Document:

Exhibit 10.2

 

SEVERANCE AGREEMENT

 

THIS
AGREEMENT, effective as of February 1, 2004, is made by and between
Stewart & Stevenson Services, Inc., a Texas corporation (the “Company”),
and Max L. Lukens (the “Executive”).

 

WHEREAS,
the Company considers it essential to the best interests of its stockholders to
foster the continued employment of key management personnel; and

 

WHEREAS,
the Board recognizes that, as is the case with many publicly held corporations,
the possibility of a Change in Control exists and that such possibility, and
the uncertainty and questions which it may raise among management, may result
in the departure or distraction of management personnel to the detriment of the
Company and its stockholders; and

 

WHEREAS,
the Board has determined that appropriate steps should be taken to reinforce
and encourage the continued attention and dedication of members of the
Company’s management, including the Executive, to their assigned duties without
distraction in the face of potentially disturbing circumstances arising from
the possibility of a Change in Control;

 

NOW,
THEREFORE, in consideration of the premises and the mutual covenants herein
contained, the Company and the Executive hereby agree as follows:

 

1.                                       Defined Terms.  The
definitions of capitalized terms used in this Agreement are provided in the
last Section hereof.

 

2.                                       Term of Agreement.  The
Term of this Agreement shall commence on the date hereof and shall continue in
effect through February 1, 2006.

 

3.                                       Company’s Covenants Summarized.  In order
to induce the Executive to remain in the employ of the Company and in
consideration of the Executive’s covenants set forth in Section 3 hereof,
the Company agrees, under the conditions described herein, to pay the Executive
the Severance Payments and the other payments and benefits described
herein.  Except as provided in
Section 8.1 hereof, no Severance Payments shall be payable under this
Agreement unless there shall have been (or, under the terms of the second
sentence of Section 5.1 hereof, there shall be deemed to have been) a
termination of the Executive’s employment with the Company following a Change
in Control and during the Term.  This
Agreement shall not be construed as creating an express or implied contract of
employment and, except as otherwise agreed in writing between the Executive and
the Company, the Executive shall not have any rights to be retained in the
employ of the Company.

 

4.                                       Compensation Other Than Severance Payments.

 

4.1                                 Following a Change in Control and during the
Term, during any period that the Executive fails to perform the Executive’s
duties with the Company as a result of incapacity due to physical or mental
illness, the Company shall pay the Executive’s full salary to the Executive at
the rate in effect at the commencement of any such period, together with all
compensation and benefits payable to the Executive under the terms of any
compensation or

 

 

benefit plan, program or arrangement maintained by the Company during
such period, until the Executive’s employment is terminated by the Company for
Disability.

 

4.2                                 If the Executive’s employment shall be
terminated for any reason following a Change in Control and during the Term,
the Company shall pay the Executive’s full salary to the Executive through the
Date of Termination at the rate in effect immediately prior to the Date of
Termination or, if higher, the rate in effect immediately prior to the first
occurrence of an event or circumstance constituting Good Reason, together with
all compensation and benefits payable to the Executive through the Date of
Termination under the terms of the Company’s compensation and benefit plans,
programs or arrangements as in effect immediately prior to the Date of
Termination or, if more favorable to the Executive, as in effect immediately
prior to the first occurrence of an event or circumstance constituting Good
Reason.

 

4.3                                 If the Executive’s employment shall be
terminated for any reason following a Change in Control and during the Term,
the Company shall pay to the Executive the Executive’s normal post-termination
compensation and benefits as such payments become due in accordance with
written plans.  Such post-termination
compensation and benefits shall be determined under, and paid in accordance
with, the Company’s retirement, insurance and other compensation or benefit
plans, programs and arrangements as in effect immediately prior to the Date of
Termination or, if more favorable to the Executive, as in effect immediately
prior to the occurrence of the first event or circumstance constituting Good
Reason.

 

4.4                                 Upon the occurrence of a Change in Control
all options to acquire shares of Company stock, all shares of restricted
Company stock and all other equity incentives held by the Executive under any
plan of the Company (including, but not limited to, the Company’s various stock
option plans) shall become immediately vested, exercisable and nonforfeitable
and all conditions thereof (including, but not limited to, any required holding
periods) shall be deemed to have been satisfied.

 

5.                                       Severance Payments.

 

5.1                                 If the Executive’s employment is terminated
following a Change in Control and during the Term, other than (A) by the
Company for Cause, (B) by reason of death or Disability, or (C) by the
Executive without Good Reason, then, the Company shall pay the Executive the
amounts, and provide the Executive the benefits, described in this
Section 5.1 (“Severance Payments”) and Section 5.2, in addition to
any payments and benefits to which the Executive is entitled under Section 4
hereof.  Solely for purposes of
determining whether termination occurred following a Change in Control pursuant
to this Agreement (and without any implication that a Change in Control has in
fact occurred), the Executive’s employment shall be deemed to have been terminated
following a Change in Control by the Company without Cause or by the Executive
with Good Reason, if (i) the Executive’s employment is terminated by the
Company without Cause prior to a Change in Control and such termination was at
the request, direction or suggestion, directly or indirectly, of a Person who
has entered into an agreement or with whom the Company contemplates will enter
into an agreement with the Company the consummation of which would constitute a
Change in Control or, (ii) the Executive terminates his employment for Good
Reason prior to a Change in Control and the circumstance or event which
constitutes Good Reason occurs at the request, direction or suggestion of such
Person

 

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described in clause (i).  For
purposes of any determination regarding the applicability of the immediately
preceding sentence, any position taken by the Executive shall be presumed to be
correct unless the Company establishes to the Committee by clear and convincing
evidence that such position is not correct.

 

(A)                              In lieu of any further salary payments to the
Executive for periods subsequent to the Date of Termination and in lieu of any
severance benefit otherwise payable to the Executive, the Company shall pay to
the Executive a lump sum severance payment, in cash, equal to $2,250,000.

 

(B)                                For the thirty-six (36) month period
immediately following the Date of Termination, the Company shall arrange to
provide the Executive and his dependents life, disability, accident and health
insurance benefits and perquisites (including, but not limited to, executive
life insurance, club memberships, financial planning and tax preparation,
annual physical examination and charitable contributions), in each case, substantially
similar to those provided to the Executive and his dependents immediately prior
to the Date of Termination or, if more favorable to the Executive, those
provided to the Executive and his dependents immediately prior to the first
occurrence of an event or circumstance constituting Good Reason, at no greater
cost to the Executive than the cost to the Executive immediately prior to such
date or occurrence; provided, however, that, unless the Executive consents to a
different method (after taking into account the effect of such method on the
calculation of “parachute payments” pursuant to Section 5.2 hereof), such
health insurance benefits shall be provided through a third-party insurer.  Benefits otherwise receivable by the
Executive pursuant to this Section 5.1(B) shall be reduced to the extent
benefits of the same type are received by the Executive under any individual or
group policy or program, or made available to the Executive under a group plan
whether by reason of the employment of the Executive or the employment of the
spouse of the Executive, during the thirty-six (36) month period following the
Executive’s termination of employment (and any such benefits received by or
made available to the Executive shall be reported to the Company by the Executive);
provided, however, that the Company shall reimburse the Executive for the
excess, if any, of the cost of such benefits to the Executive over such cost
immediately prior to the Date of Termination or, if more favorable to the
Executive, the first occurrence of an event or circumstance constituting Good
Reason.

 

(C)                                Notwithstanding any provision of that certain
Employment Agreement between the Company and the Executive effective as of
February 1, 2004 (the “Employment Agreement”), the Company shall pay to
the Executive a lump sum amount, in cash, equal to the aggregate value of the
contingent bonus award contemplated by Section 4(b) of the Employment
Agreement that the Executive would have earned as of the last day of the Base
Period (as defined in the Employment Agreement), assuming the achievement, at
the expected value target level, of the performance goals established with
respect to such award.

 

(D)                               The committee (as defined by the Stewart
& Stevenson Services, Inc. 1998 Nonstatutory Stock Option Plan) shall deem
the Executive’s termination of

 

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employment
as a retirement for purposes of the Stewart & Stevenson Services, Inc. 1998
Nonstatutory Stock Option Plan.

 

(E)                                 If a Change in Control occurs prior to
January 4, 2005 the Company shall pay to the Executive a lump sum payment,
in cash, equal to the Black-Scholes value, as reasonably determined by the
Company as of March 31, 2004, of an option to purchase 100,000 shares of
the Company’s common stock, assuming for this purpose the option was granted on
March 31, 2004, the per share exercise price under the option is $ 14.62,
the option has the same terms and conditions as applied to the option granted
by the Company to the Executive on March 31, 2004 (other than the number
of shares subject to the option), and the option remains outstanding for the
full ten year term; and utilizing the risk free interest rate, dividend yield,
and expected volatility assumptions used by the Company for purposes of valuing
stock options for its 2003 fiscal year as reflected in its fiscal year 2003
Form 10-K filed with the Securities and Exchange Commission.

 

5.2                                 (A)                              Whether or not the Executive becomes entitled to the Severance
Payments, if any of the payments or benefits received or to be received by the
Executive in connection with a Change in Control or the Executive’s termination
of employment (whether pursuant to the terms of this Agreement or any other
plan, arrangement or agreement with the Company, any Person whose actions
result in a Change in Control or any Person affiliated with the Company or such
Person) (such payments or benefits, excluding the Gross-Up Payment, being
hereinafter referred to as the “Total Payments”) will be subject to the Excise
Tax, the Company shall pay to the Executive an additional amount (the “Gross-Up
Payment”) such that the net amount retained by the Executive, after deduction
of any Excise Tax on the Total Payments and any federal, state and local income
and employment taxes and Excise Tax upon the Gross-Up Payment, shall be equal
to the Total Payments.

 

(B)                                For purposes of determining whether any of the Total Payments will be
subject to the Excise Tax and the amount of such Excise Tax, (i) all of the
Total Payments shall be treated as “parachute payments” (within the meaning of
section 280G(b)(2) of the Code) unless, in the opinion of tax counsel
(“Tax Counsel”) reasonably acceptable to the Executive and selected by the
accounting firm which was, immediately prior to the Change in Control, the
Company’s independent auditor (the “Auditor”), such payments or benefits (in
whole or in part) do not constitute parachute payments, including by reason of
section 280G(b)(4)(A) of the Code, (ii) all “excess parachute payments”
within the meaning of section 280G(b)(1) of the Code shall be treated as
subject to the Excise Tax unless, in the opinion of Tax Counsel, such excess
parachute payments (in whole or in part) represent reasonable compensation for
services actually rendered (within the meaning of section 280G(b)(4)(B) of
the Code) in excess of the Base Amount allocable to such reasonable
compensation, or are otherwise not subject to the Excise Tax, and (iii) the
value of any noncash benefits or any deferred payment or benefit shall be
determined by the Auditor in accordance with the principles of
section 280G(d)(3) and (4) of the Code. 
For purposes of determining the amount of the Gross-Up Payment, the
Executive shall be deemed to pay federal income tax at the highest marginal
rate of federal income taxation in the calendar year in which the Gross-Up
Payment is to be made and state and local income taxes at the highest marginal
rate of

 

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taxation
in the state and locality of the Executive’s residence on the Date of
Termination (or if there is no Date of Termination, then the date on which the
Gross-Up Payment is calculated for purposes of this Section 5.2), net of
the maximum reduction in federal income taxes which could be obtained from
deduction of such state and local taxes.

 

(C)                                In the event that the Excise Tax is finally determined to be less than
the amount taken into account hereunder in calculating the Gross-Up Payment,
the Executive shall repay to the Company, within five (5) business days following
the time that the amount of such reduction in the Excise Tax is fully
determined, the portion of the Gross-Up Payment”) attributable to such
reduction (plus that portion of the Gross-Up Payment attributable to the Excise
Tax and federal, state and local income and employment taxes imposed on the
Gross-Up Payment being repaid by the Executive, to the extent that such
repayment results in a reduction in the Excise Tax and a dollar-for-dollar
reduction in the Executive’s taxable income and wages for purposes of federal,
state and local income and employment taxes, plus interest on the amount of
such repayment at 120% of the rate provided in section 1274(b)(2)(B) of
the Code.  In the event that the Excise
Tax is determined to exceed the amount taken into account hereunder in
calculating the Gross-Up Payment (including by reason of any payment the
existence or amount of which cannot be determined at the time of the Gross-Up
Payment), the Company shall make an additional Gross-Up Payment in respect of
such excess (plus any interest, penalties or additions payable by the Executive
with respect to such excess) within five (5) business days following the time
that the amount of such excess is finally determined.  The Executive and the Company shall each reasonably cooperate
with the other in connection with any administrative or judicial proceedings
concerning the existence or amount of liability for Excise Tax with respect to
the Total Payments.

 

5.3                                 The payments provided in subsection (A)
and (C) of Section 5.1 hereof and in Section 5.2 hereof shall be made
not later than the fifth day following the Date of Termination; provided,
however, that if the amounts of such payments cannot be finally determined on
or before such day, the Company shall pay to the Executive on such day an
estimate, as determined in good faith by the Executive or, in the case of
payments under Section 5.2 hereof, in accordance with Section 5.2
hereof, of the minimum amount of such payments to which the Executive is
clearly entitled and shall pay the remainder of such payments (together with
interest on the unpaid remainder (or on all such payments to the extent the
Company fails to make such payments when due) at 120% of the rate provided in
section 1274(b)(2)(B) of the Code) as soon as the amount thereof can be
determined but in no event later than the thirtieth (30th) day after the Date
of Termination.  In the event that the
amount of the estimated payments exceeds the amount subsequently determined to
have been due, such excess shall constitute a loan by the Company to the
Executive, payable on the fifth (5th) business day after demand by the Company
(together with interest at 120% of the rate provided in
section 1274(b)(2)(B) of the Code), but only to the extent such amount has
not been paid by the Executive pursuant to Section 5.2(C) above.  At the time that payments are made under
this Agreement, the Company shall provide the Executive with a written
statement setting forth the manner in which such payments were calculated and
the basis for such calculations including, without limitation, any opinions or
other advice the Company has received from Tax Counsel, the Auditor or other
advisors or

 

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consultants (and any such opinions or advice which are in writing shall
be attached to the statement).

 

5.4                                 If the Executive’s employment with the
Company is terminated following a Change in Control and during the Term, the
Company shall pay to the Executive all legal fees and expenses incurred by the
Executive in disputing in good faith any issue hereunder relating to the
termination of the Executive’s employment, in seeking in good faith to obtain
or enforce any benefit or right provided by this Agreement or in connection
with any tax audit or proceeding to the extent attributable to the application
of section 4999 of the Code to any payment or benefit provided
hereunder.  Such payments shall be made
within five (5) business days after delivery of the Executive’s written
requests for payment accompanied with such evidence of fees and expenses
incurred as the Company reasonably may require.

 

6.                                       Termination Procedures and Compensation
During Dispute.

 

6.1                                 Notice of Termination. 
After a Change in Control and during the Term, any purported termination
of the Executive’s employment (other than by reason of death) shall be
communicated by written Notice of Termination from one party hereto to the
other party hereto in accordance with Section 9 hereof.  For purposes of this Agreement, a “Notice of
Termination” shall mean a notice which shall indicate the specific termination
provision in this Agreement relied upon and shall set forth in reasonable
detail the facts and circumstances claimed to provide a basis for termination
of the Executive’s employment under the provision so indicated.  Further, a Notice of Termination for Cause
is required to include a copy of a resolution duly adopted by the affirmative
vote of not less than three-quarters (3/4) of the Committee at a meeting of the
Committee which was called and held for the purpose of considering such
termination (after reasonable notice to the Executive and an opportunity for
the Executive, together with the Executive’s counsel, to be heard before the
Committee) finding on clear and convincing evidence and the good faith opinion
of the Committee, the Executive’s employment was terminated for Cause, and
specifying the particulars thereof in detail.

 

6.2                                 Date of Termination. 
“Date of Termination,” with respect to any purported termination of the
Executive’s employment after a Change in Control and during the Term, shall
mean (i) if the Executive’s employment is terminated for Disability, thirty
(30) days after Notice of Termination is given (provided that the Executive
shall not have returned to the full-time performance of the Executive’s duties
during such thirty (30) day period), and (ii) if the Executive’s employment is
terminated for any other reason, the date specified in the Notice of
Termination (which, in the case of a termination for Cause and, in the case of
a termination by the Executive, shall not be less than fifteen (15) days nor
more than sixty (60) days, respectively, from the date such Notice of
Termination is given).

 

6.3                                 Dispute Concerning Termination.  If
within fifteen (15) days after any Notice of Termination is given following a
Change in Control, or, if later, prior to the Date of Termination (as
determined without regard to this Section 6.3), the party receiving such
Notice of Termination notifies the other party that a dispute exists concerning
the termination, the Date of Termination shall be extended until the earlier of
(i) the date on which the Term ends or (ii) the date on which the dispute is
finally resolved, either by mutual written agreement of the parties or by a
final judgment, order or decree of an arbitrator or a court of competent
jurisdiction

 

6

 

(which is not appealable or with respect to which the time for appeal
therefrom has expired and no appeal has been perfected); provided, however,
that the Date of Termination shall be extended by a notice of dispute only if
such notice is given in good faith and the party giving notice pursues the
resolution of such dispute with reasonable diligence.

 

6.4                                 Compensation During Dispute.  If
a purported termination occurs following a Change in Control and during the
Term and the Date of Termination is extended in accordance with
Section 6.3 hereof, the Company shall continue to pay the Executive the
full compensation in effect when the notice giving rise to the dispute was
given (including, but not limited to, salary) and continue the Executive as a
participant in all compensation, benefit and insurance plans in which the
Executive was participating when the notice giving rise to the dispute was
given or those plans in which the Executive was participating immediately prior
to the first occurrence of an event or circumstance giving rise to the Notice
of Termination, if more favorable to the Executive, until the Date of
Termination, as determined in accordance with Section 6.3 hereof.  Amounts paid under this Section 6.4 are
in addition to all other amounts due under this Agreement (other than those due
under Section 4.2 hereof) and shall not be offset against or reduce any
other amounts due under this Agreement.

 

7.                                       No Mitigation.  The
Company agrees that, if the Executive’s employment with the Company terminates
during the Term, the Executive is not required to seek other employment or to
attempt in any way to reduce any amounts payable to the Executive by the
Company pursuant to Sections 4, 5 or 6.4 hereof.  Further, the amount of any payment or benefit provided for in
this Agreement (other than Section 5.1(B) hereof but including (but not
limited to) Section 6.4 hereof) shall not be reduced by any compensation
earned by the Executive as the result of employment by another employer, by
retirement benefits, by offset against any amount claimed to be owed by the
Executive to the Company, or otherwise.

 

8.                                       Successors; Binding Agreement.

 

8.1                                 In addition to any obligations imposed by law
upon any successor to the Company, the Company will require any successor
(whether direct or indirect, by purchase, merger, consolidation or otherwise)
to all or substantially all of the business and/or assets of the Company to
expressly assume and agree to perform this Agreement in the same manner and to
the same extent that the Company would be required to perform it if no such
succession had taken place.  Failure of
the Company to obtain such assumption and agreement prior to the effectiveness
of any such succession shall be a breach of this Agreement and shall entitle
the Executive to compensation from the Company in the same amount and on the
same terms as the Executive would be entitled to hereunder if the Executive
were to terminate the Executive’s employment for Good Reason after a Change in
Control, except that, for purposes of implementing the foregoing, the date on
which any such succession becomes effective shall be deemed the Date of
Termination.

 

8.2                                 This Agreement shall inure to the benefit of
and be enforceable by the Executive’s personal or legal representatives,
executors, administrators, successors, heirs, distributees, devisees and
legatees.  If the Executive shall die
while any amount would still be payable to the Executive hereunder (other than
amounts which, by their terms, terminate upon the death of the Executive) if
the Executive had continued to live, all such amounts, unless

 

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otherwise provided herein, shall be paid in accordance with the terms
of this Agreement to the executors, personal representatives or administrators
of the Executive’s estate.

 

9.                                       Notices.  For the purpose of this
Agreement, notices and all other communications provided for in the Agreement
shall be in writing and shall be deemed to have been duly given when delivered
or mailed by United States registered mail, return receipt requested, postage
prepaid, addressed, if to the Executive, to the address inserted below the Executive’s
signature on the final page hereof and, if to the Company, to the address set
forth below, or to such other address as either party may have furnished to the
other in writing in accordance herewith, except that notice of change of
address shall be effective only upon actual receipt:

 

To the Company:

 

Stewart
& Stevenson Services, Inc.

2707 North Loop West

Houston, Texas   77008-1088

 

Attention:  Secretary

 

10.                                 Miscellaneous.  No
provision of this Agreement may be modified, waived or discharged unless such
waiver, modification or discharge is agreed to in writing and signed by the
Executive and such officer as may be specifically designated by the
Committee.  No waiver by either party
hereto at any time of any breach by the other party hereto of, or of any lack
of compliance with, any condition or provision of this Agreement to be
performed by such other party shall be deemed a waiver of similar or dissimilar
provisions or conditions at the same or at any prior or subsequent time.  This Agreement supersedes any other
agreements or representations, oral or otherwise, express or implied, with
respect to the subject matter hereof which have been made by either party,
provided, however, that this Agreement shall supersede any agreement setting
forth the terms and conditions of the Executive’s employment with the Company
only in the event that the Executive’s employment with the Company is
terminated on or following a Change in Control, by the Company other than for
Cause or by the Executive other than for Good Reason; and provided further that
all agreements otherwise superseded by this Agreement shall be automatically
reinstated with full force and effect to the extent this Agreement is
terminated.  The validity, interpretation,
construction and performance of this Agreement shall be governed by the laws of
the State of Texas.  All references to
sections of the Exchange Act or the Code shall be deemed also to refer to any
successor provisions to such sections. 
Any payments provided for hereunder shall be paid net of any applicable
withholding required under federal, state or local law and any additional
withholding to which the Executive has agreed. 
The obligations of the Company and the Executive under this Agreement
which by their nature may require either partial or total performance after the
expiration of the Term (including, without limitation, those under Sections 5
and 6 hereof) shall survive such expiration.

 

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11.                                 Validity.  The invalidity or unenforceability
of any provision of this Agreement shall not affect the validity or
enforceability of any other provision of this Agreement, which shall remain in
full force and effect.

 

12.                                 Counterparts. 
This Agreement may be executed in several counterparts, each of which
shall be deemed to be an original but all of which together will constitute one
and the same instrument.

 

13.                                 Settlement of Disputes; Arbitration.

 

13.1                           All claims by the Executive for benefits
under this Agreement shall be directed to and determined by the Committee and
shall be in writing.  Any denial by the
Committee of a claim for benefits under this Agreement shall be delivered to
the Executive in writing within thirty (30) days after written notice of the
claim is provided to the Company in accordance with Section 10 and shall
set forth the specific reasons for the denial and the specific provisions of
this Agreement relied upon.  The
Committee shall afford a reasonable opportunity to the Executive for a review
of the decision denying a claim and shall further allow the Executive to appeal
to the Committee a decision of the Committee within sixty (60) days after
notification by the Committee that the Executive’s claim has been denied.

 

13.2                           Any further dispute or controversy arising
out of or relating to this Agreement, including without limitation, any and all
disputes, claims (whether in tort, contract, statutory or otherwise), breaches
or disagreements concerning the interpretation or application of the provisions
of this Agreement shall be resolved by arbitration before a panel of three
arbitrators and administered by the American Arbitration Association (“AAA”)
under its Commercial Arbitration Rules then in effect.  No arbitration proceeding relating to this
Agreement may be initiated by either the Company or the Executive unless the
claims review and appeals procedures specified in Section 13.1 have been
exhausted.  Within ten (10) business
days of the initiation of an arbitration hereunder, the Company and the
Executive will each separately designate an arbitrator, and within twenty (20)
business days of selection, the appointed arbitrators will appoint a neutral
arbitrator.  All arbitrators shall be
members of the National Panel of Commercial Arbitrators maintained by the
AAA.  The arbitrators shall issue their
written decision (including a statement of finding of facts) within thirty (30)
days from the date of the close of the arbitration hearing.  The decision of the arbitrators selected
hereunder will be final and binding on both parties.  This arbitration provision is expressly made pursuant to and
shall be governed by the Federal Arbitration Act, 9 U.S.C. Sections 1-16 (or
replacement or successor statute). 
Pursuant to Section 9 of the Federal Arbitration Act, the Company
and the Executive agree that a judgment of the United States District Court for
the Southern District of Texas may be entered upon the award made pursuant to
the arbitration.

 

14.                                 Definitions.  For purposes of this
Agreement, the following terms shall have the meanings indicated below:

 

(A)                              “Affiliate” shall have the meaning set forth
in Rule 12b-2 promulgated under Section 12 of the Exchange Act.

 

(B)                                “Auditor” shall have the meaning set forth in
Section 5.2 hereof.

 

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(C)                                “Base Amount” shall have the meaning set
forth in section 280G(b)(3) of the Code.

 

(D)                               “Beneficial Owner” shall have the meaning set
forth in Rule 13d-3 under the Exchange Act.

 

(E)                                 “Board” shall mean the Board of Directors of
the Company.

 

(F)                                 “Cause” for termination by the Company of the
Executive’s employment shall mean (i) the willful and continued failure by the
Executive to substantially perform the Executive’s duties with the Company
(other than any such failure resulting from the Executive’s incapacity due to
physical or mental illness or any such actual or anticipated failure after the
issuance of a Notice of Termination for Good Reason by the Executive pursuant
to Section 6.1 hereof) after a written demand for substantial performance
is delivered to the Executive by the Board, which demand specifically
identifies the manner in which the Board believes that the Executive has not
substantially performed the Executive’s duties, or (ii) the willful engaging by
the Executive in conduct which is demonstrably and materially injurious to the
Company or its subsidiaries, monetarily or otherwise.  For purposes of clauses (i) and (ii) of this definition, (x) no
act, or failure to act, on the Executive’s part shall be deemed “willful”
unless done, or omitted to be done, by the Executive not in good faith and
without reasonable belief that the Executive’s act, or failure to act, was in
the best interest of the Company and (y) the Executive has received written
notice from the Company of the specific conduct asserted as Cause for
termination and has thirty (30) business days to remedy any such occurrence
otherwise constituting Cause.

 

(G)                                A “Change in Control” shall be deemed to have
occurred if the event set forth in any one of the following paragraphs shall
have occurred:

 

(I)                                    any Person is or becomes the Beneficial
Owner, directly or indirectly, of securities of the Company (not including in
the securities beneficially owned by such Person any securities acquired
directly from the Company or its affiliates) representing 35% or more of the
combined voting power of the Company’s then outstanding securities, excluding
any Person who becomes such a Beneficial Owner in connection with a transaction
described in clause (i) of paragraph (III) below; or

 

(II)                                the following individuals cease for any
reason to constitute a majority of the number of directors then serving:
individuals who, on the date hereof, constitute the Board and any new director
(other than a director whose initial assumption of office is in connection with
an actual or threatened election contest relating to the election of directors
of the Company) whose appointment or election by the Board or nomination for
election by the Company’s stockholders was approved or recommended by a vote of
at least two-thirds (2/3) of the directors then still in office who either were
directors on the date hereof or whose appointment, election or nomination for
election was previously so approved or recommended; or

 

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(III)                            there is consummated a merger or
consolidation of the Company or any direct or indirect subsidiary of the
Company with any other corporation, other than (i) a merger or consolidation
that would result in the voting securities of the Company outstanding
immediately prior to such merger or consolidation continuing to represent
(either by remaining outstanding or by being converted into voting securities
of the surviving entity or any parent thereof), in combination with the
ownership of any trustee or other fiduciary holding securities under an
employee benefit plan of the Company or any subsidiary of the Company, at least
51% of the combined voting power of the securities of the Company or its parent
outstanding immediately after such merger or consolidation, or (ii) a merger or
consolidation effected to implement a recapitalization of the Company (or
similar transaction) in which no Person is or becomes the Beneficial Owner,
directly or indirectly, of securities of the Company (not including in the securities
Beneficially Owned by such Person any securities acquired directly from the
Company or its Affiliates other than in connection with the acquisition by the
Company or its Affiliates of a business) representing at least 51% or more of
the combined voting power of the Company’s then outstanding securities; or

 

(IV)                            the stockholders of the Company approve a
plan of complete liquidation or dissolution of the Company or there is
consummated an agreement for the sale or disposition by the Company of all or
substantially all of the Company’s assets, other than a sale or disposition by
the Company of all or substantially all of the Company’s assets to an entity,
at least 51% of the combined voting power of the voting securities of which are
owned by stockholders of the Company in substantially the same proportions as
their ownership of the Company immediately prior to such sale.  For purposes of this Agreement, it is
contemplated that a sale of substantially all of the assets of the Company
shall not be deemed to occur unless at least 75% of the book value (as stated
in the Company’s most recent audited financial statements) of the Company’s
total assets is disposed of in a single transaction.

 

Notwithstanding
the foregoing, a “Change in Control” shall not be deemed to have occurred by
virtue of the consummation of any transaction or series of integrated
transactions immediately following which the record holders of the common stock
of the Company immediately prior to such transaction or series of transactions
continue to have substantially the same proportionate ownership in an entity
which owns all or substantially all of the assets of the Company immediately
following such transaction or series of transactions.

 

(H)                               “Code” shall mean the Internal Revenue Code
of 1986, as amended from time to time.

 

(I)                                    “Committee” shall mean (i) the individuals
(not fewer than three in number) who, on the date six months before a Change in
Control, constitute the Compensation Committee of the Board, plus (ii) in the
event that fewer than three individuals are available from the group specified
in clause (i) above for any reason, such

 

11

 

individuals
as may be appointed by the individual or individuals so available (including for
this purpose any individual or individuals previously so appointed under this
clause (ii)); provided, however, that the maximum number of individuals
constituting the Committee shall not exceed six (6).

 

(J)                                   “Company” shall mean Stewart & Stevenson
Services, Inc. and, except in determining under Section 15(G) hereof
whether or not any Change in Control of the Company has occurred, shall include
any successor to its business and/or assets which assumes and agrees to perform
this Agreement by operation of law, or otherwise.

 

(K)                               “Date of Termination” shall have the meaning
set forth in Section 6.2 hereof.

 

(L)                                 “Disability” shall be deemed the reason for
the termination by the Company of the Executive’s employment, if, as a result
of the Executive’s incapacity due to physical or mental illness, the Executive
shall have been absent from the full-time performance of the Executive’s duties
with the Company for a period of six (6) consecutive months, the Company shall
have given the Executive a Notice of Termination for Disability, and, within
thirty (30) days after such Notice of Termination is given, the Executive shall
not have returned to the full-time performance of the Executive’s duties.

 

(M)                            “Exchange Act” shall mean the Securities
Exchange Act of 1934, as amended from time to time.

 

(N)                               “Excise Tax” shall mean any excise tax
imposed under section 4999 of the Code.

 

(O)                               “Executive” shall mean the individual named
in the first paragraph of this Agreement.

 

(P)                                 “Extension Date” shall have the meaning set
forth in Section 2 hereof.

 

(Q)                               “Good Reason” for termination by the
Executive of the Executive’s employment shall mean the occurrence (without the
Executive’s express written consent) after any Change in Control, or prior to a
Change in Control under the circumstances described in clause (ii) of the
second sentence of Section 5.1 hereof of any one of the following acts by
the Company, or failures by the Company to act, unless, in the case of any act
or failure to act described in paragraph (I), (V), (VI) or (VII) below, such
act or failure to act is corrected prior to the Date of Termination specified
in the Notice of Termination given in respect thereof:

 

(I)                                    the assignment to the Executive of any duties
inconsistent with the Executive’s status as a senior executive officer of the
Company or a substantial adverse alteration in the nature or status of the
Executive’s responsibilities from those in effect immediately prior to the
Change in Control;

 

12

 

(II)                                a reduction by the Company in the Executive’s
annual base salary as in effect on the date hereof or as the same may be
increased from time to time except for across-the-board salary reductions
similarly affecting all senior executives of the Company and all senior
executives of any Person in control of the Company;

 

(III)                            the relocation of the Executive’s principal
place of employment to a location more than 50 miles from the Executive’s
principal place of employment immediately prior to the Change in Control or the
Company’s requiring the Executive to be based anywhere other than such
principal place of employment (or permitted relocation thereof) except for
required travel on the Company’s business to an extent substantially consistent
with the Executive’s present business travel obligations;

 

(IV)                            the failure by the Company to pay to the
Executive any portion of the Executive’s current compensation except pursuant
to an across-the-board compensation deferral similarly affecting all senior
executives of the Company and all senior executives of any Person in control of
the Company, or to pay to the Executive any portion of an installment of
deferred compensation under any deferred compensation program of the Company,
within seven (7) days of the date such compensation is due;

 

(V)                                the failure by the Company to continue in
effect any compensation plan in which the Executive participates immediately
prior to the Change in Control which is material to the Executive’s total
compensation, including but not limited to the Company’s stock option plans or
any substitute plans adopted prior to the Change in Control, unless an
equitable arrangement (embodied in an ongoing substitute or alternative plan)
has been made with respect to such plan, or the failure by the Company to continue
the Executive’s participation therein (or in such substitute or alternative
plan) on a basis not materially less favorable, both in terms of the amount or
timing of payment of benefits provided and the level of the Executive’s
participation relative to other participants, as existed immediately prior to
the Change in Control;

 

(VI)                            the failure by the Company to continue to
provide the Executive with benefits substantially similar to those enjoyed by
the Executive under any of the Company’s pension, savings, life insurance,
medical, health and accident, or disability plans in which the Executive was
participating immediately prior to the Change in Control (except for across the
board changes similarly affecting all senior executives of the Company and all
senior executives of any Person in control of the Company), the taking of any
other action by the Company which would directly or indirectly materially
reduce any of such benefits or deprive the Executive of any material fringe
benefit or perquisite enjoyed by the Executive at the time of the Change in
Control, or the failure by the Company to provide the Executive with the number
of paid vacation days to which the Executive is entitled on the basis of years
of service with the Company in

 

13

 

accordance
with the Company’s normal vacation policy in effect at the time of the Change
in Control; or

 

(VII)                        any purported termination of the Executive’s
employment which is not effected pursuant to a Notice of Termination satisfying
the requirements of Section 6.1 hereof; for purposes of this Agreement, no
such purported termination shall be effective.

 

The Executive’s right to terminate the Executive’s employment for Good
Reason shall not be affected by the Executive’s incapacity due to physical or
mental illness.  The Executive’s
continued employment shall not constitute consent to, or a waiver of rights
with respect to, any act or failure to act constituting Good Reason hereunder.

 

For purposes of any determination regarding the existence of Good
Reason, any claim by the Executive that Good Reason exists shall be presumed to
be correct unless the Company establishes to the Committee by clear and
convincing evidence that Good Reason does not exist.

 

(R)                                “Gross-Up Payment” shall have the meaning set
forth in Section 5.2 hereof.

 

(S)                                 “Notice of Termination” shall have the
meaning set forth in Section 6.1 hereof.

 

(T)                                “Person” shall have the meaning given in
Section 3(a)(9) of the Exchange Act, as modified and used in Sections
13(d) and 14(d) thereof, except that such term shall not include (i) the
Company or any of its subsidiaries, (ii) a trustee or other fiduciary holding
securities under an employee benefit plan of the Company or any of its
Affiliates, (iii) an underwriter temporarily holding securities pursuant to an
offering of such securities, or (iv)a corporation owned, directly or
indirectly, by the stockholders of the Company in substantially the same
proportions as their ownership of stock of the Company.

 

(U)                               “Plan” shall have the meaning set forth in
Section 5.1 hereof.

 

(V)                                “Severance Payments” shall have the meaning
set forth in Section 5.1 hereof.

 

(W)                           “Tax Counsel” shall have the meaning set
forth in Section 5.2 hereof.

 

(X)                               “Term” shall mean the period of time
described in Section 2 hereof.

 

(Y)                                “Total Payments” shall mean those payments so
described in Section 5.2 hereof.

 

14

 

IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the date above first written.

 

	
   

  	
  STEWART
  & STEVENSON SERVICES, INC.

  
	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  By:

  	
  /s/ Carl B. King

  
	
   

  	
   

  	
  Carl B. King

  
	
   

  	
   

  	
  Senior Vice President, Secretary,

  and General Counsel

  
	
   

  	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  EXECUTIVE:

  
	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  /s/ Max L. Lukens

  
	
   

  	
  Max L. Lukens

  
	
   

  	
  3415 Albans

  Houston, Texas 77005

  

 

15Exhibit
10.3

 

STEWART & STEVENSON SERVICES,
INC.

NONQUALIFIED STOCK OPTION AGREEMENT

 

THIS
AGREEMENT, made and entered into as of March 31,
2004 (the “Grant
Date”), is between Stewart & Stevenson Services, Inc., a
Texas corporation (hereinafter called the “Company”) and Max L. Lukens (hereinafter
called the “Employee”).

 

WHEREAS,
the Company has determined that its interests will be advanced by providing an
incentive to the Employee to acquire a proprietary interest in the Company and,
as a stockholder, to share in its success, with added incentive to work
effectively for and in the Company’s interest;

 

NOW
THEREFORE, in consideration of the mutual promises
hereafter set forth and for other good and valuable consideration, the parties
hereby agree as follows:

 

1.                                      Grant.  Pursuant to the provisions of the Stewart
& Stevenson Services, Inc. 1988 Nonstatutory Stock Option Plan (the “Plan”)
the Company hereby grants to the Employee, subject to the terms and conditions
of the Plan and subject further to the terms and conditions herein set forth,
the right and option (the “Option”) to purchase from the Company, all
or any part of 200,000 shares of Common Stock, without par value, of the
Company  (the “Stock”) at the purchase
price of $14.62 per share, subject to adjustment as provided in the Plan.

 

2.                                      Expiration
of Option.  The Option shall
terminate and become null and void upon the earliest to occur of (1) the tenth
anniversary of the Grant Date, (2) the 30th day after the severance
of the employment relationship between the Employee and the Company and all of
its affiliates for any reason other than death, Disability, Retirement, or for
Cause, (3) the first anniversary of the severance of the employment
relationship between the Employee and the Company and all of its affiliates due
to death, Disability or Retirement, or (4) the date of the severance of the
employment relationship between the Employee and the Company and all of its
affiliates for Cause.   In the event of
the  severance of the employment  relationship between the Employee and the
Company and all of its affiliates for any reason other than death, Disability,
Retirement or Cause, the Option shall not continue to vest after such severance
of employment.

 

3.                                      Vesting
of Option.

 

The Option is exercisable in accordance with
the following schedule:

 

(i)                                     on
the first anniversary of the Grant Date, the Option may be exercised with
respect to up to fifty percent (50%) of the shares subject to the Option; and

 

(ii)                                  on
the second anniversary of the Grant Date the Option shall be exercisable in
full.

 

Notwithstanding the foregoing, upon the
death, Disability or Retirement of the Employee prior to the expiration of the
Option, the Option shall be exercisable in full.

 

 

Further, notwithstanding the foregoing or any
provision of the Plan, upon the occurrence of a “change in control” (as defined
in the Severance Agreement between the Company and the Employee dated effective
as of February 1, 2004) prior to the expiration of the Option, the Option
shall be exercisable in full.

 

Further, notwithstanding the foregoing or any
provision of the Plan, upon the termination of the Employee’s employment by the
Company other than for “cause” or by the Employee for “good reason” (as such
terms are defined in the Employment Agreement between the Company and the
Employee dated effective as of February 1, 2004) prior to the expiration
of the Option, the Option shall be exercisable in full.

 

4.                                      Certain
Terminations Agreed to Constitute Retirement.  Any termination of the Employee’s employment by the Company other
than for “cause” or by the Employee for “good reason” (as such terms are
defined in the Employment Agreement between the Company and the Employee dated
effective as of February 1, 2004) prior to the expiration of the Option
shall be treated as a Retirement for all purposes of the Plan and this
Agreement.

 

5.                                      Manner
of Exercise.  The Employee shall
exercise the Option by written notice to the Company specifying the number of
shares as to which the Option is being exercised.

 

6.                                      Payment
of Purchase Price Upon Exercise.  At
the time of any exercise, the purchase price of the shares as to which the
Option is exercised shall be paid to the Company in cash or with Stock already
owned by the Employee for at least six months (‘Mature Shares”) having a
total fair market value, as determined by the Committee appointed pursuant to
paragraph 3 of the Plan, equal to the purchase price, or a combination of cash
and Mature Shares having a total fair market value, as so determined, equal to
the purchase price.

 

7.                                      Transfer.  The Option shall not be transferable other
than by will or by the laws of descent and distribution and may not be pledged,
hypothecated, encumbered, garnished, attached, executed on or levied against.  During the lifetime of the Employee, the
Option shall be exercisable only by the Employee.

 

8.                                      Adjustments.  In the event of any change in the Stock of
the Company by reason of any stock dividend, recapitalization, reorganization,
merger, consolidation, split-up, combination or exchange of shares, or any
rights offering to purchase Stock at a price substantially below fair market
value, or of any similar change affecting the Stock, the number and kind of
shares subject to the Option and their purchase price per share shall be appropriately
adjusted consistent with such change in such manner as the Committee may deem
equitable to prevent substantial dilution or enlargement of the rights granted
to the Employee hereunder.  Any
adjustment so made shall be final and binding upon the Employee.

 

9.                                      No
Rights as Stockholder.  The Employee
shall have no rights as a stockholder with respect to any shares of Stock
subject to the Option prior to the date of exercise and payment for such
shares.

 

2

 

10.                               No
Right to Continued Employment.  The
Option shall not confer upon the Employee any right with respect to continuance
of employment by the Company, nor shall it interfere in any way with the right
of his employer to terminate the Employee’s employment at any time.

 

11.                               Compliance
with Laws and Regulations.  The
Option, and the obligation of the Company to sell and deliver shares hereunder,
shall be subject to all applicable federal and state laws, rules and
regulations and to such approvals by any government or regulatory agency as may
be required.  The Company shall not be
required to issue or deliver any certificates for shares of Stock prior to (i)
the listing of such shares on any stock exchange on which the Stock may then be
listed; and (ii) the completion of any registration or qualification of such
shares under any federal or state law, or any rule or regulation of any
government body which the Company shall, in its sole discretion, determine to
be necessary or advisable.  Moreover,
the Option may not be exercised if its exercise or the receipt of shares of
Stock pursuant thereto, would be contrary to applicable law.

 

12.                               Investment
Representation.  The Committee may
require the Employee to furnish to the Company, prior to the issuance of any
shares upon the exercise of all or any part of the Option, an agreement (in
such form as the Committee may specify) in which the Employee represents that
the shares acquired by him upon exercise are being acquired for investment and
not for resale or with a view to distribution thereof.

 

13.                               Withholding
Taxes.  The Company may directly or
indirectly withhold all federal, state, city or other taxes as a result of the
Employee’s exercise of the Option.

 

In order to provide for the necessary
withholding under this Agreement, the Company will deduct the additional amount
of withholding required from the Employee’s salary unless the Employee makes
other provision in accordance with this Agreement.  The Employee has an option to provide the Company with the necessary
funds for this purpose or advising the Company that the Employee will accept a
reduction in the amount of Stock due equal to the amount of withholding
required.

 

The Company will advise the Employee at the
appropriate time when the additional withholding funds are required so that the
Employee can provide for the necessary funds or advise the Company that the
Employee will accept a reduction in the amount of Stock due.

 

If a reduction in Stock is requested, the
Company may deliver only the number of whole shares remaining after the
withholding has been accomplished.

 

14.                               Binding
Terms.  The Employee hereby
acknowledges receipt of a copy of the Plan and agrees to be bound by all the
terms and provisions thereof, including the terms and provisions adopted after
the granting of the Option but prior to the complete exercise hereof.  This Agreement shall be binding upon, and
shall inure to the benefit of, the Employee and the Company and their
respective permitted successors, assigns, heirs, beneficiaries, and
representatives.  All capitalized terms
in this Agreement that are not specifically defined herein shall have the
meanings set forth in the Plan.

 

3

 

15.                               Notices.  All notices, requests, demands, and other
communications required or permitted hereunder shall be given in writing.

 

16.                               Headings
of No Effect.  The
section headings contained in this Agreement are included solely for
convenience of reference and shall not in any way affect the meaning or interpretation
of any of the provisions of the Agreement.

 

17.                               Counterparts.  This Agreement may be executed in two (2)
counterparts, each of which shall constitute one and the same instrument.

 

18.                               Governing
Law.  This Agreement has been
executed and delivered in the State of Texas and its validity, interpretation,
performance, and enforcement shall be governed by the laws of that state.  If any provisions of this instrument shall
be held by a court of competent jurisdiction to be invalid or unenforceable,
the remaining provisions hereof shall continue to be fully effective.  In the event the Company determines that an
adverse claim exists to payments to be made pursuant to this Agreement, the
Company shall have the right, but not the obligation, to interplead the parties
with claims to such payments and recover reasonable attorney fees and court
costs from interplead funds.

 

IN
WITNESS WHEREOF, this Agreement has been duly executed
and delivered to be effective as of the Grant Date.

 

 

	
   

  	
  STEWART & STEVENSON SERVICES, INC.

  
	
   

  	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  By:

  	
   
  /s/ Carl B. King

  	
   

  
	
   

  	
   

  
	
  ACCEPTED:

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
    /s/ Max L. Lukens

  	
   

  	
   

  	
   

  
	
  Max L. Lukens

  	
   

  	
   

  	
   

  
						

 

4

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