##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 Form 10-Q (MARK ONE)þ
    

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005o
    

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR 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 þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act). Yes þ No o Number
of shares of the Common Stock of the registrant outstanding as of
April 29, 2005: 87,035,443 shares.




---



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 5. OTHER INFORMATIONITEM 6: EXHIBITSSIGNATURESEXHIBIT INDEXEmployment Letter - Norrie MckayCertification 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




---



##### Table of Contents



Part I. Financial Information 
 ITEM 1. FINANCIAL STATEMENTS HANOVER COMPRESSOR COMPANY 
 CONDENSED CONSOLIDATED BALANCE SHEET
 March 31,
    
    
    December 31,2005
    
    
    2004(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    37,587
    
    
    $
    38,076Accounts receivable, net of allowance of $7,842 and $7,573
    
    
    206,142
    
    
    
    205,644Inventory, net
    
    
    198,253
    
    
    
    184,798Costs and estimated earnings in excess of billings on uncompleted contracts
    
    
    71,036
    
    
    
    70,103Prepaid taxes
    
    
    8,773
    
    
    
    6,988Current deferred income taxes
    
    
    12,516
    
    
    
    12,386Assets held for sale
    
    
    4,813
    
    
    
    5,169Other current assets
    
    
    25,205
    
    
    
    25,674Total current assets
    
    
    564,325
    
    
    
    548,838Property, plant and equipment, net
    
    
    1,854,460
    
    
    
    1,876,348Goodwill, net
    
    
    183,190
    
    
    
    183,190Intangible and other assets
    
    
    55,852
    
    
    
    57,070Investments in non-consolidated affiliates
    
    
    82,632
    
    
    
    90,326Assets held for sale
    
    
    6,380
    
    
    
    6,391Total assets
    
    $
    2,746,839
    
    
    $
    2,762,163LIABILITIES AND COMMON STOCKHOLDERS EQUITYCurrent liabilities:Short-term debt
    
    $
    4,387
    
    
    $
    5,106Current maturities of long-term debt
    
    
    1,630
    
    
    
    1,430Accounts payable, trade
    
    
    56,095
    
    
    
    57,402Accrued liabilities
    
    
    99,680
    
    
    
    118,429Advance billings
    
    
    47,130
    
    
    
    42,588Liabilities related to assets held for sale
    
    
    439
    
    
    
    517Billings on uncompleted contracts in excess of costs and estimated earnings
    
    
    15,854
    
    
    
    20,256Total current liabilities
    
    
    225,215
    
    
    
    245,728Long-term debt
    
    
    1,658,925
    
    
    
    1,637,080Other liabilities
    
    
    47,206
    
    
    
    47,232Deferred income taxes
    
    
    51,348
    
    
    
    53,290Total liabilities
    
    
    1,982,694
    
    
    
    1,983,330Commitments and contingencies (Note 6)Minority interest
    
    
    17,050
    
    
    
    18,778Common stockholders equity:Common stock, $.001 par value; 200,000,000 shares authorized;
87,725,176 and 87,653,970 shares issued, respectively
    
    
    88
    
    
    
    88Additional paid-in capital
    
    
    913,055
    
    
    
    913,007Deferred employee compensation  restricted stock grants
    
    
    (13,042
    )
    
    
    (15,180
    )Accumulated other comprehensive income
    
    
    15,164
    
    
    
    17,518Retained deficit
    
    
    (160,535
    )
    
    
    (148,071
    )Treasury stock689,733 and 661,810 common shares, at cost
    
    
    (7,635
    )
    
    
    (7,307
    )Total common stockholders equity
    
    
    747,095
    
    
    
    760,055Total liabilities and common stockholders equity
    
    $
    2,746,839
    
    
    $
    2,762,163
 The accompanying notes are an integral part of these condensed consolidated financial statements. 3




---



##### Table of Contents



HANOVER COMPRESSOR COMPANY 
 CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
 Three Months EndedMarch 31,2005
    
    
    2004Revenues and other income:U.S. rentals
    
    $
    87,154
    
    
    $
    86,592International rentals
    
    
    53,915
    
    
    
    51,500Parts, service and used equipment
    
    
    33,437
    
    
    
    44,382Compressor and accessory fabrication
    
    
    32,524
    
    
    
    28,150Production and processing equipment fabrication
    
    
    89,571
    
    
    
    53,429Equity in income of non-consolidated affiliates
    
    
    4,574
    
    
    
    4,683Other
    
    
    451
    
    
    
    1,095301,626
    
    
    
    269,831Expenses:U.S. rentals
    
    
    34,076
    
    
    
    35,539International rentals
    
    
    17,502
    
    
    
    14,773Parts, service and used equipment
    
    
    25,060
    
    
    
    32,969Compressor and accessory fabrication
    
    
    29,617
    
    
    
    25,913Production and processing equipment fabrication
    
    
    79,125
    
    
    
    47,696Selling, general and administrative
    
    
    42,158
    
    
    
    40,374Foreign currency translation
    
    
    271
    
    
    
    (1,073
    )Other
    
    
    119
    
    
    
    (100
    )Depreciation and amortization
    
    
    45,453
    
    
    
    42,030Interest expense
    
    
    35,940
    
    
    
    35,250309,321
    
    
    
    273,371Loss from continuing operations before income taxes
    
    
    (7,695
    )
    
    
    (3,540
    )Provision for income taxes
    
    
    4,541
    
    
    
    7,097Loss from continuing operations
    
    
    (12,236
    )
    
    
    (10,637
    )Income (loss) from discontinued operations, net of tax
    
    
    (271

    )
    
    
    1,183Income from write downs of discontinued operations, net of tax
    
    
    43
    
    
    
    Net loss
    
    $
    (12,464
    )
    
    $
    (9,454
    )Basic loss per common share:Loss from continuing operations
    
    $
    (0.15
    )
    
    $
    (0.13
    )Income (loss) from discontinued operations, net of tax
    
    
    
    
    
    
    0.02Net loss
    
    $
    (0.15
    )
    
    $
    (0.11
    )Diluted loss per common share:Loss from continuing operations
    
    $
    (0.15
    )
    
    $
    (0.13
    )Income (loss) from discontinued operations, net of tax
    
    
    
    
    
    
    0.02Net loss
    
    $
    (0.15
    )
    
    $
    (0.11
    )Weighted average common and equivalent shares outstanding:Basic
    
    
    85,691
    
    
    
    83,035Diluted
    
    
    85,691
    
    
    
    83,035
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




---



##### Table of Contents



HANOVER COMPRESSOR COMPANY 
 CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
 Three Months EndedMarch 31,2005
    
    
    2004Net loss
    
    $
    (12,464
    )
    
    $
    (9,454
    )Other comprehensive income (loss):Change in fair value of derivative financial instruments, net of tax
    
    
    608
    
    
    
    1,048Foreign currency translation adjustment
    
    
    (2,962
    )
    
    
    (907
    )Comprehensive loss
    
    $
    (14,818
    )
    
    $
    (9,313
    )
 The accompanying notes are an integral part of these condensed consolidated financial statements. 5




---



##### Table of Contents



HANOVER COMPRESSOR COMPANY 
 CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
 Three Months EndedMarch 31,2005
    
    
    2004Cash flows from operating activities:Net loss
    
    $
    (12,464
    )
    
    $
    (9,454
    )Adjustments:Depreciation and amortization
    
    
    45,453
    
    
    
    42,030Amortization of debt issuance costs and debt discount
    
    
    30
    
    
    
    30(Gain) loss from discontinued operations, net of tax
    
    
    228
    
    
    
    (1,183
    )Bad debt expense
    
    
    528
    
    
    
    750Gain on sale of property, plant and equipment
    
    
    (375
    )
    
    
    (107
    )Equity in income of non-consolidated affiliates, net of dividends received
    
    
    7,675
    
    
    
    (4,119
    )Gain on derivative instruments
    
    
    416
    
    
    
    Provision for estimated cost of litigation settlement, in excess of cash paid
    
    
    
    
    
    
    (60
    )Gain on sale of non-consolidated affiliates
    
    
    
    
    
    
    (300
    )Restricted stock compensation expense
    
    
    1,055
    
    
    
    391Pay-in-kind interest on long-term notes payable
    
    
    5,526
    
    
    
    4,965Deferred income taxes
    
    
    291
    
    
    
    3,786Changes in assets and liabilities, excluding business combinations:Accounts receivable and notes
    
    
    (3,753
    )
    
    
    (26,464
    )Inventory
    
    
    (13,510
    )
    
    
    (12,844
    )Costs and estimated earnings versus billings on uncompleted contracts
    
    
    (7,429
    )
    
    
    9,800Accounts payable and other liabilities
    
    
    (18,279
    )
    
    
    (12,393
    )Advance billings
    
    
    3,972
    
    
    
    (6,650
    )Prepaid and other
    
    
    (4,387
    )
    
    
    6,080Net cash provided by (used in) continuing operations
    
    
    4,977
    
    
    
    (5,742
    )Net cash provided by (used in) discontinued operations
    
    
    (113
    )
    
    
    3,661Net cash provided by (used in) operating activities
    
    
    4,864
    
    
    
    (2,081
    )Cash flows from investing activities:Capital expenditures
    
    
    (26,222
    )
    
    
    (16,921
    )Proceeds from sale of property, plant and equipment
    
    
    2,153
    
    
    
    5,482Proceeds from sale of non-consolidated affiliates
    
    
    
    
    
    
    4,663Net cash used in continuing operations
    
    
    (24,069
    )
    
    
    (6,776
    )Net cash provided by discontinued operations
    
    
    50
    
    
    
    189Net cash used in investing activities
    
    
    (24,019
    )
    
    
    (6,587
    )Cash flows from financing activities:Borrowings on revolving credit facilities
    
    
    85,500
    
    
    
    6,000Repayments on revolving credit facilities
    
    
    (8,500
    )
    
    
    (27,000
    )Payments for debt issue costs
    
    
    
    
    
    
    (39
    )Proceeds from warrant conversions and stock options exercised
    
    
    548
    
    
    
    5,552Net repayments of other debt
    
    
    (683
    )
    
    
    (2,681
    )Payments of 2000B equipment lease obligations
    
    
    (57,589
    )
    
    
    Net cash provided by (used in) continuing operations
    
    
    19,276
    
    
    
    (18,168
    )Net cash used in discontinued operations
    
    
    
    
    
    
    Net cash provided by (used in) financing activities
    
    
    19,276
    
    
    
    (18,168
    )Effect of exchange rate changes on cash and equivalents
    
    
    (610
    )
    
    
    298Net decrease in cash and cash equivalents
    
    
    (489
    )
    
    
    (26,538
    )Cash and cash equivalents at beginning of period
    
    
    38,076
    
    
    
    56,619Cash and cash equivalents at end of period
    
    $
    37,587
    
    
    $
    30,081
 The accompanying notes are an integral part of these condensed consolidated financial statements. 6




---



##### Table of Contents



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, 2004. 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 31,2005
    
    
    2004Weighted average common shares outstandingused in basic loss per common share
    
    
    85,691
    
    
    
    83,035Net 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
    
    
    85,691
    
    
    
    83,035
   **
    
    Excluded from diluted loss per common share as the effect would have been anti-dilutive. 7




---



##### Table of Contents



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 31,2005
    
    
    2004Net dilutive potential common shares issuable:On exercise of options and vesting of restricted stock
    
    
    2,977
    
    
    
    2,163On exercise of options-exercise price greater than
average market value at end of period
    
    
    771
    
    
    
    1,207On 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
    
    
    
    9,58322,530
    
    
    
    22,152
 Stock Options and Stock-Based Compensation Certain of our employees participate in
stock incentive plans that provide for the granting of options
to purchase shares of Hanover common stock and grants of restricted stock. In accordance with
Statement of Financial Standards No. 123, Accounting for Stock-Based Compensation,
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. Except for shares that vest based on performance, we 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. For restricted shares that vest based on performance, we will record an estimate of the
compensation expense to be expensed over three years related to these restricted shares. The
compensation expense that will be recognized in our statement of operations will be adjusted for
changes in our estimate of the number of restricted shares that will vest as well as changes in our stock price. The treasury stock received from forfeitures of restricted stock is recorded based on
the value used to measure our compensation expense for such shares.
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 31,2005
    
    
    2004Net loss as reported
    
    $
    (12,464
    )
    
    $
    (9,454
    )Add back: Restricted stock grant expense
    
    
    1,055
    
    
    
    391Deduct: Stock-based employee compensation expense
determined under the fair value method
    
    
    (1,696
    )
    
    
    (978
    )Pro forma net loss
    
    $
    (13,105
    )
    
    $
    (10,041
    )Loss per share:Basic, as reported
    
    $
    (0.15
    )
    
    $
    (0.11
    )Basic, pro forma
    
    $
    (0.15
    )
    
    $
    (0.12
    )Diluted, as reported
    
    $
    (0.15
    )
    
    $
    (0.11
    )Diluted, pro forma
    
    $
    (0.15
    )
    
    $
    (0.12
    )
 8




---



##### Table of Contents



Reclassifications Certain amounts in the prior periods financial statements have been reclassified to conform to the
2005 financial statement classification. These reclassifications have no impact on our consolidated
results of operations, cash flows or financial position. 2. INVENTORY Inventory, net of reserves, consisted of the following amounts (in thousands): March 31,
    
    
    December 31,2005
    
    
    2004Parts and supplies
    
    $
    136,207
    
    
    $
    135,751Work in progress
    
    
    54,313
    
    
    
    42,708Finished goods
    
    
    7,733
    
    
    
    6,339$
    198,253
    
    
    $
    184,798
 As of March 31, 2005 and December 31, 2004 we had inventory reserves of approximately $12.5 million
and $11.7 million, respectively. 3. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consisted of the following (in thousands): March 31,
    
    
    December 31,2005
    
    
    2004Compression equipment, facilities and other rental assets
    
    $
    2,378,207
    
    
    $
    2,360,799Land and buildings
    
    
    88,895
    
    
    
    89,573Transportation and shop equipment
    
    
    76,453
    
    
    
    78,577Other
    
    
    51,899
    
    
    
    51,0542,595,454
    
    
    
    2,580,003Accumulated depreciation
    
    
    (740,994
    )
    
    
    (703,655
    )$
    1,854,460
    
    
    $
    1,876,348
 4. DEBT Short-term debt consisted of the following (in thousands): March 31,
    
    
    December 31,2005
    
    
    2004Bellelifactored receivables
    
    $
    910
    
    
    $
    1,011Bellelirevolving credit facility
    
    
    3,477
    
    
    
    4,095Short-term debt
    
    $
    4,387
    
    
    $
    5,106
 9




---



##### Table of Contents



Bellelis factoring arrangements are typically short term in nature and bore interest at a weighted
average rate of 2.9% and 4.0% at March 31, 2005 and December 31, 2004, respectively. Bellelis
revolving credit facilities bore interest at a weighted average rate of 3.5% and 4.0% at March 31,
2005 and December 31, 2004, respectively. These revolving credit facilities are callable during
2005. Long-term debt consisted of the following (in thousands): March 31,
    
    
    December 31,2005
    
    
    2004Bank credit facility due December 2006
    
    $
    84,000
    
    
    $
    7,0004.75% 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
    
    
    
    200,0009.0% senior notes due 2014**
    
    
    200,000
    
    
    
    200,0002000B equipment lease notes, interest at 5.2%, due October 2005
    
    

    
    
    
    
    55,8612001A 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*
    
    
    211,993
    
    
    
    206,4677.25% convertible subordinated notes due 2029*
    
    
    86,250
    
    
    
    86,250Fair value adjustment  fixed to floating interest rate swaps
    
    
    (10,381
    )
    
    
    (5,996
    )Other, interest at various rates, collateralized by equipment
and other assets, net of unamortized discount
    
    
    2,943
    
    
    
    3,1781,660,555
    
    
    
    1,638,510Lesscurrent maturities
    
    
    (1,630
    )
    
    
    (1,430
    )Long-term debt
    
    $
    1,658,925
    
    
    $
    1,637,080
   *
    
    Securities issued by Hanover (parent company).**
    
    Securities issued by Hanover (parent company) and guaranteed by Hanover
Compression Limited Partnership. During
February 2005, we repaid our 2000B compressor equipment lease
obligations using borrowings from our bank credit facility. As of March 31,
2005, we had $84.0 million in outstanding borrowings under our bank credit facility. Outstanding
amounts under that facility bore interest at a weighted average rate of 5.6% and 5.2% at March 31,
2005 and December 31, 2004, respectively. As of March 31, 2005, we also had approximately $108.9
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 (a) $40 million in unsecured
indebtedness, (b) $50 million of nonrecourse indebtedness of unqualified subsidiaries and (c) $25
million of secured purchase money indebtedness. As of March 31, 2005, we had $84.0 million of
borrowings and $108.9 million of outstanding letters of credit under our bank credit facility
resulting in $157.1 million of additional capacity under such bank credit facility at March 31,
2005. As of March 31, 2005, 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 a default under the indentures and agreements relating to
certain of our other debt obligations would in some situations trigger cross-default provisions
under our bank credit facilities or the indentures and agreements relating to certain of our other
debt obligations. Such defaults would have a material adverse effect on our liquidity, financial
position and operations. Additionally, our bank credit facility requires that the minimum tangible
net worth of our wholly-owned subsidiary, Hanover Compression Limited Partnership (HCLP), not be
less than $702 million. This may limit distributions by HCLP to Hanover in future periods. 10




---



##### 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,
our 8.625% Senior Notes due 2010 and our 9% Senior Notes due 2014 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
compression equipment lease obligations, our 8.625% Senior Notes due 2010 and our 9% Senior Notes
due 2014 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, 2005, 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 $59.6 million in unsecured indebtedness and certain other permitted indebtedness,
including certain refinancing of indebtedness. 5. 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, which we designated as fair value hedges,
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, 2005 (dollars in thousands): Fair Value ofFixed Rate to be
    
    
    Notional
    
    
    Swap atFloating Rate to be Paid
    
    Maturity Date
    
    
    Received
    
    
    Amount
    
    
    March 31, 2005Six Month LIBOR +4.72%
    
    December 15, 2010
    
    
    8.625
    %
    
    $
    100,000
    
    
    $
    (5,288
    )Six Month LIBOR +4.64%
    
    December 15, 2010
    
    
    8.625
    %
    
    $
    100,000
    
    
    $
    (5,093
    )
 As of March 31, 2005, a total of approximately $0.4 million in accrued liabilities, $10.0 million
in long-term liabilities and a $10.4 million reduction of long-term debt was recorded with respect
to the fair value adjustment related to these two swaps. We estimate the effective floating rate,
that is determined in arrears pursuant to the terms of the swap, to be paid at the time of
settlement. As of March 31, 2005 we estimated that the effective rate for the six-month period
ending in June 2005 would be approximately 8.4%. 11




---



##### Table of Contents



During 2001, we entered into interest rate swaps to convert variable lease payments under certain
lease arrangements to fixed payments as follows (dollars in thousands): Fair Value ofFixed Rate to be
    
    
    Notional
    
    
    Swap atLease
    
    Maturity Date
    
    
    Paid
    
    
    Amount
    
    
    March 31, 2005March 2000
    
    March 11, 2005
    
    
    5.2550
    %
    
    $
    100,000
    
    
    $
    August 2000
    
    March 11, 2005
    
    
    5.2725
    %
    
    $
    100,000
    
    
    $
    
 These swaps, which we designated as cash flow hedging instruments, met the specific hedge criteria
and any changes in their fair values were recognized in other comprehensive income. During the
quarters ended March 31, 2005 and 2004, we recorded a reduction to other comprehensive income of
approximately $0.6 million and $1.6 million, respectively, related to these two swaps. On June 1, 2004, we repaid the outstanding indebtedness and minority interest obligations of $193.6
million and $6.4 million, respectively, under our 2000A equipment lease. As a result, the two
interest rate swaps that matured on March 11, 2005, each having a notional amount of $100 million,
associated with the 2000A equipment lease no longer met specific hedge criteria and the unrealized
loss related to the mark-to-market adjustment prior to June 1, 2004 of $5.3 million was amortized
into interest expense over the remaining life of the swap. In addition, beginning June 1, 2004,
changes in the mark-to-market adjustment were recognized as interest expense in the statement of
operations. During the three months ended March 31, 2005, $1.5 million was recorded in interest
expense. 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 financial institutions non-performance, if it
occurred, could have a material adverse effect on us. 6. COMMITMENTS AND CONTINGENCIES Hanover has issued the following guarantees that are not recorded on our accompanying balance sheet
(dollars in thousands): MaximumPotentialUndiscountedPayments as ofTerm
    
    
    March 31, 2005Indebtedness of non-consolidated affiliates:Simco/Harwat Consortium (1)
    
    
    2005
    
    
    $
    10,992El Furrial (1)
    
    
    2013
    
    
    
    35,001Other:Performance guarantees through letters of credit (2)
    
    
    2005-2007
    
    
    
    95,977Standby letters of credit
    
    
    2005
    
    
    
    16,458Commercial letters of credit
    
    
    2005-2006
    
    
    
    1,428Bid bonds and performance bonds (2)
    
    
    2005-2009
    
    
    
    107,141$
    266,997
   (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. 12




---



##### Table of Contents



(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. We are substantially self-insured for workers compensation, employers liability, auto liability,
general liability and employee group health claims in view of the relatively high per-incident
deductibles we absorb under our insurance arrangements for these risks. Losses up to deductible
amounts are estimated and accrued based upon known facts, historical trends and industry averages. 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 (Cawthorne Channel Project) as part of
the performance of a contract between an affiliate of The Royal/Dutch Shell Group (Shell) and
Global Gas and Refining Limited. (Global), a Nigerian company. We have substantially completed
the building of the required barge-mounted facilities. Under the terms of a series of contracts
between Global and us, Shell, and several other counterparties, respectively, Global is responsible
for the development of the overall project. In light of the political environment in Nigeria,
Globals capitalization level, inexperience with projects of a similar nature and 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 these contracts. This project and our other projects in Nigeria are subject to numerous risks and uncertainties
associated with operating in Nigeria. Such risks include, among other things, political, social and
economic instability, civil uprisings, riots, terrorism, the taking of property without fair
compensation and governmental actions that may restrict payments or the movement of funds or result
in the deprivation of contract rights. Any of these risks, as well as other risks normally
associated with a major construction project, could materially delay the anticipated commencement
of operations of the Cawthorne Channel Project or adversely impact any of our operations in
Nigeria. Any such delays could affect the timing and decrease the amount of revenue we may realize
from our investments in Nigeria. If Shell were to terminate its contract with Global for any
reason, or if 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. At
March 31, 2005, we had an investment of approximately $64.6 million in projects in Nigeria, a
substantial majority of which related to the Cawthorne Channel Project. We currently anticipate
investing approximately an additional $5 million in the Cawthorne Channel Project during 2005. In
addition, we have approximately $4.2 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. 7. NEW ACCOUNTING PRONOUNCEMENTS In May 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (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 13




---



##### Table of Contents



$17.1 million in sale leaseback obligations that, as of March 31, 2005, were reported as Minority
interest on our 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, 2005, the yield rates on the outstanding
equity certificates ranged from 10.6% to 11.0%. 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, 2005, 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. In November 2004, the FASB issued SFAS No. 151, Inventory Costs  an Amendment of ARB No. 43,
Chapter 4. (SFAS 151) This standard provides clarification that abnormal amounts of idle
facility expense, freight, handling costs, and spoilage should be recognized as current-period
charges. Additionally, this standard requires that allocation of fixed production overheads to the
costs of conversion be based on the normal capacity of the production facilities. The provisions of
this standard are effective for inventory costs incurred during fiscal years beginning after June
15, 2005. We do not expect the adoption of the new standard to have a material effect on our
consolidated results of operations, cash flows or financial position. In
December 2004, FASB issued SFAS No. 123 (Revised 2004),
Share-Based Payment (SFAS 123(R)).
This standard addresses the accounting for share-based payment transactions in which an enterprise
receives employee services in exchange for (a) equity instruments of the enterprise or (b)
liabilities that are based on the fair value of the enterprises equity instruments or that may be
settled by the issuance of such equity instruments. SFAS 123R eliminates the ability to account for
share-based compensation transactions using the intrinsic value method under Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees,and generally would require
instead that such transactions be accounted for using a
fair-value-based method. SFAS 123(R) is
effective as of the first interim or annual reporting period that begins after June 15, 2005.
However, on April 14, 2005, the Securities and Exchange Commission announced that the effective
date of SFAS 123R will be changed to the first annual reporting period that begins after June 15,
2005. We are evaluating the pricing models and transition provisions
of SFAS 123(R). The adoption
of SFAS 123R is not expected to have a significant effect on our financial position or cash flows,
but will impact our results of operations. An illustration of the impact on our net income and
earnings per share is presented in the Stock Options and Stock-Based Compensation section of Note
1 assuming we had applied the fair value recognition provisions of
SFAS 123(R) using the
Black-Scholes methodology. We have not yet determined whether we will use the Black-Scholes method
for future periods after our adoption of SFAS 123(R). In December 2004, the FASB issued Statement of Financial Accounting Standards No. 153, Exchange of
Nonmonetary Assets, an amendment of APB Opinion No. 29. (SFAS 153) SFAS 153 is based on the
principle that exchange of nonmonetary assets should be measured based on the fair market value of
the assets exchanged. SFAS 153 eliminates the exception of nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of nonmonetary assets that
do not have commercial substance. SFAS 153 is effective for nonmonetary asset exchanges in fiscal
periods beginning after June 15, 2005. We are currently evaluating the provisions of SFAS 153 and
do not believe that our adoption will have a material impact on our consolidated results of
operations, cash flows or financial position. 8. REPORTABLE SEGMENTS We manage our business segments primarily based upon the type of product or service provided. We
have five principal industry segments: U.S. Rentals; International Rentals; Parts, Service and Used
Equipment; Compressor and Accessory Fabrication; and Production and Processing Equipment
Fabrication. The U.S. 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
maintenance and services to full operation of a customers owned assets and surface 14




---



##### Table of Contents



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,
desalination plants and tank farms. We evaluate the performance of our segments based on segment gross profit. Segment gross profit for
each segment includes direct revenues and operating expenses. Costs excluded from segment gross
profit include selling, general and administrative, depreciation and amortization, interest, foreign currency translation, provision for cost of litigation settlement, goodwill
impairment, other expenses and income taxes. Amounts defined as
Other income include equity in income of
non-consolidated affiliates and corporate related items primarily related to cash management
activities. Revenues include sales to external
customers. Our chief executive officer does not review asset information by segment. The following tables present sales and other financial information by industry segment for the
three months ended March 31, 2005 and 2004. SegmentsProductionParts,
    
    
    Compressor
    
    
    andservice
    
    
    and
    
    
    processingU.S.
    
    
    International
    
    
    and used
    
    
    accessory
    
    
    equipment
    
    
    Otherrentals
    
    
    rentals
    
    
    equipment
    
    
    fabrication
    
    
    fabrication
    
    
    income
    
    
    Total(in thousands)March 31, 2005:Revenues from external customers
    
    $
    87,154
    
    
    $
    53,915
    
    
    $
    33,437
    
    
    $
    32,524
    
    
    $
    89,571
    
    
    $
    5,025
    
    
    $
    301,626Gross profit
    
    
    53,078
    
    
    
    36,413
    
    
    
    8,377
    
    
    
    2,907
    
    
    
    10,446
    
    
    
    5,025
    
    
    
    116,246March 31, 2004:Revenues from external customers
    
    $
    86,592
    
    
    $
    51,500
    
    
    $
    44,382
    
    
    $
    28,150
    
    
    $
    53,429
    
    
    $
    5,778
    
    
    $
    269,831Gross profit
    
    
    51,053
    
    
    
    36,727
    
    
    
    11,413
    
    
    
    2,237
    
    
    
    5,733
    
    
    
    5,778
    
    
    
    112,941
 9. 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 U.S. 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 for a small piece of our original non-oilfield power generation
business has not been completed as of March 31, 2005. 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 $0.1 million, during
the quarter ended March 31, 2005. The remaining assets are expected to be sold within the next
three to six months and the assets and liabilities are reflected as held-for-sale on our condensed
consolidated balance sheet. 15




---



##### Table of Contents



Summary of operating results of the discontinued operations (in thousands): Three Months EndedMarch 31,2005
    
    
    2004Revenues and other:U.S. rentals
    
    $
    3
    
    
    $
    5International rentals
    
    
    
    
    
    
    4,069Parts, service and used equipment
    
    
    
    
    
    
    3,472Equity in income of non-consolidated affiliates
    
    
    
    
    
    
    169Other
    
    
    
    
    
    
    (6
    )3
    
    
    
    7,709Expenses:U.S. rentals
    
    
    164
    
    
    
    160International rentals
    
    
    
    
    
    
    2,353Parts, service and used equipment
    
    
    
    
    
    
    2,450Compressor and accessory fabrication
    
    
    
    
    
    
    3Selling, general and administrative
    
    
    104
    
    
    
    485Foreign currency translation
    
    
    5
    
    
    
    (429
    )Depreciation and amortization
    
    
    
    
    
    
    954Other
    
    
    1
    
    
    
    36274
    
    
    
    6,012Income (loss) from discontinued operations before income taxes
    
    
    (271
    )
    
    
    1,697Provision for income taxes
    
    
    
    
    
    
    514Income (loss) from discontinued operations
    
    $
    (271
    )
    
    $
    1,183
 As a result of our consolidation efforts during 2003, we reclassified certain closed facilities to
assets held for sale. Summary balance sheet data for assets held for sale as of March 31, 2005 (in thousands): Non-OilfieldUsed
    
    
    PowerEquipment
    
    
    Generation
    
    
    Facilities
    
    
    TotalCurrent assets
    
    $
    2,455
    
    
    $
    2,358
    
    
    $
    
    
    
    $
    4,813Property, plant and equipment
    
    
    
    
    
    
    1,066
    
    
    
    5,314
    
    
    
    6,380Assets held for sale
    
    
    2,455
    
    
    
    3,424
    
    
    
    5,314
    
    
    
    11,193Current liabilities
    
    
    
    
    
    
    439
    
    
    
    
    
    
    
    439Liabilities held for sale
    
    
    
    
    
    
    439
    
    
    
    
    
    
    
    439Net assets held for sale
    
    $
    2,455
    
    
    $
    2,985
    
    
    $
    5,314
    
    
    $
    10,754
 16




---



##### Table of Contents



Summary balance sheet data for assets held for sale as of December 31, 2004 (in thousands): Non-OilfieldUsed
    
    
    PowerEquipment
    
    
    Generation
    
    
    Facilities
    
    
    TotalCurrent assets
    
    $
    2,455
    
    
    $
    2,714
    
    
    $
    
    
    
    $
    5,169Property, plant and equipment
    
    
    
    
    
    
    1,077
    
    
    
    5,314
    
    
    
    6,391Assets held for sale
    
    
    2,455
    
    
    
    3,791
    
    
    
    5,314
    
    
    
    11,560Current liabilities
    
    
    
    
    
    
    517
    
    
    
    
    
    
    
    517Liabilities held for sale
    
    
    
    
    
    
    517
    
    
    
    
    
    
    
    517Net assets held for sale
    
    $
    2,455
    
    
    $
    3,274
    
    
    $
    5,314
    
    
    $
    11,043
 10. INCOME TAXES During the first quarter 2005, we recorded a net tax provision of $4.5 million compared to $7.1
million for the first quarter 2004. Our effective tax rate for the first quarter 2005 was (59)%,
compared to (200)% for the first quarter 2004. The decrease in effective tax rate was primarily due to the U.S.
income tax impact of foreign operations and the relative weight of foreign income to U.S. income. As a result of 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 cumulative U.S. 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 future. We will be required to record additional valuation allowances if our
U.S. deferred tax asset position is increased and the more likely than not criteria of SFAS 109
is not met. In addition, we have recorded valuation allowances for certain international
jurisdictions. If we are required to record additional valuation allowances in the United States or
any other jurisdictions, our effective tax rate will be impacted, perhaps substantially, compared
to the statutory rate. Our preliminary analysis leads us to believe that we will likely be required
to record additional valuation allowances in 2005, unless we are able to generate additional
taxable earnings or implement additional tax planning strategies that would minimize or eliminate
the amount of such additional valuation allowance. 17




---



##### 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 and processing equipment;
    reduced profit margins or the loss of market share resulting from
competition or the introduction of competing technologies by other
companies;
    changes in economic or political conditions in the countries in which
we do business, including civil uprisings, riots, terrorism, the
taking of property without fair compensation and legislative changes;
    changes in currency exchange rates;
    the inherent risks associated with our operations, such as equipment defects, malfunctions and natural disasters;
    our inability to implement certain business objectives, such as: 
    international expansion,
    integrating acquired businesses,
    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 held for sale; 
    risks associated with any significant failure or malfunction of our enterprise resource planning system;
    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 in addition to those described in this Form 10-Q could also affect our actual
results. You should carefully consider the risks and uncertainties described above and those
described in Item 2 Managements 18




---



##### Table of Contents



Discussion and Analysis of Financial Condition and Results of Operations  Factors That May Affect
Our Financial Condition and Future Results, of this Form 10-Q in evaluating our forward-looking
statements. You should not unduly rely on these forward-looking statements, which speak only as of the date of
this Form 10-Q. Except as 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, 2004 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 us are expressly qualified in their entirety by this cautionary
statement. GENERAL Hanover Compressor Company, a Delaware
corporation (we, us, our, Hanover, or the Company), 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 production, 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, and oilfield
power generation services, primarily to our U.S. 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 and tank farms,
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, 2005 COMPARED TO THREE MONTHS ENDED MARCH 31, 2004 Overview Our revenue and other income in the first quarter 2005 was $301.6 million compared to first quarter
2004 revenue and other income of $269.8 million. Net loss for the first quarter 2005 was $12.5
million, or $0.15 per share, compared with a net loss of $9.5 million, or $0.11 per share, in the
first quarter 2004. Total compression horsepower at March 31, 2005 was approximately 3,312,000, consisting of
approximately 2,538,000 horsepower in the United States and approximately 774,000 horsepower
internationally. At March 31, 2005,
Hanovers total third-party fabrication backlog was approximately $270.5 million compared to
approximately $290.9 million at December 31, 2004 and $221.3 million at March 31, 2004.
The compressor and accessory fabrication backlog was approximately $63.9 million at March 31,
2005, compared to approximately $56.7 million at December 31, 2004, and $52.1 million at
March 31, 2004. The backlog for production and processing equipment fabrication was
approximately $206.6 million at March 31, 2005 compared to approximately $234.2 million
at December 31, 2004, and $169.2 million at March 31, 2004. 19




---



##### Table of Contents



Industry Conditions The North American rig count increased by 8% to 1,726 at March 31, 2005 from 1,598 at March 31,
2004, and the twelve-month rolling average North American rig count increased by 9% to 1,597 at
March 31, 2005 from 1,467 at March 31, 2004. In addition, the twelve-month rolling average New York
Mercantile Exchange wellhead natural gas price increased to $6.28 per MMBtu at March 31, 2005 from
$5.16 per MMBtu at March 31, 2004. Despite the increase in natural gas prices and the recent
increase in the rig count, U.S. natural gas production levels have not significantly changed.
Recently, we have not experienced any significant growth in U.S. rentals of equipment by our
customers, which we believe is primarily the result of the lack of a significant increase in U.S.
natural gas production levels. Tax Position As a result of 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 cumulative U.S. 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 future. We will be required to record additional valuation allowances if our
U.S. deferred tax asset position is increased and the more likely than not criteria of SFAS 109
is not met. In addition, we have recorded valuation allowances for certain international
jurisdictions. If we are required to record additional valuation allowances in the United States or
any other jurisdictions, our effective tax rate will be impacted, perhaps substantially, compared
to the statutory rate. Our preliminary analysis leads us to believe that we will likely be required
to record additional valuation allowances in 2005, unless we are able to generate additional
taxable earnings or implement additional tax planning strategies that would minimize or eliminate
the amount of such additional valuation allowance. Summary of Business Segment Results U.S. Rentals
(in thousands) Three Months EndedMarch 31,
    
    
    Increase2005
    
    
    2004
    
    
    (Decrease)Revenue
    
    $
    87,154
    
    
    $
    86,592
    
    
    
    1
    %Operating expense
    
    
    34,076
    
    
    
    35,539
    
    
    
    (4
    )%Gross profit
    
    $
    53,078
    
    
    $
    51,053
    
    
    
    4
    %Gross margin
    
    
    61
    %
    
    
    59
    %
    
    
    2
    %
 U.S. rental revenue increased during the quarter ended March 31, 2005, compared to the quarter
ended March 31, 2004, due primarily to improvement in market conditions that has led to an
improvement in pricing. Gross margin for the quarter ended March 31, 2005 increased compared to the
quarter ended March 31, 2004, primarily due to our efforts to reduce maintenance and repair expense. 20




---



##### Table of Contents



International Rentals
(in thousands) Three Months EndedMarch 31,
    
    
    Increase2005
    
    
    2004
    
    
    (Decrease)Revenue
    
    $
    53,915
    
    
    $
    51,500
    
    
    
    5
    %Operating expense
    
    
    17,502
    
    
    
    14,773
    
    
    
    18
    %Gross profit
    
    $
    36,413
    
    
    $
    36,727
    
    
    
    (1
    )%Gross margin
    
    
    68
    %
    
    
    71
    %
    
    
    (3
    )%
 During the
first quarter of 2005, international rental revenue increased, compared to the first
quarter of 2004, primarily due to increased compression and processing plant rental activity
in Brazil. Gross margin decreased primarily due to expected start-up costs incurred in the first
quarter of 2005 related to two major projects in Nigeria. Parts, Service and Used Equipment
(in thousands) Three Months EndedMarch 31,
    
    
    Increase2005
    
    
    2004
    
    
    (Decrease)Revenue
    
    $
    33,437
    
    
    $
    44,382
    
    
    
    (25
    )%Operating expense
    
    
    25,060
    
    
    
    32,969
    
    
    
    (24
    )%Gross profit
    
    $
    8,377
    
    
    $
    11,413
    
    
    
    (27
    )%Gross margin
    
    
    25
    %
    
    
    26
    %
    
    
    (1
    )%
 Parts,
service and used equipment revenue, gross profit and gross margin for the quarter ended March 31,
2005 were lower than the
quarter ended March 31, 2004 primarily due to lower installation sales that were partially offset
by increased parts and service revenue and gross margin. Parts, service and used equipment revenue
includes two business components: (1) parts and service and (2) used rental equipment and
installation sales. For the quarter ended March 31, 2005, parts and service revenue was $31.2
million with a gross margin of 26%, compared to $25.2 million and 24%, respectively, for the
quarter ended March 31, 2004. Used rental equipment and installation sales revenue for the quarter
ended March 31, 2005 was $2.3 million with a gross margin of 7%, compared to $19.2 million with a
28% gross margin for the quarter ended March 31, 2004. Our used rental equipment and installation
sales revenue 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. 21




---



##### Table of Contents



Compression and Accessory Fabrication
(in thousands) Three Months EndedMarch 31,
    
    
    Increase2005
    
    
    2004
    
    
    (Decrease)Revenue
    
    $
    32,524
    
    
    $
    28,150
    
    
    
    16
    %Operating expense
    
    
    29,617
    
    
    
    25,913
    
    
    
    14
    %Gross profit
    
    $
    2,907
    
    
    $
    2,237
    
    
    
    30
    %Gross margin
    
    
    9
    %
    
    
    8
    %
    
    
    1
    %
 For the quarter ended March 31, 2005, compression and accessory fabrication revenue, gross profit
and gross margin increased primarily due to increased sales activity and business conditions. As of
March 31, 2005, we had compression fabrication backlog of $63.9 million compared to $52.0 million
at March 31, 2004. Production and Processing Equipment Fabrication
(in thousands) Three Months EndedMarch 31,
    
    
    Increase2005
    
    
    2004
    
    
    (Decrease)Revenue
    
    $
    89,571
    
    
    $
    53,429
    
    
    
    68
    %Operating expense
    
    
    79,125
    
    
    
    47,696
    
    
    
    66
    %Gross profit
    
    $
    10,446
    
    
    $
    5,733
    
    
    
    82
    %Gross margin
    
    
    12
    %
    
    
    11
    %
    
    
    1
    %
 Production and processing equipment fabrication revenue for the quarter ended March 31, 2005 was
greater than for the quarter ended March 31, 2004, primarily due to our increased focus on
fabrication sales and an improvement in market conditions. We have focused on improving our sales
success ratio on new bid opportunities, which has resulted in the 2005 improvement in our
production and processing equipment backlog. As of March 31, 2005, we had a production and
processing equipment fabrication backlog of $206.6 million compared to $169.2 million at March 31,
2004, including Bellelis backlog of $133.3 million and $124.1 million at March 31, 2005 and 2004,
respectively. Expenses Selling, general, and administrative expense (SG&A) for the first quarter 2005 was $42.2 million,
compared to $40.4 million in the first quarter 2004. As a percentage of revenue, SG&A expense was
14% for the three months ended March 31, 2005 compared to 15% for the three months ended March 31,
2004. As a percentage of sales, SG&A expense decreased due to our efforts to manage SG&A costs. Depreciation and amortization expense for the first quarter 2005 increased to $45.5 million,
compared to $42.0 million for the same period a year ago. First quarter 2005 depreciation and
amortization increased primarily due to net additions to property, plant and equipment placed in
service since March 31, 2004. The increase in our interest expense was primarily due to an increase in the overall effective
interest rate on outstanding debt to 8.6% from 7.8% during the quarters ended March 31, 2005 and
2004, respectively. 22




---



##### Table of Contents



Foreign currency translation for the first quarter 2005 was a loss of $0.3 million, compared to a
gain of $1.1 million for the three months ended March 31, 2004. For the quarter ended March 31,
2005, foreign currency translation included $3.5 million in translation losses related to the
re-measurement of our international subsidiaries dollar denominated inter-company debt primarily
for our subsidiary in Italy. These losses were offset by translation gains due to the remeasurement
of our net liabilities as a result of 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 31,2005
    
    
    2004Argentina
    
    $
    (396
    )
    
    $
    221Italy
    
    
    3,195
    
    
    
    (42
    )Venezuela
    
    
    (3,009
    )
    
    
    (957
    )All other countries
    
    
    481
    
    
    
    (295
    )Exchange (gain) loss
    
    $
    271
    
    
    $
    (1,073
    )
 At March 31, 2005 we had intercompany advances outstanding to our subsidiary in Italy of
approximately $72.2 million. These advances are denominated in U.S. dollars. The impact of the
remeasurement of these advances on our statement of operations will depend on the outstanding
balance in future periods. A 10% increase or decrease in the Euro would result in a foreign
currency translation gain or loss of approximately $6.5 million. Income Taxes During the first quarter 2005, we recorded a net tax provision of $4.5 million compared to $7.1
million for the first quarter 2004. Our effective tax rate for the first quarter 2005 was (59)%,
compared to (200)% for the first quarter 2004. The decrease in effective tax rate was primarily due to the U.S.
income tax impact of foreign operations and the relative weight of foreign income to U.S. income. As a result of 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 cumulative U.S. 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 future. We will be required to record additional valuation allowances if our
U.S. deferred tax asset position is increased and the more likely than not criteria of SFAS 109
is not met. In addition, we have recorded valuation allowances for certain international
jurisdictions. If we are required to record additional valuation allowances in the United States or
any other jurisdictions, our effective tax rate will be impacted, perhaps substantially, compared
to the statutory rate. Our preliminary analysis leads us to believe that we will likely be required
to record additional valuation allowances in 2005, unless we are able to generate additional
taxable earnings or implement additional tax planning strategies that would minimize or eliminate
the amount of such additional valuation allowance. 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 (loss) from discontinued operations decreased $1.5 million to a
net loss of $0.3 million during the first quarter 2005, from income of $1.2 million during the
first quarter 2004. The decrease in income (loss) from discontinued
operations was primarily due to the sale of our Canadian rental fleet in the fourth quarter of 2004. 23




---



##### Table of Contents



LIQUIDITY AND CAPITAL RESOURCES Our unrestricted cash balance was $37.6 million at March 31, 2005 compared to $38.1 million at
December 31, 2004. Working capital increased to $339.1 million at March 31, 2005 from $303.1
million at December 31, 2004. The increase in working capital was primarily attributable to an
increase in accounts receivable and inventory and a decrease in accrued liabilities. 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 31,2005
    
    
    2004Net cash provided by (used in) continuing operations:Operating activities
    
    $
    4,977
    
    
    $
    (5,742
    )Investing activities
    
    
    (24,069
    )
    
    
    (6,776
    )Financing activities
    
    
    19,276
    
    
    
    (18,168
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    (610
    )
    
    
    298Net cash (used in) provided by discontinued operations
    
    
    (63
    )
    
    
    3,850Net change in cash and cash equivalents
    
    $
    (489
    )
    
    $
    (26,538
    )
 The increase in cash provided by operating activities for the first quarter 2005 as compared to the
first quarter 2004 was primarily due to an increase in cash distributions received from non-consolidated
affiliates. The increase in cash used in investing activities during the first quarter 2005 as compared to the
first quarter 2004 was primarily attributable to an increase in capital expenditures for the first
quarter 2005. In addition, during the first quarter of 2004, we received $4.7 million in proceeds
received from the sale of our interest in Hanover Measurement Services Company, LP. The increase in cash provided by financing activities was primarily due to a net increase in
borrowings from our bank credit facility partially offset by the repayment of our 2000B compression
lease obligation in the first quarter 2005. The decrease in cash provided by
discontinued operations was principally related to operating
activities related to the sale of our Canadian rental fleet which was discontinued and sold in November 2004. 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 exceed our return on
capital targets. We currently plan to spend approximately $125 million to $150 million on capital
expenditures during 2005, including (1) rental equipment fleet additions and (2) approximately $40
million to $50 million on equipment maintenance capital. During February 2005, we repaid our 2000B
compressor equipment lease obligations using borrowings from our bank credit facility. Subsequent to December 31,
2004, there have been no other significant changes to our obligations to make future payments under
existing contracts. We have not paid any cash dividends on our common stock since our formation and do not anticipate
paying such dividends in the foreseeable future. The Board of Directors anticipates that all cash
flow generated from operations in the foreseeable future will be retained and used to pay down debt
or develop and expand our business. Any future determinations to pay cash dividends on our common
stock will be at the discretion of the our Board of Directors 24




---



##### Table of Contents



and will be dependent upon our results of operations and financial condition, credit and loan
agreements in effect at that time and other factors deemed relevant by the Board of Directors. Our
bank credit facility prohibits us (without the lenders prior approval) from declaring or paying
any dividend (other than dividends payable solely in our common stock or in options, warrants or
rights to purchase such common stock) on, or making similar payments with respect to, our capital
stock. 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. 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 our contingencies 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 (5.6% weighted average interest rate at March 31, 2005). 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, 2005, 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 indentures and agreements relating to our other long-term debt.
While there is no assurance, we believe based on our current projections for 2005 that we will be
in compliance with the financial covenants in these agreements. A default under our bank credit
facility or a default under certain of the various indentures and agreements would trigger in some
situations cross-default provisions under our bank credit facilities or the indentures and
agreements relating to certain of our other debt obligations. Such defaults would have a material
adverse effect on our liquidity, financial position and operations. Additionally, our bank credit
facility requires that the minimum tangible net worth of HCLP not be less than $702 million. This
may limit distributions by HCLP to Hanover in future periods. 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. Our bank
credit facility permits us to incur indebtedness, subject to covenant limitations, up to a $350
million credit limit (with letters of credit treated as indebtedness), plus, in addition to certain
other indebtedness, an additional (1) $40 million in unsecured indebtedness, (2) $50 million of
nonrecourse indebtedness of unqualified subsidiaries, and (3) $25 million of secured purchase money
indebtedness. As of March 31, 2005, we had $84.0 million of borrowings and $108.9 million of
outstanding letters of credit under our bank credit facility, resulting in $157.1 million of
additional capacity under such bank credit facility at March 31, 2005. 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,
our 8.625% Senior Notes due 2010 and our 9.0% Senior Notes due 2014 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), 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 2001A and 2001B compression equipment lease
obligations, our 8.625% Senior Notes due 2010 and our 25




---



##### Table of Contents



9.0% Senior Notes due 2014 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, 2005, 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 $59.6 million in unsecured indebtedness and certain other
permitted indebtedness, including certain refinancing indebtedness. As of March 31, 2005, 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
    
    StableSenior implied rating
    
    B1
    
    BB-Liquidity rating
    
    SGL-3
    
    Bank credit facility due December 2006
    
    Ba3
    
    2001A equipment lease notes, interest at 8.5%, due September 2008
    
    B2
    
    B+2001B equipment lease notes, interest at 8.8%, due September 2011
    
    B2
    
    B+4.75% convertible senior notes due 2008
    
    B3
    
    B4.75% convertible senior notes due 2014
    
    B3
    
    B8.625% senior notes due 2010
    
    B3
    
    B9.0% senior notes due 2014
    
    B3
    
    BZero coupon subordinated notes, interest at 11%, due March 31, 2007
    
    Caa1
    
    B-7.25% convertible subordinated notes due 2029*
    
    Caa1
    
    B-
   *
    
    Rating is on the Mandatorily Redeemable Convertible Preferred
Securities issued by Hanover Compressor Capital Trust, our
wholly-owned subsidiary. Prior to adoption of FIN 46 in 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 Convertible 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 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 had no impact on our
consolidated results of operations or cash flow. 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. Derivative Financial Instruments.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 26




---



##### Table of Contents



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, which we designated as fair value hedges,
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, 2005 (dollars in thousands): Fair Value ofFixed Rate to be
    
    
    
    
    
    Swap atFloating Rate to be Paid
    
    Maturity Date
    
    
    Received
    
    Notional Amount
    
    
    March 31, 2005Six Month LIBOR +4.72%
    
    December 15, 2010
    
    
    8.625
    %
    
    $
    100,000
    
    
    $
    (5,288
    )Six Month LIBOR +4.64%
    
    December 15, 2010
    
    
    8.625
    %
    
    $
    100,000
    
    
    $
    (5,093
    )
 As of March 31, 2005, a total of approximately $0.4 million in accrued liabilities, $10.0 million
in long-term liabilities and a $10.4 million reduction of long-term debt was recorded with respect
to the fair value adjustment related to these two swaps. We estimate the effective floating rate,
that is determined in arrears pursuant to the terms of the swap, to be paid at the time of
settlement. As of March 31, 2005 we estimated that the effective rate for the six-month period
ending in June 2005 would be approximately 8.4%. During 2001, we entered into interest rate swaps to convert variable lease payments under certain
lease arrangements to fixed payments as follows (dollars in thousands): Fair Value ofSwap atLease
    
    Maturity Date
    
    
    Fixed Rate to be Paid
    
    Notional Amount
    
    
    March 31, 2005March 2000
    
    March 11, 2005
    
    
    5.2550
    %
    
    $
    100,000
    
    
    $
    August 2000
    
    March 11, 2005
    
    
    5.2725
    %
    
    $
    100,000
    
    
    $
    
 These swaps, which we designated as cash flow hedging instruments, met the specific hedge criteria
and any changes in their fair values were recognized in other comprehensive income. During the
quarters ended March 31, 2005 and 2004, we recorded a reduction to other comprehensive income of
approximately $0.6 million and $1.6 million, respectively, related to these two swaps. On June 1, 2004, we repaid the outstanding indebtedness and minority interest obligations of $193.6
million and $6.4 million, respectively, under our 2000A equipment lease. As a result, the two
interest rate swaps that matured on March 11, 2005, each having a notional amount of $100 million,
associated with the 2000A equipment lease no longer met specific hedge criteria and the unrealized
loss related to the mark-to-market adjustment prior to June 1, 2004 of $5.3 million was amortized
into interest expense over the remaining life of the swap. In addition, beginning June 1, 2004,
changes in the mark-to-market adjustment were recognized as interest expense in the statement of
operations. During the three months ended March 31, 2005, $1.5 million was recorded in interest
expense. 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 financial institutions non-performance, if it
occurred, could have a material adverse effect on us. International Operations. We have significant operations that expose us to currency risk in
Argentina and Venezuela. As a result, adverse political conditions and fluctuations in currency
exchange rates could materially and adversely affect our business. 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 27




---



##### Table of Contents



exposure to fluctuations in their value. In February 2003, the Venezuelan government fixed the
exchange rate to 1,600 bolivars for each U.S. dollar. In February 2004 and March 2005, the
Venezuelan government devalued the currency to 1,920 bolivars and 2,148 bolivars, respectively, for
each U.S. dollar. The impact of the devaluation on our results will depend upon the amount of our
assets (primarily working capital) exposed to currency fluctuation in Venezuela in future periods. For the three months ended March 31, 2005, our Argentine operations represented approximately 5% of
our revenue and 9% of our gross profit. For the three months ended March 31, 2005, our Venezuelan
operations represented approximately 9% of our revenue and 17% of our gross profit. At March 31,
2005, we had approximately $17.4 million and $27.0 million in accounts receivable related to our
Argentine and Venezuelan operations. 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. Foreign currency translation for the first quarter 2005 was a loss of $0.3 million, compared to a
gain of $1.1 million for the three months ended March 31, 2004. For the quarter ended March 31,
2005, foreign currency translation included $3.5 million in translation losses related to the
re-measurement of our international subsidiaries dollar denominated inter-company debt primarily
for our subsidiary in Italy. These losses were offset by translation gains due to the remeasurement of our net liabilities as a result of 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 31,2005
    
    
    2004Argentina
    
    $
    (396
    )
    
    $
    221Italy
    
    
    3,195
    
    
    
    (42
    )Venezuela
    
    
    (3,009
    )
    
    
    (957
    )All other countries
    
    
    481
    
    
    
    (295
    )Exchange (gain) loss
    
    $
    271
    
    
    $
    (1,073
    )
 At March 31, 2005 we had intercompany advances outstanding to our subsidiary in Italy of
approximately $72.2 million. These advances are denominated in U.S. dollars. The impact of the
remeasurement of these advances on our statement of operations will depend on the outstanding
balance in future periods. A 10% increase or decrease in the Euro would result in a foreign
currency translation gain or loss of approximately $6.5 million. 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 (Cawthorne Channel Project) as part of
the performance of a contract between an affiliate of The Royal/Dutch Shell Group (Shell) and
Global Gas and Refining Limited. (Global), a Nigerian company. We have substantially completed
the building of the required barge-mounted facilities. Under the terms of a series of contracts
between Global and us, Shell, and several other counterparties, respectively, Global is responsible
for the development of the overall project. In light of the political environment in Nigeria,
Globals capitalization level, inexperience with projects of a similar nature and 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 these contracts. This project and our other projects in Nigeria are subject to numerous risks and uncertainties
associated with operating in Nigeria. Such risks include, among other things, political, social and
economic instability, civil 28




---



##### Table of Contents



uprisings, riots, terrorism, the taking of property without fair compensation and governmental
actions that may restrict payments or the movement of funds or result in the deprivation of
contract rights. Any of these risks, as well as other risks normally associated with a major
construction project, could materially delay the anticipated commencement of operations of the
Cawthorne Channel Project or adversely impact any of our operations in Nigeria. Any such delays
could affect the timing and decrease the amount of revenue we may realize from our investments in
Nigeria. If Shell were to terminate its contract with Global for any reason, or if 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. At March 31, 2005, we had an
investment of approximately $64.6 million in projects in Nigeria, a substantial majority of which
related to the Cawthorne Channel Project. We currently anticipate investing approximately an
additional $5 million in the Cawthorne Channel Project during 2005. In addition, we have
approximately $4.2 million associated with advances to, and our investment in, Global. NEW ACCOUNTING PRONOUNCEMENTS In May 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (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 $17.1 million in sale leaseback obligations that,
as of March 31, 2005, were reported as Minority interest on our 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, 2005, the yield rates on the outstanding
equity certificates ranged from 10.6% to 11.0%. 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, 2005, 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. In November 2004, the FASB issued SFAS No. 151, Inventory Costs  an Amendment of ARB No. 43,
Chapter 4. (SFAS 151) This standard provides clarification that abnormal amounts of idle
facility expense, freight, handling costs, and spoilage should be recognized as current-period
charges. Additionally, this standard requires that allocation of fixed production overheads to the
costs of conversion be based on the normal capacity of the production facilities. The provisions of
this standard are effective for inventory costs incurred during fiscal years beginning after June
15, 2005. We do not expect the adoption of the new standard to have a material effect on our
consolidated results of operations, cash flows or financial position. In
December 2004, FASB issued SFAS No. 123 (Revised 2004),
Share-Based Payment (SFAS 123(R)).
This standard addresses the accounting for share-based payment transactions in which an enterprise
receives employee services in exchange for (a) equity instruments of the enterprise or (b)
liabilities that are based on the fair value of the enterprises equity instruments or that may be
settled by the issuance of such equity instruments. SFAS 123R eliminates the ability to account for
share-based compensation transactions using the intrinsic value method under Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees,and generally would require
instead that such transactions be accounted for using a
fair-value-based method. SFAS 123(R) is
effective as of the first interim or annual reporting period that begins after June 15, 2005.
However, on April 14, 2005, the Securities and Exchange Commission announced that the effective
date of SFAS 123R will be changed to the first annual reporting period that begins after June 15,
2005. We are evaluating the pricing models and transition provisions
of SFAS 123(R). The adoption
of SFAS 123R is not expected to have a significant effect on our financial position or cash flows,
but will impact our results of operations. An illustration of the impact on our net income and
earnings per share is presented in the Stock Options and Stock-Based Compensation section of Note
1 assuming 29




---



##### Table of Contents



we
had applied the fair value recognition provisions of SFAS 123(R) using the Black-Scholes
methodology. We have not yet determined whether we will use the Black-Scholes method for future
periods after our adoption of SFAS 123(R). In December 2004, the FASB issued Statement of Financial Accounting Standards No. 153, Exchange of
Nonmonetary Assets, an amendment of APB Opinion No. 29. (SFAS 153) SFAS 153 is based on the
principle that exchange of nonmonetary assets should be measured based on the fair market value of
the assets exchanged. SFAS 153 eliminates the exception of nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of nonmonetary assets that
do not have commercial substance. SFAS 153 is effective for nonmonetary asset exchanges in fiscal
periods beginning after June 15, 2005. We are currently evaluating the provisions of SFAS 153 and
do not believe that our adoption will have a material impact on our consolidated results of
operations, cash flows or financial position. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to interest rate and foreign currency risk. We are also exposed to risk with respect
to the price of our common stock in connection with the incurrence of compensation expense with
respect to the vesting of a portion of the restricted shares we have granted. Hanover and its subsidiaries periodically enter into interest rate swaps to manage our exposure to
fluctuations in interest rates. At March 31, 2005, the fair market value of our interest rate
swaps, excluding the portion attributable to and included in accrued interest, was a net liability
of approximately $10.4 million, of which $0.4 million was recorded in accrued liabilities and $10.0
million was recorded in other long-term liabilities. At March 31, 2005, we were a party to two interest rate swaps to convert fixed rate debt to
floating rate debt as follows (dollars in thousands): Fair Value ofFixed Rate
    
    
    
    
    
    Swap atto be
    
    Notional
    
    
    December 31,Floating Rate to be Paid
    
    Maturity Date
    
    
    Received
    
    Amount
    
    
    2005Six Month LIBOR +4.72%
    
    December 15, 2010
    
    
    8.625
    %
    
    $
    100,000
    
    
    $
    (5,288
    )Six Month LIBOR +4.64%
    
    December 15, 2010
    
    
    8.625
    %
    
    $
    100,000
    
    
    $
    (5,093
    )
 At March 31, 2005, due to these two swaps, we were exposed to variable interest rates, which
fluctuate with market interest rates, on $200.0 million in notional debt. Assuming a hypothetical
10% increase in the variable rates from those in effect at March 31, 2005, the increase in our
annual interest expense with respect to such swaps would be approximately $1.7 million. We are also exposed to interest rate risk on borrowings under our floating rate bank credit
facility. At March 31, 2005, $84.0 million was outstanding bearing interest at a weighted average
effective rate of 5.6% per annum. Assuming a hypothetical 10% increase in the weighted average
interest rate from those in effect at March 31, 2005, the increase in annual interest expense for
advances under this facility would be approximately $0.5 million. During 2004 we granted approximately 517,000 of shares of restricted stock that vest in July 2007,
subject to the achievement of certain pre-determined performance based criteria. For restricted
shares that vest based on performance, we record an estimate of the compensation expense to be
expensed over three years related to these restricted shares. The compensation expense that will be
recognized in our statement of operations will be adjusted for changes in our estimate of the
number of restricted shares that will vest as well as changes in our stock price. At March 31,
2005, approximately 417,000 shares that vest based on performance were outstanding. A 10% increase
or decrease in our stock price, from the March 31, 2005 closing price of $12.07, would increase or
decrease our compensation expense for these shares by approximately $0.5 million. 30




---



##### Table of Contents



We have significant operations that expose us to currency risk in Argentina and Venezuela. As a
result, adverse political conditions and fluctuations in currency exchange rates could materially
and adversely affect our business. 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 their value. In February
2003, the Venezuelan government fixed the exchange rate to 1,600 bolivars for each U.S. dollar. In
February 2004 and March 2005, the Venezuelan government devalued the currency to 1,920 bolivars and
2,148 bolivars, respectively, for each U.S. dollar. The impact of the devaluation on our results
will depend upon the amount of our assets (primarily working capital) exposed to currency
fluctuation in Venezuela in future periods. For the quarter ended March 31, 2005, our Argentine operations represented approximately 5% of our
revenue and 9% of our gross profit. For the quarter ended March 31, 2005, our Venezuelan operations
represented approximately 9% of our revenue and 17% of our gross profit. At March 31, 2005, we had
approximately $17.4 million and $27.0 million in accounts receivable related to our Argentine and
Venezuelan operations. 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. Foreign currency translation for the first quarter 2005 was a loss of $0.3 million, compared to a
gain of $1.1 million for the three months ended March 31, 2004. For the quarter ended March 31,
2005, foreign currency translation included $3.5 million in translation losses related to the
re-measurement of our international subsidiaries dollar denominated inter-company debt primarily
for our subsidiary in Italy. These losses were offset by translation gains due to the remeasurement of our net liabilities as a result of 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 31,2005
    
    
    2004Argentina
    
    $
    (396
    )
    
    $
    221Italy
    
    
    3,195
    
    
    
    (42
    )Venezuela
    
    
    (3,009
    )
    
    
    (957
    )All other countries
    
    
    481
    
    
    
    (295
    )Exchange (gain) loss
    
    $
    271
    
    
    $
    (1,073
    )
 At March 31, 2005 we had intercompany advances outstanding to our subsidiary in Italy of
approximately $72.2 million. These advances are denominated in U.S. dollars. The impact of the
remeasurement of these advances on our statement of operations will depend on the outstanding
balance in future periods. A 10% increase or decrease in the Euro would result in a foreign
currency translation gain or loss of approximately $6.5 million. 31




---



##### Table of Contents



ITEM 4. CONTROLS AND PROCEDURES Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures Our principal executive officer and principal financial officer evaluated the effectiveness of our
disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of
1934) as of March 31, 2005. 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 assure that the required
information has been properly recorded, processed, summarized and reported and to allow timely
decisions regarding disclosure. Changes in Internal Control over Financial Reporting There was no change in our internal control over financial reporting during our first quarter of
fiscal 2005 that has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting. 
 PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS In the ordinary course of business we are involved in various 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 5. OTHER INFORMATION Mr. Norman A. Norrie Mckay has been appointed as the Companys Vice President, Eastern
Hemisphere, based in Milan, Italy. Mr. Mckay is 45 years old and will begin employment with the
Company on or about May 16, 2005. Prior to Mr. Mckays appointment as an officer of Hanover, he was
employed by Schlumberger for over 23 years and held various positions with increasing management
responsibility. Mr. Mckays most recent appointment with Schlumberger was as its Global Account
Director, Oilfield Services. Mr. Mckays employment letter provides that he will receive a base salary of US$275,000 and will be
eligible for a bonus award of up to 50% of his annual base salary based upon Company performance
and personal performance compared with agreed upon objectives as well
as subjective measures. Mr. Mckay is entitled to receive a signing bonus of $50,000 payable within 30 days of the commencement of his
employment with Hanover. Mr. Mckay
will also receive an international benefits package covering certain housing, schooling, auto,
travel, medical and other benefits. Mr. Mckay will be considered
for a restricted stock award of 10,000 shares of Hanover common stock at
the Companys next Board of Directors meeting on May 19, 2005. 32




---



##### Table of Contents



ITEM 6: EXHIBITS (a) Exhibits 10.1
    
    Employment Letter with Norrie Mckay effective as of April 15, 2005.* 31.1
    
    Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*31.2
    
    Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*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 **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 **
   *
    
    Filed herewith.**
    
    Furnished herewith.
    
    Management contract or compensatory plan or arrangement. 33




---



##### Table of Contents



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 4, 2005By:
    
    /s/ JOHN E. JACKSONJohn E. JacksonPresident and Chief Executive OfficerDate: May 4, 2005By:
    
    /s/ LEE E. BECKELMANLee E. BeckelmanVice President and Chief Financial Officer
 34




---



##### Table of Contents



EXHIBIT INDEX 10.1
    
    Employment Letter with Norrie Mckay effective as of April 15, 2005.* 31.1
    
    Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*31.2
    
    Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*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 **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 **
   *
    
    Filed herewith.**
    
    Furnished herewith.
    
    Management contract or compensatory plan or arrangement. 35