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 JUNE 30, 2005

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM                      TO                     .

Hanover Compressor Company

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)

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 July 29, 2005: 88,711,141 shares.

 

 

TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS			3
CONDENSED CONSOLIDATED BALANCE SHEET			3
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS			4
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)			5
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS			6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS			7
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			34
ITEM 4. CONTROLS AND PROCEDURES			36
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS			36
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS			36
ITEM 5. OTHER INFORMATION			37
ITEM 6: EXHIBITS			38
SIGNATURES			39
EXHIBIT INDEX			40
Change of Control and Severance Agreement
Form of Change of Control Agreement
Certification of CEO pursuant to Section 302
Certification of CFO pursuant to Section 302
Certification of CEO pursuant to Section 906
Certification of CFO pursuant to Section 906

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HANOVER COMPRESSOR COMPANY

(in thousands of dollars, except for par value and share amounts)

		June 30,				December 31,
		2005				2004
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	31,720			$	38,076
Accounts receivable, net of allowance of $6,865 and $7,573, respectively			212,291				205,644
Inventory, net			202,916				184,798
Costs and estimated earnings in excess of billings on uncompleted contracts			85,829				70,103
Prepaid taxes			2,627				6,988
Current deferred income tax			10,737				12,386
Assets held for sale			4,643				5,169
Other current assets			35,196				25,674
Total current assets			585,959				548,838
Property, plant and equipment, net			1,828,268				1,876,348
Goodwill, net			184,757				183,190
Intangible and other assets			53,914				57,070
Investments in non-consolidated affiliates			86,682				90,326
Assets held for sale			5,714				6,391
Total assets		$	2,745,294			$	2,762,163
LIABILITIES AND COMMON STOCKHOLDERS’ EQUITY
Current liabilities:
Short-term debt		$	4,407			$	5,106
Current maturities of long-term debt			1,457				1,430
Accounts payable, trade			61,689				57,402
Accrued liabilities			111,125				118,429
Advance billings			37,837				42,588
Liabilities related to assets held for sale			472				517
Billings on uncompleted contracts in excess of costs and estimated earnings			15,162				20,256
Total current liabilities			232,149				245,728
Long-term debt			1,663,184				1,637,080
Other liabilities			36,739				47,232
Deferred income taxes			52,728				53,290
Total liabilities			1,984,800				1,983,330
Commitments and contingencies (Note 6)
Minority interest			17,050				18,778
Common stockholders’ equity:
Common stock, $.001 par value; 200,000,000 shares authorized; 88,760,786 and 87,653,970 shares issued, respectively			89				88
Additional paid-in capital			915,616				913,007
Deferred employee compensation — restricted stock grants			(11,681	)			(15,180	)
Accumulated other comprehensive income			14,069				17,518
Retained deficit			(166,951	)			(148,071	)
Treasury stock—696,139 and 661,810 common shares, at cost			(7,698	)			(7,307	)
Total common stockholders’ equity			743,444				760,055
Total liabilities and common stockholders’ equity		$	2,745,294			$	2,762,163

The accompanying notes are an integral part of these condensed consolidated financial statements.

HANOVER COMPRESSOR COMPANY

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands of dollars, except per share amounts)
(unaudited)

		Three Months Ended June 30,								Six Months Ended June 30,
		2005				2004				2005				2004
Revenues and other income:
U.S. rentals		$	87,691			$	83,680			$	174,845			$	170,272
International rentals			55,521				54,599				109,436				106,099
Parts, service and used equipment			50,531				41,414				83,968				85,796
Compressor and accessory fabrication			41,092				44,159				73,616				72,309
Production and processing equipment fabrication			104,297				63,017				193,868				116,446
Equity in income of non-consolidated affiliates			5,158				5,088				9,732				9,771
Other			492				919				943				2,014
			344,782				292,876				646,408				562,707
Expenses:
U.S. rentals			32,984				34,950				67,060				70,489
International rentals			17,144				13,967				34,646				28,740
Parts, service and used equipment			36,215				31,364				61,275				64,333
Compressor and accessory fabrication			36,587				40,454				66,204				66,367
Production and processing equipment fabrication			92,429				53,887				171,554				101,583
Selling, general and administrative			43,909				41,882				86,067				82,256
Foreign currency translation			4,955				(96	)			5,226				(1,169	)
Other			274				544				393				444
Depreciation and amortization			45,469				43,346				90,922				85,376
Interest expense			34,662				35,731				70,602				70,981
			344,628				296,029				653,949				569,400
Income (loss) from continuing operations before income taxes			154				(3,153	)			(7,541	)			(6,693	)
Provision for income taxes			6,102				6,761				10,643				13,858
Loss from continuing operations			(5,948	)			(9,914	)			(18,184	)			(20,551	)
Income (loss) from discontinued operations, net of tax			(221	)			481				(492	)			1,664
Income (loss) from sales or write-downs of discontinued operations, net of tax			(247	)			372				(204	)			372
Net loss		$	(6,416	)		$	(9,061	)		$	(18,880	)		$	(18,515	)
Basic and diluted loss per common share:
Loss from continuing operations		$	(0.07	)		$	(0.12	)		$	(0.21	)		$	(0.24	)
Income (loss) from discontinued operations, net of tax			—				0.01				(0.01	)			0.02
Net loss		$	(0.07	)		$	(0.11	)		$	(0.22	)		$	(0.22	)
Weighted average common and equivalent shares outstanding:
Basic			85,797				85,114				85,744				84,076
Diluted			85,797				85,114				85,744				84,076

The accompanying notes are an integral part of these condensed consolidated financial statements.

HANOVER COMPRESSOR COMPANY

CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
(in thousands of dollars)
(unaudited)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Net loss		$	(6,416	)		$	(9,061	)		$	(18,880	)		$	(18,515	)
Other comprehensive income (loss):
Change in fair value of derivative financial instruments, net of tax			—				4,700				608				5,748
Foreign currency translation adjustment			(1,095	)			(2,991	)			(4,057	)			(3,898	)
Comprehensive loss		$	(7,511	)		$	(7,352	)		$	(22,329	)		$	(16,665	)

The accompanying notes are an integral part of these condensed consolidated financial statements.

HANOVER COMPRESSOR COMPANY

(in thousands of dollars)

(unaudited)

		Six Months Ended
		June 30,
		2005				2004
Cash flows from operating activities:
Net loss		$	(18,880	)		$	(18,515	)
Adjustments:
Depreciation and amortization			90,922				85,376
Amortization of debt issuance costs and debt discount			60				60
(Gain) loss from discontinued operations, net of tax			696				(2,036	)
Bad debt expense			1,000				918
(Gain) loss on sale of property, plant and equipment			(1,499	)			756
Equity in income of non-consolidated affiliates, net of dividends received			3,851				(2,545	)
(Gain) loss on derivative instruments			416				(259	)
Gain on sale of non-consolidated affiliates			—				(300	)
Restricted stock compensation expense			2,223				765
Pay-in-kind interest on long-term notes payable			11,356				10,203
Deferred income taxes			3,267				7,722
Changes in assets and liabilities, excluding business combinations:
Accounts receivable and notes			(13,235	)			(24,522	)
Inventory			(18,576	)			(30,188	)
Costs and estimated earnings versus billings on uncompleted contracts			(26,882	)			4,204
Accounts payable and other liabilities			(1,615	)			3,694
Advance billings			(3,992	)			(2,444	)
Prepaid, effects of exchange rate on accounts denominated in foreign currencies and other			(114	)			10,876
Net cash provided by continuing operations			28,998				43,765
Net cash provided by (used in) discontinued operations			(239	)			4,298
Net cash provided by operating activities			28,759				48,063
Cash flows from investing activities:
Capital expenditures			(54,104	)			(36,911	)
Proceeds from sale of property, plant and equipment			8,973				7,247
Proceeds from sale of non-consolidated affiliates			—				4,663
Cash used for business acquisitions			(3,426	)			—
Cash used to acquire investments in and advances to non-consolidated affiliates			(500	)			(250	)
Net cash used in continuing operations			(49,057	)			(25,251	)
Net cash provided by discontinued operations			50				6,177
Net cash used in investing activities			(49,007	)			(19,074	)
Cash flows from financing activities:
Borrowings on revolving credit facilities			102,500				18,000
Repayments on revolving credit facilities			(32,500	)			(45,000	)
Payments for debt issue costs			—				(193	)
Proceeds from warrant conversions and stock options exercised			3,241				7,088
Net repayments of other debt			(808	)			(7,381	)
Issuance of senior notes, net			—				194,242
Payments of 2000A equipment lease obligations			—				(200,000	)
Payments of 2000B equipment lease obligations			(57,589	)			—
Net cash provided by (used in) continuing operations			14,844				(33,244	)
Net cash used in discontinued operations			—				—
Net cash provided by (used in) financing activities			14,844				(33,244	)
Effect of exchange rate changes on cash and equivalents			(952	)			(490	)
Net decrease in cash and cash equivalents			(6,356	)			(4,745	)
Cash and cash equivalents at beginning of period			38,076				56,619
Cash and cash equivalents at end of period		$	31,720			$	51,874

The accompanying notes are an integral part of these condensed consolidated financial statements.

HANOVER COMPRESSOR COMPANY

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 Ended

Six Months Ended

June 30,

June 30,

2005

2004

2005

2004

Weighted average common shares outstanding—used in basic loss per common share

85,797

85,114

85,744

84,076

Net 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 diluted loss per common share

85,797

85,114

85,744

84,076

The table below indicates the potential shares of common stock issuable that were excluded from net dilutive potential shares of common stock issuable as their effect would have been anti-dilutive (in thousands):

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Net dilutive potential common shares issuable:
On exercise of options and vesting of restricted stock			2,566				1,928				2,770				2,044
On exercise of options-exercise price greater than average market value at end of period			1,326				1,599				911				1,127
On exercise of warrants			4				4				4				4
On conversion of convertible subordinated notes due 2029			4,825				4,825				4,825				4,825
On conversion of convertible senior notes due 2008			4,370				4,370				4,370				4,370
On conversion of convertible senior notes due 2014			9,583				9,583				9,583				9,583
			22,674				22,309				22,463				21,953

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 Ended								Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Net loss as reported		$	(6,416	)		$	(9,061	)		$	(18,880	)		$	(18,515	)
Add back: Restricted stock grant expense			1,168				374				2,223				765
Deduct: Stock-based employee compensation expense determined under the fair value method			(1,853	)			(714	)			(3,549	)			(1,692	)
Pro forma net loss		$	(7,101	)		$	(9,401	)		$	(20,206	)		$	(19,442	)
Loss per share:
Basic, as reported		$	(0.07	)		$	(0.11	)		$	(0.22	)		$	(0.22	)
Basic, pro forma		$	(0.08	)		$	(0.11	)		$	(0.24	)		$	(0.23	)
Diluted, as reported		$	(0.07	)		$	(0.11	)		$	(0.22	)		$	(0.22	)
Diluted, pro forma		$	(0.08	)		$	(0.11	)		$	(0.24	)		$	(0.23	)

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):

		June 30,				December 31,
		2005				2004
Parts and supplies		$	132,222			$	135,751
Work in progress			59,162				42,708
Finished goods			11,532				6,339
		$	202,916			$	184,798

As of June 30, 2005 and December 31, 2004, we had inventory reserves of approximately $12.1 million and $11.7 million, respectively.

3. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consisted of the following (in thousands):

		June 30,				December 31,
		2005				2004
Compression equipment, facilities and other rental assets		$	2,392,061			$	2,360,799
Land and buildings			85,235				89,573
Transportation and shop equipment			77,098				78,577
Other			52,570				51,054
			2,606,964				2,580,003
Accumulated depreciation			(778,696	)			(703,655	)
		$	1,828,268			$	1,876,348

As of June 30, 2005, the compression assets owned by entities that lease equipment to us but, pursuant to our adoption of FIN 46, are included in property, plant and equipment in our consolidated financial statements had a net book value of approximately $513.5 million, including improvements made to these assets after the sale leaseback transactions.

4. DEBT

Short-term debt consisted of the following (in thousands):

		June 30,				December 31,
		2005				2004
Belleli-factored receivables		$	1,158			$	1,011
Belleli-revolving credit facility			3,249				4,095
Short-term debt		$	4,407			$	5,106

Belleli’s factoring arrangements are typically short term in nature and bore interest at a weighted average rate of 3.0% and 4.0% at June 30, 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 June 30, 2005 and December 31, 2004, respectively. These revolving credit facilities are callable during 2005.

Long-term debt consisted of the following (in thousands):

		June 30,				December 31,
		2005				2004
Bank credit facility due December 2006		$	77,000			$	7,000
4.75% convertible senior notes due 2008*			192,000				192,000
4.75% convertible senior notes due 2014*			143,750				143,750
8.625% senior notes due 2010**			200,000				200,000
9.0% senior notes due 2014**			200,000				200,000
2000B equipment lease notes, interest at 5.2%, due October 2005			—				55,861
2001A equipment lease notes, interest at 8.5%, due September 2008			300,000				300,000
2001B equipment lease notes, interest at 8.8%, due September 2011			250,000				250,000
Zero coupon subordinated notes, interest at 11.0%, due March 2007*			217,823				206,467
7.25% convertible subordinated notes due 2029*			86,250				86,250
Fair value adjustment — fixed to floating interest rate swaps			(4,667	)			(5,996	)
Other, interest at various rates, collateralized by equipment and other assets, net of unamortized discount			2,485				3,178
			1,664,641				1,638,510
Less-current maturities			(1,457	)			(1,430	)
Long-term debt		$	1,663,184			$	1,637,080

During February 2005, we repaid our 2000B compressor equipment lease obligations using borrowings from our bank credit facility.

As of June 30, 2005, we had $77.0 million in outstanding borrowings under our bank credit facility. Outstanding amounts under that facility bore interest at a weighted average rate of 6.0% and 5.2% at June 30, 2005 and December 31, 2004, respectively. 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 June 30, 2005, we had $77.0 million of borrowings and $104.5 million of outstanding letters of credit under our bank credit facility, resulting in $168.5 million of additional capacity under such bank credit facility at June 30, 2005.

As of June 30, 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.

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 June 30, 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 $59.9 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 June 30, 2005 (dollars in thousands):

														Fair Value of
						Fixed Rate to be				Notional				Swap at
Floating Rate to be Paid		Maturity Date				Received				Amount				June 30, 2005
Six Month LIBOR +4.72%		December 15, 2010					8.625	%		$	100,000			$	(2,435	)
Six Month LIBOR +4.64%		December 15, 2010					8.625	%		$	100,000			$	(2,232	)

As of June 30, 2005, a total of approximately $0.6 million in accrued liabilities, $4.1 million in long-term liabilities and a $4.7 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 June 30, 2005, we estimated that the effective rate for the six-month period ending in December 2005 would be approximately 8.8%.

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 of
				Fixed Rate to be				Notional				Swap at
Lease		Maturity Date		Paid				Amount				June 30, 2005
March 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 six months ended June 30, 2005, we recorded a reduction to other comprehensive income of approximately $0.6 million compared to an increase to other comprehensive income of approximately $6.3 million during the six months ended June 30, 2004, 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 six months ended June 30, 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):

						Maximum Potential
						Undiscounted
						Payments as of
		Term				June 30, 2005
Indebtedness of non-consolidated affiliates:
Simco/Harwat Consortium (1)			2005			$	10,364
El Furrial (1)			2013				34,022
Other:
Performance guarantees through letters of credit (2)			2005-2006				89,225
Standby letters of credit			2005-2006				17,958
Commercial letters of credit			2005				1,899
Bid bonds and performance bonds (2)			2005-2011				104,242
						$	257,710

(1)		We have guaranteed the amount included above, which is a percentage of the total debt of this non-consolidated affiliate equal to our ownership percentage in such affiliate.
(2)		We have issued guarantees to third parties to ensure performance of our obligations, some of which may be fulfilled by third parties.

As part of the Production Operators Corporation (“POC”) acquisition purchase price, Hanover may be required to make a contingent payment to Schlumberger based on the realization of certain tax benefits by Hanover through 2016. To date we have not realized any of such tax benefits or made any payments to Schlumberger in connection with them.

We are substantially self-insured for worker’s compensation, employer’s liability, auto liability, general liability, property damage/loss, 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 June 30, 2005, we had an investment of approximately $67.2 million

in projects in Nigeria, a substantial majority of which related to the Cawthorne Channel Project. We currently anticipate making an approximately $2.5 million additional investment in the Cawthorne Channel Project during 2005. In addition, we have approximately $4.2 million associated with advances to, and our investment in, Global.

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 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 and deferred taxes) exposed to currency fluctuation in Venezuela in future periods.

For the six months ended June 30, 2005, our Argentine operations represented approximately 5% of our revenue and 8% of our gross profit. For the six months ended June 30, 2005, our Venezuelan operations represented approximately 10% of our revenue and 17% of our gross profit. At June 30, 2005, we had approximately $14.3 million and $22.5 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.

Several compressor rental projects with a customer in Latin America are scheduled to terminate in accordance with the terms of our lease agreements at various times during the remainder of 2005. These projects represent in the aggregate approximately $2.8 million per month in revenues. We are in the process of negotiating extensions of these lease agreements with this customer. While we hope to renew these contracts on favorable terms, we can provide no assurance that these contracts will be renewed on terms that are as favorable to us as the existing lease agreements or at all. If the contracts were not renewed, we would be required to find alternative uses for these assets.

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. RELATED-PARTY TRANSACTIONS

On July 8, 2005, we entered into Amendment No. 2 to the Purchase Agreement dated June 28, 2001 by and among Hanover, HCLP, and Schlumberger Technology Corporation (“STC”), for itself and as successor in interest to Camco International Inc., Schlumberger Surenco S.A. (“Surenco”), and Schlumberger Oilfield Holdings Ltd. (“SOHL”). SOHL, STC and Surenco collectively are referred to as “Schlumberger”. Pursuant to Amendment No. 2, entities affiliated with Schlumberger recently agreed to eliminate Schlumberger’s right to designate a Director to serve on our Board of Directors in order for Schlumberger to position itself to have maximum flexibility in terms of its ownership of its shares of our common stock. Entities affiliated with Schlumberger have in the past, and may in the future, sell shares of our common stock from time to time pursuant to Rule 144 under the Securities Act of 1933.

Ted Collins, Jr., one of our Directors, owns 100% of Azalea Partners, which owns approximately 14% of Energy Transfer Group, LLC (“ETG”). During the six months ended June 30, 2005 and 2004 and during the twelve months ended December 31, 2004, we recorded sales of approximately $6.0 million, $4.9 million and $7.7 million, respectively, related to equipment leases and sales to ETG, including its indirectly wholly owned subsidiary Energy Transfer Technologies, LP. In addition, Hanover and ETG are co-owners of a power generation facility in Venezuela. Under the agreement of co-ownership, each party is responsible for its obligations as a co-owner. Hanover is the designated manager of the facility. As manager, Hanover received revenues related to the facility and distributed to ETG its net share of the operating cash flow of $0.3 million during the six months ended June 30, 2005 and 2004.

Mr. Collins is a passive investor in ETG through his ownership of Azalea Partners; he does not serve as an officer, director, or employee of ETG. While Mr. Collins’ relationship with ETG and the Company is not specifically excluded from independence stature under the rules of the New York Stock Exchange and the Securities and Exchange Commission, on July 7, 2005, the Governance Committee of the Board of Directors reevaluated Mr. Collins’ independence in light of recent transactions entered into between the Company and ETG to broadly consider whether such additional transactions might be considered a material relationship between Mr. Collins and the Company. The Governance Committee considered the recent increased commercial activity between the Company and ETG, and the potential impact of these transactions on ETG’s revenue. In reviewing the overall relationship, the Governance Committee determined that Mr. Collins should no longer be classified as an independent director. Mr. Collins was therefore removed from the Governance Committee, and Director Gordon T. Hall (who meets the independence requirements of the SEC, NYSE and the Company’s Governance Principles) was elected to the Governance Committee. Such action was ratified by the Board of Directors on July 8, 2005, and was reported to the New York Stock Exchange as required.

8. RECENT 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 June 30, 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 June 30, 2005, the yield rates on the outstanding equity certificates ranged from 11.1% to 11.5%. Equity certificate holders may receive a return of capital payment upon termination of the lease or our purchase of the leased compression equipment after full payment of all debt obligations of the entities that lease compression equipment to us. At June 30, 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 overhead 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, the 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 123(R) 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 123(R) will be changed to the first annual reporting period that begins after June 15, 2005. The adoption of SFAS 123(R) 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.

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.

In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). FIN 47 requires uncertainty about the timing or method of settlement of a conditional asset retirement obligation to be factored into the measurement of the liability when sufficient information exists. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. We are currently evaluating the impact FIN 47 will have on our consolidated results of operations, cash flows or financial position.

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”). SFAS 154 requires retrospective application for reporting a change in accounting principle in the absence of explicit transition requirements specific to newly adopted accounting principles, unless impracticable. Corrections of errors will continue to be reported under SFAS 154 by restating prior periods as of the beginning of the first period presented. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We are currently evaluating the provisions of SFAS 154 and do not believe that our adoption will have a material impact on our consolidated results of operations, cash flows or financial position.

9. 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 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 June 30, 2005 and 2004.

		Segments
																		Production
										Parts,				Compressor				and
										service				and				processing
		U.S.				International				and used				accessory				equipment				Other
		rentals				rentals				equipment				fabrication				fabrication				income				Total
										(in thousands)
June 30, 2005:
Revenues from external customers		$	87,691			$	55,521			$	50,531			$	41,092			$	104,297			$	5,650			$	344,782
Gross profit			54,707				38,377				14,316				4,505				11,868				5,650				129,423
June 30, 2004:
Revenues from external customers		$	83,680			$	54,599			$	41,414			$	44,159			$	63,017			$	6,007			$	292,876
Gross profit			48,730				40,632				10,050				3,705				9,130				6,007				118,254

The following tables present sales and other financial information by industry segment for the six months ended June 30, 2005 and 2004.

		Segments
																		Production
										Parts,				Compressor				and
										service				and				processing
		U.S.				International				and used				accessory				equipment				Other
		rentals				rentals				equipment				fabrication				fabrication				income				Total
		(in thousands)
June 30, 2005:
Revenues from external customers		$	174,845			$	109,436			$	83,968			$	73,616			$	193,868			$	10,675			$	646,408
Gross profit			107,785				74,790				22,693				7,412				22,314				10,675				245,669
June 30, 2004:
Revenues from external customers		$	170,272			$	106,099			$	85,796			$	72,309			$	116,446			$	11,785			$	562,707
Gross profit			99,783				77,359				21,463				5,942				14,863				11,785				231,195

10. 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 June 30, 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 six months ended June 30, 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.

     Summary of operating results of the discontinued operations (in thousands):

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Revenues and other:
U.S. rentals		$	67			$	10			$	70			$	15
International rentals			—				3,760				—				7,829
Parts, service and used equipment			—				3,270				—				6,742
Equity in income (loss) of non-consolidated affiliates			—				(181	)			—				(12	)
Other			5				(273	)			5				(279	)
			72				6,586				75				14,295
Expenses:
U.S. rentals			219				231				383				391
International rentals			—				1,229				—				3,582
Parts, service and used equipment			—				2,141				—				4,591
Compressor and accessory fabrication			—				—				—				3
Selling, general and administrative			75				490				179				975
Foreign currency translation			—				723				5				294
Depreciation and amortization			—				1,114				—				2,068
Other			(1	)			98				—				134
			293				6,026				567				12,038
Income (loss) from discontinued operations before income taxes			(221	)			560				(492	)			2,257
Provision for income taxes			—				79				—				593
Income (loss) from discontinued operations		$	(221	)		$	481			$	(492	)		$	1,664

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 June 30, 2005 (in thousands):

						Non-
						Oilfield
		Used				Power
		Equipment				Generation				Facilities				Total
Current assets		$	2,455			$	2,188			$	—			$	4,643
Property, plant and equipment			—				766				4,948				5,714
Assets held for sale			2,455				2,954				4,948				10,357
Current liabilities			—				472				—				472
Liabilities held for sale			—				472				—				472
Net assets held for sale		$	2,455			$	2,482			$	4,948			$	9,885

     Summary balance sheet data for assets held for sale as of December 31, 2004 (in thousands):

						Non-
						Oilfield
		Used				Power
		Equipment				Generation				Facilities				Total
Current assets		$	2,455			$	2,714			$	—			$	5,169
Property, plant and equipment			—				1,077				5,314				6,391
Assets held for sale			2,455				3,791				5,314				11,560
Current liabilities			—				517				—				517
Liabilities held for sale			—				517				—				517
Net assets held for sale		$	2,455			$	3,274			$	5,314			$	11,043

11. INCOME TAXES

During the three months ended June 30, 2005, we recorded a net tax provision of $6.1 million compared to $6.8 million for the three months ended June 30, 2004. Our effective tax rate for the three months ended June 30, 2005 was 3,962%, compared to (214)% for the three months ended June 30, 2004. During the six months ended June 30, 2005, we recorded a net tax provision of $10.6 million compared to $13.9 million for the six months ended June 30, 2004. Our effective tax rate for the six months ended June 30, 2005 was (141)%, compared to (207)% for the six months ended June 30, 2004. The change in the effective tax rate was primarily due to the U.S. income tax impact of foreign operations, the relative weight of foreign income to U.S. income and the reversal of $3.6 million of tax issue based reserves during the second quarter of 2005. These reserves were reversed because we no longer believe that these tax liabilities will be incurred.

As a result of continued operating losses, we are in a net deferred tax asset position for U.S. income tax purposes. 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. We believe that we will likely be required to record additional valuation allowances in future periods, unless and until 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.

12. SUBSEQUENT EVENTS

In July 2005, the Board of Directors approved grants of awards under the 2003 Stock Incentive Plan to certain employees, including our executive officers, as part of an incentive compensation program. The grants included, in the aggregate, approximately 0.4 million shares of restricted stock, 0.5 million options to purchase our common stock, and cash performance awards with an aggregate target payment of approximately $5.2 million.

The shares of restricted stock and stock options that were granted will vest over a three-year period at a rate of one-third per year, beginning on the first anniversary of the date of the grant. Recipients of performance awards are eligible to receive a cash payment ranging from 0% to 200% of target at the end of three years from the original award grant date if we meet certain pre-determined performance based criteria. The compensation expense related to the performance awards will be recognized in our statement of operations and will be adjusted for changes in our estimate of the percentage of target that is expected to be achieved.

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 our 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.

You should not unduly rely on the forward-looking statements, which speak only as of the date of this Form 10-Q. Other factors in addition to those described in this Form 10-Q could also affect our actual results. 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. In addition to the risks noted above, you should 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”).

OVERVIEW

Our revenue and other income for the second quarter 2005 was $344.8 million compared to second quarter 2004 revenue and other income of $292.9 million. Net loss for the second quarter 2005 was $6.4 million, or $0.07 per share, compared with a net loss of $9.1 million, or $0.11 per share, in the second quarter 2004.

Our revenue and other income for the six months ended June 30, 2005 was $646.4 million compared to revenue and other income of $562.7 million for the six months ended June 30, 2004. Net loss for the six months ended June 30, 2005 was $18.9 million, or $0.22 per share, compared with a net loss of $18.5 million, or $0.22 per share, for the six months ended June 30, 2004.

Total compression horsepower at June 30, 2005 was approximately 3,304,000, consisting of approximately 2,512,000 horsepower in the United States and approximately 792,000 horsepower internationally.

At June 30, 2005, Hanover’s total third-party fabrication backlog was approximately $260.4 million compared to approximately $290.9 million at December 31, 2004 and $265.7 million at June 30, 2004. The compressor and accessory fabrication backlog was approximately $67.5 million at June 30, 2005, compared to approximately $56.7 million at December 31, 2004 and $53.9 million at June 30, 2004. The backlog for production and processing equipment fabrication was approximately $192.9 million at June 30, 2005, compared to approximately $234.2 million at December 31, 2004 and $211.8 million at June 30, 2004.

Industry Conditions

The North American rig count increased by 14% to 1,648 at June 30, 2005 from 1,441 at June 30, 2004, and the twelve-month rolling average North American rig count increased by 10% to 1,650 at June 30, 2005 from 1,500 at June 30, 2004. In addition, the twelve-month rolling average New York Mercantile Exchange wellhead natural gas price increased to $6.47 per MMBtu at June 30, 2005 from $5.31 per MMBtu at June 30, 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 (i) the lack of a significant increase in U.S. natural gas production levels, (ii) the lack of immediate availability of compression equipment in the configuration currently in demand by our customers and (iii) increases in purchases of compression equipment by oil and gas companies that have available capital. However, improved market conditions have led to improved pricing in the U.S. market.

U.S. Tax Position

As a result of continued operating losses, we are in a net deferred tax asset position for U.S. income tax purposes. 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. We believe that we will likely be required to record additional valuation allowances in future periods, unless and until 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.

RESULTS OF OPERATIONS

U.S. Rentals
(in thousands)

		Three months ended
		June 30,								Increase
		2005				2004				(Decrease)
Revenue		$	87,691			$	83,680				5	%
Operating expense			32,984				34,950				(6	)%
Gross profit		$	54,707			$	48,730				12	%
Gross margin			62	%			58	%			4	%

U.S. rental revenue increased during the three months ended June 30, 2005, compared to the three months ended June 30, 2004, due primarily to improvement in market conditions that has led to an improvement in pricing. Gross profit and gross margin for the three months ended June 30, 2005 increased compared to the three months ended June 30, 2004, primarily due to improved pricing and our efforts to reduce maintenance and repair expense.

International Rentals
(in thousands)

		Three months ended
		June 30,								Increase
		2005				2004				(Decrease)
Revenue		$	55,521			$	54,599				2	%
Operating expense			17,144				13,967				23	%
Gross profit		$	38,377			$	40,632				(6	)%
Gross margin			69	%			74	%			(5	)%

During the three months ended June 30, 2005, international rental revenue increased, compared to the three months ended June 30, 2004, primarily due to increased activity in Mexico and Nigeria. Gross profit and gross margin decreased primarily due to (a) additional costs incurred in the second quarter of 2005 related to the start-up of projects in Nigeria (b) lower operating costs during the three months ended June 30, 2004 due to the timing of planned repair and maintenance activities that were scheduled to increase in the second half of 2004 and (c) the receipt of approximately $0.9 million in additional contractual inflation adjustments in Venezuela and approximately $1.1 million in negotiated start up payments received in Brazil during the second quarter of 2004 associated with a compression rental project that was scheduled to start up in the first quarter of 2004 but was delayed by the customer.

Parts, Service and Used Equipment
(in thousands)

		Three months ended
		June 30,								Increase
		2005				2004				(Decrease)
Revenue		$	50,531			$	41,414				22	%
Operating expense			36,215				31,364				15	%
Gross profit		$	14,316			$	10,050				42	%
Gross margin			28	%			24	%			4	%

Parts, service and used equipment revenue, gross profit and gross margin for the three months ended June 30, 2005 were higher than the three months ended June 30, 2004 primarily due to higher parts and service revenues in the U.S. and an increase in used rental equipment and installation sales. Parts, service and used equipment revenue includes two business components: (1) parts and service and (2) used rental equipment and installation sales. For the three months ended June 30, 2005, parts and service revenue was $38.6 million with a gross margin of 27%, compared to $35.4 million and 28%, respectively, for the three months ended June 30, 2004. Used rental equipment and installation sales revenue for the three months ended June 30, 2005 was $11.9 million with a gross margin of 32%, compared to $6.0 million with a 2% gross margin for the three months ended June 30, 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 installation sales associated with the start-up of new projects by customers.

Compression and Accessory Fabrication
(in thousands)

		Three months ended
		June 30,								Increase
		2005				2004				(Decrease)
Revenue		$	41,092			$	44,159				(7	)%
Operating expense			36,587				40,454				(10	)%
Gross profit		$	4,505			$	3,705				22	%
Gross margin			11	%			8	%			3	%

For the three months ended June 30, 2005, compression and accessory fabrication revenue decreased due to decreased revenues in our high-spec compression business in the second quarter of 2005. Gross profit and gross margin increased primarily due to improved pricing and our focus on improving operational efficiencies in our fabrication business in 2005. Strong competition in the second quarter of 2004 led to lower margins on orders received. As of June 30, 2005, we had compression fabrication backlog of $67.5 million compared to $53.9 million at June 30, 2004.

Production and Processing Equipment Fabrication
(in thousands)

		Three months ended
		June 30,								Increase
		2005				2004				(Decrease)
Revenue		$	104,297			$	63,017				66	%
Operating expense			92,429				53,887				72	%
Gross profit		$	11,868			$	9,130				30	%
Gross margin			11	%			14	%			(3	)%

Production and processing equipment fabrication revenue for the three months ended June 30, 2005 was greater than for the three months ended June 30, 2004, primarily due to our increased focus on both fabrication sales and our sales success ratio on new bid opportunities as well as an improvement in market conditions which led to improved pricing. Production and processing equipment fabrication gross margin during the second quarter 2005 was positively impacted by approximately $1.7 million due primarily to the strengthening of the U.S. Dollar, relative to the Euro. Gross margin decreased primarily due to the increase in revenues by our fabrication operations in Italy and Dubai, which typically have lower margins. As of June 30, 2005, we had a production and processing equipment fabrication backlog of $192.9 million compared to $211.8 million at June 30, 2004.

Expenses

Selling, general, and administrative expense (“SG&A”) for the three months ended June 30, 2005 was $43.9 million, compared to $41.9 million during the three months ended June 30, 2004. The increase was primarily due to an increase in compensation costs. As a percentage of revenue, SG&A for the three months ended June 30, 2005 was 13%, compared to 14% for the three months ended June 30, 2004. As a percentage of sales, SG&A expense decreased due to our efforts to manage SG&A costs and drive an increased level of business with existing infrastructure.

Depreciation and amortization expense for the three months ended June 30, 2005 increased to $45.5 million, compared to $43.3 million for the three months ended June 30, 2004. Depreciation and amortization increased during the three months ended June 30, 2005 as compared to the three months ended June 30, 2004 primarily due to net additions to property, plant and equipment placed in service since June 30, 2004, principally in rental fleet operations.

The decrease in our interest expense was primarily due to a decrease in the average debt balance, partially offset by an increase in the overall effective interest rate on outstanding debt to 8.2% from 8.0% during the three months ended June 30, 2005 and 2004, respectively.

Foreign currency translation for the three months ended June 30, 2005 was a loss of $5.0 million, compared to a gain of $0.1 million for the three months ended June 30, 2004. For the three months ended June 30, 2005, foreign currency translation included $5.4 million in translation losses related to the re-measurement of our international subsidiaries’ dollar denominated inter-company debt primarily for our subsidiary in Italy.

The following table summarizes the exchange gains and losses we recorded for assets exposed to currency translation (in thousands):

		Three Months Ended
		June 30,
		2005				2004
Canada		$	422			$	179
Argentina			78				(227	)
Venezuela			140				477
Italy			(5,698	)			51
All other countries			103				(384	)
Exchange gain (loss)		$	(4,955	)		$	96

We had intercompany advances outstanding to our subsidiary in Italy of approximately $91.9 million and $14.7 million at June 30, 2005 and June 30, 2004, respectively. 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 $8.4 million.

Income Taxes

During the three months ended June 30, 2005, we recorded a net tax provision of $6.1 million compared to $6.8 million for the three months ended June 30, 2004. Our effective tax rate for the three months ended June 30, 2005 was 3,962%, compared to (214)% for the three months ended June 30, 2004. The change in the effective tax rate was primarily due to the U.S. income tax impact of foreign operations, the relative weight of foreign income to U.S. income and the reversal of $3.6 million of tax issue based reserves during the second quarter of 2005. These reserves were reversed because we no longer believe that these tax liabilities will be incurred.

As a result of continued operating losses, we are in a net deferred tax asset position for U.S. income tax purposes. 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. We believe that we will likely be required to record additional valuation allowances in future periods, unless and until 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 our 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 $1.4 million to a net loss of $0.5 million during the three months ended June 30, 2005, from income of $0.9 million during the three months ended June 30, 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.

SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO SIX MONTHS ENDED JUNE 30, 2004

U.S. Rentals
(in thousands)

		Six months ended
		June 30,								Increase
		2005				2004				(Decrease)
Revenue		$	174,845			$	170,272				3	%
Operating expense			67,060				70,489				(5	)%
Gross profit		$	107,785			$	99,783				8	%
Gross margin			62	%			59	%			3	%