HANOVER COMPRESSION INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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Form 10-K

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(MARK ONE)

[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For fiscal year ended December 31, 1999

[_]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. 1-3071

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Hanover Compressor Company
(Exact name of registrant as specified in its charter)

Delaware 76-0625124
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)

12001 North Houston Rosslyn, Houston, Texas 77086
(Address of principal executive offices)

(281) 447-8787
(Registrant's telephone number, including area code)

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Securities registered pursuant to Section 12(b) of the Act:

Title of each class Name of each exchange in which registered
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Common Stock, $.001 par value New York Stock Exchange, Inc.

Securities registered pursuant to 12(g) of the Act:

Title of class
None

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]

The aggregate market value of the Common Stock of the registrant held by
nonaffiliates as of March 24, 2000: $648,119,000. This calculation does not
reflect a determination that such persons are affiliates for any other
purpose.

Number of shares of the Common Stock of the registrant outstanding as of
March 24, 2000: 28,830,826 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders to be held on May 18, 2000 (to be filed on or before April 30,
2000) are incorporated by reference into Part II, as indicated herein.

The Index to Exhibits is on page E-1.

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PART I

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain matters discussed in this Annual Report on Form 10-K are "forward-
looking statements" intended to qualify for the safe harbors from liability
established by the Private Securities Litigation Reform Act of 1995. These
forward-looking statements can generally be identified as such because the
context of the statement will include words such as the Company "believes",
"anticipates", "expects", "estimates" or words of similar import. Similarly,
statements that describe the Company's future plans, objectives or goals are
also forward-looking statements. Such forward-looking statements are subject
to certain risks and uncertainties which could cause actual results to differ
materially from those anticipated as of the date of this report. The risks and
uncertainties include (1) the loss of market share through competition; (2)
the introduction of competing technologies by other companies; (3) a prolonged
substantial reduction in oil and gas prices which would cause a decline in the
demand for our compression and oil and gas production equipment; (4) new
governmental safety, health and environmental regulations which could require
us to make significant capital expenditures; and (5) changes in economic or
political conditions in the countries in which the Company operates. The
forward-looking statements included herein are only made as of the date of
this report and the Company undertakes no obligation to publicly update such
forward-looking statements to reflect subsequent events or circumstances.

Item 1. Business

General

Hanover Compressor Company (the "Company") was incorporated in Delaware in
1990 and is a market leader in full-service natural gas compression and a
leading provider of contract natural gas handling service, fabrication and
equipment. As of December 31, 1999, the Company operated a fleet of 3,898
compression rental units with an aggregate capacity of approximately 1,458,000
horsepower. The Company's compression services are complemented by its
compressor and oil and gas production equipment fabrication operations.

The Company believes it is currently the largest natural gas compression
company in the United States on the basis of aggregate rental horsepower with
3,608 rental units having an aggregate capacity of approximately 1,181,000
horsepower at December 31, 1999. Internationally, the Company estimates it is
one of the largest providers of compression services in the South American
market, primarily in Argentina, Colombia and Venezuela, operating 290 units
with approximately 277,000 horsepower at December 31, 1999.

The Company's products and services are important for the production,
transportation, processing and storage of natural gas and are provided
primarily to energy producers and processors. The Company's decentralized
operating structure, technically experienced personnel and high quality
compressor fleet, allow the Company to successfully provide reliable and
timely customer service. As a result, the Company has experienced substantial
growth over the past five years and has developed and maintained a number of
long-term customer relationships. This has enabled the Company to maintain an
average horsepower utilization rate of approximately 93% over the last five
years in comparison to an industry average estimated by the Company to be
approximately 83%.

The Company currently competes primarily in the transportable natural gas
compression market for units of up to 4,450 horsepower. This market, which
includes rental and owner operated units, accounts for over 14.9 million
horsepower in the United States and is believed to have grown by approximately
8% compounded rate per annum since 1992. The Company believes that the growth
in the domestic gas compression market will continue due to the increased
consumption of natural gas, the continued aging of the natural gas reserve
base and the attendant decline of wellhead pressures, and the discovery of new
reserves.

The rental portion of the domestic gas compression market is currently
estimated to comprise approximately 4.8 million horsepower amounting to 37% of
the aggregate U.S. horsepower. Growth of rental compression capacity in the
U.S. market is primarily driven by the increasing trend toward outsourcing by
energy producers

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and processors. The Company believes that outsourcing provides the customer
greater financial and operating flexibility by minimizing the customer's
investment in equipment and enabling the customer to more efficiently resize
compression units to meet the changing needs of the well, pipeline or
processing plant. In addition, the Company also believes that outsourcing
typically provides the customer with more timely and technically proficient
service and necessary maintenance which often reduces operating costs.
Internationally, the Company believes similar growth opportunities for
compressor rental and sales exist due to (i) increased worldwide energy
consumption, (ii) implementation of international environmental and
conservation laws preventing the flaring of natural gas, and (iii) increased
outsourcing by energy producers and processors.

Compressor Rental Fleet

The size and horsepower of the Company's compressor rental fleet owned or
operated under lease on December 31, 1999 is summarized in the following table.

Number Aggregate
of Horsepower % of
Range of Horsepower per Unit Units (in thousands) Horsepower
---------------------------- ------ -------------- ----------

0-99........................................ 1,435 96 6.6%
100-199..................................... 893 131 9.0%
200-499..................................... 642 193 13.2%
500-799..................................... 277 168 11.5%
800-1199.................................... 331 349 24.0%
1200-2699................................... 302 455 31.2%
2700-UP..................................... 18 66 4.5%
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Total..................................... 3,898 1,458 100.00%
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Industry Overview

Gas Compression

Typically, compression is required several times during the natural gas
production cycle: at the wellhead, gathering lines, into and out of gas
processing facilities, into and out of storage, and throughout the intrastate
and interstate pipelines.

Over the life of an oil or gas well, natural reservoir pressure and
deliverability typically declines as reserves are produced. As the natural
reservoir pressure of the well declines below the line pressure of the gas
gathering or pipeline system used to transport the gas to market, gas no longer
naturally flows into the pipeline. It is at this time that compression
equipment is applied to economically boost the well's production levels and
allow gas to be brought to market.

In addition to such gas field gathering activities, natural gas compressors
are utilized in a number of other applications, all of which are intended to
enhance the productivity of oil and gas wells, gas transportation lines and
processing plants. Compressors are used to increase the efficiency of a low
capacity gas field by providing a central compression point from which the gas
can be removed and injected into a pipeline for transmission to facilities for
further processing. As gas is transported through a pipeline, compression
equipment is applied to allow the gas to continue to flow in the pipeline to
its destination. Additionally, compressors are utilized to re-inject associated
gas to artificially lift liquid hydrocarbons which increases the rate of crude
oil production from oil and gas wells. Furthermore, compression enables gas to
be stored in underground storage reservoirs for subsequent extraction during
periods of peak demand. Finally, in combination with oil and gas production
equipment, compressors are often utilized to process and refine oil and gas
into higher value added and more marketable energy sources.

Changing well and pipeline pressures and conditions over the life of a well
often require producers to reconfigure their compressor units to optimize the
well production or pipeline efficiency. Due to the technical nature of the
equipment, a highly trained staff of field service personnel, parts inventory
and a diversified fleet of

3

natural gas compressors are often necessary to perform such functions in the
most economic manner. These requirements, however, have typically proven to be
an extremely inefficient use of capital and manpower for independent natural
gas producers and have caused such firms as well as natural gas processors and
transporters to increasingly outsource their non-core compression activities to
specialists such as the Company.

The advent of rental and contract compression roughly 40 years ago made it
possible for natural gas producers, transporters and processors to improve the
efficiency and financial performance of their operations. Compressors leased
from specialists generally have a higher rate of mechanical reliability and
typically generate greater productivity than those owned by oil and gas
operators. Furthermore, because compression needs of a well change over time,
outsourcing of compression equipment enables an oil and gas operator to better
match variable compression requirements to the production needs throughout the
life of the well. Also, certain major domestic oil companies are seeking to
streamline their operations and reduce their capital expenditures and other
costs. To this end, they have sold certain domestic energy reserves to
independent energy producers and are outsourcing facets of their operations.
Such initiatives, in the opinion of the Company, are likely to contribute to
increased rental of compressor equipment.

Natural gas compressor fabrication involves the design, fabrication and sale
of compressors to meet the unique specifications dictated by the well pressure,
production characteristics and the particular applications for which
compression is sought. Compressor fabrication is essentially an assembly
operation in which an engine, compressor, control panel, cooler and necessary
piping are attached to a frame called a "skid". A fabricator typically
purchases the various compressor components from third party manufacturers but
employs its own engineers and design and labor force.

In order to meet customers' needs, gas compressor fabricators typically offer
a variety of services to their customers including: (i) engineering,
fabrication and assembly of the compressor unit; (ii) installation and testing
of the units; (iii) ongoing performance review to assess the need for a change
in compression; and (iv) periodic maintenance and replacement parts supply.

Production Equipment

Oil and gas reserves are generally not commercially marketable as produced at
the wellhead. Typically, such reserves must be refined before they can be
transported to market. Oil and gas production equipment is utilized to separate
and treat such oil and gas immediately after it is produced in order to
facilitate further processing, transportation and sale of such fuels and
derivative energy sources. Oil and gas production equipment is typically
installed at the wellhead immediately prior to commencing the large scale
production phase of a well and remains at the site through the life of the
well.

Market Conditions

The Company believes that the most fundamental force driving the demand for
gas compression and production equipment is the growing consumption of natural
gas. As more gas is consumed, the demand for compression and production
equipment increases.

Additionally, although natural gas has historically been a more significant
source of energy in the United States than in the rest of the world, the
Company believes that aggregate foreign natural gas consumption (excluding the
former Soviet Union) has recently grown. Despite significant growth in energy
demand, most non-U.S. energy markets, until recently, have typically lacked the
infrastructure to transport natural gas to local markets, and natural gas
historically has been flared at the wellhead. Given recent environmental
legislation and the construction of numerous natural gas-fueled power plants
built to meet international energy demand, the Company believes that
international compression markets are experiencing growth.

Natural gas is considered to be the "fuel of the future" because it provides
the best mix of environment soundness, economy and availability of any energy
source. Rising worldwide energy demand, environmental considerations, the
further development of the natural gas pipeline infrastructure and the
increasing use of natural gas as a fuel source in power generation are the
principal reasons for this steady growth.

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While gas compression and production equipment typically must be highly
engineered to meet demanding and unique customer specifications, the
fundamental technology of such equipment has been stable and has not been
subject to significant technological change.

Business Segments

The Company's revenues and income are derived from its four business
segments (comprising three operating divisions)--domestic compression rentals,
international compression rentals, compressor fabrication and production
equipment fabrication. The compression rentals segments have operations
primarily in the United States, Canada and South America. For financial data
relating to the Company's divisions, see "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and Note 17 to the Notes to
the Consolidated Financial Statements.

Compression Services and Fabrication

The Company provides its customers with a full range of compressor rental,
maintenance and contract compression services. As of December 31, 1999, the
Company's gas compressor fleet consisted of 3,898 units, ranging from 24 to
4,450 horsepower. The size, type and geographic diversity of this rental fleet
enables the Company to provide its customers with a range of compression units
that can serve a wide variety of applications, and to select the correct
equipment for the job, rather than trying to "fit" the job to its fleet of
equipment.

The Company bases its gas compressor rental rates on several factors,
including the cost and size of the equipment, the type and complexity of
service desired by the customer, the length of the contract, and the inclusion
of any other services desired, such as installation, transportation and the
degree of daily operation. Substantially all of the Company's units are
operated pursuant to "contract compression" or "rental with full maintenance"
contracts under which the Company performs all maintenance and repairs on such
units while under contract. In the United States onshore market, compression
rental fleet units are generally leased on minimum terms of 6 to 12 months,
which convert to month-to-month at the end of the stipulated minimum period.
Historically, the majority of the Company's customers have extended the length
of their contracts, on a month-to-month basis, well beyond the initial term.
Typically, the Company's compression rental units utilized in offshore and
international applications carry substantially longer lease terms than those
for onshore domestic applications.

An essential element to the Company's success is its ability to provide its
compression services to customers with contractually committed compressor run-
times of at least 97%. Historically, run time credits have been insignificant,
due largely to the Company's rigorous preventive maintenance program and
extensive field service network which permits the Company to promptly address
maintenance requirements. The Company's rental compressor maintenance
activities are conducted at nine Company facilities staffed by approximately
600 experienced and factory trained maintenance personnel. Such maintenance
facilities are situated in close proximity to actual rental fleet deployment
to permit superior service response times.

All rental fleet units are serviced at manufacturers' recommended
maintenance intervals, modified as required by the peculiar characteristics of
each individual job, and the actual operating experience of each compressor
unit. Prior to the conclusion of any rental job, the Company field management
evaluates the condition of the equipment and, where practical, corrects any
problems before the equipment is shipped out from the job site. Although
natural gas compressors generally do not suffer significant technological
obsolescence, they do require routine maintenance and periodic refurbishing to
prolong their useful life. Routine maintenance includes alignment, compression
checks, and other parametric checks which indicate a change in the condition
of the equipment. In addition, oil and wear-particle analysis is performed on
all units prior to their redeployment at specific compression rental jobs.
Overhauls are done on a condition-based interval instead of a time-based
schedule. In the Company's experience, these rigorous procedures maximize
component life and unit availability and minimize avoidable downtime.
Typically, the Company overhauls each rental compressor unit for general
refurbishment every 36-48 months and anticipates performing a comprehensive
overhaul of each rental compressor unit every 60 to 72 months. This
maintenance program has provided the Company with a highly reliable fleet of
compressors in excellent condition.

5

The Company's field service mechanics provide all operating and maintenance
services for each of the Company's compression units leased on a contract
compression or full maintenance basis and are on-call 24 hours a day. Such
field personnel receive regular mechanical and safety training both from the
Company and its vendors. Each of the Company's field mechanics is responsible
for specific compressor unit installations and has at his disposal a dedicated,
local parts inventory. Additionally, each field mechanic operates from a fully-
equipped service vehicle. Each mechanic's field service vehicle is radio or
cellular telephone equipped which allows that individual to be the Company's
primary contact with the customer's field operations staff and to be contacted
at either his residence or mobile phone 24 hours a day. Accordingly, the
Company's field service mechanics are given the responsibility to promptly
respond to customer service needs as they arise based on the mechanic's trained
judgment and field expertise.

The Company considers itself to be unique in its industry in that its sales
and field service organizations enjoy managerial parity within the Company,
enabling these two vital organizations to work together in a highly coordinated
fashion in order to deliver maximum customer service, responsiveness and
reliability. The foundation for Hanover's successful field operations effort is
the experience and responsiveness of its approximately 600 member compressor
rental field service and shop staff of factory-trained and field-tested
compressor mechanics. The Company's field service mechanics are coordinated and
supported by regional operations managers who have supervisory responsibility
for specific geographic areas.

The Company's compressor fabrication subsidiary doing business as Hanover
Maintech, designs, engineers and assembles compression units for sale to third
parties as well as for placement in its compressor fleet. As of December 31,
1999, the Company had a compressor unit fabrication backlog for sale to third
parties of $2.2 million. All backlog is expected to be produced within a 90-120
day period. In general, units to be sold to third parties are assembled
according to each customer's specifications and sold on a turnkey basis.
Components for such compressor units are acquired from third party suppliers.

Oil and Gas Production Equipment

The Company, through its wholly-owned subsidiary doing business as Hanover
Smith designs, engineers, fabricates and either sells or occasionally rents a
broad range of oil and gas production equipment designed to heat, separate,
dehydrate and measure crude oil and natural gas. The product line includes line
heaters, oil and gas separators, glycol dehydration units and skid mounted
production packages designed for both onshore and offshore production
facilities. The Company generally maintains standard product inventories in
excess of $5 million and is therefore able to meet most customers' rapid
response requirements and minimize customer downtime. As of December 31, 1999,
the Company had a production equipment fabrication backlog of $2.9 million. All
backlog is expected to be produced within a 90-120 day period. The Company also
purchases and reconditions used production equipment which is then sold or
rented.

Market and Customers

The Company's customer base consists of over 800 U.S. and international
companies engaged in all aspects of the oil and gas industry, including major
integrated oil and gas companies, large and small independent producers,
natural gas processors, gatherers and pipelines. Additionally, the Company has
negotiated more than 15 strategic alliances or preferred vendor relationships
with key customers pursuant to which the Company receives preferential
consideration in customer compressor and oil and gas production equipment
procurement decisions in exchange for enhanced product availability, product
support, automated procurement practices and limited pricing concessions. No
individual customer accounted for more than 10% of the Company's consolidated
revenues during 1998 or 1999.

The Company's domestic compressor leasing activities are currently located in
Texas, Oklahoma, Arkansas, Louisiana, New Mexico, Mississippi, Alabama, Kansas,
Colorado, California, Utah, Wyoming and offshore Gulf of Mexico. International
locations include Argentina, Venezuela, Colombia, Trinidad, Bolivia, Mexico,
Indonesia and Canada. As of December 31, 1999, approximately 9% and 19% of the
Company's compressor horsepower was being used in offshore and international
applications, respectively.

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Sales and Marketing

The Company's more than 60 salespeople are organized into eight sales regions
reporting to three sales vice presidents. The sales vice presidents report to
the Company's Senior Vice President of Sales. The Company's sales
representatives aggressively pursue the rental and sale market in their
respective territories for compressors and production equipment. Each Company
salesperson is assigned a customer list on the basis of the experience and
personal relationships of the salesperson and the individual service
requirements of the customer. This customer and relationship-focused strategy
is communicated through frequent direct contact, technical presentations, print
literature, print advertising and direct mail. The Company's advertising and
promotion strategy is a "concentrated" approach, tailoring specific messages
into a very focused presentation methodology.

Additionally, the Company's salespeople coordinate with each other to
effectively pursue customers who operate in multiple regions. The salespeople
maintain intensive contact with the Company's operations personnel in order to
promptly respond to and satisfy customer needs. The Company's sales efforts
concentrate on demonstrating the Company's commitment to enhancing the
customer's cash flow through superior product design, fabrication,
installation, customer service and after-market support.

Upon its receipt of a request for proposal or bid by a customer, the Company
assigns a team of sales, operations and engineering personnel to analyze the
application and prepare a quotation, including selection of the equipment,
pricing and delivery date. The quotation is then delivered to the customer, and
if the Company is selected as the vendor, final terms are agreed upon and a
contract or purchase order is executed. The Company's engineering and
operations personnel also often provide assistance on complex compressor
applications, field operations issues or equipment modifications.

Competition

The natural gas compression services and fabrication business is highly
competitive. Overall, the Company experiences considerable competition from
companies with significantly greater financial resources and, on a regional
basis, from several smaller companies which compete directly with the Company.
The Company believes it is currently the largest natural gas compression
company in the United States on the basis of aggregate rental horsepower.

Compressor industry participants can achieve significant advantages through
increased size and geographic breadth. As the number of rental units increases
in a rental fleet, the number of sales, engineering, administrative and
maintenance personnel required does not increase proportionately. As a result,
companies such as Hanover with larger rental fleets have relatively lower
operating costs and higher margins due to economies of scale than smaller
companies.

One of the significant cost items in the compressor rental business is the
amount of inventory required to service rental units. Each rental company must
maintain a minimum amount of inventory to stay competitive. As the size of the
rental fleet increases, the required amount of inventory does not increase in
the same proportion. The larger rental fleet companies can generate cost of
capital savings through improved purchasing power and vendor support.

The Company believes that it competes effectively on the basis of price,
customer service, including the availability of personnel in remote locations,
flexibility in meeting customer needs and quality and reliability of its
compressors and related services.

The Company's compressor fabrication business competes with other fabricators
of compressor units. The compressor fabrication business is dominated by a few
major competitors, several of which also compete with the Company in the
compressor rental business. The Company is the largest compressor fabrication
company in the United States.

The production equipment business is a highly fragmented business with
approximately eight substantial U.S. competitors. Although sufficient
information is not available to definitively estimate the Company's relative

7

position in this market, the Company believes that it is among the top three
oil and gas production equipment fabricators in the United States.

Government Regulation

The Company is subject to various federal and state laws and regulations
relating to environmental protection, including regulations regarding emission
controls. These laws and regulations may affect the costs of the Company's
operations. As with any owner of property, the Company is also subject to
clean-up costs and liability for hazardous materials, asbestos, or any other
toxic or hazardous substance that may exist on or under any of its properties.

The Company believes that it is in substantial compliance with environmental
laws and regulations and that the phasing in of emission controls and other
known regulatory requirements at the rate currently contemplated by such laws
and regulations will not have a material adverse effect on the Company's
financial condition, results of operations or cash flows.

Notwithstanding, in part because of the Company's rapid growth through
acquisitions, the Company may not be in compliance with certain environmental
requirements for recently acquired facilities. The Company investigates these
issues and takes action where appropriate.

The Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"), also known as the "Superfund" law, imposes liability, without
regard to fault or the legality of the original conduct, on certain classes of
persons who are considered to be responsible for the release of a "hazardous
substance" into the environment. These persons include the owner or operator of
the disposal site or sites where the release occurred and companies that
disposed or arranged for the disposal of the hazardous substances. Under
CERCLA, such persons may be subject to joint and several liability for the
costs of cleaning up the hazardous substances that have been released into the
environment, for damages to natural resources, and for the costs of certain
health studies. Furthermore, it is not uncommon for neighboring landowners and
other third parties to file claims for personal injury and property damage
allegedly caused by hazardous substances or other pollutants released into the
environment.

The Resource Conservation and Recovery Act ("RCRA") and regulations
promulgated thereunder govern the generation, storage, transfer and disposal of
hazardous wastes. The Company must comply with RCRA regulations for any of its
operations that involve the generation, management, or disposal of hazardous
wastes (such as painting activities or the use of solvents).

Stricter standards in environmental legislation that may affect the Company
may be imposed in the future, such as proposals to make hazardous wastes
subject to more stringent and costly handling, disposal and clean-up
requirements. While the Company may be able to pass on the additional costs of
complying with such laws to its customers, there can be no assurance that
attempts to do so will be successful. Accordingly, new laws or regulations or
amendments to existing laws or regulations could require the Company to
undertake significant capital expenditures and could otherwise have a material
adverse effect on the Company's business, results of operations, cash flows and
financial condition.

Executive Officers

The following sets forth, as of March 23, 2000, the name, age and business
experience for the last five years of each of the executive officers of the
Company.

Name Age Position
---- --- --------

Michael A. O'Connor.. 64 Chairman of the Board; Director
Michael J. McGhan.... 45 President and Chief Executive Officer; Director

8

Name Age Position
---- --- --------

Curtis Bedrich.................. 57 Chief Financial Officer and Treasurer
William S. Goldberg............. 41 Executive Vice President; Director

MICHAEL A. O'CONNOR has served as Chairman of the Board and a director of the
Company since January 1992. Mr. O'Connor also serves as an officer and a
director of certain subsidiaries of the Company.

MICHAEL J. MCGHAN has served as President and Chief Executive Officer of the
Company since October 1991. Mr. McGhan has served as a director of the Company
since March 1992. Mr. McGhan also serves as an officer and as a director of
certain subsidiaries of the Company.

CURTIS BEDRICH has served as Chief Financial Officer and Treasurer of the
Company since November 1991. Mr. Bedrich also serves as an officer of certain
subsidiaries of the Company.

WILLIAM S. GOLDBERG has served as Executive Vice President and director of
the Company since May 1991. Mr. Goldberg has been employed by GKH Investments,
L.P., a Delaware limited partnership (the "Fund") and GKH Private Limited
(collectively with the Fund, "GKH") since 1988 and has served as Managing
Director of GKH since June 1990. The Fund is the Company's largest stockholder.
Mr. Goldberg also serves as an officer and a director of certain affiliates of
the Company. Mr. Goldberg is also a director of DVI, Inc.

Employees

As of December 31, 1999, the Company had approximately 1,433 employees. No
employees are represented by labor unions and the Company believes that its
relations with its employees are satisfactory.

Item 2. Properties

The Company owns its corporate offices in Houston, Texas, which are housed in
a combination corporate office and compressor fabrication complex, including a
192,000 square foot plant located on approximately 28 acres. The Company also
owns (i) a 11,700 square foot combination office and maintenance facility
located on 6.5 acres in Yukon, Oklahoma, (ii) a 8,000 square foot combination
office and maintenance facility situated on 6 acres in Pocola, Oklahoma, (iii)
12,000 square feet of maintenance facilities situated on 3.5 acres in Midland,
Texas, (iv) a 5,000 square foot sales and service facility situated on one acre
located in Corpus Christi, Texas, (v) a 345,000 square foot manufacturing
facility in Davis, Oklahoma, (vi) a 16,750 square foot facility situated on 9.2
acres in Kilgore, Texas, (vii) a 210,000 square foot production equipment
manufacturing facility located on 82 acres in Columbus, Texas (viii) a 35,000
square foot combination of office, warehouse and maintenance facility situated
on 17 acres in Broussard, Louisiana and, (viiii) a 19,000 square foot office
and maintenance facility located on 15.3 acres in Farmington, New Mexico. The
Company also leases a maintenance facility of 19,000 square feet in Victoria,
Texas under a five year lease. In addition, the Company has a three year lease
on a 190,000 square foot fabrication facililty in Houston, Texas with an option
to purchase the facility at the end of the lease.

The Company's executive offices are located at 12001 North Houston Rosslyn,
Houston, Texas 77086 and its telephone number is (281) 447-8787.

Item 3. Legal Proceedings

The Company is not currently involved in any material litigation or
proceeding and is not aware of any such litigation or proceeding threatened
against it.

Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of the Company's shareholders during the
fourth quarter of its fiscal year ended December 31, 1999.

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PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

The Common Stock began trading on the New York Stock Exchange on July 1,
1997 under the symbol "HC." The following table sets forth the range of the
high and low on market prices for the Common Stock, for the periods indicated.

High Low
---- ----

First Quarter 1998................................ $20 3/4 $17 5/16
Second Quarter 1998............................... $29 5/8 $23 1/4
Third Quarter 1998................................ $28 11/16 $17 1/2
Fourth Quarter 1998............................... $27 1/16 $17 11/16
First Quarter 1999................................ $28 $19 1/4
Second Quarter 1999............................... $35 9/16 $26 1/8
Third Quarter 1999................................ $38 1/8 $31 3/8
Fourth Quarter 1999............................... $38 3/8 $28 1/16

As of December 31, 1999, there were 28,752,937 shares of Common Stock
outstanding, held by approximately 233 stockholders of record.

The Company has not paid any cash dividends on its Common Stock since its
formation and does 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 develop and
expand the Company's business. The Company's $200 million credit facility with
The Chase Manhattan Bank, as agent (the "Bank Credit Agreement") limits the
amount of dividends payable by the Company (without the lender's prior
approval) on its Common Stock to no more than 25% of the Company's net income
for the period from January 1, 1998 until December 15, 2002. In addition, the
Company's 7% Subordinated Notes due 2000 (the "Subordinated Notes") prohibit
the payment of cash dividends on the Company's capital stock without the
lenders' prior written consent. Any future determinations to pay cash
dividends on the Common Stock will be at the discretion of the Company's Board
of Directors and will be dependent upon the Company's 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.

In December 1999, the Company issued $86,250,000 of 7.25% Mandatorily
Redeemable Convertible Preferred Securities (the "Convertible Preferred
Securities") through Hanover Compressor Capital Trust, a Delaware business
trust and subsidiary of the Company. The Convertible Preferred Securities have
a liquidation amount of $50 per unit. The Convertible Preferred Securities
mature in 30 years but may be redeemed partially or in total any time on or
after December 20, 2002. The Convertible Preferred Securities also provide for
annual cash distributions at the rate of 7.25%, payable quarterly in arrears,
however, payments may be deferred up to 20 quarters subject to certain
restrictions. Each Convertible Preferred Security is convertible into 1.3986
shares of Hanover common stock, subject to adjustment for certain events.

10

Set forth below is certain information with respect to all securities of the
Company sold by the Company in 1999 which were not registered under the
Securities Act of 1933, as amended.

Aggregate Offering
Date of Title and Amount Price and Initial Exemption
Sale of Securities Purchasers Purchaser's Commission Claimed
------- ---------------- ---------- ---------------------- ------------

12/15/99 1,500,000 7.25% Credit Suisse First Aggregate Offering Sec. 4(2)
Convertible Boston Corporation, Price: $75,000,000
Preferred Goldman Sachs & Co., ($50 per Preferred
Securities Salomon Smith Barney, Security) Commission
Inc. and Dain Rauscher to Initial Purchasers:
Wessels Incorporated $2,250,000 ($1.50 per
Preferred Security)

12/27/99 225,000 7.25% Credit Suisse First Aggregate Offering Sec. 4(2)
Convertible Boston Corporation, Price: $11,250,000
Preferred Goldman Sachs & Co., ($50 per Preferred
Securities Salomon Smith Barney, Security) Commission
Inc. and Dain Rauscher to Initial Purchasers:
Wessels Incorporated $370,500 ($1.50 per
Preferred Security)

Item 6. Selected Financial Data

SELECTED FINANCIAL DATA (HISTORICAL)
(Dollars and shares in thousands, except per share data)

The following table presents certain selected financial data for the Company
for each of the five years in the period ended December 31, 1999. The selected
financial data have been derived from the audited consolidated financial
statements of the Company. The following information should be read together
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the Consolidated Financial Statements of the Company.

Year Ended December 31,
-------------------------------------------
1999 1998 1997 1996 1995(1)
-------- -------- -------- ------- -------

Income Statement Data:
Revenues:
Rentals.................. $192,655 $147,609 $100,685 $72,897 $43,859
Parts and service........ 34,461 23,870 10,254 6,458 4,495
Compressor fabrication... 52,531 67,453 49,764 28,764 29,593
Production equipment
fabrication............. 28,037 37,466 37,052 26,903 16,960
Gain on sale of
property, plant &
equipment............... 5,927 2,552 148 352 412
Other.................... 3,417 3,007 895 637 645
-------- -------- -------- ------- -------
Total revenues......... 317,028 281,957 198,798 136,011 95,964
======== ======== ======== ======= =======
Expenses:
Rentals.................. 64,949 49,386 35,113 26,012 13,691
Parts and service........ 21,724 17,341 6,360 4,788 4,122
Compressor fabrication... 43,663 58,144 41,584 24,657 25,265
Production equipment
fabrication............. 20,833 25,781 26,375 19,574 13,178
Selling, general and
administrative.......... 33,782 26,626 20,782 16,439 12,542
Depreciation and
amortization(2)......... 37,337 37,154 28,439 20,722 13,494
Leasing expense.......... 22,090 6,173
Interest expense......... 8,786 11,716 10,728 6,594 4,560
Distributions on
mandatorily redeemable
convertible preferred
securities.............. 278
-------- -------- -------- ------- -------
Total costs and
expenses.............. 253,442 232,321 169,381 118,786 86,852
-------- -------- -------- ------- -------
Income before income
taxes.................... 63,586 49,636 29,417 17,225 9,112
Provision for income
taxes.................... 23,145 19,259 11,314 6,844 3,498
-------- -------- -------- ------- -------
Net income................ $ 40,441 $ 30,377 $ 18,103 $10,381 $ 5,614
-------- -------- -------- ------- -------
Other comprehensive income
(loss), net of tax:
Foreign currency
translation
adjustment.............. (463) 152
-------- -------- -------- ------- -------
Comprehensive income...... $ 39,978 $ 30,529 $ 18,103 $10,381 $ 5,614
======== ======== ======== ======= =======
Net income available to
common stockholders:
Net Income............... 40,441 30,377 18,103 10,381 5,614

11

Year Ended December 31,
--------------------------------------------------
1999 1998 1997 1996 1995(1)
-------- -------- -------- -------- --------

Dividends on Series A
and Series B preferred
stock................. (1,773) (832)
Series A preferred
stock exchange........ (3,794)
Series B preferred
stock conversion...... (1,400)
-------- -------- -------- -------- --------
Net income available to
common stockholders.... $ 40,441 $ 30,377 $ 18,103 $ 3,414 $ 4,782
======== ======== ======== ======== ========
Weighted average common
and common equivalent
shares:
Basic.................. 28,524 28,468 25,623 20,498 14,373
-------- -------- -------- -------- --------
Diluted................ 30,527 30,091 27,345 22,023 15,358
-------- -------- -------- -------- --------
Earnings per common
share:
Basic.................. $ 1.42 $ 1.07 $ .71 $ .17 $ .33
======== ======== ======== ======== ========
Diluted................ $ 1.32 $ 1.01 $ .66 $ .16(3) $ .31
======== ======== ======== ======== ========
Other Data:
EBITDA (4)............. $132,077 $104,679 $ 68,584 $ 44,541 $ 27,166
======== ======== ======== ======== ========
Cashflows provided by
(used in):
Operting activities.... $ 68,222 $ 31,147 $ 32,219 $ 20,276 $ 9,088
Investing activities... (92,114) (14,699) (164,490) (87,683) (68,474)
Financing activities... 18,218 (9,328) 129,510 71,740 62,206
Balance Sheet Data (end
of period):
Working capital........ $107,966 $113,264 $ 58,027 $ 41,513 $ 23,270
Net property, plant and
equipment............. 497,465 392,498 394,070 266,406 198,074
Total assets........... 756,510 614,590 506,452 341,387 252,313
Long-term debt......... 69,681 156,943 158,838 122,756 50,451
Mandatorily redeemable
convertible preferred
securities............ 86,250
Preferred stockholders'
equity................ 26,894
Common stockholders'
equity................ 369,157 316,713 288,271 176,895 139,302

- --------
(1) The selected historical financial information includes the results of
operations of the Company and its wholly-owned subsidiaries. During 1995,
the Company acquired Astra Resources Compression, Inc., a significant
subsidiary.
(2) In order to more accurately reflect the estimated useful lives of natural
gas compressor units in the rental fleet; effective January 1, 1996 the
Company changed the lives over which these units are depreciated from 12
to 15 years. The effect of this change was a decrease in depreciation
expense of $2.6 million and an increase in net income of $1.5 million
($.07 per diluted common share) for the year ended December 31, 1996.
(3) Diluted earnings per share in 1996 was $.46 per share before the effects
of charging retained earnings for $1.8 million relating to dividends on
redeemable preferred stock and one time charges to retained earnings for
(i) $3.8 million related to the exchange of all Series A preferred stock
for subordinated notes and (ii) $1.4 million related to the conversion of
all Series B preferred stock to Common Stock.
(4) EBITDA consists of the sum of consolidated net income before interest
expense, lease expense, distributions on mandatorily redeemable preferred
securities, income tax, and depreciation and amortization. The Company
believes that EBITDA is a meaningful measure of its operating performance
and is also used to measure the Company's ability to meet debt service
requirements. EBITDA should not be considered as an alternative
performance measure prescribed by generally accepted accounting
principles.

Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

Management's discussion and analysis of the results of operations and
financial condition of the Company should be read in conjunction with the
Consolidated Financial Statements and related Notes thereto.

GENERAL

The Company's operations consist of providing gas compression services
through renting, maintaining and operating natural gas compressors and
engineering, fabricating and selling gas compression and oil and gas
production equipment. See "Business".

12

The following table summarizes revenues, expenses and gross profit
percentages for each of the Company's business segments (Dollars in millions):

Year ended December
31,
----------------------
1999 1998 1997
------ ------ ------

Revenues:
Rentals--Domestic..................................... $136.5 $107.4 $ 78.7
Rentals--International................................ 56.2 40.2 22.0
Compressor fabrication................................ 52.5 67.4 49.8
Production equipment fabrication...................... 28.0 37.5 37.1
Other................................................. 43.8 29.5 11.2
------ ------ ------
Total............................................... $317.0 $282.0 $198.8
====== ====== ======
Expenses:
Rentals--Domestic..................................... $ 46.2 $ 36.6 $ 27.5
Rentals--International................................ 18.8 12.8 7.6
Compressor fabrication................................ 43.7 58.1 41.6
Production equipment fabrication...................... 20.8 25.8 26.4
Other................................................. 31.2 22.9 7.4
------ ------ ------
Total............................................... $160.7 $156.2 $110.5
====== ====== ======
Gross profit percentage:
Rentals--Domestic..................................... 66.1% 65.9% 65.1%
Rentals--International................................ 66.6% 68.2% 65.5%
Compressor fabrication................................ 16.8% 13.8% 16.5%
Production equipment fabrication...................... 25.7% 31.2% 28.8%

YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998.

Revenues

The Company's total revenues increased by $35.0 million, or 12%, to $317.0
million during 1999 from $282.0 million during 1998. The increase resulted
from growth of the Company's natural gas compressor rental fleet but was
offset by decreases in compressor fabrication and production equipment
fabrication revenues.

Revenues from rentals increased by $45.1 million, or 31%, to $192.7 million
during 1999 from $147.6 million during 1998. Domestic revenues from rentals
increased by $29.1 million, or 27%, to $136.5 million during 1999 from $107.4
million during 1998. International revenues from rentals increased by $16.0
million, or 40%, to $56.2 million during 1999 from $40.2 million during 1998.
At December 31, 1999 the compressor rental fleet consisted of approximately
1,458,000 horsepower, a 37% increase over the 1,067,000 horsepower in the
rental fleet at December 31, 1998. Domestically, the rental fleet increased by
289,000 horsepower, or 32%, during 1999 and internationally by 103,000
horsepower, or 59%. The increase in both domestic and international rental
revenues resulted primarily from expansion of the Company's rental fleet.

Revenue from parts and service increased by $10.6 million, or 44% to $34.5
million during 1999 from $23.9 million during 1998. Revenues from the
fabrication and sale of compressor equipment to third parties decreased by
$14.9 million, or 22%, to $52.5 million during from $67.4 million during 1998.
An aggregate of 147,000 horsepower was sold during 1999. In addition, 130,000
horsepower was fabricated and placed in the rental fleet during 1999. The
Company believes the revenue decrease during 1999 was due in part to a project
where a customer supplied its own engines, which are typically provided by the
Company, and in part to lower energy prices earlier in 1999, which reduced the
demand for compressors thereby adversely impacting sales prices.

Revenues from the fabrication and sale of production equipment decreased by
$9.5 million, or 25%, to $28.0 million during 1999 from $37.5 million during
1998 primarily due to the decline in well completions resulting from lower
energy prices during the first half of 1999.
The Company recognized gains on sales of assets of $5.9 million during 1999
compared to $2.6 million during the 1998. The increase is primarily due to the
increase in horsepower sold from the rental fleet to

13

customers exercising options to purchase equipment they previously had rented.
During 1999 the Company sold approximately 20,000 horsepower compared to
14,000 horsepower during 1998.

Expenses

Operating expenses of the rentals segment increased by $15.6 million, or 32%
to $65.0 million during 1999 from $49.4 million during 1998. The increase
resulted primarily from the corresponding 31% increase in revenues from
rentals over the corresponding period in 1998. The gross profit percentage
from rentals was 66% during 1999 and 67% during 1998. Operating expenses of
parts and service increased $4.4 million, or 25% to $21.7 million during 1999
from $17.3 million during 1998, which relates to the 44% increase in parts and
service revenue. The gross profit percentage from parts and service increased
to 37% during 1999 from 27% in 1998. Operating expenses of compressor
fabrication decreased by $14.4 million, or 25% to $43.7 million from $58.1
million during 1998. The gross profit margin on compression fabrication
increased to 17% during 1999, from 14% during 1998. Production equipment
fabrication operating expenses decreased by $5.0 million, or 19%, during 1999
to $20.8 million from $25.8 million during 1998. The decrease in operating
expenses is reflective of the corresponding change in production equipment
fabrication revenues during 1999. The gross profit margin attributable to
production equipment fabrication decreased to 26% during 1999, from 31% during
1998.

Selling, general and administrative expenses increased by $7.2 million, or
27% to $33.8 million during 1999. The increase is attributable to increased
personnel and other administrative and selling expenses associated with the
increase in operating activity in the Company's rentals business segments, as
described above.

Depreciation and amortization expense increased by $.2 million, or 1% during
1999 to $37.3 million. The increase in depreciation on the additions to the
rental fleet was offset by the decrease in depreciation as a result of the
equipment leases entered into in July 1998 and June 1999.

Interest expense decreased by $2.9 million, or 25% during 1999 to $8.8
million. The decrease in interest expense was due in part to utilization of
proceeds from the equipment lease which was used to reduce indebtedness under
the Bank Credit Agreement and the capitalization of interest expense on assets
that are under construction.

The Company incurred compression equipment lease expense of $22.1 million
during 1999 and $6.2 million during 1998. As a result of the Equipment Leases,
the Company expects to incur annual operating leasing expense of approximately
$30 million.

Income Taxes

The provision for income taxes increased by $3.8 million, or 20%, to $23.1
million during 1999 from $19.3 million during 1998. The increase resulted
primarily from the corresponding increase in income before taxes. The
Company's effective income tax rate was approximately 36.4% during 1999 and
38.8% during 1998. The decrease in average effective income rates is due to
expected benefits from a foreign sales corporation established in 1998.

Net Income and Earnings Per Share

Net income increased $10.1 million, or 33%, to $40.4 million for 1999 from
$30.4 million in 1998 for the reasons discussed above.

YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997

Revenues

Revenues from rentals increased by $46.9 million, or 47% to $147.6 million
due to growth in the rental fleet. At December 31, 1998 the compressor rental
fleet consisted of approximately 1,067,000 horsepower, a 37% increase over the
781,000 horsepower in the rental fleet at December 31, 1997. Domestically, the
rental fleet increased by 224,000 horsepower, or 34%, during 1998 and
internationally by 61,000 horsepower, or 54%. Revenue from parts and service
increased by $13.6 million, or 133% to $23.9 million as a result of increased

14

marketing focus on parts and services and the increase in growth in the rental
fleet. Revenues from compressor fabrication amounted to $67.4 million,
increasing by 36% over 1997. An aggregate of 113,000 horsepower was sold
during 1998. In addition, 88,000 horsepower was fabricated and placed in the
rental fleet during 1998. Revenues from the fabrication of production
equipment remained relatively unchanged with an increase of $0.4 million from
1997, or 1% to $37.5 million during 1998. The change in 1998 production
equipment revenue was negligible as a result of declining well completions.

Expenses

Operating expenses of the rentals segment increased by $14.3 million, or 41%
to $49.4 million during 1998. The gross profit percentage from rentals
increased to 67% during 1998 from 65% in 1997. Operating expenses of parts and
service increased $11.0 million, or 173% to $17.3 million during 1998, which
relates to the 133% increase in parts and service revenue. The gross profit
percentage from parts and service decreased to 27% during 1998 from 38% in
1997. Operating expenses of compressor fabrication increased by $16.5 million,
or 40% to $58.1 million, which relates to the 36% increase in compression
fabrication revenue achieved during 1998. In addition, the gross profit margin
on compression fabrication decreased to 14% during 1998, from 16% during 1997.
Production equipment fabrication operating expenses decreased by $0.6 million,
or 2%, during 1998 to $25.8 million. The decrease in operating expenses is
reflective of the corresponding change in production equipment fabrication
revenues during 1998. The gross profit margin attributable to production
equipment fabrication increased to 31% during 1998, up from 29% during 1997.

Selling, general and administrative expenses increased by $5.8 million, or
28% to $26.6 million during 1998. The increase is attributable to increased
personnel and other administrative and selling expenses associated with the
increase in operating activity in the Company's rentals and compression
fabrication operating segments as well as increased administrative costs
relating to being a public reporting entity. Depreciation and amortization
expense increased by $8.7 million, or 31% during 1998 to $37.1 million as the
Company continued to expand its rental fleet with capital expenditures and net
business acquisitions that amounted to approximately $212.0 million. In
addition, the company sold certain compression equipment with a book value of
approximately $158.0 million in July, 1998 under a sale and lease back
arrangement. See "LIQUIDITY AND CAPITAL RESOURCES" for a description of the
Equipment Lease. Consequently, the Company incurred compression equipment
lease expense of $6.2 million during 1998. As a result of the Equipment Lease,
the Company expects to incur annual operating lease expense of approximately
$14 million. Interest expense increased by $1.0 million, or 9% during 1998 to
$11.7 million.

Income Taxes

The Company's effective income tax rate was approximately 39% during 1998
and during 1997. Accordingly, the provision for income taxes increased by $7.9
million, or 70%, during 1998 to $19.3 million as a result of income before
income taxes increasing by 69% during 1998 over 1997.

Net Income and Earnings Per Share

Net income increased $12.3 million, or 68%, to $30.4 million for 1998 from
$18.1 million in 1997 for the reasons discussed above. Weighted average shares
outstanding was affected by the additional shares issued in conjunction with
the Company's initial public offering which were outstanding for all of 1998.

LIQUIDITY AND CAPITAL RESOURCES

In June 1999 and in July 1998, the Company completed two individual $200
million sale and lease back transactions of certain compression equipment. The
transactions are recorded as a sale and lease back of the equipment and are
recorded as operating leases. Under both agreements, the equipment was sold
and leased back by the Company for a 5 year period and will continue to be
deployed by the Company under its normal operating procedures. At any time,
the Company has options to repurchase the equipment at fair market value. The
Company has substantial residual value guarantees under the agreements
(approximately $333 million for both transactions) that are due upon
termination of the leases and which may be satisfied by a cash payment or the
exercise of the Company's purchase options. The equipment sold in the June
1999 transaction had a book value

15

of approximately $162 million and resulted in a gain of approximately $38
million. The equipment sold in the July 1998 transaction had a book value of
$158 million and resulted in a gain of approximately $42 million. Both gains
are deferred until the end of the respective lease terms.

In December 1999, the Company issued $86.3 million of 7.25% Convertible
Preferred Securities through Hanover Compressor capital Trust, a Delaware
business trust and subsidiary of the Company. The Convertible Preferred
Securities have a liquidation amount of $50 per unit. The Convertible
Preferred Securities mature in 30 years but may be redeemed partially or in
total any time on or after December 20, 2002.

The Company's cash balance amounted to $5.8 million at December 31, 1999
compared to $11.5 million at December 31, 1998. Primary sources of cash during
1999 were cash provided by internal operations of $68.2 million, net proceeds
of $200 million from the sale of compression equipment under the Equipment
Lease and net proceeds of $82.9 million from the private offering of the
Convertible Preferred Securities. Principal uses of cash during the year ended
December 31, 1999 were capital expenditures of $282.9 million, business
combinations and investments in unconsolidated entities of $40.2 million and
$279.1 million repayment of long-term debt.

Total current assets increased from $165.1 million at December 31, 1998 to
$192.5 million at December 31, 1999 primarily as a result of increases in
accounts receivable and inventories. Accounts receivable at December 31, 1999
increased by $23.5 million to $93.7 million. The increase corresponds with 18%
increase in total revenue of $94.3 million realized by the Company during the
three months ended December 31, 1999 compared to $79.8 million during the
three months ended December 31, 1998. In addition, inventories increased by
$3.5 million to $66.5 million at December 31, 1999. The increase in
inventories reflects increases in parts and supplies, work in progress and
finished goods as the level of activity in the Company's domestic and
international rental and maintenance increased over 1998. Working capital at
December 31, 1999 was also affected by an $32.8 million increase in total
current liabilities at December 31, 1999 to $84.6 million. The 63% increase in
total current liabilities results largely from the increase in vendor accounts
payable caused by the expansion of the Company's operating activities and also
due to the Subordinated Notes in the aggregate principal amount of $15.4
million becoming due on December 31, 2000.

The amounts invested in property, plant and equipment and business
combinations during 1999 was $318.2 million which resulted in the addition of
approximately 391,000 horsepower to the rental fleet. At December 31, 1999,
the rental fleet consisted of 1,181,000 horsepower domestically and 277,000 in
the international rental fleet. Current plans are to spend in excess of $250
million during 2000, exclusive of any major acquisition, in continued
expansion of the rental fleet. Historically, the Company has funded capital
expenditures with a combination of internally generated cash flow, borrowings
under the revolving credit facility, lease transactions and raising additional
equity. As of December 31, 1999 the Company had approximately $138 million of
credit capacity remaining on its $200 million Bank Credit Agreement (7.7% rate
at December 31, 1999). In March 2000, the Company finalized a third sale and
lease back transaction. Under the agreement, the Company received $100 million
proceeds from the sale of the compression equipment at closing and may sell an
additional $100 million of equipment to the Trust during the next twelve
months. The equipment sold will be leased back by the Company for a five-year
period and will continue to be deployed by the Company under its normal
operating procedures. Hanover has the option to repurchase the equipment from
the Trust at any time. The Company feels it has adequate capital resources to
fund its estimated level of capital expenditures for the year 2000.

Impact of Year 2000

The Company did not experience any material problems during the rollover to
the year 2000 that affected operations and does not anticipate any year 2000
compliance problems in the future. The Company completed its year 2000
readiness in conjunction with normal expansion and upgrades of its computer
systems and hardware. The costs related to the year 2000 were not material to
the Company's operating results, cash flows or financial position.

New Accounting Pronouncements

In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities ("SFAS 133"). SFAS 133 requires that, upon
adoption, all derivative instruments (including certain

16

derivative instruments embedded in other contracts) be recognized in the
balance sheet at fair value, and that changes in such fair values be
recognized in earnings unless specific hedging criteria are met. Changes in
the values of derivatives that meet these hedging criteria will ultimately
offset related earnings effects of the hedged item pending recognition in
earnings. SFAS 133 is effective for the Company beginning in 2001. The impact
of SFAS 133 on the Company's financial statements will depend on a variety of
factors, including future interpretive guidance from the FASB, the future
level of actual foreign currency transactions, the extent of our hedging
activities, the type of hedging instruments used and the effectiveness of such
instruments. However management does not believe the effect of adoption will
have a material effect on the Company's results of operations, cash flows or
financial position.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

The Company is exposed to interest rate and foreign currency risk. The
Company periodically enters into interest rate swaps to manage its exposure to
fluctuations in interest rates. At December 31, 1999, the fair market value of
these interest rate swaps is approximately $2.9 million. The Company does not
use derivative financial instruments to mitigate foreign currency risk.

Item 8. Financial Statements and Supplementary Data

In this report, the consolidated financial statements and supplementary data
appearing on pages F-1 through F-22 are incorporated in this item 8 by
reference. See Index to the Financial Statements at 19.

Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure

None.

PART III

Item 10. Directors and Executive Officers of the Registrant

The information included or to be included in the Company's definitive proxy
statement for its 2000 Annual Meeting of Stockholders under the captions
"Nominees for Election as Directors," and "Section 16(a) Beneficial Ownership
Reporting Compliance" is incorporated by reference herein.

Item 11. Executive Compensation

The information included or to be included under the caption "Executive
Compensation" in the Company's definitive proxy statement for its 2000 Annual
Meeting of Stockholders is incorporated by reference herein.

Item 12. Security Ownership of Certain Beneficial Owners and Management

The information included or to be included under the caption "Security
Ownership of Certain Beneficial Owners and Management" in the Company's
definitive proxy statement for its 2000 Annual Meeting of Stockholders is
incorporated by reference herein.

Item 13. Certain Relationships and Related Transactions

The information included or to be included under the caption "Certain
Relationships and Related Transactions" in the Company's definitive proxy
statement for its 2000 Annual Meeting of Stockholders is incorporated by
reference herein.

PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a)The following documents are filed as part of this report:

1. FINANCIAL STATEMENTS--The financial statements listed in the
accompanying Index to Consolidated Financial Statements are filed as
part of this annual report and such Index to Consolidated Financial
Statements is incorporated herein by reference.

2. FINANCIAL STATEMENT SCHEDULES--All schedules are omitted because the
required information is inapplicable or the information is presented
in the Consolidated Financial Statements or related notes.

3. EXHIBITS--The exhibits listed on the accompanying Index to Exhibits
are filed as part of this annual report and such Index to Exhibits
is incorporated herein by reference.

17

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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 Company

/s/ Michael J. McGhan
By: _________________________________
Michael J. McGhan
President and Chief Executive
Officer

Date: March 27, 2000

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons, on behalf of the
registrant and in the capacities and on the dates indicated.

Signature Title Date
--------- ----- ----

/s/ Michael J. McGhan President and Chief March 27, 2000
______________________________________ Executive Officer
Michael J. McGhan (Principal Executive
Officer and Director)

/s/ Curtis Bedrich Chief Financial Officer March 27, 2000
______________________________________ and Treasurer (Principal
Curtis Bedrich Financial and Accounting
Officer)

/s/ Ted Collins, Jr. Director March 27, 2000
______________________________________
Ted Collins, Jr.

/s/ Robert R. Furgason Director March 27, 2000
______________________________________
Robert R. Furgason

/s/ William S. Goldberg Director March 27, 2000
______________________________________
William S. Goldberg

/s/ Melvyn N. Klein Director March 27, 2000
______________________________________
Melvyn N. Klein

/s/ Michael A. O'Connor Director March 27, 2000
______________________________________
Michael A. O'Connor

Director March 27, 2000
______________________________________
Alvin V. Shoemaker

18

INDEX TO FINANCIAL STATEMENTS

Page
----

Report of Independent Accountants.................................... F-1
Consolidated Balance Sheet........................................... F-2
Consolidated Statement of Income and Comprehensive Income............ F-3
Consolidated Statement of Cash Flows................................. F-4,F-5
Consolidated Statement of Common Stockholders' Equity................ F-6
Notes to Consolidated Financial Statements........................... F-7
Selected Quarterly Financial Data (unaudited)........................ F-22

19

INDEX TO EXHIBITS

Exhibit
Number Description
------- -----------

3.1 Certificate of Incorporation of the Hanover Compressor Holding Co.*

3.2 Certificate of Amendment of Certificate of Incorporation of Hanover
Compressor Holding Co. dated December 9, 1999.*

3.3 By-laws of Hanover Compressor Company*

4.1 Third Amended and Restated Registration Rights Agreement, dated as of
December 5, 1995, among the Company, GKH Partners, L.P., GKH
Investments, L.P., Astra Resources, Inc. and other stockholders of the
Company party thereto (1) [4.1]

4.10 Form of Warrant Agreement (1) [4.10]

4.11 Specimen Stock Certificate (1) [4.11]

4.12 Form of Second Amended and Restated Stockholders Agreement of Hanover
Compressor Company dated as of June, 1997 (1) [4.12]

4.13 Form of Amended and Restated Stockholders Agreement (JEDI) dated as of
May, 1997 (1) [4.13]

4.14 Form of Amended and Restated Stockholders Agreement (Westar Capital,
Inc.) dated as of May, 1997 (1) [4.14]

4.15 Form of Amended and Restated Stockholders Agreement (HEHC) dated as of
May, 1997 (1) [4.15]

10.1 Credit Agreement, dated as of December 15, 1997, by and between the
Company, The Chase Manhattan Bank, a New York banking corporation as
Administrative Agent and several banks and other financial
institutions that are parties thereto (2) [10.30]

10.2 Subsidiaries' Guarantee, dated as of December 15, 1997, by certain of
the Company's subsidiaries in favor of The Chase Manhattan Bank, as
agent (2) [10.31]

10.3 Management Fee Letter, dated November 14, 1995 between GKH Partners,
L.P. and the
Company (1) [10.3]

10.4 Hanover Compressor Company Senior Executive Stock Option Plan (1)
[10.4]

10.5 1993 Hanover Compressor Company Management Stock Option Plan (1)
[10.5]

10.6 Hanover Compressor Company Incentive Option Plan (1) [10.6]

10.7 Amendment and Restatement of Hanover Compressor Company Incentive
Option Plan (1) [10.7]

10.8 Hanover Compressor Company 1995 Employee Stock Option Plan (1) [10.8]

10.9 Hanover Compressor Company 1995 Management Stock Option Plan (1)
[10.9]

10.10 Hanover Compressor Company 1996 Employee Stock Option Plan (1) [10.10]

10.11 OEM Sales and Purchase Agreement, between Hanover Compressor Company
and the Waukesha Engine Division of Dresser Industries, Inc. (1)
[10.11]

10.12 Distribution Agreement, dated February 23, 1995, between Ariel
Corporation and Maintech Enterprises, Inc. (1) [10.12]

10.13 Exclusive Distribution Agreement, dated as of February 23, 1995 by and
between Hanover/Smith, Inc. and Uniglam Resources, Ltd. (1) [10.13]

E-1

Exhibit
Number Description
------- -----------

10.14 Lease Agreement, dated December 4, 1990, between Hanover Compressor
Company and Ricardo J. Guerra and Luis J. Guerra as amended (1)
[10.15]

10.15 Indemnification Agreement, dated as of December 5, 1995, between
Hanover Compressor Company and Western Resources (formerly Astra
Resources, Inc.) (1) [10.18]

10.16 Put Agreement, dated December 5th, 1995, by and between Western
Resources, Inc. (formerly Astra Resources, Inc.) an Hanover Compressor
Company and Hanover Acquisition Corporation (formerly Astra Resources
Compression, Inc.) (1) [10.19]

10.17 Exchange and Subordinated Loan Agreement dated as of December 23,
1996, among the Company and GKH Partners, L.P., GK December 23, 1996,
among the Company and GKH Partners, L.P., GK Investments, L.P., IPP95,
L.P., Hanna Investment Group, Ott Candies, Inc., Phyllis S. Hojel, Ted
Collins, Jr. and L.O. Ward (1) [10.20]

10.18 1997 Stock Option Plan, as amended (1) [10.23]

10.19 1997 Stock Purchase Plan (1) [10.24]

10.20 Exchange Agreement by and between Hanover Compressor Company and JEDI,
dated December 23, 1996 (1) [10.27]

10.21 Lease dated as of July 20, 1998 between Hanover Equipment Trust 1998A
(the "Trust") and the Company. (3) [10.1]

10.22 Guarantee dated as of July 22, 1998 and made by the Company,
Hanover/Smith, Inc., Hanover Maintech, Inc. and Hanover Land Company.
(3) [10.2]

10.23 Lessee's and Guarantor's Consent dated as of July 20, 1998 made by the
Company, Hanover/Smith, Inc., Hanover Maintech, Inc. and Hanover Land
Company. (3) [10.3]

10.24 Participation Agreement dated as of July 22, 1998 among the Company,
the Trust, The Chase Manhattan Bank, as agent, Societe General &
Financial Corporation, and Wilmington Trust Company. (3) [10.4]

10.25 Security Agreement dated as of July 22, 1998 made by the Trust in
favor of The Chase Manhattan Bank, as agent, with the Company joining
by Joinder of Lessee. (3) [10.5]

10.26 Lease Supplement No. 1 dated as of July 22, 1998 between the Trust and
the Company. (3) [10.6]

10.27 1998 Stock Option Plan (4) [10.7]

10.28 December 10, 1998 Stock Option Plan (5)

10.29 1999 Stock Option Plan (5)
10.30 1998 Amendments to Credit Agreement, dated as of December 15, 1997,
with the Chase Manhattan Bank, a New York banking corporation as
Administrative Agent and several banks and other financial
institutions that are parties thereto (7)[10.35]

10.31 Lease dated as of June 15, 1999 between Hanover Equipment Trust 1999
and the Company. (8)[10.36]

10.32 Guarantee dated as of June 15, 1999 and made by the Company,
Hanover/Smith, Inc., Hanover Maintech, Inc. and Hanover Land Company.
(8) [10.37]

10.33 Participation Agreement dated as of June 15, 1999 among the Company,
the Trust, Societe Generale Financial Corporation and FTBC Leasing
Corp., The Chase Manhattan Bank, as agent, and Wilmington Trust
Company. (8) [10.38]

10.34 Security Agreement dated as of June 15, 1999 made by the Trust in
favor The Chase Manhattan Bank, as agent. (8) [10.39]

10.35 Lease supplement No. 1 dated June 15, 1999 between the Trust and the
Company. (8) [10.40]

10.36 Lessee's and Guarantor's Consent dated as of June 15, 1999 made by the
Company, Hanover/Smith, Inc. Hanover Maintech, Inc. and Hanover Land
Company. (8) [10.41]

E-2

Exhibit
Number Description
------- -----------

10.37 Amended and Restated Declaration of Trust of Hanover Compressor
Capital Trust, dated as of December 15, 1999, among Hanover Compressor
Company, as sponsor, Wilmington Trust Company, as property trustee,
and Richard S. Meller, William S. Goldberg and Curtis A. Bedrich, as
administrative trustees. (6)[4.5]

10.38 Indenture for the Convertible Junior Subordinated Indentures due 2029,
dated as of December 15, 1999 among Hanover Compressor Company, as
issuer, and Wilmington Trust Company, as trustee. (6)[4.6]

10.39 Form of Hanover Compressor Capital Trust 7 1/4% Convertible Preferred
Securities. (6)[4.8]

10.40 Form of Hanover Compressor Company Convertible Subordinated Junior
Debentures due 2029. (6)[4.9]

10.41 Preferred Securities Guarantee, dated as of December 15, 1999, between
Hanover Compressor Company, as guarantor, and Wilmington Trust
Company, as guarantee trustee. (6)[4.10]

10.42 Common Securities Guarantee dated as of December 15, 1999, by Hanover
Compressor Company, as guarantor. (6)[4.11]

10.43 Lease dated as of March 13, 2000 between Hanover Equipment Trust 2000A
and the Hanover Compression Inc.*

10.44 Guarantee dated as of March 13, 2000 and made by the Company, Hanover
Compression Inc. and certain of their Subsidiaries.*

10.45 Participation Agreement dated as of March 13, 2000 among the Company,
the Hanover Equipment Trust 2000A and various banks.*

10.46 Security Agreement dated as of March 13, 2000 made by the Trust in
favor The Chase Manhattan Bank, as agent.*

10.47 Assignment of leases, rents and Guarantee from Hanover Equipment Trust
2000A to The Chase Manhattan Bank dated as of March 13, 2000.*

12.1 Computation of ratio of earnings to fixed charges*

21.1 List of Subsidiaries*

23.1 Consent of PricewaterhouseCoopers LLP*

27.1 Financial Data Schedule*

- --------
(1) Such exhibit previously filed as an exhibit to the registration Statement
(File No. 333-27953) on Form S-1, as amended, under the exhibit number
indicated in brackets [ ], and is incorporated by reference.
(2) Such exhibit previously filed as an exhibit to the Company's Annual Report
on Form 10-K for the Year Ended 1997 under the exhibit number indicated in
brackets [ ], and is incorporated by reference.
(3) Such exhibit previously filed as an exhibit to the Company's Current
Report on Form 8-K dated July 22, 1998, under the exhibit number indicated
in brackets [ ], and is incorporated by reference.
(4) Such exhibit previously filed as an exhibit to the Company's Quarterly
Report on Form 10-Q for the Third Quarter of 1998, under the exhibit
number indicated in brackets [ ], and is incorporated by reference.
(5) Compensatory plan or arrangement required to be filed.
(6) Such exhibit previously filed as an exhibit to the Registration Statement
(File No. 333-30344) on Form S-3 under the exhibit number indicated in
brackets [ ], and is incorporated by reference.
(7) Such exhibit previously filed as an exhibit to the Company's Annual Report
on Form 10-K for the Year Ended 1998 under the exhibit number indicated in
brackets [ ], and is incorporated by reference.
(8) Such exhibit previously filed as an exhibit to the Company's Quarterly
Report on Form 10-Q for the Second Quarter of 1999, under the exhibit
number indicated in brackets [ ], and is incorporated by reference.
*Filed herewith.

E-3

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
Hanover Compressor Company

In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income and comprehensive income, of cash flows and
of common stockholders' equity present fairly, in all material respects, the
financial position of Hanover Compressor Company and its subsidiaries at
December 31, 1999 and 1998, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements
based on our audits. We conducted our audits of these statements in accordance
with auditing standards generally accepted in the United States which require
that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.

PRICEWATERHOUSECOOPERS LLP

Houston, Texas
March 8, 2000

F-1

HANOVER COMPRESSOR COMPANY

Consolidated Balance Sheet

December 31, 1999 and 1998

1999 1998
-------- --------
(in thousands of
dollars, except
for par value and
share amounts)

ASSETS
Current assets:
Cash and cash equivalents................................ $ 5,756 $ 11,503
Accounts receivable, net................................. 93,715 70,205
Inventory................................................ 66,562 63,044
Costs and estimated earnings in excess of billings on
uncompleted contracts................................... 4,782 7,871
Prepaid taxes............................................ 16,430 9,466
Other current assets..................................... 5,287 2,967
-------- --------
Total current assets................................... 192,532 165,056
-------- --------
Property, plant and equipment:
Compression equipment and facilities..................... 520,403 422,896
Land and buildings....................................... 19,000 15,044
Transportation and shop equipment........................ 27,616 21,667
Other.................................................... 10,029 11,119
-------- --------
577,048 470,726
Accumulated depreciation................................. (79,583) (78,228)
-------- --------
Net property, plant and equipment...................... 497,465 392,498
-------- --------
Intangible and other assets................................ 66,513 57,036
-------- --------
$756,510 $614,590
======== ========
LIABILITIES AND COMMON STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt..................... $ 15,967 $ 444
Accounts payable, trade.................................. 32,308 23,361
Accrued liabilities...................................... 22,065 17,599
Advance billings......................................... 13,328 9,694
Billings on uncompleted contracts in excess of costs and
estimated earnings...................................... 898 694
-------- --------
Total current liabilities.............................. 84,566 51,792
Long-term debt............................................. 69,681 156,943
Other liabilities.......................................... 80,549 42,858
Deferred income taxes...................................... 66,307 46,284
-------- --------
Total liabilities...................................... 301,103 297,877
-------- --------
Mandatorily redeemable convertible preferred securities.... 86,250 --
Commitments and contingencies (Note 15)
Common stockholders' equity:
Common stock, $.001 par value; 100 million shares
authorized; 28,752,937 and 28,590,472 shares issued and
outstanding, respectively............................... 29 29
Additional paid-in capital............................... 272,973 269,005
Notes receivable--employee stockholders.................. (3,387) (10,146)
Accumulated other comprehensive income................... (311) 152
Retained earnings........................................ 101,439 60,998
Treasury stock--83,697 and 175,547 common shares,
respectively, at cost................................... (1,586) (3,325)
-------- --------
Total common stockholders' equity...................... 369,157 316,713
-------- --------
$756,510 $614,590
======== ========

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

F-2

HANOVER COMPRESSOR COMPANY

Consolidated Statement of Income and Comprehensive Income

Years Ended December 31, 1999, 1998 and 1997

1999 1998 1997
-------- -------- --------
(in thousands, except
per share amounts)

Revenues:
Rentals.......................................... $192,655 $147,609 $100,685
Parts and service................................ 34,461 23,870 10,254
Compressor fabrication........................... 52,531 67,453 49,764
Production equipment fabrication................. 28,037 37,466 37,052
Gain on sale of property, plant and equipment.... 5,927 2,552 148
Other............................................ 3,417 3,007 895
-------- -------- --------
317,028 281,957 198,798
-------- -------- --------
Expenses:
Rentals.......................................... 64,949 49,386 35,113
Parts and service................................ 21,724 17,341 6,360
Compressor fabrication........................... 43,663 58,144 41,584
Production equipment fabrication................. 20,833 25,781 26,375
Selling, general and administrative.............. 33,782 26,626 20,782
Depreciation and amortization.................... 37,337 37,154 28,439
Leasing expense.................................. 22,090 6,173 --
Interest expense................................. 8,786 11,716 10,728
Distributions on mandatorily redeemable
convertible preferred securities................ 278 -- --
-------- -------- --------
253,442 232,321 169,381
-------- -------- --------
Income before income taxes......................... 63,586 49,636 29,417
Provision for income taxes......................... 23,145 19,259 11,314
-------- -------- --------
Net income......................................... 40,441 30,377 18,103
-------- -------- --------
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment.......... (463) 152 --
-------- -------- --------
Comprehensive income............................... $ 39,978 $ 30,529 $ 18,103
======== ======== ========
Net income available to common stockholders........ $ 40,441 $ 30,377 $ 18,103
======== ======== ========
Weighted average common and common equivalent
shares outstanding
Basic............................................ 28,524 28,468 25,623
======== ======== ========
Diluted.......................................... 30,527 30,091 27,345
======== ======== ========
Earnings per common share
Basic............................................ $ 1.42 $ 1.07 $ 0.71
======== ======== ========
Diluted.......................................... $ 1.32 $ 1.01 $ 0.66
======== ======== ========

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

F-3

HANOVER COMPRESSOR COMPANY

Consolidated Statement of Cash Flows

Years Ended December 31, 1999, 1998 and 1997

1999 1998 1997
-------- -------- --------
(in thousands of dollars)

Cash flows from operating activities:
Net income...................................... $ 40,441 $ 30,377 $ 18,103
Adjustments:
Depreciation and amortization.................. 37,337 37,154 28,439
Amortization of debt issuance costs and debt
discount...................................... 884 852 892
Bad debt expense............................... 1,475 349 594
Gain on sale of property, plant and equipment.. (5,927) (2,552) (148)
Equity in income of nonconsolidated
affiliates.................................... (1,188) (1,369) 206
Deferred income taxes.......................... 11,396 12,358 6,233
Changes in assets and liabilities, net of
effects of business combinations:
Accounts receivable........................... (23,974) (28,337) (13,604)
Inventory..................................... (1,918) (24,169) (14,726)
Costs and estimated earnings versus billings
on uncompleted contracts..................... 3,293 (3,000) 2,929
Accounts payable and other liabilities........ 11,969 14,358 7,728
Advance billings.............................. 3,634 2,942 51
Other......................................... (9,200) (7,816) (4,478)
-------- -------- --------
Net cash provided by operating activities.... 68,222 31,147 32,219
-------- -------- --------
Cash flows from investing activities:
Capital expenditures............................ (282,940) (169,498) (150,995)
Proceeds from sale of property, plant and
equipment...................................... 223,037 208,644 2,887
Cash used for business acquisitions, net........ (35,311) (42,581) (6,287)
Cash returned from unconsolidated subsidiary.... 8,000
Cash used to acquire investments in
unconsolidated subsidiaries.................... (4,900) (11,264) (10,095)
-------- -------- --------
Net cash used in investing activities........ (92,114) (14,699) (164,490)
-------- -------- --------
Cash flows from financing activities:
Net borrowings (repayments) on revolving credit
facility....................................... (64,400) (4,700) 63,681
Proceeds from issuance of long-term debt........ 2,825 5,000
Issuance of common stock, net................... 92,088
Equity issuance costs........................... (687)
Proceeds from mandatorily redeemable convertible
preferred securities, net...................... 82,940
Proceeds from warrant conversions and stock
option exercises............................... 545 121
Repayment of long-term debt..................... (8,357) (2,226) (31,757)
Purchase of treasury stock...................... (5,950)
Repayments of shareholder notes................. 7,490 602 1,185
-------- -------- --------
Net cash provided by (used in) financing
activities.................................. 18,218 (9,328) 129,510
-------- -------- --------
Effect of exchange rate changes on cash and
equivalents..................................... (73) (178)
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents..................................... (5,747) 6,942 (2,761)
Cash and cash equivalents at beginning of year... 11,503 4,561 7,322
-------- -------- --------
Cash and cash equivalents at end of year......... $ 5,756 $ 11,503 $ 4,561
======== ======== ========

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

F-4

HANOVER COMPRESSOR COMPANY

Consolidated Statement of Cash Flows

Years Ended December 31, 1999, 1998 and 1997

1999 1998 1997
------- -------- -------
(in thousands of
dollars)

Supplemental disclosure of cash flow information:
Interest paid, net of capitalized amounts......... $ 7,897 $ 10,992 $10,069
======= ======== =======
Income taxes paid................................. $12,065 $ 2,249 $ 5,857
======= ======== =======
Supplemental disclosure of noncash transactions:
Debt issued for property, plant and equipment..... $ 379
=======
Property sold in exchange for note receivable..... $ 3,538 $ 1,500
======= ========
Common stock issued in exchange for notes
receivable....................................... $ 731 $ 5,163
======= =======
Acquisitions of businesses:
Property, plant and equipment acquired............ $39,105 $ 31,015
======= ========
Other noncash assets acquired..................... $ 9,711 $ 25,000
======= ========
Liabilities assumed............................... $(1,578) $ (1,261)
======= ========
Deferred taxes.................................... $(8,627) $(12,174)
======= ========
Common stock issued............................... $(3,300) $ (3,300)
======= ========

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

F-5

HANOVER COMPRESSOR COMPANY

Consolidated Statement of Common Stockholders' Equity

Years Ended December 31, 1999, 1998 and 1997

(in thousands of dollars, except share data)

Accumulated Notes
Common Stock Additional Other Receivable--
----------------- Paid-in Comprehensive Treasury Employee Retained
Shares Amount Capital Income Stock Stockholders Earnings
---------- ------ ---------- ------------- -------- ------------ --------

Balance at January 1,
1997................... 22,938,541 $23 $171,342 $ (218) $(6,770) $ 12,518
Issuance of common
stock.................. 5,163,843 5 92,083
Issuance of common stock
to employees........... 264,785 5,163 (5,163)
Repayment of employee
shareholder notes...... 1,185
Net income.............. 18,103
---------- --- -------- ------- ------- --------
Balance at December 31,
1997................... 28,367,169 28 268,588 (218) (10,748) 30,621
Conversion of warrants.. 198,480 1
Exercise of stock
options................ 24,823 120
Other comprehensive
income................. $ 152
Purchase of 294,200
treasury shares, at
cost................... (5,950)
Issuance of 150,000
treasury shares at
$22.00 per share....... 457 2,843
Repayment of employee
shareholder notes...... 602
Other................... (160)
Net income.............. 30,377
---------- --- -------- ----- ------- ------- --------
Balance at December 31,
1998................... 28,590,472 29 269,005 152 (3,325) (10,146) 60,998
Conversion of warrants.. 26,339
Exercise of stock
options................ 98,676 545
Other comprehensive
loss................... (463)
Issuance of common stock
to employees........... 37,450 731 (731)
Issuance of 91,850
treasury shares at
$35.93 per share....... 1,561 1,739
Repayment of employee
shareholder notes...... 7,490
Income tax benefit from
stock options
exercised.............. 1,176
Other................... (45)
Net income.............. 40,441
---------- --- -------- ----- ------- ------- --------
Balance at December 31,
1999................... 28,752,937 $29 $272,973 $(311) $(1,586) $(3,387) $101,439
========== === ======== ===== ======= ======= ========

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

F-6

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 1999, 1998 and 1997

1. The Company, Business and Significant Accounting Policies

Hanover Compressor Company and its subsidiaries ("Hanover" or the "Company")
is a leading provider of a broad array of natural gas compression rental,
operations, parts and maintenance services in the United States and select
international markets. Hanover's compression services are complemented by its
compressor and oil and gas production equipment fabrication operations.
Hanover is a Delaware corporation originally formed on October 17, 1990. In
December 1999, the Company adopted a holding company structure and merged into
the new holding company that assumed the name of Hanover Compressor Company.
The charter and by-laws of the new holding company are substantially the same
as the old Company.

On June 6, 1997, the Board of Directors approved an increase of authorized
shares of preferred stock and common stock to 3,000,000 and 100,000,000
shares, respectively. In addition, the Board of Directors approved a 158-for-1
stock split of the Company's common stock. The stock split has been effected
in the form of a stock dividend. All share and per share information included
herein reflects the stock split.

On June 30, 1997, Hanover issued 5,158,691 shares of common stock for cash
of $92,020,000 (net of approximately $1,771,000 of equity issuance costs) in
connection with the Company's initial public offering (the Offering).

Principles of Consolidation

The accompanying consolidated financial statements include Hanover and its
wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.

Use of Estimates in the Financial Statements

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets, liabilities, revenues
and expenses, as well as the disclosures of contingent assets and liabilities.
Because of the inherent uncertainties in this process, actual future results
could differ from those expected at the reporting date. Management believes
that the estimates are reasonable.

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.

Revenue Recognition

Revenue from equipment rentals is recorded when earned over the period of
rental and maintenance contracts which generally range from one month to five
years. Parts and service revenue is recorded as products are delivered or
services are performed for the customer.

Compressor and production equipment fabrication revenue is recognized using
the percentage-of-completion method. The Company estimates percentage-of-
completion for compressor fabrication on a direct labor hour-to-total labor
hour basis. Production equipment fabrication percentage-of-completion is
estimated using the cost-to-total cost basis.

F-7

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999, 1998 and 1997

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to concentrations
of credit risk consist of cash and cash equivalents and accounts receivable.
The Company believes that the credit risk in temporary cash investments that
the Company has with financial institutions is minimal. Trade accounts
receivable are due from companies of varying size engaged principally in oil
and gas activities in the United States, Canada and South America. The Company
reviews the financial condition of customers prior to extending credit and
generally does not obtain collateral for receivables. Payment terms are on a
short-term basis and in accordance with industry standards. Trade accounts
receivable are recorded net of estimated doubtful accounts of $1,730,000 and
$1,212,000 at December 31, 1999 and 1998, respectively. The Company considers
this credit risk to be limited due to these companies financial resources.

Inventory

Inventory consists of parts used for fabrication or maintenance of natural
gas compression units and production equipment, and also includes compression
units and production equipment that are held for sale. Inventory is stated at
the lower of cost or market using the average-cost method.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost and are depreciated using
the straight-line method over their estimated useful lives as follows:

Compression equipment and facilities........................ 4 to 25 years
Buildings................................................... 30 years
Transportation, shop equipment and other.................... 3 to 12 years

Major improvements that extend the useful life of an asset are capitalized.
Repairs and maintenance are expensed as incurred. When property, plant and
equipment is sold, retired or otherwise disposed of, the cost and related
accumulated depreciation are eliminated and the gain or loss is recognized.
Depreciation expense was $34,696,000, $35,768,000 and $27,789,000 in 1999,
1998 and 1997, respectively.

Assets under construction of $18,937,000 and $6,984,000 are included in
compression equipment at December 31, 1999 and 1998, respectively. Interest is
capitalized in connection with the compression equipment and facilities that
are constructed for the Company's use in its rental operations. The
capitalized interest is recorded as part of the assets to which it relates and
is amortized over the asset's estimated useful life. In 1999, $1,533,000 of
interest cost was capitalized. No interest was capitalized for 1998 and 1997.

Long-Lived Assets

The Company reviews for the impairment of long-lived assets, including
property, plant and equipment, and goodwill whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. An impairment loss exists when estimated undiscounted cash flows
expected to result from the use of the asset and its eventual disposition are
less than its carrying amount. The impairment loss recognized represents the
excess of the assets carrying value as compared to its estimated fair market
value.

Intangible and Other Assets

Investments in affiliated corporations in which the Company does not have a
controlling interest are accounted for using the equity method. The excess of
cost over net assets of acquired businesses is recorded as

F-8

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999, 1998 and 1997

goodwill and amortized on a straight-line basis over 15 years commencing on the
dates of the respective acquisitions. Accumulated amortization was $3,822,000
and $1,810,000 at December 31, 1999 and 1998, respectively.

Included in intangible and other assets are debt issuance costs, net of
accumulated amortization, totaling $1,099,000 and $1,186,000 at December 31,
1999 and 1998, respectively. Such costs are amortized over the period of the
respective debt agreements.

Stock-Based Compensation

In accordance with Statement of Financial Accounting Standards No. 123 (FAS
123) "Accounting for Stock-Based Compensation," the Company measures
compensation expense for its stock-based employee compensation plans using the
intrinsic value method prescribed in APB Opinion No. 25 (APB 25), "Accounting
for Stock Issued to Employees," and has provided in Note 12, pro forma
disclosures of the effect on net income and earnings per share as if the fair
value-based method prescribed by FAS 123 had been applied in measuring
compensation expense.

Income Taxes

The Company accounts for income taxes using an asset and liability approach
that requires the recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. In estimating future tax
consequences, all expected future events are considered other than enactments
of changes in the tax law or rates.

Foreign Currency Translation

The financial statements of subsidiaries outside the U.S., except those
located in highly inflationary economies, are measured using the local currency
as the functional currency. Assets, including goodwill, and liabilities of
these subsidiaries are translated at the rates of exchange at the balance sheet
date. Income and expense items are translated at average monthly rates of
exchange. The resulting gains and losses from the translation of accounts are
included in accumulated other comprehensive income. For subsidiaries located in
highly inflationary economies, translation gains and losses are included in net
income. The resulting translation adjustment for the year ended December 31,
1997 was not significant.

Earnings Per Common Share

Basic earnings per common share is computed using the weighted average number
of shares outstanding for the period. Diluted earnings per common share is
computed using the weighted average number of shares outstanding adjusted for
the incremental shares attributed to outstanding options and warrants to
purchase common stock.

Included in diluted shares are common stock equivalents relating to options
of 1,648,000, 1,230,000 and 1,153,000 in 1999, 1998 and 1997, respectively, and
warrants of 356,000, 393,000 and 569,000 in 1999, 1998 and 1997, respectively.
The common stock equivalents excluded from the computation of diluted earnings
per share as the effect would be anti-dilutive were approximately 106,000 and
146,000 in 1999 and 1998. No common stock equivalents were anti-dilutive in
1997.

F-9

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999, 1998 and 1997

Comprehensive Income

Components of comprehensive income are net income and all changes in equity
during a period except those resulting from transactions with owners.
Accumulated other comprehensive income consists of the foreign currency
translation adjustment.

Financial Instruments

The Company utilizes off-balance sheet derivative financial instruments with
the principal objective being to minimize the risks and/or costs associated
with financial and global operating activities by managing its exposure to
interest rate fluctuation on a portion of its variable rate debt and leasing
obligations. The Company does not utilize derivative financial instruments for
trading or other speculative purposes. The Company designates and assigns the
financial instruments as hedges of specific assets, liabilities or anticipated
transactions. The cash flow from hedges is classified in the Consolidated
Statements of Cash Flows under the same category as the cash flows from the
underlying assets, liabilities or anticipated transactions. The cash flow from
hedges is classified in the Consolidated Statements of Cash Flows under the
same category as the cash flows from the underlying assets, liabilities or
anticipated transactions. The carrying amounts reported in the balance sheet
for all financial instruments approximate fair value. See Notes 7 and 8.

Reclassifications

Certain amounts in the prior years' financial statements have been
reclassified to conform to the 1999 financial statement classification. These
reclassifications have no impact on net income.

2. Business Combinations

Acquisitions were accounted for under the purchase method of accounting.
Results of operations of companies acquired are included from the dates of
such acquisitions. The Company allocates the cost of the acquired business to
the assets acquired and the liabilities assumed based upon fair value
estimates thereof. These estimates are revised during the allocation period as
necessary when information regarding contingencies becomes available to define
and quantify assets acquired and liabilities assumed. The allocation period
varies for each acquisition but does not exceed one year. To the extent
contingencies are resolved or settled during the allocation period, such items
are included in the revised purchase price allocation. After the allocation
period, the effect of changes in such contingencies is included in results of
operations in the periods the adjustments are determined. The Company's
management does not believe potential deviations between its fair value
estimates and actual fair values to be material.

Year Ended December 31, 1999

In July 1999, the Company purchased preferred stock and a purchase option
for the common stock of CDI Holdings, Inc. and its subsidiary Compressor
Dynamics, Inc. ("CDI"). In August 1999, the Company exercised its option to
purchase CDI. The total cost for CDI was approximately $18,525,000 in cash.

In August 1999, the Company purchased the stock of Victoria Compression
Services, Inc., Contract Engineering and Operating, Inc. and Unit Partners,
Inc. ("CEO") for approximately $16,786,000 in cash, 91,850 shares of the
Company's treasury stock valued at $3,300,000 and notes payable of
approximately $452,000.

Year Ended December 31, 1998

In June 1998, the Company purchased the stock of Arkoma Compression
Services, Inc. for approximately $17,245,000 in cash. In October 1998, the
Company purchased the stock of Eureka Energy Systems, Inc. for approximately
$25,335,000 in cash.

F-10

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999, 1998 and 1997

The pro forma information set forth below assumes acquisitions in 1999 and
1998 are accounted for had the purchases occurred at the beginning of 1998.
The pro forma information is presented for informational purposes only and is
not necessarily indicative of the results of operations that actually would
have been achieved had the acquisitions been consummated at that time (in
thousands, except per share amounts):

Years Ended December 31,
---------------------------
1999 1998
------------ ------------
(unaudited) (unaudited)

Revenue..................................... $ 323,002 $ 308,870
Net income.................................. 40,412 31,391
Earnings per common share--basic............ 1.42 1.10
Earnings per common share--diluted.......... $ 1.32 $ 1.04

Year Ended December 31, 1997

In September 1997, Hanover purchased Wagner Equipment, Inc. and Gas Tech
Compression Services, Inc. for approximately $6,287,000 in cash. Results of
operations for 1997 were not materially impacted by the transaction.

3. Inventory

Inventory consisted of the following amounts (in thousands):

December 31,
----------------
1999 1998
-------- -------

Parts and supplies....................................... $ 44,058 $32,808
Work in progress......................................... 18,677 19,962
Finished goods........................................... 3,827 10,274
-------- -------
$ 66,562 $63,044
======== =======

4. Compressor and Production Equipment Fabrication Contracts

Costs, estimated earnings and billings on uncompleted contracts are as
follows (in thousands):

December 31,
----------------
1999 1998
------- -------

Costs incurred on uncompleted contracts................. $11,041 $18,605
Estimated earnings...................................... 2,150 3,488
------- -------
13,191 22,093
Less--billings to date.................................. (9,307) (14,916)
------- -------
$ 3,884 $ 7,177
======= =======

Presented in the accompanying financial statements as follows (in
thousands):

December 31,
---------------
1999 1998
------- ------

Costs and estimated earnings in excess of billings on
uncompleted contracts................................ $ 4,782 $7,871
Billings on uncompleted contracts in excess of costs
and estimated earnings............................... (898) (694)
------- ------
$ 3,884 $7,177
======= ======

F-11

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999, 1998 and 1997

5. Intangible and Other Assets

Intangible and other assets consisted of the following (in thousands)

December 31,
-----------------
1999 1998
-------- -------

Goodwill.............................................. $ 33,613 $26,686
Investments in unconsolidated subsidiaries............ 18,892 24,104
Deferred debt issuance and other transaction costs.... 10,317 4,957
Notes receivable...................................... 9,214 3,799
Other................................................. 1,862 3,237
-------- -------
73,898 62,783
Accumulated amortization.............................. (7,385) (5,747)
-------- -------
$ 66,513 $57,036
======== =======

Amortization of goodwill and other intangible assets totaled $2,641,000,
$1,386,000 and $650,000 in 1999, 1998 and 1997, respectively.

At December 31, 1999 and 1998, the Company's investments in unconsolidated
subsidiaries included a 35% interest in Collicutt Mechanical Services, Ltd.; a
35% interest in the Consortium Cosacol/Hanover (the "Consortium"); and a non-
controlling 60% interest in the Hanover/Enron Joint Venture. In September
1999, the Company acquired a 20% interest in Meter Acquisition Company LP,
LLLP for approximately $2,200,000 and a non-controlling 52.5% interest in
Hanover Measurement Services Company, LP for approximately $2,700,000. The
Company had a 33% interest in a joint venture with Wartsila Diesel
International Ltd., OY that was dissolved in 1998. There were no distributions
or dividends received during the year ended December 31, 1998. Equity in
income of joint ventures was $1,188,000 and $1,369,000 for 1999 and 1998,
respectively and a loss of $206,000 for 1997 and is included in other
revenues.

In December 1998, the Company restructured its relationship in the
Consortium. The Company purchased all of the capitalized construction from the
Consortium for 150,000 shares of Hanover common stock valued at $3,300,000.
The capitalized construction was transferred to property, plant and equipment
in 1999. In addition, the Company acquired a 10% interest in Cosacol for
$2,000,000 in cash.

In December 1998, the Company advanced $8,000,000 to Transportadora de Gas
del Sur S.A. ("TGS"), an Argentina company for a 25% interest in a joint
venture. In 1999, the Company withdrew from the joint venture and the
$8,000,000 was repaid.

In November 1997, Hanover acquired 35% of the common stock of Collicutt
Mechanical Services, Ltd. for approximately $5,608,000 in cash. The investment
is accounted for using the equity method of accounting. The excess of the
Company's investment over the underlying net equity of $703,000 is being
amortized on a straight-line basis over ten years and is included in other
assets at December 31, 1999 and 1998.

The notes receivable result primarily from customers for sales of equipment
or advances to other parties in the ordinary course of business. The notes
vary in length, are non-interest bearing or bear interest at rates ranging
from prime to 15% and are collateralized by equipment.

F-12

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999, 1998 and 1997

6. Accrued Liabilities

Accrued liabilities are comprised of the following (in thousands):

December 31,
---------------
1999 1998
------- -------

Accrued salaries and wages............................... $ 224 $ 1,055
Accrued bonuses.......................................... 1,669 1,539
Accrued income and other taxes........................... 8,033 6,105
Accrued leasing expense.................................. 3,496 2,336
Accrued other............................................ 8,643 6,564
------- -------
$22,065 $17,599
======= =======

7. Long-Term Debt

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

December 31,
------------------
1999 1998
-------- --------

Revolving credit facility........................... $ 62,100 $126,500
Subordinated promissory notes, net of unamortized
discount of $289 and $855.......................... 15,364 22,648
Real estate mortgage, interest at 7.5%,
collateralized by certain land and buildings,
payable through 2002............................... 4,250 4,583
Other, interest at various rates, collateralized by
equipment and other assets, net of unamortized
discount........................................... 3,934 3,656
-------- --------
85,648 157,387
Less--current maturities............................ (15,967) (444)
-------- --------
$ 69,681 $156,943
======== ========

The Company's primary credit agreement provides for a $200,000,000 revolving
credit facility that matures on December 17, 2002. Advances bear interest at
the bank's prime or a negotiated rate (7.7% and 6.9% at December 31, 1999 and
1998, respectively). A commitment fee of 0.35% per annum on the average
available commitment is payable quarterly.

The credit agreement contains certain financial covenants and limitations
on, among other things, indebtedness, liens, leases and sales of assets. The
credit agreement also limits the payment of cash dividends on the Company's
common stock to 25% of net income for the respective period.

The subordinated promissory notes mature on December 31, 2000 and bear
interest at 7%, payable semi-annually.

Maturities of long-term debt at December 31, 1999 are (in thousands): 2000--
$15,967; 2001--$722; 2002--$66,093; 2003--$380; 2004--$328 and $2,158
thereafter.

In January 1998 and in connection with the revolving credit facility, the
Company entered into a two-year interest rate swap transaction to manage
interest rate exposure with a notional amount of $75,000,000 and a strike rate
of 5.43%. The differential paid or received on the swap transaction was
recognized as an adjustment to interest expense. This swap transaction was
cancelled in July 1998.

F-13

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999, 1998 and 1997

8. Leasing Transactions

In June 1999 and in July 1998, the Company completed two individual
$200,000,000 sale and lease back transactions of certain compression
equipment. The transactions are recorded as a sale and lease back of the
equipment and are recorded as operating leases. Under both agreements, the
equipment was sold and leased back by the Company for a 5 year period and will
continue to be deployed by the Company under its normal operating procedures.
At any time, the Company has options to repurchase the equipment at fair
market value. The Company has substantial residual value guarantees under the
agreements (approximately $333,000,000 for both transactions) that are due
upon termination of the leases and which may be satisfied by a cash payment or
the exercise of the Company's purchase options. The equipment sold in the June
1999 transaction had a book value of approximately $162,014,000 and resulted
in a gain of approximately $37,986,000. The equipment sold in the July 1998
transaction had a book value of $158,007,000 and resulted in a gain of
approximately $41,993,000. Both gains are deferred until the end of the
respective lease terms. Should the Company not exercise its purchase options
under the agreements, the deferred gains will be recognized to the extent they
exceed any required payments under the residual value guarantees and any other
requirements under the agreements. The Company incurred transaction costs of
approximately $1,799,000 and $1,423,000 for the 1999 and 1998 transactions,
respectively. These costs are included in intangible and other assets and are
being amortized over the respective lease terms.

Both lease agreements call for variable quarterly rental payments that vary
with the London Interbank Borrowing Rate. The following provides future
minimum lease payments under the leasing arrangement exclusive of any
guarantee payments (in thousands): 2000--$30,300; 2001--$30,700; 2002--
$30,700; 2003--23,300; 2004--$7,900.

In July 1998 and in connection with the 1998 leasing transaction, the
Company entered into two-year swap transactions to manage lease rental
exposure with notional amounts of $75,000,000 and $125,000,000 and strike
rates of 5.51% and 5.56%, respectively. The differential paid or received on
the swap transactions is recognized as an adjustment to leasing expense. The
counterparty to this contractual arrangement is a major financial institution
with which the Company also has other financial relationships. The Company is
exposed to credit loss in the event of nonperformance by this counterparty.
However, the Company does not anticipate nonperformance by this party and no
material loss would be expected from their nonperformance. The fair market
value of these interest rate swaps at December 31, 1999 is approximately
$2,900,000 based on market quotes.

9. Income Taxes

The components of income before income taxes were as follows (in thousands):

Year ended December 31,
------------------------
1999 1998 1997
-------- ------- -------

Domestic......................................... $ 47,741 $39,160 $23,596
Foreign.......................................... 15,845 10,476 5,821
-------- ------- -------
$ 63,586 $49,636 $29,417
======== ======= =======

F-14

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999, 1998 and 1997

The provision for income taxes consisted of the following (in thousands):

Year ended December 31,
-----------------------
1999 1998 1997
------- ------- -------

Current tax expense:
Federal........................................ $ 6,958 $ 3,421 $ 3,308
State.......................................... 1,412 1,741 1,281
Foreign........................................ 3,379 1,739 492
------- ------- -------
Total current................................ 11,749 6,901 5,081
------- ------- -------
Deferred tax expense:
Federal........................................ 10,670 10,312 4,543
State.......................................... 151 85 (23)
Foreign........................................ 575 1,961 1,713
------- ------- -------
Total deferred............................... 11,396 12,358 6,233
------- ------- -------
Total provision.................................. $23,145 $19,259 $11,314
======= ======= =======

The income tax expense for 1999, 1998 and 1997 resulted in effective tax
rates of 36.4%, 38.8% and 38.5%, respectively. The reasons for the differences
between these effective tax rates and the U.S. statutory rate of 35% are as
follows (in thousands):

Year ended December 31,
------------------------
1999 1998 1997
------- ------- -------

Federal income tax at statutory rates......... $22,255 $17,373 $10,296
State income taxes, net of federal income tax
benefit...................................... 1,016 1,187 817
Foreign income taxes.......................... 211 33 226
Other, net.................................... (337) 666 (25)
------- ------- -------
$23,145 $19,259 $11,314
======= ======= =======

Deferred tax assets (liabilities) are comprised of the following (in
thousands):

December 31,
-------------------
1999 1998
--------- --------

Deferred tax assets:
Net operating losses.............................. $ 7,490 $ 3,345
Alternative minimum tax carryforward.............. 19,005 13,276
Other............................................. 1,572 3,683
--------- --------
Gross deferred tax assets........................... 28,067 20,304
--------- --------
Deferred tax liabilities:
Property, plant and equipment..................... (82,764) (58,249)
Other............................................. (11,610) (8,339)
--------- --------
Gross deferred tax liabilities...................... (94,374) (66,588)
--------- --------
$(66,307) $(46,284)
========= ========

The Company has net operating loss carryforwards at December 31, 1999 of
$21,400,000 expiring in 2006 to 2018. In addition, the Company has an
alternative minimum tax credit carryforward of $19,005,000 that does not
expire.

F-15

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999, 1998 and 1997

In 1999, the company recorded approximately $8,627,000 additional deferred
income tax liability resulting from the CDI and CEO acquisitions. See Note 2
for a description of the transactions.

The Company has not recorded a deferred income tax liability for additional
income taxes that would result from the distribution of earnings of its
foreign subsidiaries if they were actually repatriated. The Company intends to
indefinitely reinvest the undistributed earnings of its foreign subsidiaries.

10. Mandatorily Redeemable Convertible Preferred Securities

In December 1999, the Company issued $86,250,000 of unsecured 7.25%
Manditorily Redeemable Convertible Preferred Securities (the "Convertible
Preferred Securities") through Hanover Compressor Capital Trust, a Delaware
business trust and subsidiary of the Company. The Convertible Preferred
Securities have a liquidation amount of $50 per unit. The Convertible
Preferred Securities mature in 30 years but the Company may redeem the
Convertible Preferred Securities partially or in total any time on or after
December 20, 2002. The Convertible Preferred Securities also provide for
annual cash distributions at the rate of 7.25%, payable quarterly in arrears,
however, payments may be deferred up 20 quarters subject to certain
restrictions. During 1999, the Company accrued financing costs of
approximately $288,000 related to Convertible Preferred Securities. Each
Convertible Preferred Security is convertible into 1.3986 shares of Hanover
common stock, subject to adjustment for certain events. The Company incurred
transaction costs of approximately $3,310,000 which are included in other
assets and will be amortized over the term of the Convertible Preferred
Securities.

11. Common Stockholders' Equity

Notes Receivable-Employee Stockholders

Under various stock purchase plans, the Company's employees are eligible to
purchase shares of Hanover stock at fair market value in exchange for cash
and/or notes receivable. The notes are collateralized by the common stock and
the general credit of the employee, bear interest at a prime rate, and are
generally payable on demand or at the end of a four-year period. The notes
have been recorded as a reduction of common stockholders' equity.

In addition and in connection with the Company's initial public offering,
the Company issued 264,785 shares of common stock to employees at the Offering
price of $19.50 in exchange for employee notes receivable.

Other

As of December 31, 1999, warrants to purchase approximately 344,000 shares
of common stock at $.01 per share were outstanding. The warrants expire in
August 2005.

During 1998, the Company initiated a stock buyback program authorized to
repurchase up to 450,000 of the Company's outstanding shares to assist with
future business acquisitions and for general corporate purposes. In 1998, the
Company repurchased 294,200 shares at an average price of $20.22.

In February 1997, Hanover issued 5,152 shares of common stock for cash to a
trust for the benefit of a member of the Company's outside legal counsel.

See Notes 1, 2, 5 and 12 for a description of other common stock
transactions.

12. Stock Options

The Company has employee stock option plans that provide for the granting of
options to purchase common shares. The options are generally issued at fair
market value on the date of grant and are exercisable over a ten-

F-16

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999, 1998 and 1997

year period. Vesting of stock options issued prior to June 1997 was
accelerated as a result of completion of the initial public offering.
Accordingly, during 1997 the Company recognized a charge of $269,000 related
to unamortized compensation expense on options issued at less than fair market
value on the date of grant. No compensation expense was recorded in 1999 and
1998.

Of the options granted in 1999 and 1998, 350,000 vest 100% on July 1, 2001
and 160,000 vested immediately. The remaining options granted to employees
vest over the following schedule, which may accelerate upon a change in the
Company's controlling ownership.

Year 1............................................................... 10%
Year 2............................................................... 30%
Year 3............................................................... 60%
Year 4............................................................... 100%

The following is a summary of stock option activity for the years ended
December 31, 1999, 1998 and 1997:

Weighted Average
Shares Price Per Share
--------- ----------------

Options outstanding, December 31, 1996........ 2,400,174 $ 5.11
Options granted............................. 1,015,323 19.50
Options canceled............................ (1,138) 10.55
Options exercised...........................
---------
Options outstanding, December 31, 1997........ 3,414,359 9.39
---------
Options granted............................. 1,047,683 20.26
Options canceled............................ (42,004) 21.22
Options exercised........................... (24,823) 4.80
---------
Options outstanding, December 31, 1998........ 4,395,215 11.90
---------
Options granted............................. 136,078 27.58
Options canceled............................ (34,115) 19.43
Options exercised........................... (98,676) 5.51
---------
Options outstanding, December 31, 1999........ 4,398,502 12.47
---------

Options Outstanding December 31, 1999

The following table summarizes significant ranges of outstanding and
exercisable options at December 31, 1999:

Options
Options Outstanding Exercisable
-------------------------------- ------------------
Weighted Weighted Weighted
Average Average Average
Remaining Exercise Exercise
Range of Exercise Prices Shares Life in Years Price Shares Price
------------------------ --------- ------------- -------- --------- --------

$0.01--$4.59............... 1,660,903 3.5 $ 4.45 1,660,903 $ 4.45
$4.60--$6.96............... 421,421 4.0 5.33 421,421 5.33
$6.97--$10.13.............. 128,343 5.8 9.54 128,343 9.54
$10.14--$13.92............. 69,940 6.7 11.87 69,940 11.87
$19.50--$25.00............. 2,002,229 8.2 20.36 504,297 19.64
$25.01--$29.00............. 115,666 9.9 29.00 0 0.00
--------- ---------
4,398,502 2,784,904
========= =========

F-17

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999, 1998 and 1997

The weighted average fair value at date of grant for options where the
exercise price equals the market price of the stock on the grant date was
$12.19, $8.31 and $8.58, per option during 1999, 1998 and 1997, respectively.
The fair value of options at date of grant was estimated using the Black-
Scholes model with the following weighted average assumptions:

1999 1998 1997
------- ------- -------

Expected life.................................. 6 years 6 years 6 years
Interest rate.................................. 6.0% 4.8% 6.7%
Volatility..................................... 29.36% 32.6% 30%
Dividend yield................................. 0% 0% 0%

Stock-based compensation costs computed in accordance with FAS 123, would
have reduced net income by $2,194,000, $825,000 and $842,000 in 1999, 1998 and
1997, respectively. The pro forma impact on net income would have reduced
basic and diluted earnings per share by $.07 in 1999 and $.03 per share in
1998 and 1997. The pro forma effect on net income for 1999, 1998 and 1997 is
not representative of the pro forma effect on net income in future years
because it does not take into consideration pro forma compensation expense
related to grants made prior to 1995.

13. Benefit Plans

The Company's 401(k) retirement plan provides for optional employee
contributions up to the IRS limitation and discretionary employer matching
contributions. The Company made matching contributions of $399,000 and
$273,000 during the years ended December 31, 1999 and 1998, respectively. The
Company did not make a matching contribution for the year ended December 31,
1997.

14. Related Party Transactions

Hanover and GKH Partners, L.P., a major stockholder of the Company, have
entered into an agreement whereby in exchange for investment banking and
financial advisory services rendered and to be rendered by the major
stockholder, the Company has agreed to pay a fee to GKH Partners, L.P. equal
to .75% of the equity value of the Company determined and payable at such time
as (1) a disposition of shares of the Company's common stock resulting in GKH
Partners, L.P. owning less than 25% of the outstanding common stock or (2) any
other transaction occurs resulting in the effective sale of the Company or its
business by the current owners.

In connection with stock offerings to management, the Company has received
notes from employees for shares purchased. The total amounts owed to the
Company at December 31, 1999 and 1998 are $3,387,000 and $10,146,000,
respectively. Total interest accrued on the loans is $203,000 and $548,000 as
of December 31, 1999 and 1998, respectively.

The Company had a credit agreement with Joint Energy Developments
Investments Limited Partnership ("JEDI"), a common stockholder, that was
repaid in 1997. Interest expense in 1997 was $1,388,000. The Company also
leases compressors to affiliates of Enron Capital and Trade Resources Corp.,
an affiliate of JEDI. Rentals of $8,776,000, $6,801,000 and $1,034,000 were
paid by affiliates of Enron in 1999, 1998 and 1997, respectively. In addition,
compression fabrication of $6,320,000 was paid by affiliates of Enron in 1999.
An affiliate of Enron also owns interests in Meter Acquisition Company LP,
LLLP and Hanover Measurement Services Company, L.P.

The Company leases compressors to other companies owned or controlled by or
affiliated with related parties. Rental revenues billed to these related
parties totaled $902,000, $859,000 and $1,035,000 during 1999, 1998 and 1997,
respectively.

F-18

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999, 1998 and 1997

See Note 5 for related party investments and Note 11 for a description of
common stock transactions with related parties.

15. Commitments and Contingencies

Rent expense excluding lease payments for the leasing transactions described
in Note 8 for 1999, 1998 and 1997 was approximately $1,320,000, $455,000 and
$376,000, respectively. Commitments for future minimum rental payments
exclusive of those disclosed in Note 8 are not significant at December 31,
1999.

In the ordinary course of business the Company is involved in various
pending or threatened legal actions. 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 the
Company's consolidated financial position, operating results or cash flows.

The Company has no commitments or contingent liabilities which, in the
judgment of management, would result in losses that would materially affect
the Company's consolidated financial position, operating results or cash
flows.

16. Subsequent Event

In March 2000, the Company completed a sale and lease back of certain
compression equipment. The lease back of the equipment will be recorded as an
operating lease. Under the agreement, the Company received $100 million
proceeds from the sale of the compression equipment at closing and may sell an
additional $100 million of equipment to the Trust during the next twelve
months. The equipment sold will be leased back by the Company for a five-year
period and will continue to be deployed by the Company under its normal
operating procedures. Hanover has the option to repurchase the equipment from
the Trust at any time and has substantial residual value guarantees.

17. Industry Segments and Geographic Information

The Company manages its business segments primarily on the type of product
or service provided. The Company has four principal industry segments:
Rentals--Domestic, Rentals--International, Compressor Fabrication and
Production Equipment Fabrication. The Rentals Segments provides natural gas
compression rental and maintenance services to meet specific customer
requirements. The Compressor Fabrication Segment involves the design,
fabrication and sale of natural gas compression units to meet unique customer
specifications. The Production Equipment Fabrication Segment designs,
fabricates and sells equipment utilized in the production of crude oil and
natural gas.

The Company evaluates the performance of its segments based on segment gross
profit. Segment gross profit for each segment includes direct operating
expenses. Costs excluded from segment gross profit include selling, general
and administrative, depreciation and amortization, leasing, interest,
distributions on company-obligated mandatorily redeemable preferred securities
and income taxes. Amounts defined as "Other" include sales of property, plant
and equipment, results of other insignificant operations, corporate related
items primarily related to cash management activities and parts and service
operations which are not separately managed. Revenues include sales to
external customers and intersegment sales. Intersegment sales are accounted
for at cost and are eliminated in consolidation. Identifiable assets are
tangible and intangible assets that are identified with the operations of a
particular segment or geographic region, or which are allocated when used
jointly. Capital expenditures include fixed asset purchases.

F-19

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999, 1998 and 1997

No single customer accounts for 10% or more of the Company's revenues for
all periods presented. One vendor accounted for approximately $32,900,000 of
the Company's purchases in 1998.

The following tables present sales and other financial information by
industry segment and geographic region for the years ended December 31, 1999,
1998 and 1997.

Industry Segments

Production
Domestic International Compressor Equipment
Rentals Rentals Fabrication Fabrication Other Eliminations Consolidated
-------- ------------- ----------- ----------- ------- ------------ ------------
(in thousands of dollars)

1999:
Revenues from external
customers............ $136,430 $56,225 $52,531 $28,037 $43,805 $317,028
Intersegment sales.... 1,200 75,139 4,821 38,656 $(119,816) --
-------- ------- ------- ------- ------- --------- --------
Total revenues........ 136,430 57,425 127,670 32,858 82,461 (119,816) 317,028
Gross profit.......... 90,246 37,460 8,868 7,204 22,081 165,859
Identifiable assets... 529,667 149,968 47,608 23,511 5,756 756,510
Capital expenditures.. 180,593 99,535 1,469 1,343 282,940
Depreciation and
amortization......... 24,448 11,158 702 1,029 37,337
1998:
Revenues from external
customers............ $107,420 $40,189 $67,453 $37,466 $29,429 $281,957
Intersegment sales.... 1,200 54,369 2,902 10,735 $ (69,206) --
-------- ------- ------- ------- ------- --------- --------
Total revenues........ 107,420 41,389 121,822 40,368 40,164 (69,206) 281,957
Gross profit.......... 70,850 27,374 9,309 11,685 12,087 131,305
Identifiable assets... 422,026 129,628 33,578 17,855 11,503 614,590
Capital expenditures.. 111,289 54,830 2,524 855 169,498
Depreciation and
amortization......... 28,383 7,128 701 942 37,154
1997:
Revenues from external
customers............ $ 78,656 $22,029 $49,764 $37,052 $11,297 $198,798
Intersegment sales.... 1,200 48,072 462 7,775 $ (57,509) --
-------- ------- ------- ------- ------- --------- --------
Total revenues........ 78,656 23,229 97,836 37,514 19,072 (57,509) 198,798
Gross profit.......... 51,149 14,423 8,180 10,677 4,937 89,366
Identifiable assets... 360,362 98,421 30,088 13,020 4,561 506,452
Capital expenditures.. 109,540 36,545 993 3,917 150,995
Depreciation and
amortization......... 23,261 3,912 554 712 28,439

F-20

HANOVER COMPRESSOR COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999, 1998 and 1997

Geographic Data

United
States International Consolidated
-------- ------------- ------------
(in thousands of dollars)

1999:
Revenues from external customers.......... $256,890 $ 60,138 $317,028
Identifiable assets....................... $603,368 $153,142 $756,510
1998:
Revenues from external customers.......... $230,605 $ 51,352 $281,957
Identifiable assets....................... $484,269 $130,321 $614,590
1997:
Revenues from external customers.......... $176,045 $ 22,753 $198,798
Identifiable assets....................... $406,602 $ 99,850 $506,452

F-21

HANOVER COMPRESSOR COMPANY

Selected Quarterly Financial Data (unaudited)

The table below sets forth selected unaudited financial information for each
quarter of the last two years:

1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(in thousands, except per share
amounts)

1999
Revenue...................................... $64,444 $73,799 $84,462 $94,323
Gross profit................................. 36,947 38,681 43,373 46,858
Net income................................... 8,639 8,482 10,388 12,932
Earnings per common and common equivalent
share:
Basic...................................... $ 0.30 $ 0.30 $ 0.36 $ 0.45
Diluted.................................... $ 0.29 $ 0.28 $ 0.34 $ 0.42
1998
Revenue...................................... $61,449 $68,933 $71,796 $79,779
Gross profit................................. 28,411 31,963 34,841 36,090
Net income................................... 6,251 6,972 8,048 9,106
Earnings per common and common equivalent
share:
Basic...................................... $ 0.22 $ 0.24 $ 0.28 $ 0.32
Diluted.................................... $ 0.21 $ 0.23 $ 0.27 $ 0.30

F-22