**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

 

**FORM 10-Q**

 

**(Mark One)**

**ý****   QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended July 31, 2004**

 

**OR**

 

**o****   TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from              to              **

 

**Commission file number 0-8493**

 

**STEWART & STEVENSON SERVICES, INC.**

(Exact name of registrant as specified in its charter)

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

 

**(713) 868-7700**

(Registrant’s telephone number, including area code)

 

**not applicable**

(Former name, former address and former fiscal year,

if changed since last report)

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.      Yes  ý     No  o

 

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

 

Numberof shares outstanding of each of the registrant’s classes of common stock, asof August 17, 2004:

 

**Common Stock, without Par Value:  28,763,282 Shares**

 

 

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# **PART I. FINANCIAL INFORMATION**

 

**Item 1.  FinancialStatements**

 

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

 
|                                                                                                                  |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|
| Consolidated  Condensed Balance Sheets – July 31, 2004 and January 31, 2004.                                     |   |
|                                                                                                                  |   |
| Consolidated  Condensed Statements of Operations – Three and Six Months Ended July 31, 2004  and August 2, 2003. |   |
|                                                                                                                  |   |
| Consolidated  Condensed Statements of Cash Flows – Three and Six Months Ended July 31, 2004  and August 2, 2003. |   |
|                                                                                                                  |   |
| Notes  to Consolidated Condensed Financial Statements.                                                                |   |

 

2

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

**CONSOLIDATED CONDENSED BALANCE SHEETS**

*(In thousands, except share data)*

 
| ** **                                                                                                              | ** ** | **July 31, 2004** | ** ** | **January 31, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                                                                                                              |       | **(Unaudited)**   |       |                 |       |
|                                                                                                                    |       |              |       |                 |       |
| Assets                                                                                                                  |       |              |       |                 |       |
| Current Assets:                                                                                                         |       |              |       |                 |       |
| Cash and cash equivalents                                                                                               |       | $                 | 88,815     |                 | $          | 53,959 |   |
| Short-term investments                                                                                                  |       | 10,935            |       | 7,745                |       |
| Accounts receivable, net                                                                                                |       | 144,999           |       | 163,324              |       |
| Recoverable costs and accrued profits not  yet billed                                                                   |       | 27,100            |       | 21,653               |       |
| Inventories                                                                                                             |       | 159,451           |       | 166,315              |       |
| Excess of current cost over LIFO values                                                                                 |       | (46,325           | )          | (45,330              | )          |
| Deferred income tax asset                                                                                               |       | 20,699            |       | 23,591               |       |
| Income tax receivable                                                                                                   |       | 6,985             |       | 25,846               |       |
| Other current assets                                                                                                    |       | 12,846            |       | 17,310               |       |
| Total assets of discontinued operations                                                                                 |       | 4,719             |       | 8,059                |       |
| Total Current Assets                                                                                                    |       | 430,224           |       | 442,472              |       |
|                                                                                                                    |       |              |       |                 |       |
| Property, Plant and Equipment, net                                                                                      |       | 123,875           |       | 136,165              |       |
| Deferred Income Tax Asset                                                                                               |       | 13,491            |       | 15,523               |       |
| Intangibles and Other Assets, net                                                                                       |       | 9,852             |       | 9,300                |       |
| Total Assets                                                                                                            |       | $                 | 577,442    |                 | $          | 603,460 |   |
|                                                                                                                    |       |              |       |                 |       |
| Liabilities and Shareholders’ Equity                                                                               |       |              |       |                 |       |
| Current Liabilities:                                                                                                    |       |              |       |                 |       |
| Notes payable                                                                                                           |       | $                 | 1,823      |                 | $          | 1,932 |   |
| Current portion of long-term debt                                                                                       |       | 250               |       | 250                  |       |
| Accounts payable                                                                                                        |       | 71,367            |       | 72,028               |       |
| Accrued payrolls and incentives                                                                                         |       | 16,159            |       | 18,092               |       |
| Billings in excess of incurred costs                                                                                    |       | 31,903            |       | 69,376               |       |
| Estimated losses on uncompleted contracts                                                                               |       | 18,669            |       | 16,306               |       |
| Other current liabilities                                                                                               |       | 46,588            |       | 43,049               |       |
| Total liabilities of discontinued  operations                                                                           |       | 3,124             |       | 1,908                |       |
| Total Current Liabilities                                                                                               |       | 189,883           |       | 222,941              |       |
|                                                                                                                    |       |              |       |                 |       |
| Long-Term Debt, net of current portion                                                                                  |       | 26,125            |       | 26,260               |       |
| Accrued Postretirement Benefits and Pension                                                                             |       | 52,770            |       | 52,056               |       |
| Other Long-Term Liabilities                                                                                             |       | 4,035             |       | 4,720                |       |
| Total Liabilities                                                                                                       |       | 272,813           |       | 305,977              |       |
| Shareholders’ Equity:                                                                                              |       |              |       |                 |       |
| Common stock, without par value,  100,000,000 shares authorized; 28,763,282 and 28,644,510 shares issued,  respectively |       | 58,484            |       | 57,056               |       |
| Accumulated other comprehensive loss                                                                                    |       | (26,259           | )          | (25,534              | )          |
| Retained earnings                                                                                                       |       | 272,404           |       | 265,961              |       |
| Total Shareholders’ Equity                                                                                         |       | 304,629           |       | 297,483              |       |
| Total Liabilities and Shareholders’ Equity                                                                         |       | $                 | 577,442    |                 | $          | 603,460 |   |

 

*See accompanying notes to consolidated condensedfinancial statements.*

 

3

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

**CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS**

*(In thousands, except per share data)*

 
| ** **                                                                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                          | ** ** | **July 31, 2004**      | ** ** | **August 2, 2003**   | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
| ** **                                                                          | ** ** | **(Unaudited)**        | ** ** | **(Unaudited)**      | ** ** |
|                                                                                |       |                   |       |                 |       |   |   |   |   |
| Sales                                                                               |       | $                      | 316,322    |                 | $          | 312,851 |   | $ | 620,610 |   | $ | 602,623 |   |
| Cost of sales                                                                       |       | 275,752                |       | 271,134              |       | 539,808 |   | 519,046 |   |
|                                                                                |       |                   |       |                 |       |   |   |   |   |
| Gross profit                                                                        |       | 40,570                 |       | 41,717               |       | 80,802 |   | 83,577 |   |
|                                                                                |       |                   |       |                 |       |   |   |   |   |
| Selling and administrative expenses                                                 |       | 31,045                 |       | 37,571               |       | 62,996 |   | 73,860 |   |
| Pension curtailment expense                                                         |       | —                 |       | —               |       | — |   | 2,400 |   |
| Other income, net                                                                   |       | (2,072                 | )          | (564                 | )          | (2,678 | ) | (476 | ) |
|                                                                                |       |                   |       |                 |       |   |   |   |   |
| Operating profit                                                                    |       | 11,597                 |       | 4,710                |       | 20,484 |   | 7,793 |   |
|                                                                                |       |                   |       |                 |       |   |   |   |   |
| Interest expense                                                                    |       | 436                    |       | 693                  |       | 953 |   | 1,936 |   |
| Interest and investment income                                                      |       | (332                   | )          | (559                 | )          | (586 | ) | (1,059 | ) |
|                                                                                |       |                   |       |                 |       |   |   |   |   |
| Earnings from continuing operations before  income taxes                            |       | 11,493                 |       | 4,576                |       | 20,117 |   | 6,916 |   |
| Income tax expense                                                                  |       | 4,193                  |       | 1,348                |       | 7,311 |   | 2,029 |   |
| Net earnings from continuing operations                                             |       | 7,300                  |       | 3,228                |       | 12,806 |   | 4,887 |   |
| Loss from discontinued operations, net of  tax of ($766), ($284), ($800) and ($710) |       | (1,423                 | )          | (158                 | )          | (1,487 | ) | (982 | ) |
| Net earnings                                                                        |       | $                      | 5,877      |                 | $          | 3,070 |   | $ | 11,319 |   | $ | 3,905 |   |
|                                                                                |       |                   |       |                 |       |   |   |   |   |
| Weighted average shares outstanding:                                                |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                               |       | 28,749                 |       | 28,522               |       | 28,709 |   | 28,507 |   |
| Diluted                                                                             |       | 29,182                 |       | 28,967               |       | 29,058 |   | 28,804 |   |
|                                                                                |       |                   |       |                 |       |   |   |   |   |
| **Earnings per share:**                                                             |       |                   |       |                 |       |   |   |   |   |
| Basic:                                                                              |       |                   |       |                 |       |   |   |   |   |
| Continuing operations                                                               |       | $                      | 0.25       |                 | $          | 0.11 |   | $ | 0.44 |   | $ | 0.17 |   |
| Discontinued operations                                                             |       | (0.05                  | )          | —               |       | (0.05 | ) | (0.03 | ) |
| Net earnings per share                                                              |       | $                      | 0.20       |                 | $          | 0.11 |   | $ | 0.39 |   | $ | 0.14 |   |
|                                                                                |       |                   |       |                 |       |   |   |   |   |
| Diluted:                                                                            |       |                   |       |                 |       |   |   |   |   |
| Continuing operations                                                               |       | $                      | 0.25       |                 | $          | 0.11 |   | $ | 0.44 |   | $ | 0.17 |   |
| Discontinued operations                                                             |       | (0.05                  | )          | —               |       | (0.05 | ) | (0.03 | ) |
| Net earnings per share                                                              |       | $                      | 0.20       |                 | $          | 0.11 |   | $ | 0.39 |   | $ | 0.14 |   |
|                                                                                |       |                   |       |                 |       |   |   |   |   |
| Cash dividends per share                                                            |       | $                      | 0.085      |                 | $          | 0.085 |   | $ | 0.170 |   | $ | 0.170 |   |

 

*See accompanying notes to consolidated condensedfinancial statements.*

 

4

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

**CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS**

*(In thousands)*

 
| ** **                                                                                                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                             | ** ** | **July 31, 2004**      | ** ** | **August 2, 2003**   | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
| ** **                                                                                                             | ** ** | **(Unaudited)**        | ** ** | **(Unaudited)**      | ** ** |
| **Operating  Activities**                                                                                              |       |                   |       |                 |       |   |   |   |   |
| Net earnings                                                                                                           |       | $                      | 5,877      |                 | $          | 3,070 |   | $ | 11,319 |   | $ | 3,905 |   |
| Adjustments to reconcile net earnings to  net cash provided by (used in) operating activities:                         |       |                   |       |                 |       |   |   |   |   |
| Net loss from discontinued operations                                                                                  |       | 1,423                  |       | 158                  |       | 1,487 |   | 982 |   |
| Depreciation and amortization                                                                                          |       | 7,630                  |       | 7,202                |       | 14,671 |   | 14,223 |   |
| Deferred tax expense (benefit)                                                                                         |       | 3,634                  |       | (145                 | )          | 5,522 |   | (1,953 | ) |
| Gain on sale of assets                                                                                                 |       | (1,498                 | )          | —               |       | (1,844 | ) | — |   |
| Change in operating assets and liabilities  net of the effect of acquisition, divestiture and discontinued operations: |       |                   |       |                 |       |   |   |   |   |
| Accounts receivable, net                                                                                               |       | (11,322                | )          | (3,887               | )          | 18,889 |   | 697 |   |
| Recoverable costs and accrued profits not  yet billed                                                                  |       | (3,237                 | )          | (29,187              | )          | (5,447 | ) | (32,821 | ) |
| Inventories                                                                                                            |       | (2,851                 | )          | 13,209               |       | 3,433 |   | 7,768 |   |
| Other current and noncurrent assets                                                                                    |       | 15,221                 |       | (5,100               | )          | 20,912 |   | (4,926 | ) |
| Accounts payable                                                                                                       |       | 7,465                  |       | 16,988               |       | (661 | ) | 13,962 |   |
| Accrued payrolls and incentives                                                                                        |       | (2,498                 | )          | (4,806               | )          | (1,933 | ) | (2,289 | ) |
| Billings in excess of incurred costs                                                                                   |       | (33,527                | )          | 7,413                |       | (37,473 | ) | 9,043 |   |
| Estimated losses on uncompleted contracts                                                                              |       | 2,614                  |       | —               |       | 2,363 |   | — |   |
| Other current liabilities                                                                                              |       | 1,567                  |       | 1,465                |       | 3,991 |   | 4,944 |   |
| Accrued postretirement benefits and pension                                                                            |       | 159                    |       | (540                 | )          | 714 |   | 3,283 |   |
| Other, net                                                                                                             |       | 93                     |       | (291                 | )          | (1,577 | ) | (241 | ) |
| **Net Cash Provided  by (Used in) Continuing Operations**                                                              |       | (9,250                 | )          | 5,549                |       | 34,366 |   | 16,577 |   |
| Net Cash Provided by (Used in) Discontinued  Operations                                                                |       | (483                   | )          | 212                  |       | (524 | ) | 3,490 |   |
| **Net Cash Provided  by (Used in) Operating Activities**                                                               |       | (9,733                 | )          | 5,761                |       | 33,842 |   | 20,067 |   |
|                                                                                                                   |       |                   |       |                 |       |   |   |   |   |
| **Investing  Activities**                                                                                              |       |                   |       |                 |       |   |   |   |   |
| Capital expenditures, excluding rental  equipment                                                                      |       | (4,586                 | )          | (6,642               | )          | (6,724 | ) | (9,554 | ) |
| Additions to rental equipment                                                                                          |       | (2,153                 | )          | (3,677               | )          | (2,967 | ) | (6,301 | ) |
| Proceeds from sale of businesses                                                                                       |       | 464                    |       | —               |       | 3,632 |   | — |   |
| Acquisition of businesses                                                                                              |       | —                 |       | —               |       | — |   | (409 | ) |
| Proceeds from disposal of property, plant  and equipment                                                               |       | 11,435                 |       | 732                  |       | 13,924 |   | 1,502 |   |
| Change in short-term investments                                                                                       |       | 300                    |       | (560                 | )          | (3,190 | ) | (10,930 | ) |
| Net investing activities of discontinued  operations                                                                   |       | 37                     |       | —               |       | 74 |   | — |   |
| **Net Cash Provided  by (Used in) Investing Activities**                                                               |       | 5,497                  |       | (10,147              | )          | 4,749 |   | (25,692 | ) |
|                                                                                                                   |       |                   |       |                 |       |   |   |   |   |
| **Financing  Activities**                                                                                              |       |                   |       |                 |       |   |   |   |   |
| Change in short-term notes payable                                                                                     |       | (85                    | )          | 20                   |       | (109 | ) | 1,092 |   |
| Payments on long-term borrowings                                                                                       |       | —                 |       | (30,000              | )          | — |   | (30,000 | ) |
| Dividends paid                                                                                                         |       | (2,442                 | )          | (2,423               | )          | (4,876 | ) | (4,845 | ) |
| Proceeds from exercise of stock options                                                                                |       | 510                    |       | 855                  |       | 1,250 |   | 896 |   |
| **Net Cash Used in  Financing Activities**                                                                             |       | (2,017                 | )          | (31,548              | )          | (3,735 | ) | (32,857 | ) |
|                                                                                                                   |       |                   |       |                 |       |   |   |   |   |
| Increase (decrease) in cash and cash  equivalents                                                                      |       | (6,253                 | )          | (35,934              | )          | 34,856 |   | (38,482 | ) |
| Cash and cash equivalents, beginning of  period                                                                        |       | 95,068                 |       | 105,446              |       | 53,959 |   | 107,994 |   |
| Cash and cash equivalents, end of period                                                                               |       | $                      | 88,815     |                 | $          | 69,512 |   | $ | 88,815 |   | $ | 69,512 |   |
|                                                                                                                   |       |                   |       |                 |       |   |   |   |   |
| Cash Paid For:                                                                                                         |       |                   |       |                 |       |   |   |   |   |
| Interest                                                                                                               |       | $                      | 980        |                 | $          | 2,257 |   | $ | 1,117 |   | $ | 2,425 |   |
| Income taxes (excluding refunds)                                                                                       |       | 175                    |       | 2,907                |       | 310 |   | 3,010 |   |

 

*See accompanying notes to consolidated condensedfinancial statements.*

 

5

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

**NOTES TO CONSOLIDATEDCONDENSED FINANCIAL STATEMENTS**

(Unaudited)

 

**Note 1 - Basis of Presentation**

 

Theaccompanying unaudited consolidated condensed financial statements of Stewart& Stevenson Services, Inc. and Subsidiaries (collectively, the “Company”)have been prepared in accordance with Rule 10-01 of Regulation S-X for interimfinancial statements required to be filed with the Securities and ExchangeCommission and do not include all information and footnotes required bygenerally accepted accounting principles for complete financialstatements.  However, the informationfurnished herein reflects all normal recurring adjustments, which are, in theopinion of management, necessary for a fair statement of the results for theinterim periods.  The results ofoperations for the three and six months ended July 31, 2004 are not necessarilyindicative of the results that will be realized for the fiscal year endingJanuary 31, 2005.

 

The Company’s fiscal year begins on February 1 of the year stated andends on January 31 of the following year. For example, the Company’s “Fiscal 2004” commenced on February 1, 2004and ends on January 31, 2005.  TheCompany reports results on the fiscal quarter method with each quartercomprising 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 the Securitiesand Exchange Commission.  Theseconsolidated condensed financial statements should be read in conjunction withthe consolidated financial statements and notes thereto included in theCompany’s Annual Report on Form 10-K for the year ended January 31, 2004.

 

Theaccompanying consolidated condensed financial statements for Fiscal 2003 andrelated notes contain certain reclassifications to conform with thepresentation used in Fiscal 2004.

 

**Note 2 – Comprehensive Income**

 

Totalcomprehensive income is as follows *(inthousands*):

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                        | ** ** | **July 31, 2004**      | ** ** | **August 2, 2003**   | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
|                                              |       |                   |       |                 |       |   |   |   |   |
| Net earnings                                      |       | $                      | 5,877      |                 | $          | 3,070 |   | $ | 11,319 |   | $ | 3,905 |   |
| Unrealized loss on forward contracts, net  of tax |       | (76                    | )          | (132                 | )          | (275 | ) | (98 | ) |
| Currency translation loss, net of tax             |       | —                 |       | (287                 | )          | (450 | ) | (178 | ) |
| Comprehensive income                              |       | $                      | 5,801      |                 | $          | 2,651 |   | $ | 10,594 |   | $ | 3,629 |   |

 

**Note 3 - Segment Information**

 

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

 

6

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

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                   | ** ** | **July 31, 2004**      | ** ** | **August 2, 2003**   | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
| **Sales**                                                    |       |                   |       |                 |       |   |   |   |   |
| Tactical Vehicle Systems                                     |       | $                      | 140,737    |                 | $          | 108,365 |   | $ | 279,520 |   | $ | 219,342 |   |
| Power Products                                               |       | 123,680                |       | 127,886              |       | 244,399 |   | 253,720 |   |
| Engineered Products                                          |       | 21,936                 |       | 38,262               |       | 39,204 |   | 64,373 |   |
| Distributed Energy Solutions                                 |       | 6,235                  |       | 19,986               |       | 10,678 |   | 32,592 |   |
| Airline Products                                             |       | 23,734                 |       | 18,352               |       | 46,809 |   | 32,596 |   |
| Total sales                                                  |       | $                      | 316,322    |                 | $          | 312,851 |   | $ | 620,610 |   | $ | 602,623 |   |
|                                                         |       |                   |       |                 |       |   |   |   |   |
| **Operating profit  (loss)**                                 |       |                   |       |                 |       |   |   |   |   |
| Tactical Vehicle Systems                                     |       | $                      | 18,759     |                 | $          | 17,279 |   | $ | 38,249 |   | $ | 35,066 |   |
| Power Products                                               |       | 1,843                  |       | (5,642               | )          | 1,926 |   | (8,768 | ) |
| Engineered Products                                          |       | 1,145                  |       | 553                  |       | (642 | ) | 145 |   |
| Distributed Energy Solutions                                 |       | (5,753                 | )          | (2,788               | )          | (10,893 | ) | (6,646 | ) |
| Airline Products                                             |       | (581                   | )          | (712                 | )          | (876 | ) | (2,705 | ) |
| Coporate expenses, net                                       |       | (3,816                 | )          | (3,980               | )          | (7,280 | ) | (9,299 | ) |
| Total operating profit                                       |       | 11,597                 |       | 4,710                |       | 20,484 |   | 7,793 |   |
|                                                         |       |                   |       |                 |       |   |   |   |   |
| Interest expense                                             |       | 436                    |       | 693                  |       | 953 |   | 1,936 |   |
| Interest and investment income                               |       | (332                   | )          | (559                 | )          | (586 | ) | (1,059 | ) |
| **Earnings from  continuing operations before income taxes** |       | $                      | 11,493     |                 | $          | 4,576 |   | $ | 20,117 |   | $ | 6,916 |   |
|                                                         |       |                   |       |                 |       |   |   |   |   |
| **Operating profit  (loss) percentage**                      |       |                   |       |                 |       |   |   |   |   |
| Tactical Vehicle Systems                                     |       | 13.3                   | %          | 15.9                 | %          | 13.7 | % | 16.0 | % |
| Power Products                                               |       | 1.5                    |       | (4.4                 | )          | 0.8 |   | (3.5 | ) |
| Engineered Products                                          |       | 5.2                    |       | 1.4                  |       | (1.6 | ) | 0.2 |   |
| Distributed Energy Solutions                                 |       | (92.3                  | )          | (13.9                | )          | (102.0 | ) | (20.4 | ) |
| Airline Products                                             |       | (2.4                   | )          | (3.9                 | )          | (1.9 | ) | (8.3 | ) |
| Consolidated                                                 |       | 3.7                    | %          | 1.5                  | %          | 3.3 | % | 1.3 | % |

 

*PowerProducts*

 

Duringthe first quarter of Fiscal 2004, the Company exited the business activitiesassociated with the distribution of Mercury Marine and MerCruiserproducts.  As a result, the distributionagreement for these products was terminated in March 2004 and the assets of thisproduct line were sold for adjusted cash proceeds of $3.3 million.  Also in the first quarter of Fiscal 2004, theCompany sold the net assets and exited the activities associated with itswheelchair lift manufacturing operation. Consideration received for this asset sale included a receivable of $0.6million, which is due during the second half of Fiscal 2004, along with royaltyrights based on wheelchair lift sales over the next five years.  No material gain or loss was recognized onthese transactions, individually or in the aggregate.

 

Theactivities above resulted in the closure of two branch locations which wereprimarily focused on the sale of Mercury Marine and MerCruiser products inFlorida and Virginia.  Additionallyduring the first quarter of Fiscal 2004, the Company closed an under-performingbranch location in Auburn, Washington. Exit costs associated with these actions were $0.2 million, which wascharged to selling and administrative expenses during the first quarter ofFiscal 2004.  As of July 31, 2004, $0.1million of these exit costs remained accrued and unpaid.

 

During the second quarter of Fiscal 2004, the Company decided tooutsource the provision of lease financing associated with certain sales-typeequipment leases.  In conjunction withthis decision, the Company sold assets previously classified as rentalequipment within property, plant and equipment for cash proceeds of $7.3million, with no resulting gain or loss. Additionally during the second quarter of Fiscal 2004, the Companydisposed of an idle manufacturing facility in Commerce City, Colorado for cashproceeds of $1.2 million, resulting in a net gain of $0.3 million.

 

7

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*Engineered Products*

 

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

 

*DistributedEnergy Solutions*

 

During Fiscal 2003, the Company announced the decisionto exit the turnkey engineering, procurement and construction (“EPC”)activities within the Distributed Energy Solutions segment.  Under this exit plan, the Company expectsthat the majority of remaining EPC projects will be completed during Fiscal 2004.  The Company will, however, retain and executeobligations under certain fixed price operation and/or maintenance contractsrelated to EPC projects, which have terms ranging from two to ten years.  Total estimated exit costs, which primarilyrelate to the termination of employees, are $0.4 million, of which $0.1 millionwere expensed and paid during the six months ended July 31, 2004.  No liability was established for theremaining exit costs of approximately $0.3 million as of July 31, 2004, asthese costs do not meet the recognition criteria set forth under Statement ofFinancial Accounting Standards (“SFAS”) No. 146.

 

*AirlineProducts*

 

Duringthe second quarter of Fiscal 2004, the Company announced its intention to sellits Airline Products business located in Marietta, Georgia.  While the Company expects the sale of thisbusiness to be completed during Fiscal 2004, a buyer has not yet beenidentified and no assurance can be given as to when, or if, a transaction willtake place.

 

**Note 4 - 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.

 

A summary of warranty activity for continuing operations for the threeand six months ended July 31, 2004 and August 2, 2003 follows:

 
| ** **                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In  thousands)**                             | ** ** | **July 31, 2004**      | ** ** | **August 2, 2003**   | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
|                                            |       |                   |       |                 |       |   |   |   |   |
| Accrued warranty costs - Beginning of  period   |       | $                      | 7,467      |                 | $          | 4,795 |   | $ | 7,816 |   | $ | 6,073 |   |
| Payments for completed warranty obligations     |       | (888                   | )          | (1,401               | )          | (2,509 | ) | (3,912 | ) |
| Warranty accrual for current period  production |       | 1,553                  |       | 1,683                |       | 2,811 |   | 2,916 |   |
| Adjustments to warranty accrual                 |       | (640                   | )          | 280                  |       | (626 | ) | 280 |   |
| Accrued warranty costs - End of period          |       | $                      | 7,492      |                 | $          | 5,357 |   | $ | 7,492 |   | $ | 5,357 |   |

 

*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 July31, 2004 and January 31, 2004, the Company had letters of credit outstandingtotaling $13.6 million and $12.7 million, respectively.  Also, the Company has guaranteed theperformance output levels of equipment serviced by the Company under certainoperation and maintenance contracts, which have terms ranging from two to tenyears.  Some of these contracts containliquidated damages provisions.  Inaddition, the Company had contingent performance indemnities of approximately$6.7 million as of July 31, 2004 and January 31, 2004, which expire in Fiscal2007.

 

*U.S.Government Contingencies*:  During Fiscal 1998, the U.S. Customs Servicedetained a medium tactical vehicle that was being shipped by the Company fordisplay in a European trade show.  TheCompany is advised that the U.S. Customs Service and the Department of Justicehave conducted an investigation of potential violations by the Company of lawsrelating to the export of controlled military vehicles, weapons mountingsystems and firearms.  Such investigationcould result in the filing of civil or administrative sanctions against theCompany and/or individual employees, and could result in a suspension ordebarment of the Company from

 

8

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receivingnew contracts or subcontracts with agencies of the U.S. government or thebenefit 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 in any period or upon itsconsolidated financial condition or liquidity and believes that the resolutionof the matter that is possibly most adverse to the Company will involve thepayment of a civil penalty that will not materially adversely affect theCompany.

 

TheCompany is a defendant in a suit brought under the qui tam provision of theFalse Claims Act, *United States of America,**ex rel. Werner Stebner v. Stewart & Stevenson Services, Inc. andMcLaughlin Body Co.*, Civil Action No. H-96-3363, in the UnitedStates District Court for the Southern District of Texas, HoustonDivision.  The plaintiff’s complaintseeks penalties and damages in an unspecified amount.  The suit alleges that the Company made falsestatements and certifications in connection with claims for payment for Familyof Medium Tactical Vehicles delivered to the U.S. Army starting in 1995, andthe suit alleges that the vehicles were substandard because of corrosionproblems.  The suit was filed under sealin 1996, and following an investigation by the Justice Department, the UnitedStates declined to intervene in the suit, which was unsealed on August 29,2000.  On February 2, 2004, the DistrictCourt found in favor of the Company and dismissed all of the plaintiff’s claimsby summary judgment without proceeding to trial. After having all claimsdismissed by the District Court, the plaintiffs then filed a notice of appealon March 1, 2004 in the United States Court of Appeals for the Fifth Circuit,No. 04-20209. The briefing schedule has not yet been finally determined by theCourt of Appeals. A decision by the Fifth Circuit is not expected untilsometime in Fiscal 2005.  The Companybelieves the District Court correctly dismissed all of the plaintiff’s claimsas being without merit and will continue to vigorously defend the suit in thecourt of appeals.  While the Company doesnot believe that an adverse outcome is reasonably likely, an unexpected adverseoutcome in the suit could have a material adverse impact on the Company’sconsolidated results of operations, financial position and liquidity.  The Company is presently unable to determinewhether any liability has been incurred in this matter, other than legal feesand expenses, which have been provided for, or to reasonably estimate theamount or range of any loss that may result from this matter, and thus noaccruals have been recorded in this matter other than estimated legal fees andexpenses relating to the appeal.

 

*DiamondOffshore Litigation*:  The Company is a defendant in a suit broughtby several subsidiaries of Diamond Offshore Drilling, Inc.  (collectively, “Diamond Offshore”) on May 30,2002, arising out of claims relating to a marine riser manufactured by theCompany and purchased by Diamond Offshore for use on its Ocean Baronesssemi-submersible drilling rig, Cause No. 2002-27831; *DiamondOffshore International Corporation, Diamond Offshore Company, Diamond OffshoreServices Company, Diamond Offshore (USA), Inc., Diamond Offshore InternationalLimited, and Diamond Offshore Drilling, Ltd. v. Stewart & StevensonServices, Inc.*; in the District Court of Harris County, Texas 125thJudicial District Court (the “Baroness Litigation”).  The suit was filed following a separation ofthe marine riser during deep water drilling operations.  The suit seeks to recover damages that arenot specified in the petition, including direct damages, attorney’s fees andexpenses and punitive damages.  Discoveryin the case indicates that the direct damage claim is for approximately $36million.

 

In aseparate transaction on or about September 13, 2001, Diamond Offshorecontracted with the Company for a marine riser for use on its Ocean Roversemi-submersible drilling rig.  TheCompany was fulfilling this contract, when, on August 19, 2002, DiamondOffshore amended its petition in the Baroness Litigation to seek a declarationthat Diamond Offshore has no further contractual obligations to the Companywith respect to the Ocean Rover riser. On August 21, 2002, before being served with Diamond Offshore’s amendedpetition in the Baroness Litigation, the Company filed a separate lawsuitagainst Diamond Offshore seeking to recover damages, including attorneys’ fees,for the unilateral cancellation of the Rover contract (the “RoverLitigation”).  On August 30, 2002, theCourt transferred the Rover Litigation to the 125th Judicial District Courtwhere the Baroness Litigation is pending. The two cases have been consolidated into one lawsuit in the 125thJudicial District Court.  The Company isvigorously prosecuting its claims against Diamond Offshore and defending theclaims asserted against it by Diamond Offshore in this consolidated lawsuit.

 

It ispresently impossible for the Company to determine the ultimate outcome of theDiamond Offshore disputes or whether their resolution will, in the future, havea material adverse effect on the Company’s consolidated results of operations,financial position or liquidity.  TheCompany is presently unable to determine whether a material liability has beenincurred in these matters or to reasonably estimate the amount of any loss thatmay result from these matters. Consequently, the Company has recorded no accrual for any losses relatedto the ultimate outcome of this litigation. The Company has, however, recorded accruals that it believes areadequate for certain estimated legal fees it expects to incur associated withthese matters.  Such accruals areincluded in liabilities of discontinued operations, as the business thatmanufactured drilling risers was sold in Fiscal 2002 (see Note 5).

 

*Klickitat Litigation:*  The Company and several of its subsidiariesare named as defendants in a suit filed by the Klickitat County Public UtilityDistrict No. 1 on December 11, 2003 arising out of claims relating to alandfill gas power generation facility in Roosevelt, Washington, Cause No.CY-03-3175-LRS;*Klickitat County Public Utility DistrictNo. 1 v. Stewart & Stevenson Services, Inc., Stewart & Stevenson Power,Inc., Sierra Detroit Diesel Allison, Inc., Pamco International, Inc. andWaukesha Engine Dresser, Inc.*; in the United States District Courtfor the Eastern District of Washington. The plaintiff has asserted claims with respect to equipment installedand used since 1999 for breach of contract; promissory estoppel; violations ofthe Washington Products Liability Act; breach of warranties; intentional ornegligent misrepresentation; and violations of the Washington Consumer ProtectionAct and seeks recovery of damages in excess of $13 million.  The Company is vigorously defending this suitand is taking procedural steps to seek its dismissal.  It is presently impossible for the Company todetermine the ultimate outcome of this suit or whether its

 

9

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resolution will, in the future, have amaterial adverse effect on the Company’s consolidated results of operations,financial position or liquidity.  TheCompany is presently unable to determine whether a material liability has beenincurred in this matter or to reasonably estimate the amount of any loss thatmay result from this matter. Consequently, the Company has recorded no accrual for any losses relatedto the ultimate outcome of this litigation. The Company has, however, recorded accruals that it believes areadequate for certain estimated legal fees that it expects to incur associatedwith this matter.

 

*DistributedEnergy Solutions Contingencies*:  During the third quarter of Fiscal 2003, theCompany decided to exit the turnkey engineering, procurement and constructionactivities of the Distributed Energy Solutions business.  With respect to such turnkey activities, theCompany is not quoting any new business but continues to perform under existingcontracts.  In connection with certainexisting contracts, the Company has received a written notice of dispute from acustomer regarding equipment and services to be provided to several sites operatedby the customer.  In the dispute notice,the customer alleged various contractual claims, including claims forliquidated damages.  The customeracknowledged the expectation of continuing negotiations, but indicated that ifthe parties were unable to resolve the dispute, it would seek relief inarbitration.  Additional issues have beenraised by the customer, and issues exist with respect to the engines installedat the customer’s sites and as to engine supplier obligations.  Accordingly, the Company is activelyreviewing issues regarding this situation. In Fiscal 2003, the Company incurred substantial losses on the contractsthat are in dispute based on estimated costs to complete the contracts and tootherwise address customer issues on the contracts.  The Company is continuing to work with thecustomer on these contracts in dispute to resolve the customer’s issues.  At present, the Company is unable to predictthe outcome of this situation or even the aggregate amount of claims, if any,that may ultimately be asserted by the customer.  The Company is presently unable to determinewhether any additional liability has been incurred in this matter beyond thatwhich has been recorded or to reasonably estimate any amount or range of anyfurther losses that may result from these contracts.  The Company intends to vigorously assert itspositions in any arbitration of this matter should it not be resolved with thecustomer before any formal arbitration is initiated.

 

*EnvironmentalContingencies*:  In 2001, the Company received from the UnitedStates Environmental Protection Agency (the “EPA”) a Request for Informationunder Section 104(e) of the Comprehensive Environmental Response, Compensation,and Liability Act of 1980, for information pertaining to the R&H OilCompany Site in San Antonio, Texas (the “Site”).  Information provided to the Company by theEPA indicates that the Company may have sent waste oils to the Site forrecycling in the late 1980s, and that such waste oils may potentially accountfor between one and two percent of the volume of total wastes received by theoil recycler at the Site.  Since theCompany expects to receive a claim for cleanup and other costs related to thissite, it has established reserves which it believes to be adequate at thistime.  As additional facts are developedand definitive remediation plans and necessary regulatory approvals forimplementation of remediation are established, changes in these and otherfactors may result in actual costs exceeding the current environmentalreserves.  While uncertainties are inherentin the final outcome of these environmental matters, and it is presentlyimpossible to determine the actual costs that ultimately may be incurred,management currently believes that the resolution of such uncertainties shouldnot have a material adverse effect on the Company’s consolidated results ofoperations, financial position or liquidity. The Company believes that the mostlikely outcome in this environmental matter is the expenditure of an immaterialamount of consideration as a contribution to the remediation effort.

 

TheCompany is also a defendant in a number of lawsuits relating to contractual,product liability, personal injury and warranty matters normally incident tothe Company’s business.  No individualcase, or group of cases presenting substantially similar issues of law or fact,is expected to have a material effect on the manner in which the Companyconducts its business or on its consolidated results of operations, financialposition 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 in anysuch case could have a material adverse impact on the Company’s consolidatedresults of operations in the period it occurs. Moreover, future adverse developments in such cases could requirematerial changes in the recorded reserve amounts.

 

**Note 5 - Discontinued Operations**

 

During Fiscal 2002, the Company sold certainassets and exited the activities related to its blowout preventer and controls,valve and drilling riser business.  When the transaction was consummated, the Company retained certaincontracts and related assets as well as the receivables and certain liabilitiesof the business, including warranty responsibility for products sold beforeclosing as well as warranty responsibility for retained contracts to be completed.  In some cases, the Company has agreementswith customers on commitments to support its products, including retainedwarranties and contracts.  During thesecond quarter of Fiscal 2004, the Company recognized $2.1 million ofadditional estimated losses ($1.4 million after-tax) related to certainobligations associated with this business based on recent developments.  The assets and liabilities as well as theresults of operations of this business are reported as discontinued operations.

 

Discontinuedoperations also include a note receivable related to certain gas turbineequipment in Argentina.  In accordancewith a financing agreement negotiated between the Company and the Argentine enduser of the equipment in Fiscal 2003, the note receivable is being repaid overa nine-year term.

 

10

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Discontinuedoperations generated the following sales and operating losses in the three month and sixmonth periods ended July 31, 2004 and August 2, 2003:

 
| ** **                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In  thousands)**          | ** ** | **July 31, 2004**      | ** ** | **August 2, 2003**   | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
|                         |       |                   |       |                 |       |   |   |   |   |
| Sales                        |       | $                      | 402        |                 | $          | 942 |   | $ | 987 |   | $ | 1,380 |   |
| Operating loss               |       | (2,189                 | )          | (442                 | )          | (2,287 | ) | (1,692 | ) |
| Operating loss, net of taxes |       | (1,423                 | )          | (158                 | )          | (1,487 | ) | (982 | ) |
|                              |            |                        |            |                      |            |  |  |  |  |  |  |  |  |

 

**Note 6 – Inventories**

 

Summarizedbelow are the components of inventories related to continuing operations, netof customer deposits:

 
| **(In  thousands)**                              | ** ** | **July 31, 2004** | ** ** | **January 31, 2004** | ** ** |
|--------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                                       | ** ** | ** **        | ** ** | ** **           | ** ** |
| Inventory purchased under distributor agreements |       | $                 | 78,721     |                 | $          | 87,712 |   |
| Raw materials and spare parts                    |       | 41,731            |       | 35,932               |       |
| Work in process                                  |       | 21,173            |       | 22,517               |       |
| Finished goods                                   |       | 17,826            |       | 20,154               |       |
|                                             |       | 159,451           |       | 166,315              |       |
| Excess of current cost over LIFO values          |       | (46,325           | )          | (45,330              | )          |
| Total Inventories                                |       | $                 | 113,126    |                 | $          | 120,985 |   |

 

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

 

11

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**Note 7 – Earnings Per Share**

 

Thefollowing table is a reconciliation of the numerators and denominators used inthe calculation of basic and diluted earnings per share as presented on theconsolidated condensed statements of operations.

 
| ** **                                                      | ** **   | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------|--------------|------------------------|------------|----------------------|------------|
| **(In  thousands, except per share data)**                      | *** *** | **July 31, 2004**      | ** ** | **August 2, 2003**   | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
| Numerator:                                                      |         |                   |       |                 |       |   |   |   |   |
| Earnings (loss) available to common  shareholders               |         |                   |       |                 |       |   |   |   |   |
| From continuing operations                                      |         | $                      | 7,300      |                 | $          | 3,228 |   | $ | 12,806 |   | $ | 4,887 |   |
| From discontinued operations                                    |         | (1,423                 | )          | (158                 | )          | (1,487 | ) | (982 | ) |
| Net earnings                                                    |         | $                      | 5,877      |                 | $          | 3,070 |   | $ | 11,319 |   | $ | 3,905 |   |
|                                                            |         |                   |       |                 |       |   |   |   |   |
| Denominator:                                                    |         |                   |       |                 |       |   |   |   |   |
| Denominator for basic earnings per share                        |         |                   |       |                 |       |   |   |   |   |
| Weighted average shares outstanding                             |         | 28,749                 |       | 28,522               |       | 28,709 |   | 28,507 |   |
| Effect of dilutive securities:                                  |         |                   |       |                 |       |   |   |   |   |
| Employee and director stock options                             |         | 433                    |       | 445                  |       | 349 |   | 297 |   |
| Denominator for diluted earnings per share  -                   |         |                   |       |                 |       |   |   |   |   |
| Adjusted weighted average shares  outstanding                   |         | 29,182                 |       | 28,967               |       | 29,058 |   | 28,804 |   |
|                                                            |         |                   |       |                 |       |   |   |   |   |
| Basic earnings per share:                                       |         |                   |       |                 |       |   |   |   |   |
| From continuing operations                                      |         | $                      | 0.25       |                 | $          | 0.11 |   | $ | 0.44 |   | $ | 0.17 |   |
| From discontinued operations                                    |         | (0.05                  | )          | —               |       | (0.05 | ) | (0.03 | ) |
| Net earnings per share                                          |         | $                      | 0.20       |                 | $          | 0.11 |   | $ | 0.39 |   | 0.14 |   |
|                                                            |         |                   |       |                 |       |   |   |   |   |
| Diluted earnings per share:                                     |         |                   |       |                 |       |   |   |   |   |
| From continuing operations                                      |         | $                      | 0.25       |                 | $          | 0.11 |   | $ | 0.44 |   | $ | 0.17 |   |
| From discontinued operations                                    |         | (0.05                  | )          | —               |       | (0.05 | ) | (0.03 | ) |
| Net earnings per share                                          |         | $                      | 0.20       |                 | $          | 0.11 |   | $ | 0.39 |   | $ | 0.14 |   |
|                                                            |         |                   |       |                 |       |   |   |   |   |
| Number of shares under anti-dilutive stock  options outstanding |         | 1,000                  |       | 1,255                |       | 1,009 |   | 1,255 |   |

 

**Note 8 – Stock-Based Compensation**

 

The Company uses the intrinsic value method of accounting to accountfor its stock-based compensation programs. Accordingly, no compensation expense is recognized when the exerciseprice of an employee stock option is equal to or greater than the market priceof the Company’s common stock on the grant date.

 

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

 
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In  thousands, except per share data)**                                      | ** ** | **July 31, 2004**      | ** ** | **August 2, 2003**   | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
|                                                                            |       |                   |       |                 |       |   |   |   |   |
| Net earnings:                                                                   |       |                   |       |                 |       |   |   |   |   |
| As reported                                                                     |       | $                      | 5,877      |                 | $          | 3,070 |   | $ | 11,319 |   | $ | 3,905 |   |
| Pro forma compensation expense, determined  under fair value method, net of tax |       | (591                   | )          | (443                 | )          | (1,059 | ) | (682 | ) |
| Pro forma                                                                       |       | $                      | 5,286      |                 | $          | 2,627 |   | $ | 10,260 |   | $ | 3,223 |   |
|                                                                            |       |                   |       |                 |       |   |   |   |   |
| Basic earnings per share:                                                       |       |                   |       |                 |       |   |   |   |   |
| As reported                                                                     |       | $                      | 0.20       |                 | $          | 0.11 |   | $ | 0.39 |   | $ | 0.14 |   |
| Pro forma                                                                       |       | 0.18                   |       | 0.09                 |       | 0.36 |   | 0.11 |   |
|                                                                            |       |                   |       |                 |       |   |   |   |   |
| Diluted earnings per share:                                                     |       |                   |       |                 |       |   |   |   |   |
| As reported                                                                     |       | $                      | 0.20       |                 | $          | 0.11 |   | $ | 0.39 |   | $ | 0.14 |   |
| Pro forma                                                                       |       | 0.18                   |       | 0.09                 |       | 0.35 |   | 0.11 |   |

 

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

 

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

 

The Company has a noncontributory defined benefit pension plan thatcovered substantially all of its full-time employees and an unfunded definedbenefit supplemental executive retirement plan that covered certain highlycompensated employees.  Effective July 1,2003, the Company froze the benefits earned under both defined benefit pensionplans, with the exception of a small transition group.

 

The Company also has a defined benefit postretirement medical plan,which provides for the payment of certain medical costs of eligible employeesand dependents upon retirement.  The planis not funded, and the Company expects to continue paying postretirementmedical costs as covered claims are incurred. Effective July 1, 2003, the Company decided that postretirement medicalbenefits will not be provided to future retirees, with the exception of a smalltransition group.

 

The net periodic benefit cost associated with the Company’s definedbenefit pension plans and defined benefit postretirement medical plan consistedof the following components:

 
| ** **                         | ** ** | **Pension Benefits**   | ** ** |
|------------------------------------|------------|------------------------|------------|
| ** **                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
| **(In  thousands)**                | ** ** | **July 31, 2004**      | ** ** | **August 2, 2003** | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
| Service cost                       |       | $                      | 183        |   | $ | 649 |   | $ | 366 |   | $ | 1,298 |   |
| Interest cost                      |       | 1,888                  |       | 1,938 |   | 3,776 |   | 3,876 |   |
| Expected return on plan assets     |       | (2,048                 | )          | (1,909 | ) | (4,096 | ) | (3,818 | ) |
| Curtailment expense                |       | —                 |       | — |   | — |   | 2,369 |   |
| Amortization of prior service cost |       | —                 |       | 31 |   | — |   | 62 |   |
| Recognized actuarial loss          |       | 365                    |       | 169 |   | 730 |   | 338 |   |
| Net periodic benefit cost          |       | $                      | 388        |   | $ | 878 |   | $ | 776 |   | $ | 4,125 |   |

 
| ** **                         | ** ** | **Other Postretirement Benefits** | ** ** |
|------------------------------------|------------|-----------------------------------|------------|
| ** **                         | ** ** | **Three Months Ended**            | ** ** | **Six Months Ended** | ** ** |
| **(In  thousands)**                | ** ** | **July 31, 2004**                 | ** ** | **August 2, 2003** | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
| Service cost                       |       | $                                 | —     |   | $ | 138 |   | $ | — |   | $ | 276 |   |
| Interest cost                      |       | 164                               |       | 260 |   | 328 |   | 520 |   |
| Curtailment gain                   |       | —                            |       | — |   | — |   | (142 | ) |
| Amortization of prior service cost |       | (191                              | )          | (113 | ) | (382 | ) | (226 | ) |
| Recognized actuarial loss          |       | 73                                |       | 93 |   | 146 |   | 186 |   |
| Net periodic benefit cost          |       | $                                 | 46         |   | $ | 378 |   | $ | 92 |   | $ | 614 |   |

 

Aspreviously disclosed in the Company’s consolidated financial statements for theyear ended January 31, 2004, the Company expects to contribute at least $4.0million to its defined benefit pension plans during Fiscal 2004.  During the six months ended July 31, 2004, nocontributions were made.

 

OnDecember 8, 2003, President Bush signed into law the Medicare PrescriptionDrug, Improvement and Modernization Act of 2003 (the “Act”).  The Act introduced a prescription drugbenefit under Medicare (“Medicare Part D”) as well as a federal subsidy tosponsors of retiree health care benefit plans that provide a benefit that is atleast actuarially equivalent to Medicare Part D.  As allowed by FASB Staff Position 106-1,“Accounting and Disclosure Requirements Related to the Medicare PrescriptionDrug, Improvement and Modernization Act of 2003,” the Company has elected todefer recognizing the effects of the Act on its accumulated postretirementbenefit obligation and net periodic postretirement benefit cost in theconsolidated financial statements and notes thereto.  FASB Staff Position 106-2, issued in May2004, provides guidance on the accounting for the effects of the Act.  The Company is currently evaluating theimpact of such guidance, which the Company is required to adopt in the thirdquarter of Fiscal 2004.

 

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

 

This discussion should be read in conjunction with theattached consolidated condensed financial statements and notes thereto, andwith our Annual Report on Form 10-K and notes thereto for the fiscal year endedJanuary 31, 2004.  The followingdiscussion contains forward-looking statements. In connection therewith, please see “Factors That May Affect FutureResults” below, which identifies important factors that could cause actualresults to differ materially from those predicted or implied in theforward-looking statements.

 

Our fiscal year begins on February 1 of the year stated and ends onJanuary 31 of the following year.  Forexample, our “Fiscal 2004” commenced on February 1, 2004 and ends on January31, 2005.  We report results on thefiscal quarter method with each quarter comprising approximately 13 weeks.  The second quarter of Fiscal 2004 commencedon May 2, 2004 and ended on July 31, 2004, and the second quarter of Fiscal2003 commenced on May 4, 2003 and ended on August 2, 2003.

 

**RESULTS OF OPERATIONS**

 

**Strategic Overview**

 

As previously announced, we initiated a comprehensive strategic reviewof our primary businesses during the second half of Fiscal 2003.  As part of this review, we refocused ourprimary operating metrics and management incentive measurement to emphasize theneed for each of our businesses to achieve acceptable returns on shareholderinvested capital.  We are taking actionsin each of our business segments that we believe will help us achieve andsustain an acceptable return on invested capital.  During the first half of Fiscal 2004,we have continued to make progress in our execution of management action plansrequired to meet these objectives.  Thesignificant highlights of our progress in each operating segment are describedbelow.

 

*Tactical Vehicle Systems* – As we transitionfrom the current Family of Medium Tactical Vehicles (“FMTV”) contract with theU.S. Army to the new multi-year FMTV contract, which is expected to begin inNovember 2004, we continue to pursue opportunities to supplement the new FMTVcontract.  We were recently awarded twocontracts from Lear Siegler totaling $19.3 million to provide on-site servicesupport at a U.S. Army base where approximately 1,000 FMTVs and 400 HeavyExpanded Mobility Tactical Trucks will be reset to their full operational standards.  In addition, we were awarded a separatecontract directly with the U.S. Army, which is expected to generateapproximately $17 million of sales, to reset 200 FMTVs to their fulloperational standards.  These resetcontracts are expected to generate relatively low margins and to besubstantially completed over the next six months.  We have also received an award for long leadmaterial for 385 low signature armored cabs for the FMTV, valued at $23million.  We also continue to anticipatethe United Kingdom’s Ministry of Defence announcement of a preferred bidderrelated to their multi-year production contract for over 8,000 trucks.  We currently expect this announcement to bemade during the second half of Fiscal 2004.

 

*PowerProducts –*We**completed numerousstreamlining and cost reduction actions in the first half of Fiscal 2004, andwe continue to evaluate additional opportunities.  Key actions taken during Fiscal 2004  include the sale of assets of the MercuryMarine MerCruiser product line, the sale of assets of the wheelchair liftmanufacturing product line, the sale of certain undeveloped real estate and anidle manufacturing facility, the closure of an under-performing branch locatedin Auburn, Washington and the sale of certain assets within our rentalequipment fleet.  As a result of the manyactions taken during the second half of Fiscal 2003 and the first half of 2004,total headcount for this segment as of July 31, 2004 has been reduced by 341personnel (or 17%) since September 2003, of which 144 such reductions haveoccurred since January 31, 2004.

 

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

 

***Distributed Energy Solutions*** – Our efforts in this segment continue to be focused uponcompleting remaining contractual obligations and winding down the engineering,procurement and construction (“EPC”) activities of this business.  We anticipate that the majority of remainingEPC projects will be completed during Fiscal 2004.  Additionally, we are currently transitioning theresponsibility for the marketing and production of custom generator sets to ourPower Products segment.

 

*AirlineProducts* – As weannounced during the second quarter of Fiscal 2004, we are pursuing the sale of our Airline Products business.  We concluded that this business is not coreto the long-term direction of the Company, and therefore, it is in the bestinterest of our shareholders to redeploy the capital invested in this segmentto other more strategic activities. While we expect the sale of this business to be completed during Fiscal2004, a buyer has not yet been identified and no assurance can be given as towhen, or if, a transaction will take place.

 

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**Fiscal 2004 vs. Fiscal 2003**

 

Sales for the second quarter of Fiscal 2004 were $316.3 million, a $3.4million increase over the $312.9 million recorded in the second quarter ofFiscal 2003.  This increase in sales isprimarily attributable to a $32.4 million increase in our Tactical VehicleSystems segment along with a $5.4 million increase in our Airline ProductsSegment.  These increases were partiallyoffset by lower sales in the Engineered Products, Distributed Energy Solutionsand Power Products segments.  For thefirst half of Fiscal 2004, sales were $620.6 million, which represented anincrease of $18.0 million, or 3%, from the corresponding period in Fiscal 2003.  The increased sales volume for this periodwas also largely attributable to increases in our Tactical Vehicle Systems andAirline Products segments, which were partially offset by lower sales in allother segments.  The changes within eachsegment are explained in greater detail in the Segment Data section below.

 

Gross profit decreased by $1.1 million to $40.6 million in the secondquarter of Fiscal 2004 from the second quarter of Fiscal 2003, reflecting adecline in gross profit margin from 13.3% to 12.8%.  The decrease in gross profit is primarilyattributable to losses in our Distributed Energy Solutions segment primarilyassociated with additional costs to complete existing EPC projects and fulfillcustomer obligations.  This decline waspartially offset by a $1.7 million gross profit improvement in our TacticalVehicle Systems segment driven primarily by higher sales volume, along with a$2.6 million improvement in our Power Products Segment resulting from a varietyof strategic actions and cost reduction programs.

 

For the first half of Fiscal 2004, gross profit decreased by $2.8million to $80.8 million from the corresponding period of Fiscal 2003,reflecting a decline in gross profit margin from 13.9% to 13.0%.  The gross profit in the Distributed EnergySolutions segment declined $7.6 million in the first half of Fiscal 2004 due tothe ongoing execution of existing EPC projects and satisfaction of customerobligations.  Gross profit improved inour Tactical Vehicle Systems segment by $2.6 million and in our AirlineProducts segment by $2.0 million, primarily driven by increased sales volume,while the Engineered Products gross profit declined $2.2 million on lower salesvolume.  The Power Products segmentgenerated a $2.4 million gross profit improvement resulting from numerousstrategic actions and cost reduction programs.

 

Selling and administrative expenses decreased to $31.0 million (9.8% ofsales) in the second quarter of Fiscal 2004 from $37.6 million (12.0% of sales)in the second quarter of Fiscal 2003. This $6.6 million (17%) reduction in selling and administrative expensesis primarily attributable to a $2.3 million cost savings from employeeworkforce reductions during Fiscal 2003 and Fiscal 2004, a $1.6 millionreduction in fringe benefits expense associated with changes made in ouremployee pension, postretirement and medical benefit plans, a $1.9 millionreduction in employee separation costs and restructuring activities in Fiscal2003, and $0.8 million associated with reductions in other expenses.

 

For the first half of Fiscal 2004, selling and administrative expensesdecreased to $63.0 million (10.2% of sales) compared to $73.9 million (12.3% ofsales) in the first six months of Fiscal 2003. This $10.9 million (15%) reduction in selling and administrativeexpenses is primarily attributable to a $5.1 million cost savings from employeeworkforce reductions during Fiscal 2003, a $2.5 million reduction in fringebenefits expense associated with changes made in our employee pension,postretirement and medical benefit plans, and a $3.5 million reduction inemployee separation costs and restructuring activities from Fiscal 2003.

 

Operating results for the first half of Fiscal 2003included a one-time non-cash write-off of $2.4 million of previouslyunamortized prior service costs (pension curtailment expense).  This charge was associated with our decisionto freeze the benefits earned under our defined benefit pension plan, definedbenefit supplemental executive retirement plan and postretirement medical planeffective July 1, 2003, with the exception of a small transition group.

 

Other income, net, increased by $1.5 million in thesecond quarter of Fiscal 2004 and by $2.2 million in the first half of Fiscal2004, compared to the corresponding periods of Fiscal 2003, primarily as aresult of a $1.6 million gain on sales of assets resulting from the disposal oftwo idle manufacturing facilities during the second quarter of Fiscal 2004.

 

Net interest expense was unchanged at $0.1 millionin the second quarter of Fiscal 2004, and decreased by $0.5 million to $0.4million for the first half of Fiscal 2004 compared to the corresponding periodsof Fiscal 2003.  The decrease in interestexpense is primarily attributable to lower debt balances as a result of thescheduled debt payment of $30.0 million in May 2003.

 

The effective tax rate was 36.3% in the first halfof Fiscal 2004 compared to 29.3% for the corresponding period in Fiscal2003.  The increase in effective tax rateis primarily a result of an expected reduction in certain state tax benefitsand tax credits in Fiscal 2004 compared to Fiscal 2003.

 

Discontinued operations generated an after-tax lossof $1.4 million in the second quarter and $1.5 million in the first half ofFiscal 2004, compared to a $0.2 million after-tax loss in the second quarterand a $1.0 million after-tax loss in the first half of Fiscal 2003.  These losses primarily represent costsassociated with retained obligations associated with our discontinued blowoutpreventer and controls, valve and drilling riser business, which was soldduring Fiscal 2002.

 

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**Segment Data**

 

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

 

Thefollowing table represents sales and operating profit (loss) by businesssegment *(in thousands)*:

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                   | ** ** | **July 31, 2004**      | ** ** | **August 2, 2003**   | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
| **Sales**                                                    |       |                   |       |                 |       |   |   |   |   |
| Tactical Vehicle Systems                                     |       | $                      | 140,737    |                 | $          | 108,365 |   | $ | 279,520 |   | $ | 219,342 |   |
| Power Products                                               |       | 123,680                |       | 127,886              |       | 244,399 |   | 253,720 |   |
| Engineered Products                                          |       | 21,936                 |       | 38,262               |       | 39,204 |   | 64,373 |   |
| Distributed Energy Solutions                                 |       | 6,235                  |       | 19,986               |       | 10,678 |   | 32,592 |   |
| Airline Products                                             |       | 23,734                 |       | 18,352               |       | 46,809 |   | 32,596 |   |
| Total sales                                                  |       | $                      | 316,322    |                 | $          | 312,851 |   | $ | 620,610 |   | $ | 602,623 |   |
|                                                         |       |                   |       |                 |       |   |   |   |   |
| **Operating profit  (loss)**                                 |       |                   |       |                 |       |   |   |   |   |
| Tactical Vehicle Systems                                     |       | $                      | 18,759     |                 | $          | 17,279 |   | $ | 38,249 |   | $ | 35,066 |   |
| Power Products                                               |       | 1,843                  |       | (5,642               | )          | 1,926 |   | (8,768 | ) |
| Engineered Products                                          |       | 1,145                  |       | 553                  |       | (642 | ) | 145 |   |
| Distributed Energy Solutions                                 |       | (5,753                 | )          | (2,788               | )          | (10,893 | ) | (6,646 | ) |
| Airline Products                                             |       | (581                   | )          | (712                 | )          | (876 | ) | (2,705 | ) |
| Coporate expenses, net                                       |       | (3,816                 | )          | (3,980               | )          | (7,280 | ) | (9,299 | ) |
| Total operating profit                                       |       | 11,597                 |       | 4,710                |       | 20,484 |   | 7,793 |   |
|                                                         |       |                   |       |                 |       |   |   |   |   |
| Interest expense                                             |       | 436                    |       | 693                  |       | 953 |   | 1,936 |   |
| Interest and investment income                               |       | (332                   | )          | (559                 | )          | (586 | ) | (1,059 | ) |
| **Earnings from  continuing operations before income taxes** |       | $                      | 11,493     |                 | $          | 4,576 |   | $ | 20,117 |   | $ | 6,916 |   |

 

During 2004,manufacturers and distributors of steel have experienced sharply increasedprices and limited availability of steel and component parts containingsteel.  These higher material costs havenegatively impacted our results, particularly in our Tactical Vehicle Systemsand Airline Products segments where increased material costs have impacted ouroperating profit by $3.3 million and $1.0 million, respectively, during thefirst six months of Fiscal 2004.  We arecontinuing to work with our supply chain and pursuing all avenues to minimizethe impact.  In addition, we haveimplemented product price increases where market conditions and contracts haveallowed.  However, we anticipatecontinued negative impact to our material costs into Fiscal 2005.  We are unable to predict how long theseconditions are likely to persist, or whether further price increases will occurin the future.

 

**TacticalVehicle Systems**

 

The Tactical Vehicle Systems segment manufactures tactical vehicles under contracts with the U.S. Army andprovides sustaining design engineering, service and support.  Other contracts within and outside of theU.S. are also being pursued in the segment. During the second quarter of Fiscal 2004, this segment recorded $140.7million of sales, a $32.3 million (30%) increase from the $108.4 million ofsales recorded in the second quarter of Fiscal 2003.  Sales for the firsthalf of Fiscal 2004 were $279.5 million, a $60.2 million (27%) increase fromthe $219.3 million of sales recorded in the corresponding period of Fiscal2003.  The sales increase is primarilyattributable to increased production volume. A breakdown of this segment’s unit deliveries is as follows:

 
| ** **            | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------|------------|------------------------|------------|----------------------|------------|
| ** **            | ** ** | **July 31, 2004**      | ** ** | **August 2, 2003**   | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
| Trucks                |       | 751                    |       | 644                  |       | 1,494 |   | 1,275 |   |
| Trailers              |       | 201                    |       | 126                  |       | 405 |   | 258 |   |
| Total Unit Deliveries |       | 952                    |       | 770                  |       | 1,899 |   | 1,533 |   |

 

Theincreased unit deliveries above generated equipment sales increases of $24.5million and $48.7 million for the second quarter and first half of Fiscal 2004,respectively, compared to same periods in Fiscal 2003.  Additionally, this segment recorded parts andservice

 

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salesincreases of $7.8 million and $11.5 million in the second quarter and firsthalf of Fiscal 2004, respectively, compared to the same periods of Fiscal2003.  The increased parts and service sales are primarily due toincreased requirements for U.S. Army vehicles deployed in Iraq.

 

Operating profit for the second quarter of Fiscal 2004increased to $18.8 million (13.3% operating margin) from $17.3 million (15.9%operating margin) in the second quarter of Fiscal 2003.  The increased sales volume generated a $5.1million improvement to operating profit. This improvement was partially offset by a $2.5 million increase inmaterial costs, primarily associated with higher steel prices, along with a$1.1 million decrease associated with product mix and new product developmentcosts.

 

For the first half of Fiscal 2004, operating profitincreased to $38.3 million (13.7% operating margin) from $35.1 million (16.0%operating margin) in the corresponding period of Fiscal 2003.  The increased sales volume generated a $9.6million improvement to operating profit, partially offset by a $3.3 millionincrease in material costs, primarily associated with higher steel prices,along with a $3.2 million decrease primarily associated with sales mix.

 

As wetransition to the new multi-year FMTV contract, for which production isscheduled to begin in November 2004, unit deliveries are expected to decline to661 trucks and 146 trailers in the third quarter and 644 trucks and 179trailers in the fourth quarter of Fiscal 2004. Our profit margins in this segment are also expected to be lower in thenear future than margin levels historically achieved under the current FMTVcontract.  Actual future margins of thissegment will be dependent upon a number of factors including our ability toachieve operational efficiencies, materials and labor cost control measures,the actual quantities and variations of vehicles purchased by the U.S. Armyunder the new contract, future prices for steel and other commodities, thepotential for additional contracts, other product introductions, bid andproposal activities and other factors. The operating margin that this segment will achieve in total may also beimpacted by additional sales, if any, to other allied governments and the levelof engineering service and spare parts provided.

 

**Power Products**

 

The Power Products segment, which is responsible formarketing and aftermarket support of a wide range of industrial equipment,recorded sales of $123.7 million in the second quarter of Fiscal 2004, down$4.2 million (3%) from $127.9 million in the second quarter of Fiscal 2003.  For the first half of Fiscal 2004, thesegment recorded sales of $244.4 million, down $9.3 million (4%) from $253.7million in the first half of Fiscal 2003. A breakdown of Power Products segment sales follows:

 
| ** **               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------|------------|------------------------|------------|----------------------|------------|
| **(In  thousands)**      | ** ** | **July 31, 2004**      | ** ** | **August 2, 2003**   | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
|                     |       |                   |       |                 |       |   |   |   |   |
| Equipment sales          |       | $                      | 39,140     |                 | $          | 39,244 |   | $ | 75,400 |   | $ | 76,382 |   |
| Parts sales              |       | 55,373                 |       | 59,908               |       | 111,471 |   | 120,686 |   |
| Service and rental sales |       | 29,167                 |       | 28,734               |       | 57,528 |   | 56,652 |   |
|                     |       | $                      | 123,680    |                 | $          | 127,886 |   | $ | 244,399 |   | $ | 253,720 |   |

 

For the second quarter and first six months of Fiscal 2004,respectively, the decline in sales from the comparable period of Fiscal 2003includes approximately $16 million and $29 million attributable to the exit ofthe ThermoKing product offering in Texas and Louisiana, the wheelchair liftmanufacturing and MerCruiser product offerings, along with the closure ofcertain under-performing branch locations. Additionally, parts sales are $4.5 million and $9.2 million lower,respectively, in the second quarter and first half of Fiscal 2004, largely as aresult of changes to our distribution contracts with Detroit Diesel Corporation(“Detroit Diesel”), as discussed more fully below.  These sales declines were largely offset byhigher equipment sales in continuing locations, which were largely attributableto general improvements in the heavy equipment markets we serve.

 

Effective January 2004, we entered into newcontracts with Detroit Diesel for the distribution and servicing of its dieselengine products.  One set of contracts,which expires in December 2010, is with Detroit Diesel Corporation and coversthe “on-highway” products and services. Under the terms of the new on-highway agreements with all of its distributors,Detroit Diesel allows its affiliated Freightliner, Sterling and Western Stardealers (collectively, the “Freightliner dealers”) to purchase their on-highwayDetroit Diesel parts directly from the Freightliner Parts Distribution Centers,rather than purchasing them from a Detroit Diesel distributor such as theCompany, as was previously required. Consequently, our parts sales to Freightliner dealers have declined inthe first six months of Fiscal 2004, compared to the same period in Fiscal2003.  Additionally, under the terms ofthe new contract, we have received direct compensation from Detroit Dieseltotaling $0.6 million for the first six months of Fiscal 2004 related toFreightliner dealer purchases made directly from the Freightliner Parts DistributionCenters.

 

The second set of Detroit Diesel agreementsis with DaimlerChrysler Off-Highway Holding Gmbh, and covers “off-highway”products and services.  This contractexpires in December 2004 and includes terms similar to the previousdistribution agreement.  At 

 

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present, we are unable to predict the effectof these “off-highway” contract arrangements on future operations or whetherthey will be renewed and, if so, on what terms upon their expiration.

 

This segment recorded an operating profit of $1.8 millionin the second quarter of Fiscal 2004 compared to a $5.6 million operating lossin the second quarter of Fiscal 2003. The improvement in operating profit is primarily attributable to on-goingcost reduction programs.  Workforcereductions resulted in a $4.8 million decrease in employee compensation costsbetween the two periods.  Additionally,changes in employee benefit programs previously described resulted in anadditional $1.5 million decrease in operating expenses.  This segment also recognized a $0.3 milliongain in the second quarter of Fiscal 2004 associated with the sale of an idlemanufacturing facility.  Reductions inother operating expenses provided an additional $0.8 million improvement.

 

Operating profit for the first half of Fiscal 2004 was $1.9million, representing a $10.7 million improvement over the $8.8 millionoperating loss recognized in the corresponding period of Fiscal 2003.  This improvement was driven primarily by thecost reduction programs, including $7.8 million from workforce reductions, $2.7million from employee benefit program changes, the $0.3 million gain on thesale of an idle manufacturing facility and $0.7 million from other operatingexpense reductions.  These improvementswere partially offset by a $0.8 million decline from lower sales volume andchanges in sales mix.

 

As mentioned above, we sold the assets of our wheelchair liftmanufacturing and MerCruiser distribution product offerings during the firstquarter of Fiscal 2004 for aggregate cash proceeds of $3.2 million and areceivable of $0.9 million.  No materialgain or loss was recognized on these transactions, individually or in theaggregate.  During the second quarter ofFiscal 2004, we sold a vacant manufacturing facility and certain rentalequipment assets for aggregate proceeds of $8.6 million, resulting in a gain of$0.3 million to the segment. We continue to evaluate the various product andservice offerings, distribution channels and cost structure in this businesssegment and intend to take further action, as necessary, to improve thesegment’s contribution to the Company’s return on invested capital.

 

**Engineered Products**

 

The Engineered Products segment consists of two primary product lines,petroleum equipment and utilities equipment. The petroleum equipment business manufactures equipment primarily forthe well stimulation segment of the oil service industry.  The utilities equipment products includemobile railcar movers, snowblowers and off-road seismic vehicles.  Sales in this segment decreased to $21.9million in the second quarter of Fiscal 2004 from $38.3 million in the secondquarter of Fiscal 2003, representing a 42% decline. For the first half ofFiscal 2004, sales decreased $25.2 million (39%) to $39.2 million from $64.4million in the corresponding period of Fiscal 2003. The decreases experiencedin Fiscal 2004 are largely due to the timing of execution on several largepetroleum equipment orders which were largely completed during the first halfof Fiscal 2003.  Compared to thecorresponding periods in Fiscal 2003, petroleum equipment sales represented$24.1 million and $36.7 million of this segment’s sales decline in the secondquarter and first half, respectively. The declines in petroleum equipment sales were partially offset byincreases in utilities equipment sales, largely associated with the sales ofoff-road seismic vehicles.

 

Operating profit for the second quarter of Fiscal 2004 was $1.1million, a $0.5 million increase from the $0.6 million operating profit in thesecond quarter of Fiscal 2003, despite the decline in sales volume.  The second quarter of Fiscal 2004 included a$0.6 million gain resulting from the sale of an idle manufacturing facility,which was vacated as a result of the consolidation of manufacturing operationsin Houston, Texas during Fiscal 2003. Additionally, the second quarter of Fiscal 2003 included $0.5 million ofnon-recurring project costs associated with the consolidation effort.  The remainder of the change in operatingprofit is attributable to sales volume and mix changes as the decline in profitassociated with the large international equipment orders in Fiscal 2003 waslargely offset by the improved profitability of the utilities equipment anddomestic petroleum equipment sales.

 

For the first half of Fiscal 2004, this segment generated a $0.6million operating loss, which reflected a $0.7 million decrease from the $0.1million operating profit in the corresponding period of Fiscal 2003.  Included in the Fiscal 2004 loss was a $0.4million charge for potential inventory impairment associated with the recentU.S. trade sanctions against Syria. Other issues contributing to the increased loss in the first half ofFiscal 2004 were $2.2 million associated with declining sales volume, partiallyoffset by $1.0 million of non-recurring costs in Fiscal 2003 associated withthe consolidation of manufacturing operations and the $0.6 million gain fromthe manufacturing facility sale in Fiscal 2004. Additionally, sales mix improvements generated an additional $0.3million improvement.

 

Our order backlog in this segment has increased to $26.6 million atJuly 31, 2004 from $20.1 million at the end of Fiscal 2003.  Additionally, this segment obtained an orderfor petroleum equipment subsequent to the end of the second quarter of Fiscal2004 totaling $17.5 million.  Theexecution of these contracts currently in backlog is expected to improve salesand operating profits in future quarters.

 

**Distributed Energy Solutions**

 

The Distributed Energy Solutions segment packages and marketsreciprocating diesel and natural gas engine generator sets and markets powergeneration solutions primarily in domestic and certain internationalmarkets.  As previously communicated, we 

 

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announced the decision to exit EPC activities within this segmentduring the third quarter of Fiscal 2003. With respect to such EPC activities, we are not quoting any new businessbut we continue to perform under existing contracts.  We are currently transitioning theresponsibility for the marketing and production of custom generator sets to ourPower Products segment.

 

Sales for this segment decreased $13.8 million to $6.2 million in thesecond quarter of Fiscal 2004 compared to $20.0 million in the second quarterof Fiscal 2003.  For the first half ofFiscal 2004, this segment generated sales of $10.7 million, compared to $32.6million in the corresponding period in Fiscal 2003.  The decline in sales is primarily the resultof our decision to exit the EPC activities. Sales in the first half of Fiscal 2004 primarily relate to our continuedexecution of remaining customer obligations under existing contracts.

 

Operating loss for the second quarter of Fiscal 2004 was $5.8 million,compared to a $2.8 million operating loss in the second quarter of Fiscal 2003.  For the first half of Fiscal 2004, thissegment’s operating loss was $10.9 million, compared to $6.6 million in thecorresponding period of Fiscal 2003.  Theincreased operating loss is largely attributable to continued costs incurred onexisting contractual obligations, costs related to certain contract issues anddisputes and the overall low volume of sales and margin that is not sufficientto cover this segment’s infrastructure costs remaining in place to serviceexisting obligations.

 

As mentioned above, we are continuing to perform our remainingobligations associated with the EPC activities of this segment.  We expect that the majority of theseremaining obligations will be completed during the second half of Fiscal2004.  While we have recognized all knownestimated losses on these uncompleted contracts, continued uncertainty remainsrelated to the execution of the remaining obligations.  These uncertainties may result in additionalunexpected losses until all remaining EPC projects are completed.  Additionally, upon completing our remainingEPC projects, we will retain and execute obligations under certain fixed-priceoperation and /or maintenance contracts related to EPC projects, which haveterms ranging from two to ten years.

 

**Airline Products**

 

As previously mentioned, we are currently pursuing the sale of ourAirline Products business, which designs, manufactures and sells ground supportequipment.  Until a suitable buyer isfound for this business, the sale process is not expected to have a materialimpact on the operations of this segment. Additionally, we will continue to provide the capital and otherresources needed to continue our improvement and growth of this business.

 

TheAirline Products segment recorded sales of $23.7 million in the second quarterof Fiscal 2004, a $5.3 million or 29% increase from the $18.4 million of salesrecorded in the second quarter of Fiscal 2003. For the first half of Fiscal 2004, this segment recorded sales of $46.8million, which reflected a $14.2 million or 44% increase over the same periodin Fiscal 2003.  The increased salesreflect a growing demand for equipment resulting from the continued recovery ofthe airline industry and the lack of replacement purchases over the past threeyears.

 

Thissales improvement resulted from the following increase in unit deliveries,which reflect an 80% increase in the second quarter of Fiscal 2004 and a 78% increasein the first half of Fiscal 2004, compared to the same periods of Fiscal 2003:

 
| ** **            | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------|------------|------------------------|------------|----------------------|------------|
| ** **            | ** ** | **July 31, 2004**      | ** ** | **August 2, 2003**   | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
| Total Unit Deliveries |       | 653                    |       | 363                  |       | 1,224 |   | 688 |   |

 

Unitvolumes have increased at a higher rate than sales dollars, primarily as aresult of our Fiscal 2002 acquisition of the DAVCO product line, which hasexpanded this segment’s market into the rapidly growing regional airlinesector.  The DAVCO equipment tends to beof smaller size, and therefore has a lower selling price per unit.

 

Thissegment produced an operating loss of $0.6 million in the second quarter ofFiscal 2004 compared to a $0.7 million operating loss in the second quarterFiscal 2003.  The reduced operating lossfor the second quarter of Fiscal 2004 is attributable to the increase in salesvolume, which contributed a $1.0 million improvement.  This improvement was offset by highermaterial costs, including a $0.6 million increase attributable to steel pricesalong with other operating cost increases and sales mix changes.

 

Forthe first half of Fiscal 2004, this segment reduced its operating loss by $1.8million from the prior year, recording an operating loss of $0.9 million ascompared to a $2.7 million operating loss in the comparable period for Fiscal2003.  A $2.5 million improvement wasgenerated by higher sales volume along with $0.3 million of improvementassociated with favorable sales mix and operating expenses, partially offset byhigher material costs including $1.0 million due to steel price increases.

 

Groundsupport equipment purchases by the airline industry have increased in the firsthalf of Fiscal 2004, as reflected by our increased sales volume and increasedbacklog to $12.8 million at the end of the second quarter of Fiscal 2004,compared to $7.0 million at January 31, 2004 and $2.5 million at the end of thesecond quarter of Fiscal 2003.  Weanticipate that the continued 

 

19

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recoveryof the airline industry, as well as regulatory requirements for reducedemission ground support vehicles, will have a positive impact on the AirlineProducts segment.  While we expect therecent increases in steel prices to affect our product costs in the nearfuture, we expect to offset this impact significantly through product priceincreases.

 

During the first quarter of Fiscal 2004, the Airline Products businesswas awarded contracts by the U.S. Navy, Naval Air Warfare Center todeliver tow tractors and air conditioning units.  The initial contract awards of $2.5 millioncover the design and testing of 5 pilot-production tow tractor units and 5pilot-production air conditioning units, along with associated technical dataand training and pilot-production testing. These contracts are currently being executed and are expected to becompleted in the third quarter of Fiscal 2004. Assuming successful completion of the initial awards, the contractsinclude four individual option years beginning in late Fiscal 2004 or earlyFiscal 2005, which have a total contract value of approximately $72 million ifall options are fully exercised.

 

**Corporate**

 

Corporateexpenses consist of costs incurred by the corporate headquarters group thatcannot be directly attributed to the activities of the business segments.  Corporate expenses incurred in the secondquarter of Fiscal 2004 were $3.8 million, down $0.2 million from the $4.0million incurred in the second quarter of Fiscal 2003.  The decrease in corporate expenses is primarilyattributable to a $0.9 million reduction in employee separation costs relatedto corporate office workforce reductions. The second quarter of Fiscal 2004 included $0.4 million of employeeseparation costs, compared to $1.3 million in the second quarter of Fiscal2003.  This reduction was partiallyoffset by higher legal and professional expenses, including costs associatedwith the implementation of the internal control reporting requirements of theSarbanes-Oxley Act of 2002.

 

Forthe first half of Fiscal 2004, corporate expenses were $7.3 million, comparedto $9.3 million in the comparable period of Fiscal 2003.  Fiscal 2003 included a $2.4 million one-timenon-cash pension curtailment expense resulting from changes made to our definedbenefit pension and postretirement medical plans.  The impact of other cost reduction effortsincluding corporate staff reductions were offset by higher legal andprofessional expenses, including $0.9 million associated with theimplementation of the internal control reporting requirements of theSarbanes-Oxley Act of 2002.  While therequirements of the Sarbanes-Oxley Act are expected to result in some level ofincreased ongoing corporate expenses, we expect such ongoing costs to besignificantly lower than the levels experienced in the first half of Fiscal2004.

 

**UNFILLED ORDERS**

 

TheCompany’s unfilled orders consist of written purchase orders and signedcontracts.  Historically, cancellationsare rare; however, these unfilled orders are generally subject to cancellationor modification due to customer relationships or other conditions.  Purchase options are not included in unfilledorders until exercised.  Unfilled ordersrelating to continuing operations were as follows:

 

| ** **                   | ** ** | **July 31, 2004** | ** ** | **January 31, 2004** | ** ** |
|------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                   | ** ** | **(In millions)** | ** ** |
|                         |       |              |       |                 |       |
| Tactical Vehicle Systems     |       | $                 | 496.7      |                 | $          | 453.0 |   |
| Power Products               |       | 44.2              |       | 26.4                 |       |
| Engineered Products          |       | 26.6              |       | 20.1                 |       |
| Distributed Energy Solutions |       | 10.6              |       | 19.5                 |       |
| Airline Products             |       | 12.8              |       | 7.0                  |       |
|                         |       | $                 | 590.9      |                 | $          | 526.0 |   |

 

Additionally, subsequent to July 31, 2004, the Engineered Productssegment obtained an order for petroleum equipment totaling $17.5 million.  Unfilled orders of the Tactical VehicleSystems segment at July 31, 2004 included $121.2 million associated with theremaining production related to the sixth program year under the U.S. Armycontract awarded in October 1998, as well as the funded portion of the newmulti-year FMTV contract awarded in April 2003. Production under the October 1998 contract is expected to be completedin December 2004, and scheduled production under the new FMTV contract isexpected to begin in November 2004.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Our sources of cash liquidity include cash and cash equivalents,short-term investments and cash from operations.  We believe that these sources will providesufficient capital to fund our working capital requirements, capitalexpenditure needs, dividends and other financial commitments.

 

We had a $150 million unsecured revolving credit facility, whichexpired on January 31, 2004.  Noborrowings were outstanding under the facility at any time during the pastthree fiscal years.  Based on non-usageof the revolving credit facility combined with the current cash and cashequivalents balance and the expected cash from operations for the foreseeablefuture, we elected not to renew 

 

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the facility.  To provideadditional financial flexibility, we intend to negotiate a smaller revolvingcredit facility during the second half of Fiscal 2004.  There can be no assurance that we will beable to successfully negotiate such a facility or, if we do, that such facilitywill include terms and conditions similar to the expired facility.  Failure to negotiate a new facility on termsacceptable to us could restrict our future ability to make acquisitions andfund working capital, capital expenditures, common stock dividends or otherfinancial obligations.

 

During Fiscal 2003, we entered into letter of credit facilitiestotaling $17.5 million with financial institutions, to allow us to issueletters of credit as needed to support our commercial operations.  Approximately $13.6 million of letters ofcredit under these facilities were outstanding as of July 31, 2004.

 

We have $25.0 million in unsecured senior notes outstanding, which bearinterest at a rate of 7.38% and are due and payable in May 2006.  The senior notes agreement limits sales ofassets and other items and contains a maximum debt-to-total capitalizationcovenant. Based on our financial condition as of July 31, 2004, therestrictions imposed by our senior notes do not currently restrict our abilityto meet our obligations or to declare and pay dividends at historical levels.

 

In Fiscal 2002, we entered into an interest rate swap agreement, whichexpires in November 2004, with a notional amount of $15 million related to $15million of the senior notes due in 2006. This transaction, which is designated as a fair value hedge, effectivelyconverts $15 million of fixed rate debt with an interest rate of 7.38% intofloating rate debt with an interest rate of LIBOR plus 436 basis points.  The applicable floating interest rate as ofJuly 31, 2004 was approximately 6.29%. The net interest received or paid as a result of the interest rate swap isincluded in interest expense on the consolidated statements of operations.  The recorded value of the swap and therelated fair value adjustment to the debt are carried on the consolidatedbalance sheets at fair value.

 

In addition, our international subsidiaries had foreign currency banknotes payable totaling $1.8 million at July 31, 2004 and $1.9 million atJanuary 31, 2004.  Such notes payableconsist of renewable, secured loans for the purpose of financing our SouthAmerican operations.  These loans aredenominated in local currency (Colombian Pesos and Venezuelan Bolivars) and aresecured by letters of credit issued by us and principally bear market-basedvariable rates of interest.  We useforeign denominated debt to offset the impact of foreign currency exchange ratefluctuations on our South America operations.

 

In the event that any acquisition of additional operations, growth inexisting operations, settlements of lawsuits or disputes, changes in inventorylevels, accounts receivable, tax payments or other working capital items createa need for working capital or capital expenditures in excess of the existingcash and cash equivalents and committed lines of credit, we may seek to borrowunder other long-term financing instruments or seek additional equity capital.

 

**Statements of Cash Flows Data**

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In  thousands)**                               | ** ** | **July 31, 2004**      | ** ** | **August 2, 2003**   | ** ** | **July 31, 2004** | ** ** | **August 2, 2003** | ** ** |
| Net cash provided by (used in):                   |       |                   |       |                 |       |   |   |   |   |
| Operating activities                              |       | $                      | (9,733     | )                    | $          | 5,761 |   | $ | 33,842 |   | $ | 20,067 |   |
| Investing activities                              |       | 5,497                  |       | (10,147              | )          | 4,749 |   | (25,692 | ) |
| Financing activities                              |       | (2,017                 | )          | (31,548              | )          | (3,735 | ) | (32,857 | ) |
| Increase (decrease) in cash and cash  equivalents |       | $                      | (6,253     | )                    | $          | (35,934 | ) | $ | 34,856 |   | $ | (38,482 | ) |

 

**Selected Balance Sheet Data**

 
| **(In  thousands)**                                 | ** ** | **July 31, 2004** | ** ** | **January 31, 2004** | ** ** |
|-----------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| Cash, cash equivalents, and short-term  investments |       | $                 | 99,750     |                 | $          | 61,704 |   |
| Working capital                                     |       | 240,341           |       | 219,531              |       |
| Total debt                                          |       | 28,198            |       | 28,442               |       |
|                                                     |            |                   |            |                      |            |  |  |

 

Total cash flows improved by $29.7 million in the second quarter ofFiscal 2004 compared to the second quarter of Fiscal 2003.  Net cash provided by operating activitiesdecreased by $15.5 million primarily as a result of a $31.1 million cashoutflow in the second quarter of Fiscal 2004 attributable to a reduction inbillings in excess of incurred costs associated with the Tactical VehicleSystems segment payment and production schedule under the existing FMTVcontract and transition to the new multi-year FMTV contract.  The impact of this cash outflow was partiallyoffset by other changes in operating assets and liabilities, including a $17.8million receipt of a federal income tax refund receivable.

 

Investing activities contributed a $15.6 million improvement in cashflow during the second quarter of Fiscal 2004 compared to the second quarter ofFiscal 2003.  This improvement isprimarily attributable to $11.4 million of cash proceeds associated with thesale of rental equipment assets and related customer leases and two idlemanufacturing facilities.  Additionally,capital expenditures in the 

 

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second quarter of Fiscal 2004 were $3.6 million lower than thecomparative period of the previous year due to capital spending in Fiscal 2003related to the consolidation of two manufacturing facilities.

 

Financing activities contributed a $29.5 million improvement in cashflow during the second quarter of Fiscal 2004 compared to the second quarter ofFiscal 2003.  This improvement relatedprimarily to a scheduled debt payment of $30.0 million in May of 2003.

 

Total cash flows for the first half of 2004 improved by $73.3 comparedto the same period of Fiscal 2003.  Netcash provided by operating activities increased $13.7 million as a $35.0million cash usage in Fiscal 2004 related to the payment and productionschedule under the existing FMTV contract and transition to the new multi-yearFMTV contract was more than offset by a $43.4 million cash flow improvementrelated to customer receipts on large Engineered Products equipment orderscompleted during the fourth quarter of Fiscal 2003, as well as the $17.8million collection of the income tax refund.

 

Investing activities contributed a $30.4 million improvement in cashflow during the first half of Fiscal 2004 compared to the first half of Fiscal2003.  This improvement is primarilyattributable to $17.5 million of cash proceeds associated with the sale ofbusinesses and property, plant and equipment. Additionally, cash invested in short-term investments decreased by $7.7million and capital expenditures were $6.2 million lower due to themanufacturing facility consolidation project in Fiscal 2003.

 

Financing activities contributed a $29.2 million improvement in cashflow during the first half of Fiscal 2004 compared to the first half of Fiscal2003, resulting from the scheduled debt payment of $30.0 million in May of2003.

 

Asa result of the cash provided by operating activities in the first half ofFiscal 2004, total cash and short-term investments has increased since January31, 2004 by $38.0 million to $99.8 million as of July 31, 2004.  We anticipate that this balance will remainrelatively stable in the near-term; however, we anticipate that we will usecash during the second half of Fiscal 2004 primarily to fund working capitalrelated to additional orders in the Engineered Products segment.

 

Ourworking capital balance increased by $20.8 million during the first half ofFiscal 2004, primarily attributable to the $20.1 million of earnings beforeincome taxes along with $9.9 million of plant, property and equipmentdisposals, partially offset by $4.9 million of dividend payments and otherreductions of working capital.

 

**FACTORS THAT MAY AFFECT FUTURERESULTS**

** **

*Risksas to Rising Steel Prices.*  During 2004, manufacturers anddistributors of steel, which is used in many of our products, have experiencedsharply increased prices and limited availability of steel and component partscontaining steel. These increased steel prices have had and are expected to continueto have a negative impact on our margins in the near future, particularly onfixed-price contracts and other contracts for which we are unable to pass suchcost increases on to our customers.  Ifthese steel price conditions continue, and if we are unable to raise our pricesto keep pace with the material cost increases, our sales trends, operatingmargins and results of operations could be adversely impacted in futureperiods.

 

**Forward-Looking Statements**

 

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

 

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**Item 3. Quantitative and Qualitative Disclosuresabout Market Risk**

 

Ourquantitative and qualitative disclosures about market risk for changes ininterest rates and foreign exchange risk are incorporated by reference in Item7A of our Annual Report on Form 10-K for the year ended January 31, 2004 andhave not materially changed since that report was filed.

 

**Item 4. Controls and Procedures**

 

Wecarried out an evaluation required by the Securities Exchange Act of 1934, asamended (the “Exchange Act”), under the supervision and with the participationof management, including the Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures pursuant to Rule 13a-15 under the Exchange Act as ofJuly 31, 2004.  Based upon thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures are effective in alerting them on atimely basis to material information relating to the Company and required to beincluded in our periodic filings under the Exchange Act.

 

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

 

**PART II.  OTHERINFORMATION**

 

**Item 1. Legal Proceedings**

 

*U.S. Government Contingencies:*  During Fiscal 1998, the U.S. Customs Servicedetained a medium tactical vehicle that was being shipped by the Company fordisplay in a European trade show.  TheCompany is advised that the U.S. Customs Service and the Department of Justicehave conducted an investigation of potential violations by the Company of lawsrelating to the export of controlled military vehicles, weapons mountingsystems, and firearms.  Suchinvestigation could result in the filing of civil or administrative sanctionsagainst the Company and/or individual employees, and could result in asuspension or debarment of the Company from receiving new contracts orsubcontracts with agencies of the U.S. government or the benefit of federalassistance payments.  While they arepossible, the Company does not believe that criminal sanctions will be sought.  The Company believes that resolution of thismatter will not have a material adverse effect on its consolidated results ofoperations in any period or upon its consolidated financial condition orliquidity and believes that the resolution of the matter that is possibly mostadverse to the Company will involve the payment of a civil penalty that willnot materially adversely affect the Company.

 

The Company is a defendant in a suit brought under the *qui tam* provision of the False Claims Act,*United States of America,**ex rel.  WernerStebner v. Stewart & Stevenson Services, Inc. and McLaughlin Body Co*.,Civil Action No. H-96-3363, in the United States District Court for theSouthern District of Texas, Houston Division. The plaintiff’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 Family of Medium Tactical Vehicles delivered to the U.S. Armystarting in 1995, and the suit alleges that the vehicles were substandardbecause of corrosion problems.  The suitwas filed under seal in 1996, and following an investigation by the JusticeDepartment, the United States declined to intervene in the suit, which wasunsealed on August 29, 2000.  On February2, 2004, the District Court found in favor of the Company and dismissed all ofthe plaintiff’s claims by summary judgment without proceeding to trial.  After having all claims dismissed by theDistrict Court, the plaintiffs then filed a notice of appeal on March 1, 2004in the United States Court of Appeals for the Fifth Circuit, No. 04-20209. Thebriefing schedule has not yet been finally determined by the Court ofAppeals.  A decision by the Fifth Circuitis not expected until sometime in Fiscal 2005. The Company believes the District Court correctly dismissed all of theplaintiff’s claims as being without merit and will continue to vigorouslydefend the suit in the court of appeals. While the Company does not believe that an adverse outcome is reasonablylikely, an unexpected adverse outcome in the suit could have a material adverseimpact on the Company’s consolidated results of operations, financial positionand liquidity.  The Company is presentlyunable to determine whether any liability has been incurred in this matter,other than legal fees and expenses, which have been provided for, or toreasonably estimate the amount or range of any loss that may result from thismatter, and thus no accruals have been recorded in this matter other thanestimated legal fees and expenses relating to the appeal.

 

*Diamond Offshore Litigation:*  The Company is a defendant in a suit broughtby several subsidiaries of Diamond Offshore on May 30, 2002, arising out ofclaims relating to a marine riser manufactured by the Company and purchased byDiamond Offshore for use on its Ocean Baroness semi-submersible drilling rig,Cause No. 2002-27831; *Diamond OffshoreInternational Corporation, Diamond Offshore Company, Diamond Offshore ServicesCompany, Diamond Offshore (USA), Inc., Diamond Offshore International Limited,and Diamond Offshore Drilling, Ltd. v. Stewart & Stevenson Services, Inc.*;in the District Court of Harris County, Texas 125th JudicialDistrict Court (the “Baroness Litigation”). The suit was filed following a parting of the marine riser during deepwater 

 

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drilling operations.  The suitseeks to recover damages that are not specified in the petition, includingdirect damages, attorney’s fees and expenses and punitive damages.  Discovery in the case indicates that thedirect damage claim is for approximately $36 million.

 

In a separate transaction on or about September 13, 2001, DiamondOffshore contracted with the Company for a marine riser for use on its OceanRover semi-submersible drilling rig.  TheCompany was fulfilling this order, when, on August 19, 2002, Diamond Offshoreamended its petition in the Baroness Litigation to seek a declaration thatDiamond Offshore has no further contractual obligations to the Company withrespect to the Ocean Rover riser.  OnAugust 21, 2002, before being served with Diamond Offshore’s amended petitionin the Baroness Litigation, the Company filed a separate lawsuit againstDiamond Offshore seeking to recover damages, including attorneys’ fees, for theunilateral cancellation of the Rover contract, (the “Rover Litigation”).  On August 30, 2002, the Court transferred theRover Litigation to the 125th Judicial District Court where theBaroness Litigation is pending.  The twocases have been consolidated into one lawsuit in the 125th JudicialDistrict Court.  The Company isvigorously prosecuting its claims against Diamond Offshore and defending theclaims asserted against it by Diamond Offshore in this consolidated lawsuit.

 

Itis presently impossible for the Company to determine the ultimate outcome ofthe Diamond Offshore disputes or whether their resolution will, in the future,have a material adverse effect on the Company’s consolidated results ofoperations, financial position or liquidity. The Company is presently unable to determine whether a materialliability has been incurred in these matters or to reasonably estimate theamount of any loss that may result from these matters.  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 certain estimated legal fees it expects toincur associated with these matters. Such accruals are included in liabilities of discontinued operations, asthe business that manufactured drilling risers was sold in Fiscal 2002.

 

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

 

*Environmental Contingencies:*  In 2001,the Company received from the United States Environmental Protection Agency(“EPA”) a Request for Information under Section 104(e) of the ComprehensiveEnvironmental Response, Compensation, and Liability Act of 1980, forinformation pertaining to the R&H Oil Company Site in San Antonio, Texas(the “Site”).  Informationprovided to the Company by the EPA indicates that the Company may have sentwaste oils to the Site for recycling in the late 1980s, and that such wasteoils may potentially account for between one and two percent of the volume oftotal wastes received by the oil recycler at the Site.  Since the Company expects to receive a claimfor cleanup and other costs related to this site, it has established reserveswhich it believes to be adequate at this time. As additional facts are developed and definitive remediation plans andnecessary regulatory approvals for implementation of remediation areestablished, changes in these and other factors may result in actual costsexceeding the current environmental reserves. While uncertainties are inherentin the final outcome of these environmental matters, and it is presentlyimpossible to determine the actual costs that ultimately may be incurred,management currently believes that the resolution of such uncertainties shouldnot have a material adverse effect on the Company’s consolidated results ofoperations, financial position or liquidity. The Company believes that the most likely outcome in this environmentalmatter is the expenditure of an immaterial amount of consideration as acontribution to the remediation effort.

 

The Company is also a defendant in a number of lawsuits relating tocontractual, product liability, personal injury and warranty matters normallyincident to the Company’s business.  Noindividual case, or group of cases presenting substantially similar issues oflaw or fact, is expected to have a material effect on the manner in which theCompany conducts its business or on its consolidated results of operations,financial position or liquidity.  TheCompany maintains certain insurance policies that provide coverage for productliability and personal injury cases.  TheCompany has established reserves that it believes to be adequate based oncurrent evaluations and its experience in these types of claim situations.  Nevertheless, an unexpected outcome in anysuch case could have a material adverse impact on the Company’s consolidatedresults of operations in the period it occurs. Moreover, future adverse developments in such cases could requirematerial changes in the recorded reserve amounts.

 

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**Item 4. Submission of Matters to a Vote ofSecurity Holders**

 

On July 9, 2004 the Company’s Annual Meetingof Shareholders was held.  Set forthbelow is a brief description of each matter acted upon at the meeting and thenumber of votes cast for, against or withheld, abstaining or not voting as toeach matter.

 
| ** **                | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|---------------------------|------------|------------|------------|--------------|------------|
| 1. Election of Directors: |       |       |       |         |       |
| Max L. Lukens             |       | 26,315,474 |       | 1,378,872    |       |
| Robert S. Sullivan        |       | 25,934,460 |       | 1,759,886    |       |
| James M. Tidwell          |       | 26,311,539 |       | 1,382,807    |       |
|                      |       |       |       |         |       |

 

The following directors’ terms of officecontinued after the meeting:  Monroe M.Luther, Charles R. Ofner, Khleber V. Attwell, Darvin M. Winick, and HowardWolf.

 
| ** **                                                                                                                   | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker Non-votes** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|----------------------|------------|
| 2. Ratification of Ernst & Young LLP as to the  Company’s auditor:                                                  |       | 27,456,009 |       | 225,862     |       | 12,475      |       | —               |       |
|                                                                                                                         |       |       |       |        |       |        |       |                 |       |
| 3. Approval of Amendment No. 1 to the Stewart  & Stevenson Services, Inc. Amended and Restated 1996 Director Stock Plan: |       | 17,006,187 |       | 5,849,912   |       | 1,529,946   |       | 3,308,301            |       |
|                                                                                                                         |       |       |       |        |       |        |       |                 |       |
| 4. Approval of the Stewart & Stevenson  Services, Inc. Amended and Restated 1993 Nonofficer Employee Stock Option  Plan: |       | 21,687,611 |       | 4,480,386   |       | 1,526,349   |       | —               |       |
|                                                                                                                         |       |       |       |        |       |        |       |                 |       |
| 5. Approval of Any Proposal to Postpone or Adjorn  the Meeting:                                                              |       | 17,730,911 |       | 9,907,937   |       | 55,498      |       | —               |       |

 

**Item 6. Exhibits**

 

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

 
| 3.2        |   | Seventh  Restated Bylaws of Stewart & Stevenson Services, Inc. effective July 9,  2004, as amended.                                                                                                                      |
|------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                                                                         |
| †10.1 |   | Form  of Severance Agreement, dated as of July 19, 2004, by and between Stewart  & Stevenson Services, Inc. and Carl B.   King, John B. Simmons, Stephen A. Hines, Dennis M. Dellinger, Don Kyle  and Mark Whitman. |
|       |   |                                                                                                                                                                                                                         |
| 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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†  Identifies management contracts orcompensation plans or arrangements required to be filed as an exhibit hereto.

 

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**SIGNATURES**

** **

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized on the 26th day of August 2004.

 

**STEWART & STEVENSON SERVICES, INC**.

 

 
| By:                                         | /s/  Max L. Lukens |   |   |
|---------------------------------------------|-------------------------|--------|--------|
| Max  L. Lukens                              |                    |
| President  and Chief Executive Officer      |                    |
| (Principal  Executive Officer)              |                    |
|                                        |                    |
|                                        |                    |
| By:                                         | /s/  John B. Simmons    |   |   |
| John  B. Simmons                            |                    |
| Vice  President and Chief Financial Officer |                    |
| (Principal  Financial Officer)              |                    |
|                                        |                    |
|                                        |                    |
| By:                                         | /s/  L. Scott Biar      |   |   |
| L.  Scott Biar                              |                    |
| Controller  and Chief Accounting Officer    |                    |
| (Principal  Accounting Officer)             |                    |
|                                             |                         |        |        |  |  |

 

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**EXHIBIT INDEX**

 

 Exhibit Number and Description

 
| 3.2    |   | Seventh  Restated Bylaws of Stewart & Stevenson Services, Inc. effective July 9,  2004, as amended.                                                                                                              |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                 |
| 10.1   |   | Form  of Severance Agreement, dated as of July 19, 2004, by and between Stewart  & Stevenson Services, Inc. and Carl B.King, John B. Simmons, Stephen A.  Hines, Dennis M. Dellinger, Don Kyle and Mark Whitman. |
|   |   |                                                                                                                                                                                                                 |
| 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.                     |

 

27

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