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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
   Form 10-Q  (MARK
ONE)x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004ORo
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934FOR THE TRANSITION PERIOD FROM __________________ TO __________________.
 Commission File No. 1-13071   Hanover Compressor Company (Exact name of registrant as specified in its charter)
 
 Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
    
    76-0625124
(I.R.S. Employer
Identification No.)
 12001 North Houston Rosslyn, Houston, Texas
(Address of principal executive offices)
    
    77086
(Zip Code)
 (281) 447-8787
(Registrants telephone number, including area code)   Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes x No o Number of shares of the Common Stock of the registrant outstanding as of April
30, 2004: 85,536,100 shares.




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TABLE OF CONTENTS Part I. Financial InformationITEM 1. FINANCIAL STATEMENTSCONDENSED CONSOLIDATED BALANCE SHEETCONDENSED CONSOLIDATED STATEMENT OF OPERATIONSCONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWSNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONSITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 4. CONTROLS AND PROCEDURESPART II. OTHER INFORMATIONITEM 1. LEGAL PROCEEDINGSITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIESITEM 3. DEFAULT UPON SENIOR SECURITIESITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSITEM 5. OTHER INFORMATIONITEM 6: EXHIBITS AND REPORTS ON FORM 8-KSIGNATURESEXHIBIT INDEXPromissory Note & IndentureComputation of Ratio of Earnings to Fixed ChargesCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
  2




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Part I. Financial Information 
 ITEM 1. FINANCIAL STATEMENTS HANOVER COMPRESSOR COMPANY 
 CONDENSED CONSOLIDATED BALANCE SHEET
   March 31,
    
    December 31,2004
    
    2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    30,081
    
    
    $
    56,619Restricted cashsecurities settlement escrow
    
    
    
    
    
    
    29,649Accounts receivable, net of allowance of $8,047 and $5,460
    
    
    224,692
    
    
    
    195,183Inventory, net
    
    
    168,100
    
    
    
    155,297Costs and estimated earnings in excess of billings on uncompleted contracts
    
    
    57,247
    
    
    
    50,128Prepaid taxes
    
    
    3,194
    
    
    
    4,677Assets held for sale
    
    
    17,356
    
    
    
    17,344Other current assets
    
    
    35,674
    
    
    
    35,105Total current assets
    
    
    536,344
    
    
    
    544,002Property, plant and equipment, net
    
    
    1,996,898
    
    
    
    2,027,654Goodwill, net
    
    
    176,104
    
    
    
    176,629Intangible and other assets
    
    
    65,545
    
    
    
    67,482Investments in non-consolidated affiliates
    
    
    88,980
    
    
    
    88,718Assets held for sale
    
    
    11,419
    
    
    
    13,981Total assets
    
    $
    2,875,290
    
    
    $
    2,918,466LIABILITIES AND COMMON STOCKHOLDERS EQUITYCurrent liabilities:Short-term debt
    
    $
    28,536
    
    
    $
    32,519Current maturities of long-term debt
    
    
    196,929
    
    
    
    3,511Accounts payable, trade
    
    
    57,101
    
    
    
    53,354Accrued liabilities
    
    
    111,279
    
    
    
    155,441Advance billings
    
    
    28,444
    
    
    
    34,380Liabilities held for sale
    
    
    1,057
    
    
    
    1,128Billings on uncompleted contracts in excess of costs and estimated earnings
    
    
    25,741
    
    
    
    8,427Total current liabilities
    
    
    449,087
    
    
    
    288,760Long-term debt
    
    
    1,541,709
    
    
    
    1,746,793Other liabilities
    
    
    43,178
    
    
    
    72,464Deferred income taxes
    
    
    32,668
    
    
    
    28,333Total liabilities
    
    
    2,066,642
    
    
    
    2,136,350Commitments and contingencies (Note 8)Minority interest
    
    
    28,628
    
    
    
    28,628Common stockholders equity:Common stock, $.001 par value; 200,000,000 shares authorized; 85,768,328
and 82,649,629 shares issued, respectively
    
    
    86
    
    
    
    83Additional paid-in capital
    
    
    890,921
    
    
    
    856,020Deferred employee compensation  restricted stock grants
    
    
    (4,510
    )
    
    
    (5,452
    )Accumulated other comprehensive income
    
    
    9,367
    
    
    
    9,227Retained deficit
    
    
    (113,519
    )
    
    
    (104,065
    )Treasury stock252,815 common shares, at cost
    
    
    (2,325
    )
    
    
    (2,325
    )Total common stockholders equity
    
    
    780,020
    
    
    
    753,488Total liabilities and common stockholders equity
    
    $
    2,875,290
    
    
    $
    2,918,466
 The accompanying notes are an integral part of these condensed consolidated financial statements. 3




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HANOVER COMPRESSOR COMPANY 
 CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
   Three Months EndedMarch 31,2004
    
    2003Revenues and other income:Domestic rentals
    
    $
    86,592
    
    
    $
    78,649International rentals
    
    
    55,569
    
    
    
    51,440Parts, service and used equipment
    
    
    44,607
    
    
    
    37,770Compressor and accessory fabrication
    
    
    28,150
    
    
    
    21,380Production and processing equipment fabrication
    
    
    53,429
    
    
    
    80,140Equity in income of non-consolidated affiliates
    
    
    4,852
    
    
    
    2,880Other
    
    
    1,092
    
    
    
    1,428274,291
    
    
    
    273,687Expenses:Domestic rentals
    
    
    35,539
    
    
    
    31,204International rentals
    
    
    17,126
    
    
    
    15,020Parts, service and used equipment
    
    
    33,230
    
    
    
    24,463Compressor and accessory fabrication
    
    
    25,916
    
    
    
    18,638Production and processing equipment fabrication
    
    
    47,696
    
    
    
    69,562Selling, general and administrative
    
    
    39,873
    
    
    
    39,272Foreign currency translation
    
    
    (1,502
    )
    
    
    373Cost of litigation settlement
    
    
    (60
    )
    
    
    42,103Other
    
    
    (40
    )
    
    
    1,367Depreciation and amortization
    
    
    42,984
    
    
    
    34,578Leasing expense
    
    
    
    
    
    
    22,335Interest expense
    
    
    35,250
    
    
    
    12,147276,012
    
    
    
    311,062Loss from continuing operations before income taxes
    
    
    (1,721
    )
    
    
    (37,375
    )Provision for (benefit from) income taxes
    
    
    7,647
    
    
    
    (11,745
    )Loss from continuing operations
    
    
    (9,368
    )
    
    
    (25,630
    )Income (loss) from discontinued operations, net of tax
    
    
    (86
    )
    
    
    475Loss from write downs of discontinued operations, net of tax
    
    
    
    
    
    
    (1,444
    )Net loss
    
    $
    (9,454
    )
    
    $
    (26,599
    )Basic loss per common share:Loss from continuing operations
    
    $
    (0.11
    )
    
    $
    (0.32
    )Loss from discontinued operations, net of tax
    
    
    
    
    
    
    (0.01
    )Net loss
    
    $
    (0.11
    )
    
    $
    (0.33
    )Diluted loss per common share:Loss from continuing operations
    
    $
    (0.11
    )
    
    $
    (0.32
    )Loss from discontinued operations, net of tax
    
    
    
    
    
    
    (0.01
    )Net loss
    
    $
    (0.11
    )
    
    $
    (0.33
    )Weighted average common and equivalent shares outstanding:Basic
    
    
    83,035
    
    
    
    80,435Diluted
    
    
    83,035
    
    
    
    80,435
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




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HANOVER COMPRESSOR COMPANY 
 CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
   Three Months EndedMarch 31,2004
    
    2003Net loss
    
    $
    (9,454
    )
    
    $
    (26,599
    )Other comprehensive income (loss):Change in fair value of derivative financial instruments, net of tax
    
    
    1,048
    
    
    
    426Foreign currency translation adjustment
    
    
    (907
    )
    
    
    3,310Comprehensive loss
    
    $
    (9,313
    )
    
    $
    (22,863
    )
 The accompanying notes are an integral part of these condensed consolidated financial statements. 5




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HANOVER COMPRESSOR COMPANY 
 CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
   Three Months EndedMarch 31,2004
    
    2003Cash flows from operating activities:Net loss
    
    $
    (9,454
    )
    
    $
    (26,599
    )Adjustments:Depreciation and amortization
    
    
    42,984
    
    
    
    34,578Amortization of debt issuance costs and debt discount
    
    
    30
    
    
    
    30Loss from discontinued operations, net of tax
    
    
    86
    
    
    
    969Bad debt expense
    
    
    750
    
    
    
    1,002Gain on sale of property, plant and equipment
    
    
    (4
    )
    
    
    (886
    )Equity in income of non-consolidated affiliates, net of dividends received
    
    
    (4,288
    )
    
    
    (2,880
    )Gain on derivative instruments
    
    
    
    
    
    
    (1,960
    )Provision for inventory impairment and reserves
    
    
    757
    
    
    
    1,251Provision for estimated cost of litigation settlement, in excess of cash paid
    
    
    (60
    )
    
    
    42,103Gain on sale of non-consolidated affiliates
    
    
    (300
    )
    
    
    Restricted stock compensation expense
    
    
    391
    
    
    
    169Pay-in-kind interest on long-term notes payable
    
    
    4,965
    
    
    
    5,171Deferred income taxes
    
    
    3,786
    
    
    
    (13,402
    )Changes in assets and liabilities, excluding business combinations:Accounts receivable and notes
    
    
    (27,450
    )
    
    
    (9,321
    )Inventory
    
    
    (13,601
    )
    
    
    (8,254
    )Costs and estimated earnings versus billings on uncompleted contracts
    
    
    9,800
    
    
    
    (2,685
    )Accounts payable and other liabilities
    
    
    (11,140
    )
    
    
    (20,803
    )Advance billings
    
    
    (5,708
    )
    
    
    (2,336
    )Other
    
    
    6,076
    
    
    
    (71
    )Net cash used in continuing operations
    
    
    (2,380
    )
    
    
    (3,924
    )Net cash provided by discontinued operations
    
    
    299
    
    
    
    1,182Net cash used in operating activities
    
    
    (2,081
    )
    
    
    (2,742
    )Cash flows from investing activities:Capital expenditures
    
    
    (17,074
    )
    
    
    (36,383
    )Payments for deferred lease transaction costs
    
    
    
    
    
    
    (1,097
    )Proceeds from sale of property, plant and equipment
    
    
    5,657
    
    
    
    4,442Proceeds from sale of non-consolidated affiliates
    
    
    4,663
    
    
    
    Cash used to acquire investments in and advances to non-consolidated affiliates
    
    
    
    
    
    
    (1,531
    )Net cash used in continuing operations
    
    
    (6,754
    )
    
    
    (34,569
    )Net cash provided by (used in) discontinued operations
    
    
    167
    
    
    
    (281
    )Net cash used in investing activities
    
    
    (6,587
    )
    
    
    (34,850
    )Cash flows from financing activities:Borrowings on revolving credit facilities
    
    
    6,000
    
    
    
    46,500Repayments on revolving credit facilities
    
    
    (27,000
    )
    
    
    (13,500
    )Payments for debt issue costs
    
    
    (39
    )
    
    
    (687
    )Proceeds from warrant conversions and stock options exercised
    
    
    5,552
    
    
    
    108Net borrowings (repayments) of other debt
    
    
    (2,681
    )
    
    
    7,196Net cash provided by (used in) continuing operations
    
    
    (18,168
    )
    
    
    39,617Net cash used in discontinued operations
    
    
    
    
    
    
    (378
    )Net cash provided by (used in) financing activities
    
    
    (18,168
    )
    
    
    39,239Effect of exchange rate changes on cash and equivalents
    
    
    298
    
    
    
    90Net increase (decrease) in cash and cash equivalents
    
    
    (26,538
    )
    
    
    1,737Cash and cash equivalents at beginning of period
    
    
    56,619
    
    
    
    19,011Cash and cash equivalents at end of period
    
    $
    30,081
    
    
    $
    20,748
 The accompanying notes are an integral part of these condensed consolidated financial statements. 6




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HANOVER COMPRESSOR COMPANY 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  1.
    
    BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements of
Hanover Compressor Company (Hanover, we, us, our or the Company)
included herein have been prepared in accordance with accounting principles
generally accepted in the United States of America for interim financial
information and the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America are not required in these
interim financial statements and have been condensed or omitted. It is the
opinion of our management that the information furnished includes all
adjustments, consisting only of normal recurring adjustments, which are
necessary to present fairly the financial position, results of operations, and
cash flows of Hanover for the periods indicated. The financial statement
information included herein should be read in conjunction with the consolidated
financial statements and notes thereto included in our Annual Report on Form
10-K for the year ended December 31, 2003. These interim results are not
necessarily indicative of results for a full year. Earnings Per Common Share Basic
loss per common share is computed by dividing loss available to common stockholders by the weighted average number of shares
outstanding for the period. Diluted loss per common share is
computed using the weighted average number of shares outstanding adjusted for
the incremental common stock equivalents attributed to outstanding options and
warrants to purchase common stock, restricted stock, convertible senior notes
and convertible subordinated notes, unless their effect would be anti-dilutive. The table below indicates the potential shares of common stock that were
included in computing the dilutive potential shares of common stock used in
diluted loss per common share (in thousands): Three Months EndedMarch 31,2004
    
    2003Weighted average common shares outstandingused in basic loss per common share
    
    
    83,035
    
    
    
    80,435Net dilutive potential common stock issuable:On exercise of options and vesting of restricted stock
    
    
    *
    *
    
    
    *
    *On exercise of warrants
    
    
    *
    *
    
    
    *
    *On conversion of convertible subordinated notes due 2029
    
    
    *
    *
    
    
    *
    *On conversion of convertible senior notes due 2008
    
    
    *
    *
    
    
    *
    *On conversion of convertible senior notes due 2014
    
    
    *
    *
    
    
    *
    *Weighted average common shares and dilutive potential common shares used in dilutive
loss per common share
    
    
    83,035
    
    
    
    80,435
  **
    
    Excluded from diluted loss per common share as the effect would have been anti-dilutive. 7




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The table below indicates the potential shares of common stock issuable which
were excluded from net dilutive potential shares of common stock issuable as
their effect would be anti-dilutive (in thousands): Three Months EndedMarch 31,2004
    
    2003Net dilutive potential common shares issuable:On exercise of options and vesting of restricted stock
    
    
    2,163
    
    
    
    1,347On exercise of options-exercise price greater than
average market value at end of period
    
    
    1,207
    
    
    
    4,319On exercise of warrants
    
    
    4
    
    
    
    4On conversion of convertible subordinated notes due 2029
    
    
    4,825
    
    
    
    4,825On conversion of convertible senior notes due 2008
    
    
    4,370
    
    
    
    4,370On conversion of convertible senior notes due 2014
    
    
    9,583
    
    
    
    22,152
    
    
    
    14,865
 Stock-Based Compensation Certain of our employees participate in stock option plans that provide for the
granting of options to purchase shares of Hanover common stock. In accordance
with Statement of Financial Standards No. 123, Accounting for Stock-Based
Compensation, (SFAS 123) Hanover measures compensation expense for its
stock-based employee compensation plans using the intrinsic value method
prescribed in APB Opinion No. 25, Accounting for Stock Issued to Employees
(APB 25). The following pro forma net loss and loss per share data
illustrates the effect on net loss and net loss per share if the fair value
method had been applied to all outstanding and unvested stock options in each
period (in thousands). Three Months EndedMarch 31,2004
    
    2003Net loss as reported
    
    $
    (9,454
    )
    
    $
    (26,599
    )Add back: Restricted stock grant expense, net of tax
    
    
    391
    
    
    
    110Deduct: Stock-based employee compensation expense
determined under the fair value method, net of tax
    
    
    (978
    )
    
    
    (398
    )Pro forma net loss
    
    $
    (10,041
    )
    
    $
    (26,887
    )Loss per share:Basic, as reported
    
    $
    (0.11
    )
    
    $
    (0.33
    )Basic, pro forma
    
    $
    (0.12
    )
    
    $
    (0.33
    )Diluted, as reported
    
    $
    (0.11
    )
    
    $
    (0.33
    )Diluted, pro forma
    
    $
    (0.12
    )
    
    $
    (0.33
    )
 As
of March 31, 2004, 469,000 shares of restricted stock were outstanding under our
incentive compensation plans. We will recognize compensation expense equal to
the fair value of the restricted stock at the date of grant over the vesting period
related to these grants. During the three months ended March 31, 2004 and 2003,
we recognized $0.4 million and $0.1 million, respectively, in compensation
expense related to these grants. Reclassifications Certain amounts in the prior periods financial statements have been
reclassified to conform to the 2004 financial statement classification. These
reclassifications have no impact on net income. 8




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2.
    
    INVENTORIES Inventory, net of reserves, consisted of the following amounts (in thousands): March 31,
    
    December 31,2004
    
    2003Parts and supplies
    
    $
    124,063
    
    
    $
    114,063Work in progress
    
    
    28,367
    
    
    
    29,412Finished goods
    
    
    15,670
    
    
    
    11,822$
    168,100
    
    
    $
    155,297
 As of March 31, 2004 and December 31, 2003 we had inventory reserves of
approximately $13.2 million and $12.7 million, respectively.  3.
    
    PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consisted of the following (in thousands): March 31,
    
    December 31,2004
    
    2003Compression equipment, facilities and other rental assets
    
    $
    2,414,218
    
    
    $
    2,407,873Land and buildings
    
    
    80,702
    
    
    
    80,142Transportation and shop equipment
    
    
    75,219
    
    
    
    77,912Other
    
    
    41,494
    
    
    
    41,7412,611,633
    
    
    
    2,607,668Accumulated depreciation
    
    
    (614,735
    )
    
    
    (580,014
    )$
    1,996,898
    
    
    $
    2,027,654
  4.
    
    INVESTMENTS IN NON-CONSOLIDATED AFFILIATES On March 5, 2004, we sold our 50.384% limited partnership interest and 0.001%
general partnership interest in Hanover Measurement Services Company, L.P. to
EMS Pipeline Services, L.L.C. for $4.9 million, of which $0.2 million has been
put in escrow subject to the outcome of post closing working capital
adjustments. We have no obligation to the purchaser with respect to any
post-closing adjustment in excess of the escrowed amount. We accounted for our
interest in Hanover Measurement under the equity method. As a result of the
sale, we recorded a $0.3 million gain that is included in other revenue.  5.
    
    DEBT Short-term debt consisted of the following (in thousands): March 31,
    
    December 31,2004
    
    2003Bellelifactored receivables
    
    $
    15,369
    
    
    $
    13,261Bellelirevolving
credit facilities
    
    
    13,167
    
    
    
    16,141Other, interest at 5.0%
    
    
    
    
    
    
    3,117Short-term debt
    
    $
    28,536
    
    
    $
    32,519
 Belleli
finances its operations through the factoring of its receivables and a revolving credit facility.
Bellelis factoring arrangements are typically short term in nature and at each of March 31, 2004 and
December 31, 2003 bore interest at a weighted average rate of
4.0%. Bellelis revolving credit facilities bore interest at a weighted
average rate of 3.4% and 3.2% at March 31, 2004 and December 31, 2003,
respectively. These revolving credit facilities are all short-term and expire at different
times in 2004 and are
partially secured by letters of credit issued and outstanding under Hanovers
bank credit facility of $9.7 million as of March 31, 2004. 9




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Long-term debt consisted of the following (in thousands): March 31,
    
    December 31,2004
    
    2003Bank credit facility due December 2006
    
    $
    6,000
    
    
    $
    27,0004.75% convertible senior notes due 2008
    
    
    192,000
    
    
    
    192,0004.75% convertible senior notes due 2014
    
    
    143,750
    
    
    
    143,7508.625% senior notes due 2010
    
    
    200,000
    
    
    
    200,0002000A equipment lease notes, interest at 4.1%, due March 2005
    
    
    193,600
    
    
    
    193,6002000B equipment lease notes, interest at 4.1%, due October 2005
    
    
    167,411
    
    
    
    167,4112001A equipment lease notes, interest at 8.5%, due September 2008
    
    
    300,000
    
    
    
    300,0002001B equipment lease notes, interest at 8.8%, due September 2011
    
    
    250,000
    
    
    
    250,000Zero coupon subordinated notes, interest at 11.0%, due March 2007
    
    
    190,465
    
    
    
    185,5017.25% convertible subordinated notes due 2029
    
    
    86,250
    
    
    
    86,250Real estate mortgage, interest at 3.1%, collateralized by
certain land and buildings, payable through September 2004
    
    
    2,833
    
    
    
    2,917Fair value adjustment  fixed to floating interest rate swaps
    
    
    (1,080
    )
    
    
    Other, interest at various rates, collateralized by equipment
and other assets, net of unamortized discount
    
    
    7,409
    
    
    
    1,8751,738,638
    
    
    
    1,750,304Lesscurrent maturities
    
    
    (196,929
    )
    
    
    (3,511
    )Long-term debt
    
    $
    1,541,709
    
    
    $
    1,746,793
 Maturities of long-term debt (excluding interest to be accrued thereon) at
March 31, 2004 are (in thousands): March 31,20042004
    
    $
    3,2132005
    
    
    361,5122006
    
    
    6,2972007
    
    
    196,4742008
    
    
    492,045Thereafter
    
    
    679,097$
    1,738,638
 As of March 31, 2004, we had approximately $6 million in borrowings and
approximately $90 million in letters of credit outstanding under our bank
credit facility. Our bank credit facility permits us to incur indebtedness,
subject to covenant limitations, up to a $350 million credit limit, plus, in
addition to certain other indebtedness, an additional (i) $40 million in
unsecured indebtedness, (ii) $50 million of nonrecourse indebtedness of
unqualified subsidiaries and (iii) $25 million of secured purchase money
indebtedness. As of March 31, 2004, we were in compliance with all material covenants and
other requirements set forth in our bank credit facility, the indentures and
agreements related to our compression equipment lease obligations and the
indentures and agreements relating to our other long-term debt. A default under our bank credit facility or these agreements would
trigger cross-default provisions under the agreements relating to certain of
our other debt obligations. Such defaults would have a material adverse effect
on our liquidity, financial position and operations. Giving effect
to the covenant limitations in our bank credit facility, the liquidity
available under that facility as of March 31, 2004 was
approximately $245
million. We
have classified our 2000A equipment lease note as current since it
matures in March 2005. Our availability under our bank credit
facility may be used to finance maturing debt obligations or we may
seek other sources of financing. 10




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##### Table of Contents



In addition to purchase money and similar obligations, the indentures and the
agreements related to our compression equipment lease obligations for our 2001A
and 2001B sale leaseback transactions and our 8.625% Senior Notes due 2010
permit us to incur indebtedness up to the $350 million credit limit under our
bank credit facility, plus (1) an additional $75 million in unsecured
indebtedness and (2) any additional indebtedness so long as, after incurring
such indebtedness, our ratio of the sum of consolidated net income before
interest expense, income taxes, depreciation expense, amortization of
intangibles, certain other non-cash charges and rental expense to total fixed
charges (all as defined and adjusted by the agreements governing such
obligations), or our coverage ratio, is greater than 2.25 to 1.0 and no
default or event of default has occurred or would occur as a consequence of
incurring such additional indebtedness and the application of the proceeds
thereon. The indentures and agreements for our 2001A and 2001B sale leaseback
transactions define indebtedness to include the present value of our rental
obligations under sale leaseback transactions and under facilities similar to
our compression equipment operating leases. As of March 31, 2004, Hanovers
coverage ratio was less than 2.25 to 1.0 and therefore as of such date we could
not incur indebtedness other than under our bank credit facility and up to an
additional $75 million in unsecured indebtedness and certain other permitted
indebtedness, including certain refinancing indebtedness.  6.
    
    ACCRUED LIABILITIES Accrued liabilities consisted of the following (in thousands): March 31,
    
    December 31,2004
    
    2003Accrued salaries, bonuses and other employee benefits
    
    $
    20,218
    
    
    $
    20,533Accrued income and other taxes
    
    
    29,016
    
    
    
    15,948Current portion of hedge instruments
    
    
    11,556
    
    
    
    11,703Shareholder litigation settlement accrual
    
    
    968
    
    
    
    32,692Accrued interest
    
    
    15,425
    
    
    
    23,228Accrued other
    
    
    34,096
    
    
    
    51,337$
    111,279
    
    
    $
    155,441
  7.
    
    ACCOUNTING FOR DERIVATIVES We use derivative financial instruments to minimize the risks and/or costs
associated with financial and global operating activities by managing our
exposure to interest rate fluctuations on a portion of our debt and leasing
obligations. Our primary objective is to reduce our overall cost of borrowing
by managing the fixed and floating interest rate mix of our debt portfolio. We
do not use derivative financial instruments for trading or other speculative
purposes. The cash flow from hedges is classified in our consolidated
statements of cash flows under the same category as the cash flows from the
underlying assets, liabilities or anticipated transactions. For derivative instruments designated as fair value hedges, the gain or loss is
recognized in earnings in the period of change together with the gain or loss
on the hedged item attributable to the risk being hedged. For derivative
instruments designated as cash flow hedges, the effective portion of the
derivative gain or loss is included in other comprehensive income, but not
reflected in our consolidated statement of operations until the corresponding
hedged transaction is settled. The ineffective portion is reported in earnings
immediately. In March 2004, we entered into two interest rate swaps to hedge the risk of
changes in fair value of our 8.625% Senior Notes due 2010 resulting from
changes in interest rates. These interest rate swaps, under which we receive
fixed payments and make floating payments, result in the conversion of the
hedged obligation into floating rate debt. The following table summarizes, by
individual hedge instrument, these interest rate swaps as of March 31, 2004: Floating Rate to be Paid
    
    Maturity Date
    
    Fixed Rate to be Received
    
    Notional AmountSix Month LIBOR +4.72%
    
    December 15, 2010
    
    
    8.625
    %
    
    $
    100,000,000Six Month LIBOR +4.64%
    
    December 15, 2010
    
    
    8.625
    %
    
    $
    100,000,000
 11




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As of March 31, 2004, a total of approximately $4.0 million in
other current assets, $5.0 million in long-term liabilities and a
$1.1 million reduction of long-term debt was recorded with respect to the fair value adjustment
related to these two swaps. During 2001, we entered into three additional interest rate swaps to convert
variable lease payments under certain lease arrangements to fixed payments as
follows: Lease
    
    Maturity Date
    
    Fixed Rate to be Paid
    
    Notional AmountMarch 2000
    
    March 11, 2005
    
    
    5.2550
    %
    
    $
    100,000,000August 2000
    
    March 11, 2005
    
    
    5.2725
    %
    
    $
    100,000,000October 2000
    
    October 26, 2005
    
    
    5.3975
    %
    
    $
    100,000,000
 These three swaps, which we have designated as cash flow hedging instruments,
meet the specific hedge criteria and any changes in their fair values have been
recognized in other comprehensive income. During the quarters ended March 31,
2004 and 2003, we recorded income of approximately $1.6 million and $0.7
million, respectively, related to these three swaps ($1.6 million and $0.4
million net of tax) in other comprehensive income. As of March 31, 2004, a
total of approximately $11.6 million was recorded in current liabilities and
approximately $1.9 million in long-term liabilities with respect to the fair
value adjustment related to these three swaps. Prior to 2001, we entered into two interest rate swaps with notional amounts of
$75 million and $125 million and strike rates of 5.51% and 5.56%, respectively.
The difference paid or received on the swap transactions was recorded as an
accrued liability and recognized in leasing expense in all periods before July
1, 2003, and in interest expense thereafter. Because management decided not to
designate the interest rate swaps as hedges, we recognized unrealized gains of approximately $2.0 million
related to the change in the fair value of these interest rate swaps in lease
expense in our statement of operations during the three months ended March 31,
2003. The counterparties to our interest rate swap agreements are major international
financial institutions. We monitor the credit quality of these financial
institutions and do not expect non-performance by any counterparty, although
such non-performance could have a material adverse effect on us.  8.
    
    COMMITMENTS AND CONTINGENCIES Hanover has issued the following guarantees that are not recorded on our
accompanying balance sheet: Maximum PotentialUndiscountedPayments as ofTerm
    
    March 31, 2004Indebtedness of non-consolidated affiliates:Simco/Harwat Consortium (1)
    
    
    2005
    
    
    $
    10,387El Furrial (1)
    
    
    2013
    
    
    
    39,028Other:Performance guarantees through letters of credit (2)
    
    
    2004-2007
    
    
    
    76,420Standby letters of credit
    
    
    2004
    
    
    
    25,415Bid bonds and performance bonds (2)
    
    
    2004-2007
    
    
    
    82,570$
    233,820
   (1)
    
    We have guaranteed the amount included above, which is a percentage of the total debt of
this non-consolidated affiliate equal to our ownership percentage in such affiliate.(2)
    
    We have issued guarantees to third parties to ensure performance of our obligations some of
which may be fulfilled by third parties. As part of the Production Operators Corporation (POC) acquisition purchase
price, Hanover may be required to make a contingent payment to Schlumberger
based on the realization of certain tax benefits by Hanover through 2016. To
date we have not realized any of such tax benefits or made any payments to
Schlumberger in connection with them. 12




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Litigation and Securities
and Exchange Commission Investigation Commencing in February 2002, approximately 15 putative securities class action
lawsuits were filed against us and certain of our current and former officers
and directors in the United States District Court for the Southern District of
Texas. These class actions (together with subsequently filed actions) were
consolidated into one case, Pirelli Armstrong Tire Corporation Retiree Medical
Benefits Trust, On Behalf of Itself and All Others Similarly Situated,Civil
Action No. H-02-0410, naming as defendants Hanover, Mr. Michael J. McGhan, Mr.
William S. Goldberg and Mr. Michael A. OConnor. The complaints asserted
various claims under Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 and sought unspecified amounts of compensatory damages, interest and
costs, including legal fees. The court entered an order appointing Pirelli
Armstrong Tire Corporation Retiree Medical Benefits Trust and others as lead
plaintiffs on January 7, 2003 and appointed Milberg, Weiss, Bershad, Hynes &
Lerach LLP as lead counsel. On September 5, 2003, lead plaintiffs filed an
amended complaint in which they sought relief under Sections 10(b) of the
Securities Exchange Act and Section 11 of the Securities Act against Hanover,
certain former officers and directors and our auditor, PricewaterhouseCoopers
LLP, on behalf of themselves and the class of persons who purchased Hanover
securities between May 4, 1999 and December 23, 2002. In the securities action, the plaintiffs allege generally that the defendants
violated the federal securities laws by making misstatements and omissions in
Hanovers periodic filings with the SEC as well as in other public statements
in connection with the transactions that were restated in 2002. Commencing in February 2002, four derivative lawsuits were filed in the United
States District Court for the Southern District of Texas, two derivative
lawsuits were filed in state district court for Harris County, Texas (one of
which was nonsuited and the second of which was removed to Federal District
Court for the Southern District of Texas) and one derivative lawsuit was filed
in the Court of Chancery for the State of Delaware in and for New Castle
County. These derivative lawsuits, which were filed by certain of our
shareholders purportedly on behalf of Hanover, alleged, among other things,
that our directors breached their fiduciary duties to shareholders in
connection with certain of the transactions that were restated in 2002, and
sought unspecified amounts of damages, interest and costs, including legal
fees. The derivative lawsuits in the United States District Court for the
Southern District of Texas were consolidated on August 19 and August 26, 2002
into the Harbor Finance Partners derivative lawsuit. With that consolidation,
the pending derivative lawsuits were: DatePlaintiff
    
    Defendants
    
    Civil Action No.
    
    Court
    
    InstitutedHarbor Finance
Partners,
derivatively on
behalf of
Hanover Compressor
Company
    
    Michael J. McGhan, William S. Goldberg,
Ted Collins, Jr., Robert R. Furgason,
Melvyn N. Klein, Michael A. OConnor, and
Alvin V. Shoemaker, Defendants and
Hanover Compressor Company, Nominal
Defendant
    
    H-02-0761
    
    United States
District Court
for the Southern
District of
Texas
    
    03/01/02Coffelt Family, LLC,
derivatively on
behalf of
Hanover Compressor
Company
    
    Michael A. OConnor, Michael J. McGhan,
William S. Goldberg, Ted Collins, Jr.,
Melvyn N. Klein, Alvin V. Shoemaker and
Robert R. Furgason, Defendants and
Hanover Compressor Company, Nominal
Defendant
    
    19410-NC
    
    Court of Chancery
for the
State of Delaware
State
Court in New Castle
County
    
    02/15/02
 On October 2, 2003, the Harbor Finance Partners derivative lawsuit was
consolidated into the Pirelli Armstrong Tire Corporation Retiree Medical
Benefits Trustsecurities class action. On and after March 26, 2003, three plaintiffs filed separate putative class
actions against Hanover, certain named individuals and other purportedly
unknown defendants, in the United States District Court for the Southern
District of 13




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Texas. The alleged class was composed of persons who participated in or were
beneficiaries of The Hanover Companies Retirement and Savings Plan, which was
established by Hanover pursuant to Section 401(k) of the United States Internal
Revenue Code of 1986, as amended. The purported class action sought relief
under ERISA based upon Hanovers and the individual defendants alleged
mishandling of Hanovers 401(k) Plan. The three ERISA putative class actions
were entitled: Kirkley v. Hanover,Case No. H-03-1155; Angleopoulos v. Hanover,
Case No. H-03-1064; and Freeman v. Hanover,Case No. H-03-1095. On August 1,
2003, the three ERISA class actions were consolidated into the Pirelli
Armstrong Tire Corporation Retiree Medical Benefits Trustfederal securities
class action. On October 9, 2003, a consolidated amended complaint was filed by
the plaintiffs in the ERISA class action against Hanover, Michael McGhan,
Michael OConnor and William Goldberg on behalf of themselves and a class of
persons who purchased or held Hanover securities in their 401(k) Plan between
May 4, 1999 and December 23, 2002. This action alleged generally that, in connection with the transactions that
were restated in 2002, we and certain individuals acting as fiduciaries of
Hanovers 401(k) Plan breached our fiduciary duties to the plan participants by
offering Hanover common stock as an investment option, failing to provide
material information to plan participants regarding the suitability of Hanover
common stock as an investment alternative, failing to monitor the performance
of plan fiduciaries, and failing to provide material information to other
fiduciaries. On October 23, 2003, we entered into a Stipulation and Agreement of Settlement
to settle all of the claims underlying the putative securities class action,
the putative ERISA class action and the shareholder derivative actions
described above. The terms of the settlement provided for us to: (1) make a
cash payment of approximately $30 million (of which $26.7 million was funded by
payments from Hanovers directors and officers insurance carriers), (2) issue
2.5 million shares of our common stock, and (3) issue a contingent note with a
principal amount of $6.7 million. The note is payable, together with accrued
interest, on March 31, 2007 but will be extinguished (with no money owing under
it) if our common stock trades at or above the average price of $12.25 per
share for 15 consecutive trading days at any time between March 31, 2004 and
March 31, 2007. In addition, upon the occurrence of a change of control of
Hanover, if the change of control or shareholder approval of the change of
control occurs before February 9, 2005, which is twelve months after the entry
of the final court approval of the settlement, we will be obligated to
contribute an additional $3 million to the settlement fund. As part of the
settlement, we have also agreed to implement corporate governance enhancements,
including allowing shareholders owning more than 1% but less than 10% of our
outstanding common stock to participate in the process to appoint two
independent directors to our board of directors (pursuant to which on February
4, 2004 we appointed Margaret K. Dorman and Stephen M. Pazuk to our board of
directors) and making certain changes to our code of conduct. GKH Investments, L.P. and GKH Private Limited (collectively GKH) which
formerly owned more than 10% of Hanovers outstanding common stock and which
sold shares in our March 2001 secondary offering of common stock, are parties
to the settlement and have agreed to settle claims against them that arise out
of that offering as well as other potential securities, ERISA, and derivative
claims. The terms of the settlement provided for GKH to transfer 2.5 million
shares of Hanover common stock from their holdings or from other sources to the
settlement fund. On October 24, 2003, the parties moved the United States District Court for the
Southern District of Texas for preliminary approval of the proposed settlement
and sought permission to provide notice to the potentially affected persons and
to set a date for a final hearing to approve the proposed settlement. On
December 5, 2003, the court held a hearing and granted the parties motion for
preliminary approval of the proposed settlement and, among other things,
ordered that notice be provided to appropriate persons and
set the date for the final hearing. The final hearing was held on February 6,
2004, and no objections to the settlement or requests to be excluded from the
terms of the settlement had been received prior to the deadline set by the
court. On February 9, 2004, the United States District Court for the Southern District
of Texas entered three Orders and Final Judgments approving the settlement on
the terms agreed upon in the Stipulation of Settlement with respect to all of
the claims described above, including the dismissal of each of the actions other
than the Coffelt Family derivative action filed in the Delaware Chancery Court.
The court also entered an Order and Final Judgment approving the plans of
allocation with respect to each action, as well as an Order and Final Judgment
approving the schedule of attorneys fees for counsel for the settling
plaintiffs. The time in which these Orders and Final Judgments may be appealed
expired on March 10, 2004 without any appeal being lodged. On March 16, 2004,
the Delaware Chancery Court dismissed the Coffelt Family derivative action. The
settlement has therefore become final and will be implemented according to its
terms. In March 2004, we issued and delivered to the escrow agent for the
settlement fund 2.5 million shares of Hanover common stock, as required by the
settlement. Our independent auditor, PricewaterhouseCoopers, is not a party to
the settlement and remains a 14




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party to the securities class action. The
estimated $3.6 million fair value of the contingent note issued was based on the present value of
the future cash flows discounted at borrowing rates currently available to us
for debt with similar terms and maturities. Using a market-borrowing rate of
9.3%, the principal value and the stipulated interest rate required by the note
of 5% per annum, a discount of $0.8 million was computed on the note to be
issued. Upon the issuance of the note, the discount will be amortized to
interest expense over the term of the note. The note could be extinguished
without a payment (if our common stock trades at or above the average price of
$12.25 per share for 15 consecutive trading days at any time between March 31,
2004 and March 31, 2007). At March 31, 2004, we recorded an asset for the value
of the embedded derivative, as required by SFAS 133. We estimated the value of
the derivative and reduced the amount we included for the estimate of the value
of the note by approximately $2.3 million at each of March 31, 2004 and
December 31, 2003. This asset will be marked to market in future periods with
any increase or decrease included in our statement of operations. On April 21,
2004, we issued the contingent note in the principal amount of $6.7 million to the escrow
agent for the settlement fund. As of December 31, 2003, our accompanying balance sheet included a $33.4
million long-term liability and $32.7 million in accrued liabilities related to
amounts that were expected to be paid in the next twelve months. In the first
quarter of 2004, we released the escrow settlement fund, issued the shares and
reclassified $29.8 million, the estimated value of our common stock issued,
from other liabilities to stockholders equity and included the shares in our
weighted average outstanding shares used for earnings per share calculations. On June 25, 1999, we notified the Air Quality Bureau of the Environmental
Protection Division, New Mexico Environmental Department (the Division), of
potential violations of State regulatory and permitting requirements. The
potential violations included failure to conduct required performance tests,
failure to file required notices and failure to pay annual filing fees for
compressor units located on sites for more than one year. We promptly paid the
required fees and filed the required notices, correcting the potential
violations. On June 12, 2001, after the potential violations had been
corrected, the Director of the Division issued a compliance order to us in
connection with the potential violations. The compliance order assessed a
civil penalty of $15,000 per day per alleged regulatory violation and permit;
no total penalty amount was proposed in the compliance order. On October 3,
2003, the Division notified us that the total proposed penalty would be
$759,072. However, since the alleged violations had been self-disclosed, the
amount was reduced to $189,768. We subsequently responded to the penalty
assessment, challenging the basis of the Divisions penalty calculation. As a
result of our challenge, the Division agreed to a Stipulated Motion for Time to
File Answer and further agreed to meet with us and negotiate a final
settlement. On April 8, 2004, Hanover met with Division officials in Santa Fe
and agreed to a final settlement of all alleged violations in the amount of
$105,464, to be paid in a lump sum in the month of July 2004. We have
submitted a Settlement Agreement and Stipulated Final Order summarizing the
settlement to the Division for execution and final resolution of this matter. We are involved in a project to build and operate barge-mounted gas compression
and gas processing facilities to be stationed in a Nigerian coastal waterway as
part of the performance of a contract between an affiliate of The Royal/ Dutch
Shell Group (Shell) and Global Energy and Refining Ltd. (Global), a
Nigerian company. We have completed the building of the required barge-mounted
facilities. We understand that Global must complete a significant financing for
part of the project in the near term or Shell would be able to terminate its
contract with Global. Global has orally informed us that they have completed a
financing, although it is not clear to us whether the funds raised will be
sufficient to perform their obligations under the Shell contract. In light of
the political environment in Nigeria, Globals lack of a successful track
record with respect to this project and other factors, there is no assurance
that Global will be able to comply with its obligations under the Shell
contract. We believe that Global is in default with respect to certain
agreements they have with us, as a result of which we believe we have certain
termination rights. We are currently in discussions with Global regarding our
relationship with them and this project. We cannot currently predict the
outcome of such discussions. If Shell were to terminate its contract with Global for any reason or we were
to terminate our involvement in the project, we would be required to find an
alternative use for the barge facility which could result in a write-down of
our investment. We currently have an investment of approximately $30.2 million
associated with the barge facility and approximately $4.1 million associated
with advances to, and our investment in, Global. In the ordinary course of business we are involved in various other pending or
threatened legal actions, including environmental matters. While management is
unable to predict the ultimate outcome of these actions, it believes that any
ultimate liability arising from these actions will not have a material adverse
effect on our consolidated financial position, results of operations or cash
flows.  9.
    
    RELATED-PARTY TRANSACTIONS We received a letter on March 11, 2004 from the administrative trustee of the
GKH Liquidating Trust indicating it and one of its affiliates had decided to
distribute 5.8 million shares of the 8.3 million shares of Hanover common stock
owned by the GKH Liquidating Trust (formerly held by GKH) and its affiliate to
the relevant beneficiaries. We understand that in April 2004 GKH
contributed the remaining 2.5 million shares of our common stock
held by GKH to the settlement fund.  10.
    
    NEW ACCOUNTING PRONOUNCEMENTS In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of
Variable Interest Entities, an interpretation of ARB 51 as revised in December
2003 (FIN 46). The primary objectives of FIN 46 are to provide guidance on
the identification of entities for which control is achieved by means other
than through voting rights and the determination of when and which business
enterprise should consolidate the variable interest entity (VIE) in its
financial statements. FIN 46 applies to an entity in which either (1) the
equity investors (if any) do not have a controlling financial interest or (2)
the equity investment at risk is insufficient to finance that entitys
activities without receiving additional subordinated financial support from
other parties. In addition, FIN 46 requires that both the primary beneficiary
and all 15




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other enterprises with a significant variable interest in a VIE make additional
disclosures. As revised, FIN 46 was effective immediately for VIEs created
after January 31, 2003. For special-purposes entities created prior to February
1, 2003, FIN 46 is effective at the first interim or annual reporting period
ending after December 15, 2003, or December 31, 2003 for us. For entities,
other than special purpose entities, created prior to February 1, 2003, FIN 46
is effective for us as of March 31, 2004. Prior to 2004, we had
adopted the provisions of FIN 46 related to equipment leases and
mandatorily redeemable convertible preferred securities as discussed below. During the quarter ended March 31,
2004, no further adjustments were made to our consolidated financial
statements under the provisions of FIN 46. Prior to July 1, 2003, we entered into five lease transactions that were
recorded as a sale and leaseback of the compression equipment and were treated
as operating leases for financial reporting purposes. On July 1, 2003, we
adopted the provisions of FIN 46 as they relate to the special purpose entities
that lease compression equipment to us. As a result of the adoption, we added
approximately $1,089 million in compressor equipment assets, $192.3 million of
accumulated depreciation (including approximately $58.6 million of accumulated
depreciation related to periods before the sale and leaseback of the
equipment), $1,105.0 million in debt and $34.6 million in minority interest
obligations to our balance sheet, and we reversed $108.8 million of deferred
gains that were recorded on our balance sheet as a result of the sale leaseback
transactions. On July 1, 2003, we recorded a $133.7 million charge ($86.9
million net of tax) to record the cumulative effect from the adoption of FIN 46
related to prior period depreciation of the compression equipment assets.
Additionally, we estimate that we will record approximately $17 million per
year in additional depreciation expense on our leased compression equipment as
a result of the inclusion of the compression equipment on our balance sheet and
will also record the payments made under our compression equipment leases as
interest expense. We have a subsidiary trust that we consolidated prior to our adoption of FIN 46
that has mandatorily redeemable convertible preferred securities outstanding
that have a liquidation value of $86.3 million. Prior to December 31, 2003,
these securities were reported on our balance sheet as mandatorily
redeemable convertible preferred securities. Because we only have a limited
ability to make decisions about its activities and we are not the primary
beneficiary of the trust, the trust is a VIE under FIN 46. As such, the
mandatorily redeemable preferred securities issued by the trust are no longer
reported on our balance sheet. Instead, we now report our subordinated notes
payable to the trust as a debt. These intercompany notes have previously been
eliminated in our consolidated financial statements. The changes related to our
mandatorily redeemable convertible preferred securities for our balance sheet
are reclassifications and no impact on our consolidated results of operations
or cash flow. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity (SFAS 150).
SFAS 150 changes the accounting for certain financial instruments that, under
previous guidance, issuers could account for as equity. SFAS 150 requires that
those instruments be classified as liabilities in statements of financial
position. SFAS 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective for interim periods
beginning after June 15, 2004. On November 7, 2003 the FASB issued Staff Position
150-3 that delayed the effective date for certain types of financial
instruments. We do not believe the adoption of the guidance currently provided
in SFAS 150 will have a material effect on our consolidated results of
operations or cash flow. However, we may be required to classify as debt
approximately $28.6 million in sale leaseback obligations that are currently
reported as Minority interest on our condensed consolidated balance sheet
pursuant to FIN 46. These minority interest obligations represent the equity of the entities that
lease compression equipment to us. In accordance with the provisions of our
compression equipment lease obligations, the equity certificate holders are
entitled to quarterly or semi-annual yield payments on the aggregate
outstanding equity certificates. As of March 31, 2004, the yield rates on the
outstanding equity certificates ranged from 4.3% to 9.5%. Equity certificate
holders may receive a return of capital payment upon termination of the lease
or our purchase of the leased compression equipment after full payment of all
debt obligations of the entities that lease compression equipment to us. At
March 31, 2004, the carrying value of the minority interest obligations
approximated the fair market value of assets that would be required to be
transferred to redeem the minority interest obligations.  11.
    
    REPORTABLE SEGMENTS We manage our business segments primarily based upon the type of product or
service provided. We have five principal industry segments: Domestic Rentals;
International Rentals; Parts, Service and Used Equipment; Compressor and
Accessory Fabrication; and Production and Processing Equipment Fabrication. The
Domestic and International Rentals segments primarily provide natural gas
compression and production and processing equipment rental and maintenance
services to meet specific customer requirements on Hanover-owned assets. The
Parts, Service and Used Equipment segment provides a full range of services to
support the surface production needs of customers from installation and normal 16




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maintenance and services to full operation of a customers owned assets and
surface equipment as well as sales of used equipment. The Compressor and
Accessory Fabrication Segment involves the design, fabrication and sale of
natural gas compression units and accessories to meet unique customer
specifications. The Production and Processing Equipment Fabrication Segment
designs, fabricates and sells equipment used in the production and treating of
crude oil and natural gas and engineering, procurement and construction of
heavy wall reactors for refineries and desalination plants. We evaluate the performance of our segments based on segment gross profit.
Segment gross profit for each segment includes direct revenues and operating
expenses attributable to that segment. Costs excluded from segment gross profit
include selling, general and administrative, depreciation and amortization,
leasing, interest, foreign currency translation, provision for cost of
litigation settlement, goodwill impairment, other expenses and income taxes.
Amounts defined as Other include equity in income of non-consolidated
affiliates, results of other insignificant operations and corporate related
items primarily related to cash management activities. Revenues include sales
to external customers. Intersegment sales and any resulting profits are
eliminated in consolidation. We no longer include intersegment sales
when we evaluate the performance of our segments and have adjusted
prior periods to conform to the 2004 presentation. The following tables present sales and other financial information by industry
segment for the three months ended March 31, 2004 and 2003. Parts, service
    
    
    
    
    
    ProductionDomestic
    
    International
    
    and used
    
    Compressor
    
    equipmentrentals
    
    rentals
    
    equipment
    
    fabrication
    
    fabrication
    
    Other
    
    Eliminations
    
    Consolidated(in thousands)March 31, 2004:Revenues from external customers
    
    $
    86,592
    
    
    $
    55,569
    
    
    $
    44,607
    
    
    $
    28,150
    
    
    $
    53,429
    
    
    $
    5,944
    
    
    $
    
    
    
    $
    274,291Gross profit
    
    
    51,053
    
    
    
    38,443
    
    
    
    11,377
    
    
    
    2,234
    
    
    
    5,733
    
    
    
    5,944
    
    
    
    
    
    
    
    114,784March 31, 2003:Revenues from external customers
    
    $
    78,649
    
    
    $
    51,440
    
    
    $
    37,770
    
    
    $
    21,380
    
    
    $
    80,140
    
    
    $
    4,308
    
    
    $
    
    
    
    $
    273,687Gross profit
    
    
    47,445
    
    
    
    36,420
    
    
    
    13,307
    
    
    
    2,742
    
    
    
    10,578
    
    
    
    4,308
    
    
    
    
    
    
    
    114,800
  12.
    
    DISCONTINUED OPERATIONS AND OTHER ASSETS HELD FOR SALE During the fourth quarter of 2002, Hanovers Board of Directors approved
managements plan to dispose of our non-oilfield power generation projects,
which were part of our domestic rental business, and certain used equipment
businesses, which were part of our parts and service business. These disposals
meet the criteria established for recognition as discontinued operations under
SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets,
(SFAS 144). SFAS 144 specifically requires that such amounts must represent a
component of a business comprised of operations and cash flows that can be
clearly distinguished, operationally and for financial reporting purposes, from
the rest of the entity. These businesses are reflected as discontinued
operations in our condensed consolidated statement of operations. Due to changes in
market conditions, the disposal plan was not completed in 2003. We are
continuing to actively market these assets and have made valuation adjustments
as a result of the change in market conditions. As a result of our
consolidation efforts during 2003, we reclassified certain closed facilities to
assets held for sale. We have sold certain assets for total sales
proceeds of $1.8 million, during the quarter ended
March 31, 2004. The remaining assets are expected to be sold within the next 12
months and the assets and liabilities are reflected as held-for-sale on our
condensed consolidated balance sheet. 17




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##### Table of Contents



Summary of operating results of the discontinued operations (in thousands): Three Months EndedMarch 31,2004
    
    2003Revenues and other:Domestic rentals
    
    $
    5
    
    
    $
    1,671Parts, service and used equipment
    
    
    3,247
    
    
    
    3,629Equity in income of non-consolidated affiliates
    
    
    
    
    
    
    414Other
    
    
    (3
    )
    
    
    (87
    )3,249
    
    
    
    5,627Expenses:Domestic rentals
    
    
    160
    
    
    
    299Parts, service and used equipment
    
    
    2,189
    
    
    
    2,504Selling, general and administrative
    
    
    986
    
    
    
    1,684Interest expense
    
    
    
    
    
    
    304Other
    
    
    
    
    
    
    463,335
    
    
    
    4,837Income (loss) from discontinued operations before income taxes
    
    
    (86
    )
    
    
    790Provision for income taxes

    
    
    
    
    
    
    315Income (loss) from discontinued operations
    
    $
    (86
    )
    
    $
    475
 Summary balance sheet data for assets held for sale as of March 31, 2004 (in
thousands): Non-OilfieldUsed
    
    PowerEquipment
    
    Generation
    
    Facilities
    
    TotalCurrent assets
    
    $
    6,829
    
    
    $
    10,527
    
    
    $
    
    
    
    $
    17,356Property, plant and equipment
    
    
    620
    
    
    
    1,135
    
    
    
    9,664
    
    
    
    11,419Assets held for sale
    
    
    7,449
    
    
    
    11,662
    
    
    
    9,664
    
    
    
    28,775Current liabilities
    
    
    
    
    
    
    1,057
    
    
    
    
    
    
    
    1,057Liabilities held for sale
    
    
    
    
    
    
    1,057
    
    
    
    
    
    
    
    1,057Net assets held for sale
    
    $
    7,449
    
    
    $
    10,605
    
    
    $
    9,664
    
    
    $
    27,718
 Summary balance sheet data for assets held for sale as of December 31, 2003 (in
thousands): Non-OilfieldUsed
    
    PowerEquipment
    
    Generation
    
    Facilities
    
    TotalCurrent assets
    
    $
    6,820
    
    
    $
    10,524
    
    
    $
    
    
    
    $
    17,344Property, plant and equipment
    
    
    924
    
    
    
    1,386
    
    
    
    11,671
    
    
    
    13,981Assets held for sale
    
    
    7,744
    
    
    
    11,910
    
    
    
    11,671
    
    
    
    31,325Current liabilities
    
    
    
    
    
    
    1,128
    
    
    
    
    
    
    
    1,128Liabilities held for sale
    
    
    
    
    
    
    1,128
    
    
    
    
    
    
    
    1,128Net assets held for sale
    
    $
    7,744
    
    
    $
    10,782
    
    
    $
    11,671
    
    
    $
    30,197
 13. INCOME TAXES During
the first quarter 2004, we recorded a net tax provision of $7.6 million
compared to a benefit from taxes of $11.7 million for the first quarter 2003.
Our effective tax rate for the first quarter 2004 was (444)%, compared to 31%
for the first quarter 2003. Due to Hanovers recent domestic tax losses, we
cannot reach the conclusion that it is more likely than not that certain of
our U.S. deferred tax assets will be realized in the near future. Accordingly,
our provision for income taxes for the first quarter 2004 did not include a tax
benefit for our estimate of anticipated U.S. losses because the benefit is not
anticipated to be realized during 2004. As a result, our provision includes
a 0% effective tax rate on our U.S. loss and a 30.6% tax rate on our
international source income. 18




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Certain matters discussed in this Quarterly Report on Form 10-Q are
forward-looking statements intended to qualify for the safe harbors from
liability established by the Private Securities Litigation Reform Act of 1995
and Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements can generally be identified as such because the
context of the statement will include words such as we believe, anticipate,
expect, estimate or words of similar import. Similarly, statements that
describe Hanovers future plans, objectives or goals or future revenues or
other future financial metrics are also forward-looking statements. Such
forward-looking statements are subject to certain risks and uncertainties that
could cause our actual results to differ materially from those anticipated as
of the date of this report. These risks and uncertainties include:  
    
    our inability to renew our short-term leases of equipment with our customers so as to fully recoup our cost of the equipment;  
    
    a prolonged substantial reduction in oil and natural gas prices, which could cause a decline in the demand for our compression and oil and natural gas production equipment;  
    
    reduced profit margins or the loss of market share resulting from competition or the introduction of competing technologies by other companies;  
    
    legislative changes or changes in economic or political conditions in the countries in which we do business;  
    
    the inherent risks associated with our operations, such as equipment defects, malfunctions and failures and natural disasters;  
    
    our inability to implement certain business objectives, such as:  
    
    integrating acquired businesses,  
    
    implementing our new enterprise resource planning systems,  
    
    generating sufficient cash,  
    
    accessing the capital markets,  
    
    refinancing existing or incurring additional indebtedness to fund our business, and  
    
    executing our exit and sale strategy with respect to assets classified on our
balance sheet as discontinued operations and held for sale;  
    
    governmental safety, health, environmental and other regulations, which could require us to make significant expenditures; and  
    
    our inability to comply with covenants in our debt agreements and the decreased financial flexibility associated with our substantial debt. Other factors besides those described in this Form 10-Q could also affect our
actual results. You should not unduly rely on the forward-looking statements
contained in this Form 10-Q, which speak only as of the date of this Form 10-Q.
Except as otherwise required by law, we undertake no obligation to publicly
revise any forward-looking statement to reflect circumstances or events after
the date of this Form 10-Q or to reflect the occurrence of unanticipated
events. You should, however, review the factors and risks we describe in our
Annual Report on Form 10-K for the year ended December 31, 2003 and the reports
we file from time to time with the SEC after the date of this Form 10-Q. All
forward-looking statements attributable to Hanover are expressly qualified in
their entirety by this cautionary statement. 19




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##### Table of Contents



GENERAL Hanover Compressor Company, (we, Hanover, or the Company) a Delaware
corporation, together with its subsidiaries, is a global market leader in the
full service natural gas compression business and is also a leading provider of
service, fabrication and equipment for oil and natural gas processing and
transportation applications. We sell and rent this equipment and provide
complete operation and maintenance services, including run-time guarantees, for
both customer-owned equipment and our fleet of rental equipment. Hanover was
founded as a Delaware corporation in 1990, and has been a public company since
1997. Our customers include both major and independent oil and gas producers
and distributors as well as national oil and gas companies in the countries in
which we operate. Our maintenance business, together with our parts and service
business, provides solutions to customers that own their own compression and
surface production and processing equipment, but want to outsource their
operations. We also fabricate compressor and oil and gas production and
processing equipment and provide gas processing and treating, gas measurement
and oilfield power generation services, primarily to our domestic and
international customers as a complement to our compression services. In
addition, through our subsidiary, Belleli Energy S.r.l. (Belleli), we provide
engineering, procurement and construction services primarily related to the
manufacturing of heavy wall reactors for refineries and construction of
desalination plants, primarily for use in Europe and the Middle East. Substantially all of our assets and operations are owned or conducted by our
wholly-owned subsidiary, Hanover Compression Limited Partnership (HCLP). RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THREE MONTHS ENDED MARCH 31, 2003 Overview Our revenue and other income in the first quarter 2004 was $274.3 million
compared to first quarter 2003 revenue and other income of $273.7 million. Net
loss for the first quarter 2004 was $9.5 million, or $0.11 per share, compared
with a net loss of $26.6 million, or $0.33 per share, in the first quarter
2003. Our provision for income taxes for the first quarter 2004 did not
include a tax benefit for our estimate of anticipated U.S. losses. Based on a statutory
rate, we estimate that our tax expense was approximately $9.4 million higher
because of our current tax position in the U.S. This expense is discussed in
detail under Income Taxes below. In
the first quarter 2004, we realized continued improvement in our domestic rental
fleet utilization which increased from approximately 76% at year end 2003 to
78% at the end of the first quarter 2004. During the quarter ended March 31,
2004, we also achieved an improvement in backlog in both the compression and
production and processing fabrication lines of business. Our parts, service
and used equipment business segment benefited from strong installation revenue
and gross profit in the first quarter 2004, but the base parts and service
revenue was lower than anticipated due to continued delays in maintenance by
our customers because of the current strong gas price environment, particularly
in North America. Total compression horsepower at March 31, 2004 was approximately 3,478,000,
consisting of approximately 2,564,000 horsepower in the United States and
approximately 914,000 horsepower internationally. Hanovers total compression
horsepower utilization rate at March 31, 2004 was approximately 82%, an
increase over utilization of approximately 81% at December 31, 2003 and
approximately 79% at March 31, 2003. Domestic and international utilization at
March 31, 2004 was approximately 78% and 94%, respectively, compared to
approximately 76% and 94%, respectively, at December 31, 2003, and
approximately 73% and 94%, respectively, at March 31, 2003. At March 31, 2004, Hanovers total third-party fabrication backlog, excluding
Belleli, was approximately $97 million compared to approximately $46 million at
December 31, 2003 and $94 million at March 31, 2003. Backlog for Belleli at
March 31, 2004 was approximately $124 million, compared to approximately $107
million at December 31, 2003 and $64 million at March 31, 2003. The compressor
and accessory fabrication backlog was approximately $52 million at March 31,
2004, compared to approximately $28 million at December 31, 2003, and $43
million at March 31, 2003. The backlog for production and processing equipment
fabrication, excluding Belleli, was approximately $45 million at
March 31, 2004 compared to
approximately $18 million at December 31, 2003, and $52 million at March 31,
2003. 20




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##### Table of Contents



Industry Conditions The North American rig count increased by 15% to 1,598 at March 31, 2004 from
1,390 at March 31, 2003, and the twelve-month rolling average North American
rig count increased by 28% to 1,467 at March 31, 2004 from 1,145 at March 31,
2003. In addition, the twelve-month rolling average New York Mercantile
Exchange wellhead natural gas price increased to $5.16 per Mcf at March 31,
2004 from $4.29 per Mcf at March 31, 2003. During 2003, we did
not experience any significant growth in domestic rentals or
purchases of equipment and services by our customers, which we
believe is primarily the result of the lack of a significant increase
in U.S. natural gas production levels. However, with several
non-operational issues behind us, we are focused on improving our
sales success ratio on new bid opportunities and anticipate some
revenue growth in 2004. Facility Consolidation We
had previously announced our plan to reduce our U.S. headcount by
approximately 500 employees worldwide and to close four fabrication
facilities. During the year ended December 31, 2002, we accrued
approximately $2.7 million in employee separation costs related
to the reduction in workforce. During the year ended
December 31, 2003, we paid approximately $2.0 million in
employee separation costs, implemented further cost saving
initiatives and closed two additional facilities. During the first
quarter of 2004, we incurred an
additional $0.7 million in employee separation costs related to
the completion of these activities. From December 31, 2002 to
March 31, 2004, our U.S. workforce has decreased by
approximately 700 employees. U.S. Tax Position As
a result of recent operating losses, we were in a net deferred tax
asset position (for U.S. income tax purposes) for the first time in
2003. Due to our recent domestic tax losses, we could not reach the
conclusion that it was more likely than not that certain
of our U.S. deferred tax assets will be realized in the near future.
Accordingly, for 2003 we provided a $25.7 million deferred tax valuation allowance against our net U.S.
deferred tax asset. We will be required to record additional
valuation allowances if our domestic deferred tax asset position is
increased and the more likely than not criteria of SFAS
109 is not met. If we are required to record additional valuation
allowances, our effective tax rate will be above the statutory rate.
Our preliminary analysis leads us to believe that we will likely be
required to record additional valuation allowances in 2004, unless we
are able to implement tax planning strategies that would minimize or
eliminate the amount of such additional valuation allowances prior to
the end of the year, and we may be required to record additional
valuation allowances in future periods. Summary of Business Segment Results Domestic Rentals
(in thousands) Three Months EndedMarch 31,Increase2004
    
    2003
    
    (Decrease)Revenue
    
    $
    86,592
    
    
    $
    78,649
    
    
    
    10
    %Operating expense
    
    
    35,539
    
    
    
    31,204
    
    
    
    14
    %Gross profit
    
    $
    51,053
    
    
    $
    47,445
    
    
    
    8
    %Gross margin
    
    
    59
    %
    
    
    60
    %
    
    
    (1
    )%
 Domestic rental revenue and gross profit increased in the first quarter 2004,
compared to the first quarter 2003, due primarily to improved utilization in
our compression rental fleet. We believe that our utilization increased due to
an improvement in market conditions and our focus on putting idle units into
service. Utilization of our domestic compression rental fleet
increased to approximately 78% at March 31, 2004 from approximately 73% at
March 31, 2003. Our utilization increased due to a 2% increase in contracted units,
the retirement of units to be sold or scrapped and the deployment of units into
international operations. Gross margin for the first quarter 2004 decreased slightly,
compared to the first quarter 2003, due to increased maintenance and repair
expense and increased start up costs associated with bringing idle compression
units online. International Rentals
(in thousands) Three Months EndedMarch 31,Increase2004
    
    2003
    
    (Decrease)Revenue
    
    $
    55,569
    
    
    $
    51,440
    
    
    
    8
    %Operating expense
    
    
    17,126
    
    
    
    15,020
    
    
    
    14
    %Gross profit
    
    $
    38,443
    
    
    $
    36,420
    
    
    
    6
    %Gross margin
    
    
    69
    %
    
    
    71
    %
    
    
    (2
    )%
 First quarter 2004 international rental revenue and gross profit increased,
compared to the first quarter 2003, due to increased compression rental
activity, primarily in Argentina and Mexico, and the addition in the second
half of 2003 of two gas processing plants in Mexico and Brazil. Gross margin
for the first quarter 2004 decreased when compared to the first quarter 2003,
primarily because of the inclusion of approximately $1.7 million of 2002 revenue
that was recognized in the first quarter 2003 as a result of concerns about the
ultimate receipt of this revenue due to the unofficial national strike in
Venezuela. 21




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##### Table of Contents



Parts, Service and Used Equipment
(in thousands) Three Months EndedMarch 31,Increase2004
    
    2003
    
    (Decrease)Revenue
    
    $
    44,607
    
    
    $
    37,770
    
    
    
    18
    %Operating expense
    
    
    33,230
    
    
    
    24,463
    
    
    
    36
    %Gross profit
    
    $
    11,377
    
    
    $
    13,307
    
    
    
    (15
    )%Gross margin
    
    
    26
    %
    
    
    35
    %
    
    
    (9
    )%
 Parts, service and used equipment revenue for the first quarter 2004 was higher
than the first quarter 2003 due primarily to increased installation sales which
were partly offset by a decrease in revenue from our domestic parts and service business. We
believe our North American customers have delayed maintenance in
order to keep their equipment on-line for longer periods due to the
increase in price of natural gas. Gross profit and gross margin for the first
quarter 2004 were lower than the results for the first quarter 2003 primarily
due to slower activity in parts and service in North America and a high margin
on a used equipment sale in the first quarter 2003. For the first quarter
2004, parts and service revenue was $25.2 million with a gross margin of 25%,
compared to $29.8 million and 32%, respectively, for the first quarter 2003.
Used rental equipment and installation sales revenue in the first quarter 2004
was $19.4 million with a gross margin of 27%, compared to
$8.0 million with a 48%
gross margin for the first quarter 2003. Our used rental equipment and
installation sales and gross margins vary significantly from period
to period and are dependent on the exercise of
purchase options on rental equipment by customers and the start-up of new
projects by customers. Compression and Accessory Fabrication
(in thousands) Three Months EndedMarch 31,Increase2004
    
    2003
    
    (Decrease)Revenue
    
    $
    28,150
    
    
    $
    21,380
    
    
    
    32
    %Operating expense
    
    
    25,916
    
    
    
    18,638
    
    
    
    39
    %Gross profit
    
    $
    2,234
    
    
    $
    2,742
    
    
    
    (19
    )%Gross margin
    
    
    8
    %
    
    
    13
    %
    
    
    (5
    )%
 For the first quarter 2004, compression fabrication revenue increased primarily
due to our increased focus on fabrication that led to increased sales. Gross
profit and gross margin declined in the first quarter 2004, compared to first
quarter 2003, due primarily to continued strong competition for new orders,
which negatively impacted sales prices and the resulting gross margin. Production and Processing Equipment Fabrication
(in thousands) Three Months EndedMarch 31,Increase2004
    
    2003
    
    (Decrease)Revenue
    
    $
    53,429
    
    
    $
    80,140
    
    
    
    (33
    )%Operating expense
    
    
    47,696
    
    
    
    69,562
    
    
    
    (31
    )%Gross profit
    
    $
    5,733
    
    
    $
    10,578
    
    
    
    (46
    )%Gross margin
    
    
    11
    %
    
    
    13
    %
    
    
    (2
    )%
 22




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##### Table of Contents



Production
and processing equipment fabrication revenue for the first quarter 2004 was lower than for the first quarter 2003, primarily due
to a decrease in orders experienced in the second half of 2003 from our
customers. We believe our consolidation efforts, management changes and
non-operational issues impacted our sales efforts. However, we are focusing on
improving our sales success ratio on new bid opportunities which has resulted
in the recent improvement in our backlog. Included in production and processing
equipment fabrication revenue and expense for the first quarter 2004 was $30.3
million in revenue and $26.9 million in expense for Belleli, compared to $35.4
million in revenue and $31.7 million in expense in the first quarter 2003.
Belleli revenue was down, compared to the first quarter 2003, due to reduced
activity in the Middle East. Gross profit and gross margin for production and
processing equipment fabrication for the first quarter of 2004 declined,
compared to the first quarter 2003, due primarily to a decrease in
revenue which led to
lower utilization of our fabrication facilities resulting in less absorption of
fixed overhead that negatively impacts gross margins. Other Income Equity in income of non-consolidated affiliates increased by $2.0 million to
$4.9 million during the for the first quarter 2004, from $2.9 million during
the first quarter 2003. This increase is primarily due to an
improvement in results from our equity interest in El Furrial that experienced
a fire in the first quarter 2003, offset partly by a decrease in earnings due
to our sale of our interest in Hanover Measurement. Expenses Selling, general, and administrative expense (SG&A) for the first quarter
2004 was $39.9 million, compared to $39.3 million in the first quarter 2003.
For the first quarter 2004, Belleli SG&A expense was $3.6 million, compared to
$2.5 million in the first quarter 2003. The increase in SG&A expense at
Belleli was primarily due to the appreciation of the Euro relative to the U.S.
Dollar. This increase was partially offset by the reversal of a $1.3 million legal accrual
for our domestic operations for which a settlement was reached. Depreciation and amortization expense for the first quarter 2004 increased to
$43.0 million, compared to $34.6 million for the same period a year ago. First
quarter 2004 depreciation and amortization increased primarily due to
additional depreciation expense of approximately $4.2 million associated with
the compression equipment operating leases that were consolidated into
Hanovers financial statements in the third quarter 2003 and increased
depreciation expense due to additions to the rental fleet, including
maintenance capital, placed in service during the first quarter 2004 and during
2003. Beginning in July 2003, payments accrued under our sale leaseback transactions
are included in interest expense as a result of consolidating on our balance
sheet the entities that lease compression equipment to us. See the discussion
of the adoption of FIN 46 under New Accounting Pronouncements below. As a
result, during the first quarter 2004 as compared to the first quarter 2003,
our interest expense increased $23.1 million to $35.3 million and our leasing
expense decreased $22.3 million to $0. Foreign currency translation for the first quarter 2004 was a gain of $1.5
million, compared to a loss of $0.4 million for the three months ended March
31, 2003. The foreign currency translation gain was primarily due to the
devaluation of the Venezuelan bolivar. The following table summarizes the
exchange gains and losses we recorded for assets exposed to currency
translation (in thousands): Three Months
EndedMarch 31,2004
    
    2003Argentina
    
    $
    (221
    )
    
    $
    1,313Venezuela
    
    
    956
    
    
    
    (1,526
    )All other countries
    
    
    767
    
    
    
    (160
    )Exchange gain (loss)
    
    $
    1,502
    
    
    $
    (373
    )
 23




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##### Table of Contents



Provision for Securities Litigation Settlement During
the first quarter 2003, we recorded a $42.1 million charge as the
estimated cost of our securities litigation settlement compared to a $0.1
million reduction resulting from the marked-to-market impact of the embedded
derivative related to the shareholder note recorded during the first quarter
2004. For further detail on the securities litigation settlement see the
discussion under Legal Proceedings. Income Taxes During
the first quarter 2004, we recorded a net tax provision of $7.6 million
compared to a benefit from taxes of $11.7 million for the first quarter 2003.
Our effective tax rate for the first quarter 2004 was (444)%, compared to 31%
for the first quarter 2003. Due to Hanovers recent domestic tax losses, we
cannot reach the conclusion that it is more likely than not that certain of
our U.S. deferred tax assets will be realized in the near future. Accordingly,
our provision for income taxes for the first quarter 2004 did not include a tax
benefit for our estimate of anticipated U.S. losses because the benefit is not
anticipated to be realized during 2004. As a result, our provision includes
a 0% effective tax rate on our U.S. loss and a 30.6% tax rate on our
international source income. Based on a U.S. statutory rate, we estimate that
our tax expense for the first quarter of 2004 was approximately $9.4 million
higher because of its current tax position in the U.S. Discontinued Operations During the fourth quarter 2002, we reviewed our business lines and the board of
directors approved managements recommendation to exit and sell our
non-oilfield power generation and certain used equipment business lines. Income
from discontinued operations decreased $0.6 million to a net loss of $0.1
million during the first quarter 2004, from an income of $0.5 million during
the first quarter 2003. LIQUIDITY AND CAPITAL RESOURCES Our unrestricted cash balance amounted to $30.1 million at March 31, 2004
compared to $56.6 million at December 31, 2003. Working
capital decreased to
$87.3 million at March 31, 2004 from $255.2 million at December 31, 2003. The
decrease in working capital was primarily attributable to the
reclassification of our 2000A equipment lease notes, due March 2005, to
current liabilities. Our availability under our bank credit facility
may be used to finance maturing debt obligations or we may seek other
sources of financing. Our cash flow from operating, investing and financing activities, as reflected
in the Consolidated Statement of Cash Flow, are summarized in the table below
(dollars in thousands): Three Months EndedMarch 31,2004
    
    2003Net cash provided by (used in) continuing operations:Operating activities
    
    $
    (2,380
    )
    
    $
    (3,924
    )Investing activities
    
    
    (6,754
    )
    
    
    (34,569
    )Financing activities
    
    
    (18,168
    )
    
    
    39,617Effect of exchange rate changes on cash and cash equivalents
    
    
    298
    
    
    
    90Net cash provided by discontinued operations
    
    
    466
    
    
    
    523Net change in cash and cash equivalents
    
    $
    (26,538
    )
    
    $
    1,737
 The decrease in cash used in operating activities for the first quarter 2004 as
compared to the first quarter 2003 was primarily due to an increase in accounts
receivable and inventory. The decrease in cash used in investing activities during the first quarter 2004
as compared to the first quarter 2003 was primarily attributable to a decrease
in capital expenditures and the $4.7 million in proceeds received from the sale
of our interest in Hanover Measurement Services Company, LP. The increase in cash used in financing activities was primarily due to a net
reduction in borrowings from our bank credit facility. We may carry out new customer projects through rental fleet additions and other
related capital expenditures. We generally invest funds necessary to make these
rental fleet additions when our idle equipment cannot economically fulfill a
projects requirements and the new equipment expenditure is matched with
long-term contracts whose expected economic terms 24




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exceed our return on capital targets. During 2004, we plan to spend
approximately $100 million to $150 million on capital expenditures, including (1) rental
equipment fleet additions and (2) approximately $50 million to $60 million on equipment
maintenance capital. Since capital expenditures are largely discretionary, we
believe we would be able to significantly reduce them, in a reasonably short
time frame, if expected cash flows from operations were not realized.
Historically, we have funded our capital requirements with a combination of
internally generated cash flow, borrowings under a bank credit facility, sale
leaseback transactions, raising additional equity and issuing long-term debt.
Subsequent to December 31, 2003, there have been no significant changes to our
obligations to make future payments under existing contracts. As part of our business, we are a party to various financial guarantees,
performance guarantees and other contractual commitments to extend guarantees
of credit and other assistance to various subsidiaries, investees and other
third parties. To varying degrees, these guarantees involve elements of
performance and credit risk, which are not included on our consolidated balance
sheet. The possibility of our having to honor
these commitments is largely dependent upon future operations of various
subsidiaries, investees and other third parties, or the occurrence of certain
future events. We would record a reserve for these guarantees if events
occurred that required that one be established. Our bank credit facility provides for a $350 million revolving credit
facility in which advances bear interest at (a) the greater of the
administrative agents prime rate, the federal funds effective rate, or the
base CD rate, or (b) a eurodollar rate, plus, in each case, a specified margin
(4.1% weighted average interest rate at March 31, 2004). A commitment fee equal
to 0.625% times the average daily amount of the available commitment under the
bank credit facility is payable quarterly to the lenders participating in the
bank credit facility. Our bank credit facility contains certain financial
covenants and limitations on, among other things, indebtedness, liens, leases
and sales of assets. As of March 31, 2004, we were in compliance with all material covenants and
other requirements set forth in our bank credit facility, the indentures and
agreements related to our compression equipment lease obligations and the
indentures and agreements relating to our other long-term debt. A default under our bank credit facility or these
agreements would trigger cross-default provisions under the agreements relating
to certain of our other debt obligations. Such defaults would have a material
adverse effect on our liquidity, financial position and operations. Giving effect
to the covenant limitations in our bank credit facility, the liquidity
available under that facility as of March 31, 2004 was
approximately $245 million. While there is no assurance, we believe based on our current
projections for 2004 that we will be in compliance with the financial covenants
in our bank credit facility and the agreements related to our compression
equipment lease obligations. We expect that our
bank credit facility and cash flow from operations will
provide us adequate capital resources to fund our estimated level of capital
expenditures for the short term. As of March 31, 2004, we had approximately
$6.0 million in borrowings and approximately $90.0 million in letters of credit
outstanding under our bank credit facility (4.1% weighted average effective
rate at March 31, 2004). Our bank credit facility permits us to incur
indebtedness, subject to covenant limitations described above, up to a $350
million credit limit, plus, in addition to certain other indebtedness, an
additional (1) $40 million in unsecured indebtedness, (2) $50 million of
non-recourse indebtedness of unqualified subsidiaries, and (3) $25 million of
secured purchase money indebtedness. In June 2003, we filed a shelf registration statement with the SEC pursuant to
which we may from time to time publicly offer equity, debt or other securities
in an aggregate amount not to exceed $700 million. The SEC subsequently
declared the shelf registration statement effective on November 19, 2003 and in
December 2003 we issued approximately $344 million in securities under our
shelf registration statement. Subject to market conditions, the shelf
registration statement will be available to offer one or more series of
additional debt or other securities in an aggregate principal amount up to the
remaining amount available. In addition to purchase money and similar obligations, the indentures and the
agreements related to our compression equipment lease obligations for our 2001A
and 2001B sale leaseback transactions and our 8.625% Senior Notes due 2010
permit us to incur indebtedness up to the $350 million credit limit under our
bank credit facility, plus (1) an additional $75 million in unsecured
indebtedness and (2) any additional indebtedness so long as, after incurring
such indebtedness, our ratio of the sum of consolidated net income before
interest expense, income taxes, depreciation expense, amortization of
intangibles, certain other non-cash charges and rental expense to total fixed
charges (all as defined and adjusted by the 25




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agreements governing such obligations), or our coverage ratio, is greater
than 2.25 to 1.0 and no default or event of default has occurred or would occur
as a consequence of incurring such additional indebtedness and the application
of the proceeds thereon. The indentures and agreements related to our
compression equipment lease obligations for our 2001A and 2001B sale leaseback
transactions define indebtedness to include the present value of our rental
obligations under sale leaseback transactions and under facilities similar to
our compression equipment operating leases. As of March 31, 2004, Hanovers
coverage ratio was less than 2.25 to 1.0 and therefore as of such date we could
not incur indebtedness other than under our bank credit facility and up to an
additional $75 million in unsecured indebtedness and certain other permitted
indebtedness, including certain refinancing indebtedness. As of March 31, 2004, our credit ratings as assigned by Moodys
Investors Service, Inc. (Moodys) and Standard & Poors Ratings Services
(Standard & Poors) were: StandardMoody's
    
    & Poor'sOutlook
    
    Stable
    
    NegativeSenior implied rating
    
    
    B1
    
    
    BB-Bank credit facility due December 2006
    
    Ba3
    
    
    4.75% convertible senior notes due 2008
    
    
    B3
    
    
    
    4.75% convertible senior notes due 2014
    
    
    B3
    
    
    
    B8.625% senior notes due 2010
    
    
    B3
    
    
    
    B2001A equipment lease notes, interest at 8.5%, due September 2008
    
    
    B2
    
    
    
    2001B equipment lease notes, interest at 8.8%, due September 2011
    
    
    B2
    
    
    
    Zero coupon subordinated notes, interest at 11%, due March 31, 2007
    
    Caa1
    
    
    B-7.25% convertible subordinated notes due 2029*
    
    Caa1
    
    
    Senior secured
    
    
    
    
    
    
    B+Senior unsecured
    
    
    
    
    
    
    B
   *
    
    Rating is on the Mandatorily Redeemable Convertible Preferred Securities that
were issued by Hanover Compressor Capital Trust, our wholly-owned subsidiary.
See discussion of the impact of FIN 46 in Managements Discussion and
Analysis of Financial Condition and Results of Operations  New Accounting
Pronouncements under Item 2 of this quarterly report on Form
10-Q. We do not have any credit rating downgrade provisions in our debt agreements or
the agreements related to our compression equipment lease obligations that
would accelerate their maturity dates. However, a downgrade in our credit
rating could materially and adversely affect our ability to renew existing, or
obtain access to new, credit facilities in the future and could increase the
cost of such facilities. Should this occur, we might seek alternative sources
of funding. In addition, our significant leverage puts us at greater risk of
default under one or more of our existing debt agreements if we experience an
adverse change to our financial condition or results of operations. Our ability
to reduce our leverage depends upon market and economic conditions, as well as
our ability to execute liquidity-enhancing transactions such as sales of
non-core assets or our equity securities. We use derivative financial instruments to minimize the risks and/or costs
associated with financial and global operating activities by managing our
exposure to interest rate fluctuation on a portion of our debt and leasing
obligations. Our primary objective is to reduce our overall cost of borrowing
by managing the fixed and floating interest rate mix of our debt portfolio. We
do not use derivative financial instruments for trading or other speculative
purposes. The cash flow from hedges is classified in our consolidated
statements of cash flows under the same category as the cash flows from the
underlying assets, liabilities or anticipated transactions. For derivative instruments designated as fair value hedges, the gain or loss is
recognized in earnings in the period of change together with the gain or loss
on the hedged item attributable to the risk being hedged. For derivative
instruments designated as cash flow hedges, the effective portion of the
derivative gain or loss is included in other comprehensive income, but not
reflected in our consolidated statement of operations until the corresponding
hedged transaction is settled. The ineffective portion is reported in earnings
immediately. 26




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In March 2004, we entered into two interest rate swaps to hedge the risk of
changes in fair value of our 8.625% Senior Notes due 2010 resulting from
changes in interest rates. These interest rate swaps, under which we receive
fixed payments and make floating payments, result in the conversion of the
hedged obligation into floating rate debt. The following table summarizes, by
individual hedge instrument, these interest rate swaps as of March 31, 2004: Floating Rate to be Paid
    
    Maturity Date
    
    Fixed Rate to be Received
    
    Notional AmountSix Month LIBOR +4.72%
    
    December 15, 2010
    
    
    8.625
    %
    
    $
    100,000,000Six Month LIBOR +4.64%
    
    December 15, 2010
    
    
    8.625
    %
    
    $
    100,000,000
 As of March 31, 2004,
a total of approximately $4.0 million in
other current assets, $5.0 million in long term liabilities and a
$1.1 million reduction of long-term debt was recorded with respect to the fair value adjustment
related to these two swaps. During 2001, we entered into three additional interest rate swaps to convert
variable lease payments under certain lease arrangements to fixed payments as
follows: Lease
    
    Maturity Date
    
    Fixed rate to be paid
    
    Notional AmountMarch 2000
    
    March 11, 2005
    
    
    5.2550
    %
    
    $
    100,000,000August 2000
    
    March 11, 2005
    
    
    5.2725
    %
    
    $
    100,000,000October 2000
    
    October 26, 2005
    
    
    5.3975
    %
    
    $
    100,000,000
 These three swaps, which we have designated as cash flow hedging instruments,
meet the specific hedge criteria and any changes in their fair values have been
recognized in other comprehensive income. During the quarters ended March 31,
2004 and 2003, we recorded income of approximately $1.6 million and $0.7
million, respectively, related to these three swaps ($1.6 million and $0.4
million net of tax) in other comprehensive income. As of March 31, 2004, a
total of approximately $11.6 million was recorded in current liabilities and
approximately $1.9 million in long-term liabilities with respect to the fair
value adjustment related to these three swaps. Prior to 2001, we entered into two interest rate swaps with notional amounts of
$75 million and $125 million and strike rates of 5.51% and 5.56%, respectively.
The difference paid or received on the swap transactions was recorded as an
accrued liability and recognized in leasing expense in all periods before July
1, 2003, and in interest expense thereafter. Because management decided not to
designate the interest rate swaps as hedges, we recognized unrealized gains of approximately $2.0 million
related to the change in the fair value of these interest rate swaps in lease
expense in our statement of operations during the three months ended March 31,
2003. The counterparties to the interest rate swap agreements are major international
financial institutions. We monitor the credit quality of these financial
institutions and do not expect non-performance by any counterparty, although
such non-performance could have a material adverse effect on us. We have significant operations that expose us to currency risk in Argentina and
Venezuela. To mitigate that risk, the majority of our existing contracts
provide that we receive payment in or based on U.S. dollars rather than
Argentine pesos and Venezuelan bolivars, thus reducing our exposure to
fluctuations in the value of these currencies relative to the U.S. dollar. For the three months
ended March 31, 2004, our Argentine operations represented
approximately 5% of our revenue and 10% of our gross profit.  For the three months ended March 31, 2004, our Venezuelan operations
represented approximately 15% of our revenue and 23% of our gross profit. At
March 31, 2004, we had approximately $26.2 million in accounts receivable
related to our Venezuelan operations. 27




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The following table summarizes the exchange gains and losses we recorded for
assets exposed to currency translation (in thousands): Three Months
EndedMarch 31,2004
    
    2003Argentina
    
    $
    (221
    )
    
    $
    1,313Venezuela
    
    
    956
    
    
    
    (1,526
    )All other countries
    
    
    767
    
    
    
    (160
    )Exchange gain (loss)
    
    $
    1,502
    
    
    $
    (373
    )
 In December 2002, opponents of Venezuelan President Hugo Chávez initiated a
country-wide strike by workers of the national oil company in Venezuela. This
strike, a two-month walkout, had a significant negative impact on Venezuelas
economy and temporarily shut down a substantial portion of Venezuelas oil
industry. As a result of the strike, Venezuelas oil production dropped
substantially. In addition, exchange controls have been put in place that put
limitations on the amount of Venezuelan currency that can be exchanged for
foreign currency by businesses operating inside Venezuela. In May 2003, after
six months of negotiation, the Organization of the American States brokered an
agreement between the Venezuelan government and its opponents. Although the
accord does offer the prospect of stabilizing Venezuelas economy, if another
national strike is staged, exchange controls remain in place, or economic and
political conditions in Venezuela continue to deteriorate, our results of
operations in Venezuela could be materially and adversely affected, which could
result in reductions in our net income. As a result of the disruption of our
operations in Venezuela, during the fourth quarter of 2002, our international
rental revenues decreased by approximately $2.7 million. In the three months
ended March 31, 2003, we recognized approximately $1.7 million of billings to
Venezuelan customers that were not recognized in 2002 due to concerns about the
ultimate receipt of those revenues. In addition, a movement to
call a referendum for early presidential elections has resulted in renewed civil strife in Venezuela. If such
strife continues or escalates, our results of operations in Venezuela could be
further materially and adversely affected. In February 2003, the Venezuelan government fixed the
exchange rate to 1,600 bolivars for each U.S. dollar. In February
2004, the government devalued the currency by approximately 17%. The
impact of any further devaluation on our results will depend upon the amount
of our assets exposed to currency
fluctuation in Venezuela in future periods. The economic situation in Argentina and Venezuela is subject to change. To the
extent that the situation deteriorates, exchange controls continue in place and
the value of the peso and bolivar against the dollar is reduced further, our
results of operations in Argentina and Venezuela could be materially and
adversely affected which could result in reductions in our net income. We are involved in a project to build and operate barge-mounted gas compression
and gas processing facilities to be stationed in a Nigerian coastal waterway as
part of the performance of a contract between an affiliate of The Royal/ Dutch
Shell Group (Shell) and Global Energy and Refining Ltd. (Global), a
Nigerian company. We have completed the building of the required barge-mounted
facilities. We understand that Global must complete a significant financing for
part of the project in the near term or Shell would be able to terminate its
contract with Global. Global has orally informed us that they have completed a
financing, although it is not clear to us whether the funds raised will be
sufficient to perform their obligations under the Shell contract. In light of
the political environment in Nigeria, Globals lack of a successful track
record with respect to this project and other factors, there is no assurance
that Global will be able to comply with its obligations under the Shell
contract. We believe that Global is in default with respect to certain
agreements they have with us, as a result of which we believe we have certain
termination rights. We are currently in discussions with Global regarding our
relationship with them and this project. We cannot currently predict the
outcome of such discussions. If Shell were to terminate its contract with Global for any reason or we were
to terminate our involvement in the project, we would be required to find an
alternative use for the barge facility which could result in a write-down of
our investment. We currently have an investment of approximately $30.2 million
associated with the barge facility and approximately $4.1 million associated
with advances to, and our investment in, Global. NEW ACCOUNTING PRONOUNCEMENTS In January 2003, the FASB issued FIN 46. The primary objectives of FIN 46 are
to provide guidance on the identification of entities for which control is
achieved by means other than through voting rights and the determination of
when and which business enterprise should consolidate the VIE in its financial
statements. FIN 46 applies to an entity in which either (1) the equity
investors (if any) do not have a controlling financial interest or (2) the
equity investment at risk is insufficient to finance that entitys activities
without receiving additional subordinated financial support from other parties.
In addition, FIN 46 requires that both the primary beneficiary and all other
enterprises with a significant variable interest in a VIE make 28




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additional disclosures. As revised, FIN 46 was effective immediately for VIEs
created after January 31, 2003. For special-purposes entities created prior to
February 1, 2003, FIN 46 is effective at the first interim or annual reporting
period ending after December 15, 2003, or December 31, 2003 for us. For
entities, other than special purpose entities, created prior to February 1,
2003, FIN 46 is effective for us as of March 31, 2004.
Prior to 2004, we had
adopted the provisions of FIN 46 related to equipment leases and
mandatorily redeemable convertible preferred securities as discussed below. During the quarter ended March 31,
2004, no further adjustments were made to our consolidated financial
statements under the provisions of FIN 46. Prior to July 1, 2003, we entered into five lease transactions that were
recorded as a sale and leaseback of the compression equipment and were treated
as operating leases for financial reporting purposes. On July 1, 2003, we
adopted the provisions of FIN 46 as they relate to the special purpose entities
that lease compression equipment to us. As a result of the adoption, we added
approximately $1,089 million in compressor equipment assets, $192.3 million of
accumulated depreciation (including approximately $58.6 million of accumulated
depreciation related to periods before the sale and leaseback of the
equipment), $1,105.0 million in debt and $34.6 million in minority interest
obligations to our balance sheet, and we reversed $108.8 million of deferred
gains that were recorded on our balance sheet as a result of the sale leaseback
transactions. On July 1, 2003, we recorded a $133.7 million charge ($86.9
million net of tax) to record the cumulative effect from the adoption of FIN 46
related to prior period depreciation of the compression equipment assets.
Additionally, we estimate that we will record approximately $17 million per
year in additional depreciation expense on our leased compression equipment as
a result of the inclusion of the compression equipment on our balance sheet and
will also record the payments made under our compression equipment leases as
interest expense. We have a subsidiary trust that we consolidated prior to our adoption of FIN 46
that has mandatorily redeemable convertible preferred securities outstanding
that have a liquidation value of $86.3 million. Prior to December 31, 2003,
these securities were reported on our balance sheet as mandatorily
redeemable convertible preferred securities. Because we only have a limited
ability to make decisions about its activities and we are not the primary
beneficiary of the trust, the trust is a VIE under FIN 46. As such, the
mandatorily redeemable preferred securities issued by the trust are no longer
reported on our balance sheet. Instead, we now report our subordinated notes
payable to the trust as a debt. These intercompany notes have previously been
eliminated in our consolidated financial statements. The changes related to our
mandatorily redeemable preferred securities for our balance sheet are
reclassifications and have no impact on our consolidated results of operations
or cash flow. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity (SFAS 150).
SFAS 150 changes the accounting for certain financial instruments that, under
previous guidance, issuers could account for as equity. SFAS 150 requires that
those instruments be classified as liabilities in statements of financial
position. SFAS 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective for interim periods
beginning after June 15, 2004. On November 7, the FASB issued Staff Position
150-4 that delayed the effective date for certain types of financial
instruments. We do not believe the adoption of the guidance currently provided
in SFAS 150 will have a material effect on our consolidated results of
operations or cash flow. However, we may be required to classify as debt
approximately $28.6 million in sale leaseback obligations that are currently
reported as Minority interest on our condensed consolidated balance sheet
pursuant to FIN 46. These minority interest obligations represent the equity of the entities that
lease compression equipment to us. In accordance with the provisions of our
compression equipment lease obligations, the equity certificate holders are
entitled to quarterly or semi-annual yield payments on the aggregate
outstanding equity certificates. As of March 31, 2004, the yield rates on the
outstanding equity certificates ranged from 4.3% to 9.5%. Equity certificate
holders may receive a return of capital payment upon termination of the lease
or our purchase of the leased compression equipment after full payment of all
debt obligations of the entities that lease compression equipment to us. At
March 31, 2004, the carrying value of the minority interest obligations
approximated the fair market value of assets that would be required to be
transferred to redeem the minority interest obligations. 29




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##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to interest rate and foreign currency risk. Hanover and its
subsidiaries periodically enter into interest rate swaps to manage our exposure
to fluctuations in interest rates. At March 31, 2004, the fair market value of
our interest rate swaps, excluding the portion attributable to and included in
accrued interest, was a liability of approximately $14.6 million. At March 31, 2004 we were party to three interest rate swaps to convert
variable lease payments under certain lease arrangements to fixed payments as
follows (dollars in thousands): Fair Value of theCompany Pays
    
    
    
    
    
    Swap atMaturity Date
    
    Fixed Rate
    
    Notional Amount
    
    March 31, 20043/11/2005
    
    
    5.2550
    %
    
    $
    100,000
    
    
    $
    (3,755
    )3/11/2005
    
    
    5.2725
    %
    
    $
    100,000
    
    
    $
    (3,772
    )10/26/2005
    
    
    5.3975
    %
    
    $
    100,000
    
    
    $
    (5,950
    )
 At March 31, 2004 we were party to two interest rate swaps to convert fixed
rate debt to floating rate debt as follows (dollars in thousands): Fair Value of theCompany Receives
    
    
    
    
    
    Swap atMaturity Date
    
    Fixed Rate
    
    Notional Amount
    
    March 31, 200412/15/2010
    
    
    8.625
    %
    
    $
    100,000
    
    
    $
    (1,238
    )12/15/2010
    
    
    8.625
    %
    
    $
    100,000
    
    
    $
    158
 At March 31, 2004, due to these swaps we were exposed to variable interest
rates, which fluctuate with market interest rates, on $200 million in notional
debt. Assuming a hypothetical 10% increase in the variable rates from those in
effect at March 31, 2004, the increase in our annual interest expense would be
approximately $1.2 million. At March 31, 2004, we were exposed to variable rental rates, which fluctuate
with market interest rates, on a portion of the equipment leases we entered
into in 2001 and 2000. Assuming a hypothetical 10% increase in the variable
rates from those in effect at March 31, 2004, the increase in annual interest
expense on the equipment lease notes would be approximately $0.5 million. We are also exposed to interest rate risk on borrowings under our bank credit
facility under which interest may be accrued on advances at a floating interest
rate. At March 31, 2004, $6.0 million was outstanding bearing interest at a
weighted average effective rate of 4.1% per annum. Assuming a hypothetical 10%
increase in the weighted average interest rate from those in effect at March
31, 2004, the increase in annual interest expense for advances under this
facility would be approximately $25 thousand. We have significant operations that expose us to currency risk in Argentina and
Venezuela. To mitigate that risk, the majority of our existing contracts
provide that we receive payment in or based on U.S. dollars rather than
Argentine pesos and Venezuelan bolivars, thus reducing our exposure to
fluctuations in the value of those currencies relative to the U.S.
dollar. In February 2003, the Venezuelan government fixed the
exchange rate to 1,600 bolivars for each U.S. dollar. In February
2004, the government devalued the currency by approximately 17%. The
impact of any further devaluation on our results will depend upon the amount
of our assets exposed to currency
fluctuation in Venezuela in future periods. For
the three months ended March 31, 2004, our Argentine operations represented
approximately 5% of our revenue and 10% of our gross profit. For the
three months ended March 31, 2004, our Venezuelan operations represented
approximately 15% of our revenue and 23% of our gross profit. At March 31,
2004, we had approximately $26.2 million in accounts receivable related to our
Venezuelan operations. The following table summarizes the exchange gains and losses we recorded for
assets exposed to currency translation (in thousands): Three Months
EndedMarch 31,2004
    
    2003Argentina
    
    $
    (221
    )
    
    $
    1,313Venezuela
    
    
    956
    
    
    
    (1,526
    )All other countries
    
    
    767
    
    
    
    (160
    )Exchange gain (loss)
    
    $
    1,502
    
    
    $
    (373
    )
 30




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##### Table of Contents



The economic situation in Argentina and Venezuela is subject to change. To the
extent that the situation deteriorates, exchange controls continue in place and
the value of the peso and bolivar against the dollar is reduced further, our
results of operations in Argentina and Venezuela could be materially and
adversely affected which could result in reductions in our net income. 
 ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures.Hanovers principal
executive officer and principal financial officer evaluated the effectiveness
of our disclosure controls and procedures as of March 31, 2004 (as defined in
Rule 13a-15(e) of the Securities Exchange Act of 1934). Based on the
evaluation, our principal executive officer and principal financial officer
believe that our disclosure controls and procedures were effective to ensure
that material information was accumulated and communicated to our management,
including our principal executive officer and principal financial officer, as
appropriate to allow timely decisions regarding required disclosure. (b) Changes in Internal Controls.Under the direction of our President and
Chief Executive Officer and Senior Vice President and Chief Financial Officer,
we continued the process of reviewing our internal controls and procedures for
financial reporting and have changed or are in the process of changing some of
those controls and procedures, including changes relating to: information
systems (including controls over access to the systems and segregation of
duties); human resources; internal audit; tax accounting; planning and
analysis; reconciliation of intercompany accounts; approval of capital
expenditures; preparation, approval and closing of significant agreements and
transactions; review and quantification of compressor substitutions under
compression equipment lease agreements; integration of acquired businesses and
assets (including integration of certain financial and accounting systems
related thereto); standardization of internal controls and policies across the
organization; and the development, implementation and enhancements of corporate
governance policies and procedures and performance management systems. As part
of our review of our internal controls and procedures for financial reporting,
we have made personnel changes and hired additional qualified staff in the
legal, accounting/finance and human resource areas and are utilizing third
parties to assist with some of our integration and internal audit functions.
This review is ongoing, and the review to date constitutes the evaluation
required by Rule 13a-15(d) of the Securities Exchange Act of 1934. 31




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PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS Commencing in February 2002, approximately 15 putative securities class action
lawsuits were filed against us and certain of our current and former officers
and directors in the United States District Court for the Southern District of
Texas. These class actions (together with subsequently filed actions) were
consolidated into one case, Pirelli Armstrong Tire Corporation Retiree Medical
Benefits Trust, On Behalf of Itself and All Others Similarly Situated,Civil
Action No. H-02-0410, naming as defendants Hanover, Mr. Michael J. McGhan, Mr.
William S. Goldberg and Mr. Michael A. OConnor. The complaints asserted
various claims under Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 and sought unspecified amounts of compensatory damages, interest and
costs, including legal fees. The court entered an order appointing Pirelli
Armstrong Tire Corporation Retiree Medical Benefits Trust and others as lead
plaintiffs on January 7, 2003 and appointed Milberg, Weiss, Bershad, Hynes &
Lerach LLP as lead counsel. On September 5, 2003, lead plaintiffs filed an
amended complaint in which they sought relief under Sections 10(b) of the
Securities Exchange Act and Section 11 of the Securities Act against Hanover,
certain former officers and directors and our auditor, PricewaterhouseCoopers
LLP, on behalf of themselves and the class of persons who purchased Hanover
securities between May 4, 1999 and December 23, 2002. In the securities action, the plaintiffs allege generally that the defendants
violated the federal securities laws by making misstatements and omissions in
Hanovers periodic filings with the SEC as well as in other public statements
in connection with the transactions that were restated in 2002. Commencing in February 2002, four derivative lawsuits were filed in the United
States District Court for the Southern District of Texas, two derivative
lawsuits were filed in state district court for Harris County, Texas (one of
which was nonsuited and the second of which was removed to Federal District
Court for the Southern District of Texas) and one derivative lawsuit was filed
in the Court of Chancery for the State of Delaware in and for New Castle
County. These derivative lawsuits, which were filed by certain of our
shareholders purportedly on behalf of Hanover, alleged, among other things,
that our directors breached their fiduciary duties to shareholders in
connection with certain of the transactions that were restated in 2002, and
sought unspecified amounts of damages, interest and costs, including legal
fees. The derivative lawsuits in the United States District Court for the
Southern District of Texas were consolidated on August 19 and August 26, 2002
into the Harbor Finance Partners derivative lawsuit. With that consolidation,
the pending derivative lawsuits were: DatePlaintiff
    
    Defendants
    
    Civil Action No.
    
    Court
    
    InstitutedHarbor Finance
Partners,
derivatively on
behalf of
Hanover Compressor
Company
    
    Michael J. McGhan, William S. Goldberg,
Ted Collins, Jr., Robert R. Furgason,
Melvyn N. Klein, Michael A. OConnor, and
Alvin V. Shoemaker, Defendants and
Hanover Compressor Company, Nominal
Defendant
    
    H-02-0761
    
    United States
District Court
for the Southern
District of
Texas
    
    03/01/02Coffelt Family, LLC,
derivatively on
behalf of
Hanover Compressor
Company
    
    Michael A. OConnor, Michael J. McGhan,
William S. Goldberg, Ted Collins, Jr.,
Melvyn N. Klein, Alvin V. Shoemaker and
Robert R. Furgason, Defendants and
Hanover Compressor Company, Nominal
Defendant
    
    19410-NC
    
    Court of Chancery
for the
State of Delaware
State
Court in New Castle
County
    
    02/15/02
 On October 2, 2003, the Harbor Finance Partners derivative lawsuit was
consolidated into the Pirelli Armstrong Tire Corporation Retiree Medical
Benefits Trustsecurities class action. On and after March 26, 2003, three plaintiffs filed separate putative class
actions against Hanover, certain named individuals and other purportedly
unknown defendants, in the United States District Court for the Southern
District of Texas. The alleged class was composed of persons who participated in or were
beneficiaries of The Hanover Companies Retirement and Savings Plan, which was
established by Hanover pursuant to Section 401(k) of the United States Internal
Revenue Code of 1986, as amended. The purported class action sought relief
under ERISA based upon Hanovers and the individual defendants alleged
mishandling of Hanovers 401(k) Plan. The three ERISA putative class actions
were entitled: Kirkley v. Hanover,Case No. H-03-1155; Angleopoulos v. Hanover,
Case No. H-03-1064; and Freeman v. Hanover,Case No. H-03-1095. On August 1,
2003, the three ERISA class actions were consolidated into the Pirelli
Armstrong Tire Corporation Retiree Medical Benefits Trustfederal securities
class action. On October 9, 2003, a consolidated amended complaint was filed by
the plaintiffs in the ERISA class action against Hanover, Michael McGhan,
Michael OConnor and William Goldberg on behalf of themselves and a class of
persons who purchased or held Hanover securities in their 401(k) Plan between
May 4, 1999 and December 23, 2002. This action alleged generally that, in connection with the transactions that
were restated in 2002, we and certain individuals acting as fiduciaries of
Hanovers 401(k) Plan breached our fiduciary duties to the plan participants by
offering Hanover common stock as an investment option, failing to provide
material information to plan participants regarding the suitability of Hanover
common stock as an investment alternative, failing to monitor the performance
of plan fiduciaries, and failing to provide material information to other
fiduciaries. On October 23, 2003, we entered into a Stipulation and Agreement of Settlement
to settle all of the claims underlying the putative securities class action,
the putative ERISA class action and the shareholder derivative actions
described above. The terms of the settlement provided for us to: (1) make a
cash payment of approximately $30 million (of which $26.7 million was funded by
payments from Hanovers directors and officers insurance carriers), (2) issue
2.5 million shares of our common stock, and (3) issue a contingent note with a
principal amount of $6.7 million. The note is payable, together with accrued
interest, on March 31, 2007 but will be extinguished (with no money owing under
it) if our common stock trades at or above the average price of $12.25 per
share for 15 consecutive trading days at any time between March 31, 2004 and
March 31, 2007. In addition, upon the occurrence of a change of control of
Hanover, if the change of control or shareholder approval of the change of
control occurs before February 9, 2005, which is twelve months after the entry
of the final court approval of the settlement, we will be obligated to
contribute an additional $3 million to the settlement fund. As part of the
settlement, we have also agreed to implement corporate governance enhancements,
including allowing shareholders owning more than 1% but less than 10% of our
outstanding common stock to participate in the process to appoint two
independent directors to our board of directors (pursuant to which on February
4, 2004 we appointed Margaret K. Dorman and Stephen M. Pazuk to our board of
directors) and making certain changes to our code of conduct. GKH Investments, L.P. and GKH Private Limited (collectively GKH) which
formerly owned more than 10% of Hanovers outstanding common stock and which
sold shares in our March 2001 secondary offering of common stock, are parties
to the settlement and have agreed to settle claims against them that arise out
of that offering as well as other potential securities, ERISA, and derivative
claims. The terms of the settlement provided for GKH to transfer 2.5 million
shares of Hanover common stock from their holdings or from other sources to the
settlement fund. On October 24, 2003, the parties moved the United States District Court for the
Southern District of Texas for preliminary approval of the proposed settlement
and sought permission to provide notice to the potentially affected persons and
to set a date for a final hearing to approve the proposed settlement. On
December 5, 2003, the court held a hearing and granted the parties motion for
preliminary approval of the proposed settlement and, among other things,
ordered that notice be provided to appropriate persons and
set the date for the final hearing. The final hearing was held on February 6,
2004, and no objections to the settlement or requests to be excluded from the
terms of the settlement had been received prior to the deadline set by the
court. On February 9, 2004, the United States District Court for the Southern District
of Texas entered three Orders and Final Judgments approving the settlement on
the terms agreed upon in the Stipulation of Settlement with respect to all of
the claims described above, including the dismissal of each of the actions other
than the Coffelt Family derivative action filed in the Delaware Chancery Court.
The court also entered an Order and Final Judgment approving the plans of
allocation with respect to each action, as well as an Order and Final Judgment
approving the schedule of attorneys fees for counsel for the settling
plaintiffs. The time in which these Orders and Final Judgments may be appealed
expired on March 10, 2004 without any appeal being lodged. On March 16, 2004,
the Delaware Chancery Court dismissed the Coffelt Family derivative action. The
settlement has therefore become final and will be implemented according to its
terms. In March 2004, we issued and delivered to the escrow agent for the
settlement fund 2.5 million shares of Hanover common stock, as required by the
settlement. Our independent auditor, PricewaterhouseCoopers, is not a party to
the settlement and remains a party to the securities class action. The
estimated $3.6 million fair value of the contingent note issued was based on the present value of
the future cash flows discounted at borrowing rates currently available to us
for debt with similar terms and maturities. Using a market-borrowing rate of
9.3%, the principal value and the stipulated interest rate required by the note
of 5% per annum, a discount of $0.8 million was computed on the note to be
issued. Upon the issuance of the note, the discount will be amortized to
interest expense over the term of the note. The note could be extinguished
without a payment (if our common stock trades at or above the average price of
$12.25 per share for 15 consecutive trading days at any time between March 31,
2004 and March 31, 2007). At March 31, 2004, we recorded an asset for the value
of the embedded derivative, as required by SFAS 133. We estimated the value of
the derivative and reduced the amount we included for the estimate of the value
of the note by approximately $2.3 million at each of March 31, 2004 and
December 31, 2003. This asset will be marked to market in future periods with
any increase or decrease included in our statement of operations. On April 21,
2004, we issued the contingent note in the principal amount of $6.7 million to the escrow
agent for the settlement fund. As of December 31, 2003, our accompanying balance sheet included a $33.4
million long-term liability and $32.7 million in accrued liabilities related to
amounts that were expected to be paid in the next twelve months. In the first
quarter of 2004, we released the escrow settlement fund, issued the shares and
reclassified $29.8 million, the estimated value of our common stock issued,
from other liabilities to stockholders equity and included the shares in our
weighted average outstanding shares used for earnings per share calculations. On June 25, 1999, we notified the Air Quality Bureau of the Environmental
Protection Division, New Mexico Environmental Department (the Division), of
potential violations of State regulatory and permitting requirements. The
potential violations included failure to conduct required performance tests,
failure to file required notices and failure to pay annual filing fees for
compressor units located on sites for more than one year. We promptly paid the
required fees and filed the required notices, correcting the potential
violations. On June 12, 2001, after the potential violations had been
corrected, the Director of the Division issued a compliance order to us in
connection with the potential violations. The compliance order assessed a
civil penalty of $15,000 per day per alleged regulatory violation and permit;
no total penalty amount was proposed in the compliance order. On October 3,
2003, the Division notified us that the total proposed penalty would be
$759,072. However, since the alleged violations had been self-disclosed, the
amount was reduced to $189,768. We subsequently responded to the penalty
assessment, challenging the basis of the Divisions penalty calculation. As a
result of our challenge, the Division agreed to a Stipulated Motion for Time to
File Answer and further agreed to meet with us and negotiate a final
settlement. On April 8, 2004, Hanover met with Division officials in Santa Fe
and agreed to a final settlement of all alleged violations in the amount of
$105,464, to be paid in a lump sum in the month of July 2004. We have
submitted a Settlement Agreement and Stipulated Final Order summarizing the
settlement to the Division for execution and final resolution of this matter. In the ordinary course of business we are involved in various other pending or
threatened legal actions, including environmental matters. While management is
unable to predict the ultimate outcome of these actions, it believes that any
ultimate liability arising from these actions will not have a material adverse
effect on our consolidated financial position, results of operations or cash
flows. 
 ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES On March 10, 2004, the settlement of certain putative class and derivative
actions filed against the Company and others (the Settled Actions) became
effective. (The settlement is discussed further in Part II, Item 1 Legal
Proceedings of this Quarterly Report.) Pursuant to the terms of the
settlement, the Company (i) paid $30,200,000 in cash to the settlement fund
prior to and immediately after the entry of the final order and judgment, (ii)
has the obligation to pay an additional $3,000,000 in cash to the settlement
fund within five business days after a change of control of the Company, but
only if the change of control or shareholder approval of the change of control
occurs within 12 months after the order and final judgment for the settlement
was entered (which was February 9, 2004), (iii) on March 16, 2004, issued
2,500,000 shares of its common stock, par value $0.001 per share, to the
settlement fund, (iv) on April 21, 2004, issued a note in the principal amount
of $6,650,000, and with the other terms and conditions described in Part II,
Item 1 Legal Proceedings of this Quarterly Report to the escrow agent for
the settlement fund, and (v) agreed to implement certain corporate governance
enhancements. We understand that in April 2004 GKH contributed
the remaining 2,500,000 shares of our common stock held by GKH to the settlement fund. The financial
portion of the settlement consideration will be allocated to the plaintiffs and
their counsel in accordance with the Stipulation and Agreement of Settlement
and plans of allocation approved by the court that approved the settlement. In
consideration for the payment of the settlement consideration, the plaintiffs
in the Settled Actions released any and all claims that had been or could have
been asserted against the Company, the other defendants or GKH in connection
with the Settled Actions, except for our independent auditor,
PricewaterhouseCoopers who is not a party to the settlement. Based upon, among
other things, a No-Action letter issued by the Securities and Exchange
Commission on January 27, 2004, the Company believes that the issuance and
delivery of the shares of the Companys common stock in accordance with the
settlement were exempt from the registration provisions of Section 5 of the
Securities Act of 1933, as amended, pursuant to Section 3(a)(10) thereof. 
 ITEM 3. DEFAULT UPON SENIOR SECURITIES None. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 
 ITEM 5. OTHER INFORMATION In connection with the settlement of our securities class actions, we agreed to
implement corporate governance enhancements, including, among other things,
allowing stockholders owning more than 1% but less than 10% of our outstanding
common stock to participate in the process to appoint two independent directors
to our board of directors. 
 ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits  10.1
    
    Promissory Note and Indenture dated April 21, 2004 relating to $6,650,000 payable to Milberg,
Weiss, Bershad, Hynes & Lerach LLP as Escrow Agent with respect to the settlement fund as defined in
that certain Stipulation and Agreement and Settlement dated as of October 23, 2003(1)12.1
    
    Computation of Ratio of earnings to fixed charges(1)31.1
    
    Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)31.2
    
    Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)32.1
    
    Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the 32




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Sarbanes-Oxley Act of 2002(2)32.2
    
    Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002(2)  (1)
    
    Filed herewith.(2)
    
    Furnished herewith. (b) Reports submitted on Form 8-K:  1.
    
    A report on Form 8-K was filed on January 12, 2004, which reported
under the caption Item 9Regulation FD Disclosure the press release
announcing the resignation of Melvyn N. Klein from the Board of
Directors. The date of such report (the date of the earliest event
reported) was January 8, 2004.2.
    
    A report on Form 8-K was filed on February 12, 2004, which reported
under caption Item 9Regulation FD Disclosure the announcement of
the approval of the global settlement of Hanovers outstanding
shareholder litigation by the United States District Court for the
Southern District of Texas. The date of such report (the date of the
earliest event reported) was February 9, 2004.3.
    
    A report on Form 8-K was filed on February 17, 2004, which reported
under caption Item 12Results of Operations and Financial Condition
Hanovers financial results for the fourth quarter ended and year
ended December 31, 2003. A copy of the press release was attached as
Exhibit 99.1. The date of such report (the date of the earliest event
reported) was February 17, 2004.4.
    
    A report on Form 8-K was filed on March 2, 2004, which reported under
caption Item 12Results of Operations and Financial Condition a
revision of the previously announced 2003 fourth quarter and fiscal
year unaudited results. The date of such report (the date of the
earliest event reported) was March 1, 2004.5.
    
    A report on Form 8-K was filed on March 12, 2004, which reported under
caption Item 5Other Events the announcement made by GKH Liquidating
Trust of their intentions to distribute 5,774,795 shares of Hanover
common stock to the relevant beneficiaries. A copy of the letter from
the administrative trustee to Hanover was attached as Exhibit 99.1.
The date of such report (the date of the earliest event reported) was
March 11, 2004.6.
    
    A report on Form 8-K was filed on March 17, 2004, which reported under
caption Item 12Results of Operations and Financial Condition that
Hanover filed a Notification of Late Filing on Form 12b-25. The date
of such report (the date of the earliest event reported) was March 16,
2004. 33




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. HANOVER COMPRESSOR COMPANYDate: May 7, 2004By:
    
    /s/ CHAD C. DEATONChad C. DeatonPresident and Chief Executive OfficerDate: May 7, 2004By:
    
    /s/ JOHN E. JACKSONJohn E. JacksonSenior Vice President and Chief Financial Officer
 34




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##### Table of Contents



EXHIBIT INDEX 10.1
    
    Promissory Note and Indenture dated April 21, 2004 relating to $6,650,000 payable to Milberg,
Weiss, Bershad, Hynes & Lerach LLP as Escrow Agent with respect to the settlement fund as defined in
that certain Stipulation and Agreement and Settlement dated as of October 23, 2003(1)12.1
    
    Computation of Ratio of earnings to fixed charges(1)31.1
    
    Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)31.2
    
    Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)32.1
    
    Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002(2)32.2
    
    Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002(2)
  (1)
    
    Filed herewith.(2)
    
    Furnished herewith. 35