   | )          | (78,422 | ) | 22,287 |   |
| Cash and cash equivalents, beginning of  period                                                                        |       | 60,491                    |       | 87,522                    |       | 128,515 |   | 52,186 |   |
| Cash and cash equivalents, end of period                                                                               |       | $                         | 50,093     |                      | $          | 74,473 |   | $ | 50,093 |   | $ | 74,473 |   |
|                                                                                                                   |       |                      |       |                      |       |   |   |   |   |
| Cash Paid For:                                                                                                         |       |                      |       |                      |       |   |   |   |   |
| Interest                                                                                                               |       | $                         | 42         |                      | $          | 6 |   | $ | 1,014 |   | $ | 1,017 |   |
| Income taxes (excluding refunds)                                                                                       |       | 172                       |       | 768                       |       | 433 |   | 1,078 |   |

 

*See accompanying notes to consolidatedcondensed financial statements.*

 

5

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

**NOTES TO CONSOLIDATED CONDENSED FINANCIALSTATEMENTS**

(Unaudited)

 

**Note 1 – Summary of Significant Accounting Policies and Basisof Presentation**

 

Theaccompanying unaudited consolidated condensed financial statements of Stewart &Stevenson Services, Inc. and Subsidiaries (collectively, the “Company”)have been prepared in accordance with Rule 10-01 of Regulation S-X forinterim 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 and nine months ended October 29, 2005 are notnecessarily indicative of the results that will be realized for the fiscal yearending 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 fiscal 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 compensationexpense is recognized when the exercise price of an employee stock option isequal to or greater than the market price of the Company’s common stock on thegrant date and all other provisions of the award are fixed.  In December 2004, the FinancialAccounting Standards Board (the “FASB”) issued SFAS No. 123 (revised2004), “Share-Based Payment,” which requires all share-based payments toemployees, including grants of employee stock options, to be recognized ascompensation expense in the statements of operations based on their fairvalues.  The Company is currentlyevaluating the impact of the new standard, which is required to be adopted inthe first quarter 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**    | ** ** | **Nine Months Ended**     | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                      | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** |
| Net earnings:                                                                   |       |                      |       |                      |       |   |   |   |   |
| As reported                                                                     |       | $                         | 3,350      |                      | $          | 2,083 |   | $ | 20,344 |   | $ | 13,402 |   |
| Pro forma compensation expense, determined  under fair value method, net of tax |       | (635                      | )          | (601                      | )          | (1,849 | ) | (1,661 | ) |
| Pro forma                                                                       |       | $                         | 2,715      |                      | $          | 1,482 |   | $ | 18,495 |   | $ | 11,741 |   |
|                                                                            |       |                      |       |                      |       |   |   |   |   |
| Basic earnings per share:                                                       |       |                      |       |                      |       |   |   |   |   |
| As reported                                                                     |       | $                         | 0.11       |                      | $          | 0.07 |   | $ | 0.70 |   | $ | 0.47 |   |
| Pro forma                                                                       |       | 0.09                      |       | 0.05                      |       | 0.64 |   | 0.41 |   |
|                                                                            |       |                      |       |                      |       |   |   |   |   |
| Diluted earnings per share:                                                     |       |                      |       |                      |       |   |   |   |   |
| As reported                                                                     |       | $                         | 0.11       |                      | $          | 0.07 |   | $ | 0.69 |   | $ | 0.46 |   |
| Pro forma                                                                       |       | 0.09                      |       | 0.05                      |       | 0.63 |   | 0.40 |   |

 

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 is as follows *(inthousands*):

 
| ** **                                               | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|----------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                               | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** |
| ** **                                               | ** ** | ** **                | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net earnings                                             |       | $                         | 3,350      |                      | $          | 2,083 |   | $ | 20,344 |   | $ | 13,402 |   |
| Unrealized gain (loss) on forward  contracts, net of tax |       | 6                         |       | (34                       | )          | (60 | ) | (310 | ) |
| Currency translation gain (loss), net of  tax            |       | 553                       |       | 120                       |       | (1,860 | ) | (330 | ) |
| Comprehensive income                                     |       | $                         | 3,909      |                      | $          | 2,169 |   | $ | 18,424 |   | $ | 12,762 |   |

 

**Note 3– Acquisitions and Divestitures**

 

OnSeptember 27, 2005, the Company entered into a definitive agreement withHushang Ansary to sell substantially all the operating assets and business ofthe Engineered Products Division for cash consideration of approximately $60million and the assumption of certain liabilities, subject to adjustment basedon assets delivered at closing.  On October 24,2005, the Company entered into a separate definitive agreement with Mr. Ansaryto sell substantially all remaining operating assets and business of the PowerProducts Division for cash consideration of approximately $180 million and theassumption of certain liabilities, subject to adjustment based on assetsdelivered at closing.  Both of thesesales are expected to be completed during the fourth quarter of Fiscal 2005,subject to customary conditions and third party consents.  The Company expects to record a net gain onthese sales, and is currently evaluating how it will invest the proceeds fromthese transactions.

 

InAugust 2005, the Company sold substantially all of the inventory,property, plant and equipment, distribution rights, and operations of fourPower Products Division distribution locations in California for cashconsideration of approximately $9.4 million. As a result of this sale, the Company recorded a $3.1 million pre-taxloss on disposal of discontinued operations during the second quarter of Fiscal2005, which included a $3.3 million estimated withdrawal liability from a unionpension plan.

 

OnApril 8, 2005, the Company acquired all outstanding shares of AutomotiveTechnik (Holdings) Limited (“ATHL”), a light tactical vehicle manufacturerheadquartered in the United Kingdom.  Theaggregate purchase price for the transaction was approximately $48.2 million,including cash of $45.3 million, notes of $1.9 million and transaction costs ofapproximately $1.0 million.  The acquisitionof ATHL broadens the Company’s product offerings and provides additionalmarketing opportunities for the Company’s Tactical Vehicle Systems business.  ATHL currently has contracts to producevehicles for the United Kingdom Ministry of Defence and the New ZealandMinistry of Defence, in addition to other programs worldwide.  The results of operations for ATHL areincluded in the Company’s consolidated condensed financial statements since thedate of acquisition.  Since the date ofacquisition, the ATHL operations generated sales of $35.6 million and a pre-taxoperating loss of $2.1 million during Fiscal 2005.  Pro forma information is not presented, asthis acquisition is not material to the Company’s

 

7

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consolidatedresults of operations.

 

Thefollowing table summarizes the estimated fair value of the assets acquired andliabilities assumed at the date of acquisition. The Company is in the processof finalizing valuations of certain long-lived and intangible assets;consequently, the allocation of the purchase price is subject to refinement.  The Company believes that a substantialportion of the long-term asset balance will be allocated to goodwill and otheridentified intangibles.

 

| ***(In thousands)***                   | ** ** | **April 8, 2005** | ** ** |
|----------------------------------------|------------|------------------------|------------|
|                                   |       |                   |       |
| Cash and cash equivalents              |       | $                      | 3,552      |   |
| Other current assets                   |       | 15,642                 |       |
| Total Current Assets                   |       | 19,194                 |       |
|                                   |       |                   |       |
| Property, Plant and Equipment          |       | 2,553                  |       |
| Other Long-Term Assets                 |       | 44,575                 |       |
| Total Assets Acquired                  |       | 66,322                 |       |
|                                   |       |                   |       |
| 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               |       | $                      | 48,204     |   |

 

During the fourth quarter of Fiscal 2004, the Company sold substantiallyall of the assets and business of the Airline Products business for proceeds of$60 million as well as the assumption of certain liabilities, subject to finaladjustment based on the amount of working capital conveyed at closing.  In November 2005, the Company reached anagreement with the buyer regarding certain contractual issues related to thesale, pursuant to which the Company agreed to refund $4.0 million of purchaseprice to the buyer.  Primarily as aresult of this dispute, the Company recorded pre-tax charges of $3.0 millionand $7.0 million during the third quarter and first nine months of Fiscal 2005,respectively.  

 

**Note 4 - Discontinued Operations**

 

Asa result of the divestitures described in Note 3, the identified assets,liabilities and results of operations for the Airline Products, Power Productsand Engineered Products businesses are reported as discontinued operations forall periods presented.  Pursuant to thesales agreements for these divestitures, the Company retained certainobligations of these businesses, for which the Company has recorded accruals itbelieves to be adequate at this time.

 

Additionally,the Company’s discontinued operations continue to include the wind-down of theturnkey engineering, procurement and construction activities of the DistributedEnergy Solutions business, which the Company decided to exit in Fiscal 2003,and the retained warranty and contract obligations from the Fiscal 2002 sale ofthe blowout preventer and controls, valve and drilling riser business previouslyincluded in the Engineered Products segment. 

 

Duringthe second quarter of Fiscal 2005, the Company recorded a $4.0 million pre-taxcharge related to the settlement of a customer dispute in the DistributedEnergy Solutions business, which was paid in August 2005.  

 

8

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Salesand operating profit (loss) for the three and nine months ended October 29,2005 and October 30, 2004 from discontinued operations were as follows (*in thousands)*:

 
| ** **                                        | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|---------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                        | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** |
| **Sales**                                         |       |                      |       |                      |       |   |   |   |   |
| Power Products                                    |       | $                         | 142,693    |                      | $          | 129,813 |   | $ | 411,275 |   | $ | 374,212 |   |
| Engineered Products                               |       | 50,025                    |       | 25,799                    |       | 119,064 |   | 65,989 |   |
| Airline Products                                  |       | —                    |       | 26,750                    |       | — |   | 73,558 |   |
| Distributed Energy Solutions                      |       | 1,554                     |       | 2,560                     |       | 5,415 |   | 13,239 |   |
| Total Sales                                       |       | $                         | 194,272    |                      | $          | 184,922 |   | $ | 535,754 |   | $ | 526,998 |   |
|                                              |       |                      |       |                      |       |   |   |   |   |
| **Operating profit (loss)**                       |       |                      |       |                      |       |   |   |   |   |
| Power Products                                    |       | $                         | 4,501      |                      | $          | 3,705 |   | $ | 9,877 |   | $ | 6,267 |   |
| Engineered Products                               |       | 3,593                     |       | (10,389                   | )          | 7,687 |   | (13,156 | ) |
| Airline Products                                  |       | (3,026                    | )          | (195                      | )          | (7,023 | ) | (676 | ) |
| Distributed Energy Solutions                      |       | (860                      | )          | (5,084                    | )          | (6,278 | ) | (15,848 | ) |
| Total operating profit (loss)                     |       | 4,208                     |       | (11,963                   | )          | 4,263 |   | (23,413 | ) |
| Income tax expense (benefit)                      |       | 1,497                     |       | (5,557                    | )          | 1,387 |   | (9,454 | ) |
| Net earnings (loss) from discontinued  operations |       | $                         | 2,711      |                      | $          | (6,406 | ) | $ | 2,876 |   | $ | (13,959 | ) |

 

Assetsand liabilities of discontinued operations as of October 29, 2005 and January 31,2005 consisted of the following *(in thousands)*:

 
| ** **                                           | ** ** | **October 29, 2005** | ** ** | **January 31, 2005** | ** ** |
|------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                           | ** ** | ** **                | ** ** | ** **                | ** ** |
| Cash and cash equivalents                            |       | $                         | 2,570      |                      | $          | 1,942 |   |
| Accounts receivable, net                             |       | 100,564                   |       | 111,317                   |       |
| Recoverable costs and accrued profits not yet billed |       | 51,286                    |       | 27,557                    |       |
| Inventories                                          |       | 99,381                    |       | 71,788                    |       |
| Property, plant and equipment, net                   |       | 77,906                    |       | 84,924                    |       |
| Other assets                                         |       | 13,031                    |       | 24,421                    |       |
| Total assets of discontinued operations              |       | $                         | 344,738    |                      | $          | 321,949 |   |
|                                                 |       |                      |       |                      |       |
| Notes payable                                        |       | $                         | 2,447      |                      | $          | 1,671 |   |
| Accounts payable                                     |       | 48,226                    |       | 41,688                    |       |
| Accrued payrolls and incentives                      |       | 10,547                    |       | 10,812                    |       |
| Other liabilities                                    |       | 50,785                    |       | 45,022                    |       |
| Total liabilities of discontinued  operations        |       | $                         | 112,005    |                      | $          | 99,193 |   |

 

**Note 5 - Guarantees and Contingencies**

 

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

 

Asummary of warranty activity associated with continuing operations for three andnine months ended October 29, 2005 and October 30, 2004 follows (*in thousands*):

 
| ** **                                                   | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|--------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                   | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** |
|                                                         |       |                      |       |                      |       |   |   |   |   |
| Accrued warranty costs at beginning of  period               |       | $                         | 2,443      |                      | $          | 1,501 |   | $ | 1,817 |   | $ | 1,353 |   |
| Payments for warranty obligations                            |       | (319                      | )          | (197                      | )          | (841 | ) | (614 | ) |
| Warranty accrual for current period sales                    |       | 761                       |       | 297                       |       | 1,803 |   | 862 |   |
| Changes related to pre-existing warranties  and acquisitions |       | (320                      | )          | —                    |       | (214 | ) | — |   |
| Accrued warranty costs at end of period                      |       | $                         | 2,565      |                      | $          | 1,601 |   | $ | 2,565 |   | $ | 1,601 |   |

 

9

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*Guarantees*:  The Company is occasionally required to issueperformance indemnities or to post letters of credit, generally issued by abank, to collateralize certain insurance programs, to secure credit facilitiesor to ensure performance under contracts. A letter of credit commits the issuer to remit specified amounts to theholder, if the holder demonstrates that the Company has failed to meet itsobligations under the letter of credit. If this were to occur, the Company would be obligated to reimburse theissuer for any payments the issuer was required to remit to the holder of theletter of credit.  Generally, a letter ofcredit is released when the Company has satisfied the obligations that theletter of credit is securing.  As of October 29,2005 and January 31, 2005, the Company had letters of credit outstandingtotaling approximately $13.2 million.  Inaddition, the Company had contingent performance indemnities of approximately $2.6million and $3.8 million as of October 29, 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.**and McLaughlin Body Co.*,Civil Action No. H-96-3363, in the U.S. District Court for the SouthernDistrict of Texas, Houston Division.  Theplaintiff’s complaint seeks penalties and damages in an unspecifiedamount.  The suit alleges that theCompany made false statements and certifications in connection with claims forpayment for medium tactical vehicles delivered to the U.S. Army before 1998,and that the vehicles were substandard because of corrosion problems.  Following an investigation by the JusticeDepartment, the United States declined to intervene in the suit.  In February 2004, the District Courtfound in favor of the Company and dismissed all of the plaintiff’s claims bysummary judgment without proceeding to trial. The plaintiff filed a notice of appeal in March 2004 in the U.S.Court of Appeals for the Fifth Circuit, No. 04-20209.  On August 8, 2005, a panel of the FifthCircuit issued an opinion affirming the district court’s summary judgmentorder.  On November 8, 2005, theplaintiff filed a petition for writ of certiorari with the U.S. Supreme Court, askingthat the Fifth Circuit’s opinion be overturned.  The Company believes the writ of certiorari isunlikely to be successful.  However,until all issues are exhausted, the Company’s consolidated results ofoperations, financial position and liquidity could still be affected by thissuit.

 

*Klickitat Litigation*:  The Company and several of itssubsidiaries in the Distributed Energy Solutions business are defendants in asuit filed by the Klickitat County Public Utility District No. 1 on December 11,2003 arising out of claims relating to a landfill gas power generation facilityin Roosevelt, Washington, Cause No. CY-03-3175-LRS;*KlickitatCounty Public Utility District No. 1 v. Stewart & StevensonServices, Inc., Stewart & Stevenson Power, Inc., SierraDetroit Diesel Allison, Inc., Pamco International, Inc. and WaukeshaEngine Dresser, Inc.*; in the U.S. District Court for theEastern District of Washington.  Theplaintiff has asserted claims with respect to equipment installed and usedsince 1999 for breach of contract; promissory estoppel; violations of theWashington 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. 

 

*Antitrust Litigation*:  The Company is a co-defendantwith Detroit Diesel Corporation and other Detroit Diesel distributors in twoputative class action suits related to the Power Products business filed on February 9,2005, Civil Action No. 05-616; *Cumberland Truck EquipmentCo. et al. v. Detroit Diesel Corp., et al.* (the “CumberlandLitigation”), and Civil Action No. 05-625; *DiamondInternational Trucks, Inc. et al. v. Detroit Diesel Corp., et al.*(the “DIT Litigation”).  The suits wereinitially filed**in the U.S. District Court forthe Eastern District of Pennsylvania.  OnNovember 14, 2005, the cases were transferred to the Eastern District ofMichigan.  In the Cumberland Litigation,plaintiffs were dealers of Detroit Diesel parts whose agreements wereterminated or not renewed on or after February 9, 2001.  The plaintiffs are claiming antitrustviolations arising out of the termination or non-renewal of their dealeragreements.  In the DIT Litigation,plaintiffs are dealers of Detroit Diesel

 

10

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parts whose dealership classification was changed on or after February 9,2001.  The plaintiffs in the DITLitigation are claiming antitrust violations arising out of changes to theclassification of their dealerships.  TheCompany is a distributor of Detroit Diesel parts and had a dealer agreementwith one or more of the named plaintiffs in each suit.  The plaintiffs in each suit have also allegedprice fixing and group boycott in violation of Section 1 of the ShermanAct and have made claims for treble damages and injunctive and other relief.  The Company is vigorously defending bothsuits.  It is presently impossible forthe Company to determine the ultimate outcome of either suit or whether theirresolution will, in the future, have a material adverse effect on the Company’sconsolidated results of operations, financial position or liquidity.  The Company is presently unable to determinewhether a material liability has been incurred in these matters or toreasonably estimate the amount of any loss that may result from 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 legal feesthat it expects to incur associated with these matters. 

 

*Environmental Contingencies*:  In 2001, theCompany received from the U.S. Environmental Protection Agency (the “EPA”) aRequest 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 tothe Company by the EPA indicates that the Company may have sent waste oils tothe Site for recycling in the late 1980s, and that such waste oils maypotentially account for between one and two percent of the volume of totalwastes 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 recorded accrualswhich 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 amounts accrued.  Whileuncertainties are inherent in the final outcome of these environmental matters,and it is presently impossible to determine the actual costs that ultimatelymay be incurred, management currently believes that the resolution of suchuncertainties should not have a material adverse effect on the Company’sconsolidated results of operations, financial position or liquidity. 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.  

 

**Note 6– Inventories**

 

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

 
| ** **                    | ** ** | **October 29, 2005** | ** ** | **January 31, 2005** | ** ** |
|-------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                    | ** ** | ** **                | ** ** | ** **                | ** ** |
| Raw materials and spare parts |       | $                         | 15,721     |                      | $          | 8,422 |   |
| Work in process               |       | 5,739                     |       | 9,381                     |       |
| Total Inventories             |       | $                         | 21,460     |                      | $          | 17,803 |   |

 

Inventory balances have increased since January 31, 2005 primarilydue to the ATHL acquisition during the first quarter of Fiscal 2005.  See Note 3 for further discussion.

 

11

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**Note 7– Earnings 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**    | ** ** | **Nine Months Ended**     | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                                 | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** |
| Numerator:                                                                                 |       |                      |       |                      |       |   |   |   |   |
| Earnings (loss) available to common  shareholders                                          |       |                      |       |                      |       |   |   |   |   |
| From continuing operations                                                                 |       | $                         | 639        |                      | $          | 8,489 |   | $ | 17,468 |   | $ | 27,361 |   |
| From discontinued operations                                                               |       | 2,711                     |       | (6,406                    | )          | 2,876 |   | (13,959 | ) |
| Net earnings                                                                               |       | $                         | 3,350      |                      | $          | 2,083 |   | $ | 20,344 |   | $ | 13,402 |   |
|                                                                                       |       |                      |       |                      |       |   |   |   |   |
| Denominator:                                                                               |       |                      |       |                      |       |   |   |   |   |
| Denominator for basic earnings per share                                                   |       |                      |       |                      |       |   |   |   |   |
| Weighted average shares outstanding                                                        |       | 29,194                    |       | 28,768                    |       | 29,060 |   | 28,729 |   |
| Effect of dilutive securities:                                                             |       |                      |       |                      |       |   |   |   |   |
| Employee and director stock options                                                        |       | 480                       |       | 418                       |       | 495 |   | 372 |   |
| Denominator for diluted earnings per share  - Adjusted weighted average shares outstanding |       | 29,674                    |       | 29,186                    |       | 29,555 |   | 29,101 |   |
|                                                                                       |       |                      |       |                      |       |   |   |   |   |
| Basic earnings per share:                                                                  |       |                      |       |                      |       |   |   |   |   |
| From continuing operations                                                                 |       | $                         | 0.02       |                      | $          | 0.30 |   | $ | 0.60 |   | $ | 0.95 |   |
| From discontinued operations                                                               |       | 0.09                      |       | (0.23                     | )          | 0.10 |   | (0.48 | ) |
| Net earnings per share                                                                     |       | $                         | 0.11       |                      | $          | 0.07 |   | $ | 0.70 |   | $ | 0.47 |   |
|                                                                                       |       |                      |       |                      |       |   |   |   |   |
| Diluted earnings per share:                                                                |       |                      |       |                      |       |   |   |   |   |
| From continuing operations                                                                 |       | $                         | 0.02       |                      | $          | 0.29 |   | $ | 0.59 |   | $ | 0.94 |   |
| From discontinued operations                                                               |       | 0.09                      |       | (0.22                     | )          | 0.10 |   | (0.48 | ) |
| Net earnings per share                                                                     |       | $                         | 0.11       |                      | $          | 0.07 |   | $ | 0.69 |   | $ | 0.46 |   |
|                                                                                       |       |                      |       |                      |       |   |   |   |   |
| Number of shares under anti-dilutive stock  options outstanding                            |       | 410                       |       | 1,000                     |       | 410 |   | 1,009 |   |

 

**Note 8 - 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.  The defined benefit postretirement medicalplan has been amended such that, effective January 1, 2006, prescriptionmedication coverage will be discontinued for all participants who are botheligible for prescription drug benefits under Medicare and for whom Medicare isthe primary payor.  This plan change hasreduced the plan’s net periodic benefit cost beginning in Fiscal 2005.

 

12

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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 *(in thousands)*:

 
| ** **                     | ** ** | **Pension Benefits**      | ** ** |
|--------------------------------|------------|---------------------------|------------|
| ** **                     | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended** | ** ** |
| ** **                     | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** |
| Service cost                   |       | $                         | 154        |   | $ | 183 |   | $ | 462 |   | $ | 549 |   |
| Interest cost                  |       | 1,988                     |       | 1,888 |   | 5,964 |   | 5,664 |   |
| Expected return on plan assets |       | (2,241                    | )          | (2,048 | ) | (6,723 | ) | (6,144 | ) |
| Recognized actuarial loss      |       | 728                       |       | 365 |   | 2,184 |   | 1,095 |   |
| Net periodic benefit cost      |       | $                         | 629        |   | $ | 388 |   | $ | 1,887 |   | $ | 1,164 |   |

 
| ** **                                     | ** ** | **Other Postretirement Benefits** | ** ** |
|------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                     | ** ** | **Three Months Ended**            | ** ** | **Nine Months Ended** | ** ** |
| ** **                                     | ** ** | **October 29, 2005**         | ** ** | **October 30, 2004** | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** |
| Interest cost                                  |       | $                                 | 40         |   | $ | 164 |   | $ | 120 |   | $ | 492 |   |
| Amortization of deferred plan amendment  gains |       | (363                              | )          | (191 | ) | (1,089 | ) | (573 | ) |
| Recognized actuarial loss                      |       | 125                               |       | 73 |   | 375 |   | 219 |   |
| Net periodic benefit cost (income)             |       | $                                 | (198       | ) | $ | 46 |   | $ | (594 | ) | $ | 138 |   |

 

The Company does not expect to make any contributions to its definedbenefit pension plans during Fiscal 2005. 

 

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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 the attachedconsolidated condensed financial statements and notes thereto, and with ourAnnual Report on Form 10-K and notes thereto for the fiscal year ended January 31,2005.  The following discussion containsforward-looking statements.  Inconnection therewith, please see “Factors That May Affect Future Results”below, which identifies important factors that could cause actual results todiffer materially from those predicted or implied in the forward-lookingstatements. 

 

Ourfiscal year begins on February 1 of the year stated and ends on January 31of the following year.  For example, our “Fiscal2005” commenced on February 1, 2005 and ends on January 31,2006.  We report results on the fiscalquarter method with each quarter comprising approximately 13 weeks.  The third quarter of Fiscal 2005 commenced onJuly 31, 2005 and ended on October 29, 2005, and the third quarter ofFiscal 2004 commenced on August 1, 2004 and ended on October 30,2004.

 

**RESULTS OF OPERATIONS**

 

**StrategicOverview**

 

In September 2003, we began a strategic reviewof all of our primary businesses in an effort to identify and implementnecessary actions to enhance value for our shareholders. Between that time and January 2005,we exited the turnkey engineering, procurement and construction activities ofthe Distributed Energy Solutions segment; implemented numerous actions in thePower Products and Engineered Products segments aimed at improvingprofitability and sold the Airline Products business. During Fiscal 2005, we have continued toexecute our action plan toward this objective, including completing one businessdivestiture and entering into definitive agreements to sell two othersignificant businesses.

 

InAugust 2005, we completed the sale of substantially all of the inventory,property, plant and equipment, distribution rights, and operations of fourPower Products distribution locations in California.  As a result of this sale, we recorded a $3.1million pre-tax charge during the second quarter of Fiscal 2005, which includeda $3.3 million estimated withdrawal liability from a union pension plan.  

 

OnSeptember 27, 2005, we entered into a definitive agreement with HushangAnsary to sell substantially all operating assets and business of theEngineered Products Division for cash consideration of approximately $60million and the assumption of certain liabilities, subject to adjustment basedon assets delivered at closing.  On October 24,2005, we entered into a separate definitive agreement with Mr. Ansary tosell substantially all remaining operating assets and business of the PowerProducts Division for cash consideration of approximately $180 million and theassumption of certain liabilities, subject to adjustment based on assetsdelivered at closing.  Both of thesesales are expected to be completed during the fourth quarter of Fiscal 2005subject to customary conditions and third party consents.  We expect to record a net gain on thesesales, and we are currently evaluating how we will invest the proceeds from thesetransactions.

 

Upon completing the sales of the Power Products andEngineered Products businesses, we will primarily be engaged in the design,manufacture and service of tactical military vehicles and related products.  Consistent with this strategic direction, wehave taken actions in Fiscal 2005 to expand our Tactical Vehicle Systemsbusiness.

 

InApril 2005, we acquired all outstanding shares of Automotive Technik(Holdings) Limited (“ATHL”), the manufacturer of the Pinzgauer light tacticalvehicle headquartered in the United Kingdom, for a total purchase price ofapproximately $48.2 million.  Theacquisition of ATHL broadens our product offerings in the Tactical VehicleSystems business and provides additional marketing opportunitiesworldwide.  ATHL currently has contractsto produce vehicles for the United Kingdom Ministry of Defence and the NewZealand Ministry of Defence, in addition to other programs worldwide.

 

Additionally,we received contract modifications from the U.S. Army in June 2005, valuedat approximately $483 million.  Thesemodifications are funded by the 2005 U.S. Congress Supplemental Spending Billand added 3,016 truck and trailer deliveries to the current U.S. Armyproduction contract.  Currently, we areexpanding the capacity of our Sealy, Texas production facility in order to meetthese additional order deliveries, which are scheduled from June 2006 to September 2008.

 

**Continuing Operations**

 

Asa result of the planned divestitures of the Engineered Products and PowerProducts businesses and the resulting reclassification of these operatingsegments to discontinued operations, continuing operations primarily consist ofthe Tactical Vehicle Systems business, which manufactures the Family of MediumTactical Vehicles (“FMTV”) and related armoring under

 

14

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contractswith the U.S. Army and provides sustaining design engineering, service andsupport.  With the ATHL acquisitiondescribed above, this business also manufactures Pinzgauer light tacticalvehicles for the United Kingdom Ministry of Defence, the New Zealand Ministryof Defence and other customers.  Continuingoperations also include certain corporate office expenses, including thefacility-related costs of maintaining the corporate office, chief executive,legal, finance, internal audit, investor relations, human resources, tax andother similar costs.  

 

Salesfrom continuing operations during the third quarter of Fiscal 2005 were $161.8million, a $28.4 million (21%) increase from $133.4 million of sales recordedin the third quarter of Fiscal 2004.  Forthe first nine months of Fiscal 2005, sales were $531.5 million, a $118.6million (29%) increase from $413.0 million recorded in the first nine months ofFiscal 2004.  The sales increase isprimarily attributable to production of Low Signature Armored Cabs (“LSAC”) inFiscal 2005.  A breakdown of unitdeliveries follows:

 
| ** **                 | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|----------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                 | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** |
| Trucks                     |       | 704                       |       | 683                       |       | 2,042 |   | 2,177 |   |
| Trailers                   |       | 373                       |       | 146                       |       | 1,001 |   | 551 |   |
| Low Signature Armored Cabs |       | 230                       |       | —                    |       | 1,703 |   | — |   |

 

We recorded $18.8 million of sales in the third quarter and $146.3 millionin the first nine months of Fiscal 2005 associated with the LSACproduction.  Additionally, we recorded$14.0 million of sales in the third quarter and $32.7 million in the first ninemonths of Fiscal 2005 attributable to Pinzgauer truck sales in our recently acquiredU.K. manufacturing operation.  Thesesales increases were partially offset by declines in sales attributable to theU.S. Army FMTV production contracts. Equipment sales under the FMTV contracts declined $23.0 million in thethird quarter and $97.6 million in the first nine months of Fiscal 2005 fromthe comparable periods of Fiscal 2004, primarily due to lower truck volumes andlower pricing under the current FMTV production contract.  Parts and service sales increased to $37.6million in the third quarter and $94.3 million in the first nine months ofFiscal 2005, compared to $18.9 million and $57.1 million, respectively, in thecomparable periods of Fiscal 2004.  Theincrease in parts and service sales is primarily attributable to $9.0 millionand $25.3 million of sales in the third quarter and first nine months of Fiscal2005, respectively, related to vehicle reset programs awarded during Fiscal2004, along with stronger spare parts requirements and sales generated by the recentlyacquired ATHL operation in Fiscal 2005.

 

Grossprofit decreased to $6.4 million in the third quarter of Fiscal 2005 from $18.5million in the third quarter of Fiscal 2004, reflecting a decline in grossprofit margin from 13.8% to 4.0% on the higher revenue base.  For the first nine months of Fiscal 2005,gross profit decreased to $42.2 million from $61.2 million in the first ninemonths of Fiscal 2004, reflecting a decline in gross profit margin from 14.8%to 7.9%.  The decrease in gross profitmargin for the third quarter and first nine months of Fiscal 2005 is primarilyattributable to the transition to the current multi-year FMTV productioncontract, which began in the fourth quarter of Fiscal 2004.  Lower gross profit margins on the new FMTVproduction contract were partially offset by higher profit margins generatedfrom the LSAC production.

 

Sellingand administrative expenses, which include our corporate office expenses alongwith selling and product development expenses within the Tactical VehicleSystems business, decreased to $4.7 million (2.9% of sales) in the thirdquarter of Fiscal 2005 from $6.2 million (4.6% of sales) in the third quarterof Fiscal 2004.  For the first ninemonths of Fiscal 2005, selling and administrative expenses decreased to $14.9million (2.8% of sales) from $19.3 million (4.7% of sales) in the first ninemonths of Fiscal 2004.  Corporate officeexpenses declined to $3.4 million and $10.6 million in the third quarter andfirst nine months of Fiscal 2005, respectively, from $4.0 million and $13.1million in the comparable periods of Fiscal 2004.  This decline in spending is the result ofcost control programs combined with lower compliance costs associated with theprovisions of Section 404 of the Sarbanes-Oxley Act of 2002.  Selling and administrative expenses withinthe Tactical Vehicle Systems business declined to $1.3 million and $4.3 millionin the third quarter and first nine months of Fiscal 2005, respectively, from$2.2 million and $6.2 million in the comparable periods of Fiscal 2004.  This decrease in spending is primarily attributableto LSAC product development costs incurred in Fiscal 2004, which did not recurin Fiscal 2005. 

 

Net interest expense in the third quarter of Fiscal 2005 remainedrelatively unchanged from the third quarter of Fiscal 2004, as interest expensewas substantially offset by interest earned on invested cash balances.  For the first nine months of Fiscal 2005 andFiscal 2004, interest income exceeded interest expense, primarily due to ofhigher invested cash balances and higher interest rates on invested cash. 

 

The effective tax rate was 37.3% in the first nine months of Fiscal 2005compared to 33.9% for the first nine months of Fiscal 2004.  The increase in Fiscal 2005 effective tax rateincludes the impact of certain non-deductible expenses.

 

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Duringthe first quarter of Fiscal 2005, the third program year of the current FMTVcontract valued at $316 million was funded, extending production through September 2006.  Additionally, we received contract modificationsfrom the U.S. Army in June 2005 valued at approximately $483 million.  These modifications were funded by the 2005U.S. Congress Supplemental Spending Bill and added 3,016 truck and trailerdeliveries between June 2006 and September 2008 to the U.S. Armyproduction contract.  Consequently, totalbacklog for the Tactical Vehicle Systems business at October 29, 2005 was$1.1 billion, compared to $457 million at January 31, 2005.  While the additional contract modificationsreceived in the second quarter of Fiscal 2005 will significantly increaseanticipated sales volumes in Fiscal 2006 and Fiscal 2007, we are still in theprocess of assessing the net impact that this sales volume will have on futureoperating profits.

 

Scheduled deliveries for the fourth quarter of Fiscal 2005 currentlyinclude 937 trucks, 554 trailers and 62 LSAC units.  The current delivery schedule is subjectto change at the request of the customer. Expected operating margins on the components of backlog varyconsiderably 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 operatingmargin could vary significantly from one fiscal quarter to the next.  Operating margins may also be impacted byadditional contract awards and modifications, the level of engineering serviceand spare parts provided, and the timing and recognition of other costs andrevenues during each period.  

 

**DiscontinuedOperations**

 

As noted above, pursuant to the definitive agreements to sellsubstantially all assets and operations of the Power Products and EngineeredProducts businesses, the assets and liabilities, along with the results ofoperations for these two operating segments have been re-classified todiscontinued operations for all periods presented.  In addition, discontinued operations includethe results of our exited Distributed Energy Solutions and Airline Products businesses,as well as certain Power Products distribution locations in California whichwere sold in August 2005 and costs associated with retained obligationsassociated with our discontinued blowout preventer and controls, valve anddrilling riser business, which was sold during Fiscal 2002.  

 

Salesand operating loss in the three and nine months ended October 29, 2005 andOctober 30, 2004 from discontinued operations were as follows (*in thousands)*:

 
| ** **                    | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|-------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                    | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** |
| **Sales**                     |       |                      |       |                      |       |   |   |   |   |
| Power Products                |       | $                         | 142,693    |                      | $          | 129,813 |   | $ | 411,275 |   | $ | 374,212 |   |
| Engineered Products           |       | 50,025                    |       | 25,799                    |       | 119,064 |   | 65,989 |   |
| Airline Products              |       | —                    |       | 26,750                    |       | — |   | 73,558 |   |
| Distributed Energy Solutions  |       | 1,554                     |       | 2,560                     |       | 5,415 |   | 13,239 |   |
| Total Sales                   |       | $                         | 194,272    |                      | $          | 184,922 |   | $ | 535,754 |   | $ | 526,998 |   |
|                          |       |                      |       |                      |       |   |   |   |   |
| **Operating profit (loss)**   |       |                      |       |                      |       |   |   |   |   |
| Power Products                |       | $                         | 4,501      |                      | $          | 3,705 |   | $ | 9,877 |   | $ | 6,267 |   |
| Engineered Products           |       | 3,593                     |       | (10,389                   | )          | 7,687 |   | (13,156 | ) |
| Airline Products              |       | (3,026                    | )          | (195                      | )          | (7,023 | ) | (676 | ) |
| Distributed Energy Solutions  |       | (860                      | )          | (5,084                    | )          | (6,278 | ) | (15,848 | ) |
| Total operating profit (loss) |       | $                         | 4,208      |                      | $          | (11,963 | ) | $ | 4,263 |   | $ | (23,413 | ) |

 

**Power Products**

 

The Power Products business, which is responsible for marketing andaftermarket support of a wide range of industrial equipment, recorded sales of$142.7 million in the third quarter of Fiscal 2005, a $12.9 million (10%)increase from $129.9 million recorded in the third quarter of Fiscal 2004.  For the first nine months of Fiscal 2005, the PowerProducts business recorded sales of $411.3 million, a $37.1 million (10%)increase from $374.2 million recorded in the first nine months of Fiscal2004.  

 

Theimproved sales volume in the third quarter and first nine months of Fiscal 2005from the comparable periods of Fiscal 2004 is primarily attributable toimproved pricing and sales execution along with general improvements in theheavy equipment markets we serve.  Theseimprovements are partially offset by a decline in sales volume associated withthe four California locations which were exited in August 2005.  As a result of this exit, sales from theaffected locations declined by $12.3 million in the third quarter of Fiscal2005 compared to the third quarter of Fiscal 2004.

 

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ThePower Products business recorded an operating profit of $4.5 million in thethird quarter of Fiscal 2005 compared to $3.7 million in the third quarter ofFiscal 2004.  For the first nine monthsof Fiscal 2005, this business recorded an operating profit of $9.9 millioncompared to $6.3 million in the comparable period of Fiscal 2004.  The improvement in operating profit in Fiscal2005 is primarily attributable to the additional gross profit generated by thehigher sales volume while selling and administrative expenses have remainedrelatively flat to comparable periods of Fiscal 2004.  This improvement in operating results ispartially offset by a $3.1 million pre-tax charge recorded in Fiscal 2005relating to the exit of the four California locations.  This charge included the estimated withdrawalliability from a union pension plan and a reduction in the carrying value ofthe net assets of this business to their fair value less selling costs.

 

Excludingthe California operations, which were sold in August 2005, our orderbacklog in the Power Products business has increased to $92.6 million at October 29,2005 compared to $39.3 million at January 31, 2005.  

 

**Engineered Products**

 

TheEngineered Products business consists of two primary product lines, petroleumequipment and utilities equipment.  Thepetroleum equipment operation manufactures equipment primarily for the wellstimulation segment of the oil service industry.  The utilities equipment products includemobile railcar movers, snowblowers and off-road seismic vehicles.  This business also includes retainedobligations attributable to the blowout preventer and drilling riser businessthat was sold in Fiscal 2002.  EngineeredProducts sales increased to $50.0 million in the third quarter of Fiscal 2005from $25.8 million in the third quarter of Fiscal 2004, representing anincrease of $24.2 million (94%).  For thefirst nine months of Fiscal 2005, the Engineered Products business recordedsales of $119.1 million, an increase of $53.1 million (80%) from the $66.0million of sales recorded in the comparable period of Fiscal 2004.  The sales increase resulted from thecontinued progress and execution of several large petroleum equipment ordersthat were received over the past year.  

 

Operatingprofit for the third quarter of Fiscal 2005 was $3.6 million, a $14.0 millionimprovement from the $10.4 million operating loss in the third quarter ofFiscal 2004.  The improvement inoperating profit is primarily attributable to the Fiscal 2004 settlement ofoutstanding litigation related to the exited blowout preventer and drillingriser business, which resulted in a $11.2 million pre-tax charge.  The remaining $2.8 million improvement fromthe third quarter of Fiscal 2004 is primarily attributable to the increasedsales volume.  

 

Forthe first nine months of Fiscal 2005, operating profit was $7.7 million, a$20.9 million improvement from the $13.2 million operating loss for the firstnine months of Fiscal 2004.  The Fiscal2004 results include the $11.2 million charge related to the litigationsettlement described above, as well as a $0.6 million gain associated with thedisposal of an idle manufacturing facility. The remaining $10.3 million improvement is primarily attributable to theincreased sales volume along with margin improvements realized through pricingand manufacturing and other cost reductions on the Fiscal 2005 equipmentprojects.  

 

Ourorder backlog in the Engineered Products business was $106.5 million at October 29,2005 compared to $91.9 million at January 31, 2005. 

 

**Airline Products**

 

During the fourth quarter of Fiscal 2004, we sold substantially all of theassets and business of the Airline Products segment for proceeds of $60 millionas well as the assumption of certain liabilities, subject to final adjustmentbased on the amount of working capital conveyed at closing.  In November 2005, we reached anagreement with the buyer regarding certain contractual issues related to thesale, pursuant to which we agreed to refund $4.0 million of purchase price tothe buyer.  Primarily as a result of thisdispute, we recorded pre-tax charges of $3.0 million and $7.0 million duringthe third quarter and first nine months of Fiscal 2005, respectively.

 

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**Distributed Energy Solutions**

 

DuringFiscal 2003, we announced our decision to discontinue the turnkey engineering,procurement and construction activities of the Distributed Energy Solutionssegment.  The continued wind-down activitiesassociated with retained warranty and other contractual obligations of thisbusiness are reflected in discontinued operations.  The operating loss for the first nine monthsof Fiscal 2005 includes a $4.3 million pre-tax charge related to the settlementof a customer dispute during the second quarter of Fiscal 2005.

 

**UNFILLED ORDERS**

 

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 otherconditions.  Purchase options are notincluded in unfilled orders until exercised. Due to the inherent uncertainties of the Congressional appropriationsprocess, the Company includes only the funded portions of awarded U.S.government contracts in unfilled orders. Unfilled orders relating to continuing operations increased to $1.121billion, at October 29, 2005, from $457 million at January 31, 2005.

 

Unfilled orders at October 29, 2005 consisted primarily of vehicleproduction funded under the FMTV contract, production of Pinzgauer trucks inthe recently-acquired U.K. operation and uncompleted reset contracts forvehicles ongoing in Sealy and Ft. Hood, Texas. During the first quarter of Fiscal 2005, the third program year of theFMTV contract was funded, extending production through September 2006 andincreasing backlog by $316 million. During the second quarter of Fiscal 2005,we received contract modifications from the U.S. Army resulting from the 2005U.S. Congress Supplemental Spending Bill, increasing backlog by $483 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 $7.1million in letters of credit under the revolving credit facility wereoutstanding at October 29, 2005 and $92.9 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 October 29,2005, the restrictions imposed by the Company’s revolving credit facility donot currently restrict our ability to meet our obligations or to declare andpay dividends at historical levels.  

 

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 contains certainrestrictions, including a maximum debt-to-total capitalization covenant.  The restrictions imposed by our senior notesdo not restrict our ability to meet our obligations or to declare and paydividends at historical levels.  

 

To facilitate the purchase of new and used inventory for ourFreightliner truck dealership in the discontinued Power Products business, weentered into a floor plan financing agreement with a commercial bank duringFiscal 2004.  The secured facility, whichmatures in December 2005, allows for short-term borrowings up to $3.0million, of which $1.8 million and $0.5 million were outstanding at October 29, 2005 and January 31,2005, respectively, which are classified as liabilities of discontinuedoperations.  Advances under this facilitybear interest at the prime rate.

 

In addition, our South American subsidiaries in the discontinued PowerProducts business had foreign currency bank notes payable totaling $0.7 millionand $1.1 million at October 29,2005 and January 31, 2005, respectively, which are classified asliabilities of discontinued operations. Such notes payable consist of renewable, secured loans for the purposeof financing our South American operations. These loans are denominated in local currency (Colombian Pesos andVenezuelan Bolivars) and are secured by letters of credit issued by us andprincipally bear market-based variable rates of interest.  We use foreign denominated debt to limit ourexposure to foreign currency exchange rate fluctuations on our South Americaoperations.

 

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As a result of the ATHL acquisition in the first quarter of Fiscal2005, our U.K. subsidiaries have $1.9 million of notes payable at October 29, 2005, which aredenominated in British pounds.  Thesenotes include $1.7 million of deferred consideration payable to ATHL’s formershareholders, bearing interest at 2% per annum, and $0.2 million of assumedcapital lease obligations.

 

We incurred $9.0 million of capital spending during the first ninemonths of Fiscal 2005 compared to $6.6 million for the comparable period inFiscal 2004.  This higher capitalspending is required to increase production capacity in order to meet therequired delivery schedule under the FMTV contract modifications resultingfrom the 2005 U.S. Congress Supplemental Spending Bill.  The higher production capacity will requiretotal capital expenditures of approximately $25 million for additionalequipment and buildings to be committed through the first half of Fiscal 2006.

 

Pursuant to the definitive agreements to sell substantially all of theoperating assets and operations of the Power Products and Engineered Productsbusinesses, we expect to receive cash payments at closing of $240 million,subject to adjustment based on the assets delivered at closing.  We expect both of these transactions to becompleted during the fourth quarter of Fiscal 2005, subject to customaryconditions and third party consents.

 

**Statements of Cash Flows Data**

 
| ** **                                       | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ***(In thousands)***                             | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** |
| Net cash provided by (used in):                  |       |                      |       |                      |       |   |   |   |   |
| Operating activities                             |       | $                         | (13,265    | )                         | $          | (11,358 | ) | $ | (41,415 | ) | $ | 34,087 |   |
| Investing activities                             |       | 2,710                     |       | 685                       |       | (35,397 | ) | (5,798 | ) |
| Financing activities                             |       | (191                      | )          | (2,376                    | )          | (1,553 | ) | (6,002 | ) |
| Effect of exchange rate changes on cash          |       | 348                       |       | —                    |       | (57 | ) | — |   |
| Increase (decrease) in cash and cash equivalents |       | $                         | (10,398    | )                         | $          | (13,049 | ) | $ | (78,422 | ) | $ | 22,287 |   |

 

**SelectedBalance Sheet Data**

 
| ***(In thousands)***                               | ** ** | **October 29, 2005** | ** ** | **January 31, 2005** | ** ** |
|----------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| Cash, cash equivalents, and short-term investments |       | $                         | 60,883     |                      | $          | 130,995 |   |
| Working capital                                    |       | 254,612                   |       | 305,773                   |       |
| Total debt                                         |       | 26,950                    |       | 25,000                    |       |
|                                                    |            |                           |            |                           |            |  |  |

 

Totalcash flows improved $2.7 million during the third quarter of Fiscal 2005compared to the third quarter of Fiscal 2004. Net cash used in operating activities increased by $1.9 millionprimarily as a result of increased cash usage for inventory and recoverablecost and accrued profits not yet billed in the discontinued operations,partially offset by the timing of progress payments related to the U.S. Armyproduction contracts which provided $19.6 million of cash.  Investing activities provided $2.7 million ofnet cash in the third quarter of Fiscal 2005 compared to $0.7 million of netcash provided in the third quarter of Fiscal 2004.  This $2.0 million change is primarilyattributable to $9.4 million of proceeds from the sale of four Power Productslocations in August 2005, partially offset by a $3.3 million decline incash provided from short-term investment maturities, along with a $4.1 millionincrease in capital expenditures resulting from our expansion of productioncapacity at our Tactical Vehicle Systems facility in Sealy, Texas.  Financing activities used $0.2 million ofcash in the third quarter of Fiscal 2005 compared to $2.4 million in Fiscal2004, with the decrease being primarily attributable to increased proceeds fromthe exercise of employee stock options.

 

Forthe first nine months of Fiscal 2005, total cash flows decreased by $100.7million compared to the first nine months of Fiscal 2004.  Operating activities contributed $75.5million to this decrease, including $63.8 million attributable to discontinuedoperations, resulting primarily from a $51.3 million increase in inventory andrecoverable costs and accrued profits not yet billed within the EngineeredProducts and Power Products businesses. All other operating activities generated the remaining $11.7 milliondecrease.

 

Investingactivities consumed $35.4 million in the first nine months of Fiscal 2005,compared to $5.8 million in the first nine months of Fiscal 2004.  This $29.6 million change is primarilyattributable to the ATHL acquisition in Fiscal 2005, which consumed $42.8million, partially offset by the $9.4 million of proceeds from the sale of PowerProducts locations in California.

 

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Cashused in financing activities decreased by $4.4 million, primarily as a resultof increased proceeds from the exercise of stock options.

 

Total cash and short-terminvestments declined to $60.9 million at October 29, 2005 from $131.0million at January 31, 2005.  Thedecline in cash is primarily attributable to a $41.8 decrease in billings inexcess of incurred costs relating to the execution of LSAC production duringFiscal 2005 under contracts that provided advance payments in Fiscal 2004.  Additionally, the acquisition of ATHL duringthe first quarter consumed $42.8 million. These reductions in cash arepartially offset by net earnings of $21.9 million and adjustments for non-cashitems.  

 

The $51.2 milliondecline in working capital is also driven by the ATHL acquisition describedabove, along with the reclassification of $25.0 million of senior notes payableMay 2006 to current liabilities.  The ATHL acquisition is also responsible for the $2.0 million increasein total debt.

 

**FACTORS THAT MAY AFFECT FUTURE RESULTS**

 

**Forward-LookingStatements**

 

This filing contains forward-looking statements that are based onmanagement’s current expectations, estimates, and projections. These statementsare not guarantees of future performance and involve a number of risks,uncertainties, and assumptions and are made pursuant to the Safe HarborProvisions of the Private Securities Litigation Reform Act of 1995.  Many factors, including those discussed morefully elsewhere herein, in the Company’s latest annual report on Form 10-K,and in the Company’s quarterly reports on Form 10-Q, as well as others,could cause results to differ materially from those stated.  Specific important factors that could 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 government contracts,risks of supply interruptions to Tactical Vehicle Systems segment, risksassociated with Distributed Energy Solutions segment, risks of fixed-pricecontracts, risks as to rising steel prices, risks as to cost controls, risks ofgeneral economic conditions, risks of oil and gas industry economic conditions,risks as to distributorships, risks as to licenses, risk of competition, risksrelating to technology, risks as to terrorist attacks on the U.S. and theirimpact on the U.S. economy, risks relating to personnel, risks of claims andlitigation, risks of product defects, risks as to foreign sales and globaltrade matters, risks as to acquisitions and restructuring activities, risks asto currency fluctuations, risks as to environmental and safety matters, andcredit risks, all as more specifically outlined in the Company’s latest annualreport on Form 10-K.  In addition,such forward-looking statements could be affected by general industry andmarket conditions and growth rates, general domestic and internationalconditions including interest rates, inflation and currency exchange rates andother future factors.  Actual outcomesand results may differ materially from what is expressed or forecasted in suchforward-looking statements.

 

**Item 3.  Quantitative and Qualitative Disclosures aboutMarket Risk**

 

Our quantitative and qualitative disclosures about market risk for changesin interest rates and foreign exchange risk are incorporated by reference inItem 7A of our Annual Report on Form 10-K for the fiscal 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.

 

*ForeignCurrency Risk*

 

Duringthe first quarter of Fiscal 2005, the Company acquired all outstanding sharesof ATHL, a light tactical vehicle manufacturer headquartered in the UnitedKingdom, for a total purchase price, denominated in British pounds, of approximately$48.2 million.   The functional currencyfor ATHL is the British pound.  Inconnection with the acquisition, the Company established a British pounddenominated inter-company note in the amount of £12.5 million (approximately $22.2million at October 29, 2005), which is to be repaid in annual installmentsthrough December 2009, and entered into a series of forward foreignexchange contracts to mitigate the exposure related to the inter-company notesreceivable denominated in British pounds.

 

Substantiallyall of the sales of ATHL are denominated in British pounds.  Purchases of materials and component partsare also substantially denominated in British pounds; however, some componentpurchases are denominated in Euros and other foreign currencies.  As a result, the earnings from ATHL areaffected by fluctuation in the value of the British pound against the Euro, theU.S. dollar and other currencies.

 

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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, the intercompanynote and hedging program described above are intended to mitigate the exposurerelated to £12.5 million, or $23.5 million of the original purchase price.  The remaining portion of the initialinvestment is impacted by fluctuations in the U.S. dollar equivalent to the Britishpound.

 

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

 

**Evaluationof Disclosure Controls and Procedures**

 

Atthe end of the period covered by this Quarterly Report on Form 10-Q, theCompany carried out an evaluation required by the Securities Exchange Act of1934, as amended (the “Exchange Act”), under the supervision and with theparticipation of the Company’s management, including the Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of the Company’sdisclosure controls and procedures pursuant to Rule 13a-15 under theExchange Act.  Based upon thatevaluation, the Company’s Chief Executive Officer and Chief Financial Officerhave concluded that the Company’s disclosure controls and procedures areeffective as of the end of the period covered by this report in alerting themon a timely basis to material information relating to the Company and requiredto be included in the Company’s periodic filings under the Exchange Act.

 

**Internal Controls over Financial Reporting**

** **

Therehave been no changes in the Company’s internal controls over financialreporting that occurred during the third quarter of Fiscal 2005 that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrols over financial reporting.

 

**PART II.  OTHER INFORMATION**

 

**Item 1.  LegalProceedings**

 

*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.**and McLaughlin Body Co.*,Civil Action No. H-96-3363, in the U.S. District Court for the SouthernDistrict of Texas, Houston Division.  Theplaintiff’s complaint seeks penalties and damages in an unspecifiedamount.  The suit alleges that theCompany made false statements and certifications in connection with claims forpayment for medium tactical vehicles delivered to the U.S. Army before 1998,and that the vehicles were substandard because of corrosion problems.  Following an investigation by the JusticeDepartment, the United States declined to intervene in the suit.  In February 2004, the District Courtfound in favor of the Company and dismissed all of the plaintiff’s claims bysummary judgment without proceeding to trial. The plaintiff filed a notice of appeal in March 2004 in the U.S.Court of Appeals for the Fifth Circuit, No. 04-20209.  On August 8, 2005, a panel of the FifthCircuit issued an opinion affirming the district court’s summary judgmentorder.  On November 8, 2005, theplaintiff filed a petition for writ of certiorari with the U.S. Supreme Court,asking that the Fifth Circuit opinion be overturned.  The Company believes the writ of certiorari isunlikely to be successful; however, until all issues are exhausted, the Company’sconsolidated results of operations, financial position and liquidity couldstill be affected by this suit.

 

*Klickitat Litigation*:  The Company and several of itssubsidiaries in the Distributed Energy Solutions business are defendants in asuit filed by the Klickitat County Public Utility District No. 1 on December 11,2003 arising out of claims relating to a landfill gas power generation facilityin Roosevelt, Washington, Cause No. CY-03-3175-LRS;*KlickitatCounty Public Utility District No. 1 v. Stewart & StevensonServices, Inc., Stewart & Stevenson Power, Inc., SierraDetroit Diesel Allison, Inc., Pamco International, Inc. and WaukeshaEngine Dresser, Inc.*; in the U.S. District Court for theEastern District of Washington.  The

 

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plaintiff has asserted claims with respect to equipment installed andused since 1999 for breach of contract; promissory estoppel; violations of theWashington 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.

 

*Antitrust Litigation*:  The Company is a co-defendantwith Detroit Diesel Corporation and other Detroit Diesel distributors in twoputative class action suits related to the Power Products business filed on February 9,2005, Civil Action No. 05-616; *Cumberland Truck EquipmentCo. et al. v. Detroit Diesel Corp., et al.* (the “Cumberland Litigation”),and Civil Action No. 05-625; *Diamond InternationalTrucks, Inc. et al. v. Detroit Diesel Corp., et al.* (the “DITLitigation”).  The suits were initially filed**in the U.S. District Court for the Eastern District ofPennsylvania.  On November 14, 2005,the cases were transferred to the Eastern District of Michigan.  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 parts whosedealership classification was changed on or after February 9, 2001.  The Company also had a dealer agreement withone or more of these plaintiffs.  Theplaintiffs are claiming antitrust violations arising out of changes to theclassification of their dealerships.  Theplaintiffs have also alleged price fixing and group boycott in violation of Section 1of the Sherman Act.  The plaintiffs havemade claims for treble damages and injunctive and other relief.  The Company is vigorously defending bothsuits.  It is presently impossible forthe Company to determine the ultimate outcome of either suit or whether theirresolution will, in the future, have a material adverse effect on the Company’sconsolidated results of operations, financial position or liquidity.  The Company is presently unable to determinewhether a material liability has been incurred in these matters or toreasonably estimate the amount of any loss that may result from 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 U.S. Environmental Protection Agency (the “EPA”) aRequest 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 tothe Company by the EPA indicates that the Company may have sent waste oils tothe Site for recycling in the late 1980s, and that such waste oils maypotentially account for between one and two percent of the volume of totalwastes 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 of considerationas 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.  The Companymaintains 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.

 
| 10.1   |   | Asset  Purchase Agreement dated September 27, 2005, by and among Stewart &  Stevenson Services, Inc., Stewart & Stevenson Petroleum Services, Inc.,  Stewart & Stevenson International, Inc., Sierra Detroit Diesel  Allison, Inc., and S & S Trust, as sellers, and Hushang Ansary,  as buyer.*                                                                   |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.2   |   | Asset  Purchase Agreement dated October 24, 2005, by and among Stewart &  Stevenson Services, Inc., IPSC Co. Inc., Stewart & Stevenson  Holdings, Inc., Stewart & Stevenson De Las Americas, Inc.,  Stewart & Stevenson International, Inc., Stewart &  Stevenson Power, Inc., and S & S Trust, as sellers, and Hushang  Ansary, as buyer.* |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 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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*Certainportions omitted pursuant to a request for confidential treatment.  The omitted material has been filedseparately with the Securities and Exchange Commission.  The representations and warranties of theCompany contained in these two Asset Purchase Agreements speak only as of thedate of the agreement, and have been made solely for purposes of riskallocation and to provide contractual rights and other remedies.  They should not be relied upon as necessarilyrepresenting the actual state of affairs of the Company.

 

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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 6th day of December 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)                    |
|                                                    |                      |        |  |  |

 

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