UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

(MARK ONE)

OR

Hanover Compressor Company

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No o

Number of shares of the Common Stock of the registrant outstanding as of October 29, 2004: 86,819,229 shares.

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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

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HANOVER COMPRESSOR COMPANY

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

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HANOVER COMPRESSOR COMPANY

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

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HANOVER COMPRESSOR COMPANY

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

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HANOVER COMPRESSOR COMPANY

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of Hanover Compressor Company (“Hanover”, “we”, “us”, “our” or the “Company”) included herein have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America are not required in these interim financial statements and have been condensed or omitted. It is the opinion of our management that the information furnished includes all adjustments, consisting only of normal recurring adjustments, which are necessary to present fairly the financial position, results of operations, and cash flows of Hanover for the periods indicated. The financial statement information included herein should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2003. These interim results are not necessarily indicative of results for a full year.

Earnings Per Common Share

Basic loss per common share is computed by dividing loss available to common stockholders by the weighted average number of shares outstanding for the period. Diluted loss per common share is computed using the weighted average number of shares outstanding adjusted for the incremental common stock equivalents attributed to outstanding options and warrants to purchase common stock, restricted stock, convertible senior notes and convertible subordinated notes, unless their effect would be anti-dilutive.

The table below indicates the potential shares of common stock that were included in computing the dilutive potential shares of common stock used in diluted loss per common share (in thousands):

     ** Excluded from diluted loss per common share, as the effect would have been anti-dilutive.

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

Stock-Based Compensation

Certain of our employees participate in stock option plans that provide for the granting of options to purchase shares of Hanover common stock. In accordance with Statement of Financial Standards No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”), Hanover measures compensation expense for its stock-based employee compensation plans using the intrinsic value method prescribed in APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). The following pro forma net loss and loss per share data illustrates the effect on net loss and net loss per share if the fair value method had been applied to all outstanding and unvested stock options in each period (in thousands).

As of September 30, 2004 and 2003, approximately 1,540,000 and 535,000 shares, respectively, of restricted stock were outstanding under our incentive compensation plans. We will recognize compensation expense equal to the fair value of the restricted stock at the date of grant over the vesting period related to these grants. During the nine months ended September 30, 2004 and 2003, we recognized $1.6 million and $0.7 million, respectively, in compensation expense related to these grants. We record restricted shares forfeited as additions to treasury stock on our Condensed Consolidated Balance Sheet.

In July 2004, we granted approximately 1,207,000 shares of restricted Hanover common stock under our 2003 Stock Incentive Plan to certain employees, including our executive officers, as part of an incentive compensation plan.

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Approximately 690,000 of the shares of restricted stock that were granted will vest over a three-year period at a rate of one-third per year, beginning on the first anniversary of the date of the grant, and approximately 517,000 of the shares of restricted stock that were granted will vest in July 2007, subject to the achievement of certain pre-determined performance based criteria. In the event of a change of control of Hanover, a portion of these grants are subject to accelerated vesting. Because 517,000 of the restricted shares vest based on performance, we will record an estimate of the compensation expense to be expensed over three years related to these restricted shares. The compensation expense that will be recognized in our statement of operations will be adjusted for changes in our estimate of the number of restricted shares that will vest as well as changes in our stock price.

Reclassifications

Certain amounts in the prior period’s financial statements have been reclassified to conform to the 2004 financial statement classification. These reclassifications have no impact on our consolidated results of operations, cash flows or financial position.

2. INVENTORIES

Inventory, net of reserves, consisted of the following amounts (in thousands):

As of September 30, 2004 and December 31, 2003 we had inventory reserves of approximately $13.5 million and $12.7 million, respectively.

3. COMPRESSOR AND PRODUCTION EQUIPMENT FABRICATION CONTRACTS

Costs, estimated earnings and billings on uncompleted contracts consisted of the following (in thousands):

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

An increase in the business activity related to our compressor fabrication and production and processing equipment businesses resulted in increases for both costs and billings on uncompleted contracts as of September 30, 2004.

4. PROPERTY, PLANT AND EQUIPMENT

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

Cumulative Effect of Accounting Change

During the three months ended September 30, 2003, we recorded a cumulative effect of accounting change of $86.9 million net of tax, related to the adoption of FIN 46 on July 1, 2003. Prior to July 1, 2003, we entered into five lease transactions that were recorded as a sale and leaseback of the compression equipment and were treated as operating leases for financial reporting purposes. On July 1, 2003, we adopted the provisions of FIN 46 as they relate to the special purpose entities that lease compression equipment to us. As a result of the adoption, we added approximately $1,089 million in compressor equipment assets, $192.3 million of accumulated depreciation (including approximately $58.6 million of accumulated depreciation related to periods before the sale and leaseback of the equipment), $1,105.0 million in debt and $34.6 million in minority interest obligations to our balance sheet, and we reversed $108.8 million of deferred gains that were recorded on our balance sheet as a result of the sale leaseback transactions. On July 1, 2003, we recorded a $133.7 million charge ($86.9 million net of tax) to record the cumulative effect from the adoption of FIN 46 related to prior period depreciation of the compression equipment assets.

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5. INVESTMENTS IN NON-CONSOLIDATED AFFILIATES

During the second quarter of 2004, we increased our ownership in CrystaTech, Inc. a process technology company, to 47.24% for approximately $0.3 million.

On March 5, 2004, we sold our 50.384% limited partnership interest and 0.001% general partnership interest in Hanover Measurement Services Company, L.P. to EMS Pipeline Services, L.L.C. for $4.9 million, of which $0.2 million was put in escrow subject to the outcome of post closing working capital adjustments and other matters that have resulted in the $0.2 million being returned to the purchaser. We had no obligation to the purchaser with respect to any post-closing adjustment in excess of the escrowed amount. We accounted for our interest in Hanover Measurement under the equity method. As a result of the sale, we recorded a $0.3 million gain that is included in other revenue.

6. DEBT

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

Belleli’s factoring arrangements are typically short term in nature and bore interest at a weighted average rate of 4.0% and 4.0% at September 30, 2004 and December 31, 2003, respectively. Belleli’s revolving credit facilities bore interest at a weighted average rate of 3.7% and 3.2% at September 30, 2004 and December 31, 2003, respectively. These revolving credit facilities are all short-term and expire at different times in 2004 and 2005.

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

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Maturities of long-term debt (excluding interest to be accrued thereon) at September 30, 2004 are (in thousands):

During the third quarter of 2004, we paid off $65.0 million in indebtedness and minority interest obligations under our 2000B compressor equipment lease.

In June 2004, we issued under our shelf registration statement $200.0 million aggregate principal amount of our 9.0% Senior Notes due 2014, which are fully and unconditionally guaranteed on a senior subordinated basis by our wholly owned subsidiary, Hanover Compressor Limited Partnership (“HCLP”). The net proceeds from this offering and available cash were used to repay the outstanding indebtedness and minority interest obligations of $193.6 million and $6.4 million, respectively, under our 2000A equipment lease that was to expire in March 2005.

We expect that our bank credit facility and cash flow from operations will provide us adequate capital resources to fund our estimated level of capital expenditures for the short term. As of September 30, 2004, we had $13.0 million in outstanding borrowings under our bank credit facility. Outstanding amounts under that facility bore interest at a weighted average rate of 5.7% and 4.2% at September 30, 2004 and December 31, 2003. As of September 30, 2004, we also had approximately $94.7 million in letters of credit outstanding under our bank credit facility. Our bank credit facility permits us to incur indebtedness, subject to covenant limitations, up to a $350 million credit limit, plus, in addition to certain other indebtedness, an additional (a) $40 million in unsecured indebtedness, (b) $50 million of nonrecourse indebtedness of unqualified subsidiaries and (c) $25 million of secured purchase money indebtedness.

As of September 30, 2004, we were in compliance with all material covenants and other requirements set forth in our bank credit facility, the indentures and agreements related to our compression equipment lease obligations and the indentures and agreements relating to our other long-term debt. A default under our bank credit facility or these agreements would trigger cross-default provisions under the agreements relating to certain of our other debt obligations. Such defaults would have a material adverse effect on our liquidity, financial position and operations. Giving effect to our $94.7 million in outstanding letters of credit, the liquidity available under our bank credit facility as of September 30, 2004 was approximately $242.3 million.

In addition to purchase money and similar obligations, the indentures and the agreements related to our compression equipment lease obligations for our 2001A and 2001B sale leaseback transactions, our 8.625% Senior Notes due 2010 and our 9% Senior Notes due 2014 permit us to incur indebtedness up to the $350 million credit limit under our bank credit facility, plus (1) an additional $75 million in unsecured indebtedness and (2) any additional indebtedness so long as, after incurring such indebtedness, our ratio of the sum of consolidated net income before interest expense, income taxes, depreciation expense, amortization of intangibles, certain other non-cash charges and rental expense to total fixed charges

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(all as defined and adjusted by the agreements governing such obligations), or our “coverage ratio,” is greater than 2.25 to 1.0, and no default or event of default has occurred or would occur as a consequence of incurring such additional indebtedness and the application of the proceeds thereon. The indentures and agreements for our 2001A and 2001B compression equipment lease obligations, our 8.625% Senior Notes due 2010 and our 9% Senior Notes due 2014 define indebtedness to include the present value of our rental obligations under sale leaseback transactions and under facilities similar to our compression equipment operating leases. As of September 30, 2004, Hanover’s coverage ratio was less than 2.25 to 1.0, and therefore as of such date we could not incur indebtedness other than under our bank credit facility and up to an additional $75 million in unsecured indebtedness and certain other permitted indebtedness, including certain refinancing of indebtedness.

In May 2003, Hanover reached agreement that was subject to court approval, to settle securities class actions, ERISA class actions and the shareholder derivative actions. The terms of the settlement became final in March 2004 and provided for Hanover to: (a) make a cash payment of approximately $30 million to the securities settlement fund (of which $26.7 million was funded by payments from Hanover’s directors and officers insurance carriers), (b) issue 2.5 million shares of Hanover common stock, and (c) issue a contingent note with a principal amount of $6.7 million. The contingent feature was determined to be a derivative that we recorded as an asset, as required by SFAS 133. During the nine months ended September 30, 2004 and 2003, respectively, we recorded income of $3.9 million and a $40.3 million charge, respectively, for the cost of the litigation settlement. For further details regarding the securities settlement, see our Form 10-Q for the three months ended March 31, 2004.

In April 2004, we issued the $6.7 million contingent note related to the securities settlement. The note was payable, together with accrued interest, on March 31, 2007 but was extinguished (with no money owing under it) under the terms of the note since our common stock traded above the average price of $12.25 per share for 15 consecutive trading days during the third quarter of 2004. As a result of the cancellation of the note in the third quarter of 2004, we reversed the note and the embedded derivative, which resulted in a $4.0 million reduction to the cost of the securities-related litigation.

As of December 31, 2003, our accompanying balance sheet included a $33.4 million long-term liability related to the Hanover common stock and the fair value of the contingent note payable in connection with the securities settlement. In addition, as of December 31, 2003, our balance sheet included approximately $32.7 million in accrued liabilities and $29.6 million in restricted cash related to the securities related settlement. In the first quarter of 2004, we released the escrow settlement fund, which was included on our balance sheet as restricted cash and securities settlement accrual, issued the shares and reclassified $29.8 million, the estimated value of our common stock issued, from other liabilities to stockholders’ equity and included the shares in our weighted average outstanding shares used for earnings per share calculations.

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7. ACCRUED LIABILITIES

Accrued liabilities consisted of the following (in thousands):

See Note 6 for a discussion of the securities settlement.

8. COMMON STOCKHOLDERS’ EQUITY

In March 2004, we issued and delivered to the escrow agent for the settlement fund 2.5 million shares of Hanover common stock, as required by the settlement. In July 2004, we granted approximately 1.2 million shares of restricted Hanover common stock under our 2003 Stock Incentive Plan to certain employees, including our executive officers, as part of an incentive compensation plan. (See Note 1.)

9. ACCOUNTING FOR DERIVATIVES

We use derivative financial instruments to minimize the risks and/or costs associated with financial and global operating activities by managing our exposure to interest rate fluctuations on a portion of our debt and leasing obligations. Our primary objective is to reduce our overall cost of borrowing by managing the fixed and floating interest rate mix of our debt portfolio. We do not use derivative financial instruments for trading or other speculative purposes. The cash flow from hedges is classified in our consolidated statements of cash flows under the same category as the cash flows from the underlying assets, liabilities or anticipated transactions.

For derivative instruments designated as fair value hedges, the gain or loss is recognized in earnings in the period of change together with the gain or loss on the hedged item attributable to the risk being hedged. For derivative instruments designated as cash flow hedges, the effective portion of the derivative gain or loss is included in other comprehensive income, but not reflected in our consolidated statement of operations until the corresponding hedged transaction is settled. The ineffective portion is reported in earnings immediately.

In March 2004, we entered into two interest rate swaps, which we designated as fair value hedges, to hedge the risk of changes in fair value of our 8.625% Senior Notes due 2010 resulting from changes in interest rates. These interest rate swaps, under which we receive fixed payments and make floating payments, result in the conversion of the hedged obligation into floating rate debt. The following table summarizes, by individual hedge instrument, these interest rate swaps as of September 30, 2004:

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As of September 30, 2004, a total of approximately $1.7 million in other current assets, $6.8 million in long-term liabilities and a $5.1 million reduction of long-term debt was recorded with respect to the fair value adjustment related to these two swaps. We estimate the effective floating rate, that is determined in arrears pursuant to the terms of the swap, to be paid at the time of settlement. As of September 30, 2004 we estimated that the effective rate to be paid (in December 2004) will be approximately 7.1%.

During 2001, we entered into three interest rate swaps to convert variable lease payments under certain lease arrangements to fixed payments as follows:

These three swaps, which we have designated as cash flow hedging instruments, meet the specific hedge criteria and any changes in their fair values have been recognized in other comprehensive income. During the nine months ended September 30, 2004 and 2003, we recorded approximately $7.5 million and $4.3 million, respectively, related to these three swaps ($7.5 million and $2.8 million, respectively, net of tax) in other comprehensive income. As of September 30, 2004, a total of approximately $5.8 million was recorded in current liabilities and approximately $0.2 million in long-term liabilities with respect to the fair value adjustment related to these three swaps.

On June 1, 2004, we repaid the outstanding indebtedness and minority interest obligations of $193.6 million and $6.4 million, respectively, under our 2000A equipment lease. As a result, the two interest rate swaps maturing on March 11, 2005, each having a notional amount of $100 million, associated with the 2000A equipment lease no longer meet specific hedge criteria and the unrealized loss related to the mark-to-market adjustment prior to June 1, 2004 of $5.3 million will be amortized into interest expense over the remaining life of the swap. In addition, beginning June 1, 2004, changes in the mark-to-market adjustment are recognized as interest expense in the statement of operations.

Prior to 2001, we entered into two interest rate swaps with notional amounts of $75 million and $125 million and strike rates of 5.51% and 5.56%, respectively. The difference paid or received on the swap transactions was recorded as an accrued liability and recognized in leasing expense in all periods before July 1, 2003, and in interest expense until expiration in July 2003. Because management decided not to designate the interest rate swaps as hedges, we recognized unrealized gains of approximately $4.1 million related to the change in the fair value of these interest rate swaps in lease expense in our statement of operations during the nine months ended September 30, 2003.

The counterparties to our interest rate swap agreements are major international financial institutions. We monitor the credit quality of these financial institutions and do not expect non-performance by any counterparty, although such non-performance could have a material adverse effect on us.

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10. COMMITMENTS AND CONTINGENCIES

Hanover has issued the following guarantees that are not recorded on our accompanying balance sheet:

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

Upon the occurrence of a change of control of Hanover, if the change of control or shareholder approval of the change of control occurs before February 9, 2005, which is twelve months after the entry of the final court approval of the securities related settlement that became final in March 2004, we will be obligated to contribute an additional $3 million to the securities settlement fund. (See Note 6.)

On June 30, 2004, the Texas Commission on Environmental Quality (TCEQ) informed the Company that it was pursuing an enforcement action against the Company’s subsidiary, HCLP, for alleged violations of the Texas Health and Safety Code and Commission Rules at the Redwood Hanover Gateway Plant (RHG Plant) in Madison County, Texas. The alleged violations include failure to comply with certain permit limitations relating to sulfur emissions during certain periods in 2003 and 2004 and failure to provide certain required notifications in connection therewith. TCEQ has proposed a settlement of $149,625 in respect of the alleged violations in the form of a proposed Agreed Order dated June 29, 2004. The Company requested a meeting with the TCEQ to discuss the allegations and to challenge certain assumptions made by the TCEQ. Such meeting occurred on August 18, 2004 in which we presented our revised calculations and other responses to the TCEQ, the result of which was a settlement of the action for $46,200 that is subject to publication of the proposed Agreed Order by the TCEQ for a 30-day public comment period and final approval by the TCEQ. The comment period commenced on October 8, 2004 and will end on November 8, 2004. The Agreed Order is currently set for hearing on November 10, 2004, if approved at the hearing, the Agreed Order will become final.

On July 6, 2004 the California South Coast Air Quality Management District (the “CSAD”) informed the Company that the CSAD was pursuing an enforcement action against the Company’s subsidiary, HCLP for alleged violations involving failure to comply with the permitted emission limitations applicable to certain of HCLP’s compressed natural gas (“CNG”) fueling stations located in the State of California. The alleged violations center on excess emissions of oxides of nitrogen and carbon monoxide from twelve natural gas-fired internal combustion engines. The CSAD initially estimated they would

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seek a penalty against us of approximately $200,000. After settlement discussions over the last several months, we believe that HCLP now has an agreement in principle with CSAD to settle the matter for a $50,000 penalty and a future obligation to replace two HCLP trucks with CNG vehicles. The Company is waiting for the final resolution letter confirming the settlement from CSAD.

In the ordinary course of business we are involved in various other pending or threatened legal actions, including environmental matters. While management is unable to predict the ultimate outcome of these actions, it believes that any ultimate liability arising from these actions will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

We are involved in a project to build and operate barge-mounted gas compression and gas processing facilities to be stationed in a Nigerian coastal waterway as part of the performance of a contract between an affiliate of The Royal/ Dutch Shell Group (“Shell”) and Global Energy and Refining Ltd. (“Global”), a Nigerian company. We have completed the building of the required barge-mounted facilities. Under the terms of a series of contracts between Global and us, Shell, and several other counterparties, respectively, Global is responsible for the development of the overall project. In light of the political environment in Nigeria, Global’s capitalization level and lack of a successful track record with respect to this project and other factors, there is no assurance that Global will be able to comply with its obligations under these contracts. In May 2004, we reached an agreement with Global whereby Global prepaid to us $5.0 million in equipment rental fees that we recorded in other liabilities on our condensed consolidated balance sheet in return for our agreement to waive certain defaults by Global with respect to some of our agreements with them.

If Shell were to terminate its contract with Global for any reason or we were to terminate our involvement in the project, we would be required to find an alternative use for the barge-mounted facility which could result in a write-down of our investment. At September 30, 2004, we had an investment of approximately $33.8 million associated with the barge-mounted facility and approximately $4.2 million associated with advances to, and our investment in, Global.

In July 2004, Wilpro Energy Services (PIGAP II) Limited (referred to as “PIGAP II”) received a notice of default from the Venezuelan state oil company, PDVSA, alleging that PIGAP II is not in compliance under a services agreement as a result of certain operational issues. PIGAP II is a joint venture, currently owned 70% by a subsidiary of The Williams Companies, Inc. (“Williams”) and 30% by Hanover, that operates a natural gas compression facility in Venezuela. PIGAP II has informed us that it does not believe a basis exists for such notice and that it is contesting the giving of this notice. Nonetheless, the giving of this notice of default could be deemed an event of default under PIGAP II’s outstanding project loans totaling approximately $207.7 million. We understand, however, that the lenders under the PIGAP II project loan agreement have confirmed to PIGAP II in writing that based on the facts they currently know, they have no intention of exercising any rights or remedies under the PIGAP II project loan agreements until the issues raised in the notice and PIGAP II’s response are clarified, but have cautioned PIGAP II to refrain from undertaking any extraordinary expenses or restricted payments until the issue has been fully resolved. In any event, Hanover has not guaranteed and is not otherwise liable for the PIGAP II project loans and an event of default under such project loans does not trigger a default under Hanover’s debt obligations. Hanover’s net book investment in PIGAP II at September 30, 2004 was approximately $30.9 million and Hanover’s pretax income with respect to PIGAP II for the nine months ended September 30, 2004 was approximately $9.6 million.

11. RELATED-PARTY TRANSACTIONS

We received a letter on March 11, 2004 from the administrative trustee of the GKH Liquidating Trust indicating it and one of its affiliates had decided to distribute 5.8 million shares of the 8.3 million shares of Hanover common stock owned by the GKH Liquidating Trust (formerly held by GKH Investments, L.P. and GKH Private Limited, collectively “GKH”) and its affiliate to the relevant beneficiaries. We understand that in April 2004 GKH contributed the remaining 2.5 million shares of our common stock held by GKH to the settlement fund. (See Note 6.)

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12. NEW ACCOUNTING PRONOUNCEMENTS

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS 150 changes the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. SFAS 150 requires that those instruments be classified as liabilities in statements of financial position. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective for interim periods beginning after June 15, 2004. On November 7, 2003 the FASB issued Staff Position 150-3 that delayed the effective date for certain types of financial instruments. We do not believe the adoption of the guidance currently provided in SFAS 150 will have a material effect on our consolidated results of operations or cash flow. However, we may be required to classify as debt approximately $20.3 million in sale leaseback obligations that, as of September 30, 2004, were reported as “Minority interest” on our condensed consolidated balance sheet pursuant to FIN 46.

These minority interest obligations represent the equity of the entities that lease compression equipment to us. In accordance with the provisions of our compression equipment lease obligations, the equity certificate holders are entitled to quarterly or semi-annual yield payments on the aggregate outstanding equity certificates. As of September 30, 2004, the yield rates on the outstanding equity certificates ranged from 4.9% to 10.0%. Equity certificate holders may receive a return of capital payment upon termination of the lease or our purchase of the leased compression equipment after full payment of all debt obligations of the entities that lease compression equipment to us. At September 30, 2004, the carrying value of the minority interest obligations approximated the fair market value of assets that would be required to be transferred to redeem the minority interest obligations.

In April 2004, the Emerging Issues Task Force reached a consensus on Issue No. 03-06, “Participating Securities and the Two-Class Method Under FASB Statement No. 128, Earnings Per Share” (“EITF 03-06”). EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earning per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security. EITF 03-06 is effective for fiscal periods beginning after March 31, 2004. The adoption of EITF 03-06 did not have an effect on our net income (loss) per share.

In September 2004, the Emerging Issues Task Force reached a consensus on Issue No. 04-08, “The Effect of Contingently Convertible Debt on Diluted Earnings per Share,” which changes the treatment of contingently convertible debt instruments in the calculation of diluted earnings per share. Contingently convertible debt instruments are financial instruments that include a contingent feature, such as a feature by which the debt becomes convertible into common shares of the issuer if the issuer’s common stock price has exceeded a predetermined threshold for a specified time period. Prior to the new consensus, most issuers excluded the potential dilutive effect of the conversion feature from diluted earnings per share until the contingency threshold is met. EITF Issue No. 04-08 provides that these debt instruments should be included in the earnings per share computation (if dilutive) regardless of whether the contingent feature has been met. This change does not have any effect on net income (loss), but may affect the related per share amounts. The new rules will be effective for reporting periods ending after December 15, 2004. We are currently evaluating the impact of adoption of EITF 04-08 on our earnings (loss) per share.

In October 2004, the Emerging Issues Task Force reached a consensus on Issue No. 04-10, “Determining Whether to Aggregate Operating Segments That Do Not Meet the Quantitative Thresholds,” which clarifies the guidance in paragraph 19 of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” According to EITF Issue No. 04-10, operating segments that do not meet the quantitative thresholds can be aggregated only if aggregation is consistent with the objective and basic principles of SFAS No. 131, the segments have similar economic characteristics,

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and the segments share a majority of the aggregation criteria listed in items (a)-(e) in paragraph 17 of SFAS No. 131. The consensus applies to fiscal years ending after October 13, 2004. We are currently evaluating the impact of applying this guidance.

13. REPORTABLE SEGMENTS

We manage our business segments primarily based upon the type of product or service provided. We have five principal industry segments: Domestic Rentals; International Rentals; Parts, Service and Used Equipment; Compressor and Accessory Fabrication; and Production and Processing Equipment Fabrication. The Domestic and International Rentals segments primarily provide natural gas compression and production and processing equipment rental and maintenance services to meet specific customer requirements on Hanover-owned assets. The Parts, Service and Used Equipment segment provides a full range of services to support the surface production needs of customers from installation and normal maintenance and services to full operation of a customer’s owned assets and surface equipment as well as sales of used equipment. The Compressor and Accessory Fabrication Segment involves the design, fabrication and sale of natural gas compression units and accessories to meet unique customer specifications. The Production and Processing Equipment Fabrication Segment designs, fabricates and sells equipment used in the production and treating of crude oil and natural gas and engineering, procurement and construction of heavy wall reactors for refineries and desalination plants.

We evaluate the performance of our segments based on segment gross profit. Segment gross profit for each segment includes direct revenues and operating expenses attributable to that segment. Costs excluded from segment gross profit include selling, general and administrative, depreciation and amortization, leasing, interest, foreign currency translation, provision for cost of litigation settlement, goodwill impairment, other expenses and income taxes. Amounts defined as “Other” include equity in income of non-consolidated affiliates, results of other insignificant operations and corporate related items primarily related to cash management activities. Revenues include sales to external customers. Intersegment sales and any resulting profits are eliminated in consolidation. We no longer include intersegment sales when we evaluate the performance of our segments and have adjusted prior periods to conform to the 2004 presentation. Our chief executive officer does not review asset information by segment.

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The following tables present sales and other financial information by industry segment for the three months ended September 30, 2004 and 2003.

     The following tables present sales and other financial information by industry segment for the nine months ended September 30, 2004 and 2003.

14. DISCONTINUED OPERATIONS AND OTHER ASSETS HELD FOR SALE

During the fourth quarter of 2002, Hanover’s Board of Directors approved management’s plan to dispose of our non-oilfield power generation projects, which were part of our domestic rental business, and certain used equipment businesses, which were part of our parts and service business. These disposals meet the criteria established for recognition as discontinued operations under SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (“SFAS 144”). SFAS 144 specifically requires that such amounts must represent a component of a business comprised of operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. These businesses are reflected as discontinued operations in our condensed consolidated statement of operations. Due to changes in market conditions, the disposal plan was not completed in 2003. We are continuing to actively market these assets and have made valuation adjustments as a result of the change in market conditions. We have sold certain assets related to our used equipment business for total sales proceeds of $6.2 million during the nine months ended September 30, 2004 that resulted in $0.2 million in income, net of write downs of approximately $0.7 million of assets held for sale. In the nine months ended September 2004, we sold certain assets held for sale including a fabrication facility that was closed as part of the consolidation of our fabrication operations in 2003 and was classified as an asset held for sale on our balance sheet. We received proceeds of $6.8 million from these sales that resulted in a $0.2 million gain and is reflected in other revenue. We expect to sell the majority of remaining assets within the next 6 months and the assets and liabilities are reflected as held-for-sale on our condensed consolidated balance sheet.

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

As a result of our consolidation efforts during 2003, we reclassified certain closed facilities to assets held for sale.

Summary balance sheet data for assets held for sale as of September 30, 2004 (in thousands):

Summary balance sheet data for assets held for sale (including assets related to discontinued operations) as of December 31, 2003 (in thousands):

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15. INCOME TAXES

During the first nine months of 2004, we recorded a net tax provision of $18.0 million compared to a benefit from taxes of $18.5 million for the first nine months of 2003. Our effective tax rate for the nine months ending September 30, 2004 was (302)%, compared to 20% for the nine months ended September 30, 2003. Due to Hanover’s recent domestic tax losses, we cannot reach the conclusion that it is “more likely than not” that certain of our U.S. deferred tax assets will be realized in the near future. Accordingly, our provision for income taxes for the nine months ended September 30, 2004 did not include a full tax benefit for our estimate of anticipated U.S. losses because the benefit is not anticipated to be realized in the near future.

We reclassified approximately $23.8 million, net of a valuation allowance of $2.4 million, to current deferred income taxes that, at December 31, 2003, had previously been included as part of our net deferred income tax liability. This immaterial reclassification had no impact on our consolidated results of operations, cash flows or shareholders’ equity. Due to our current tax position in the U.S., we recorded a full valuation allowance, $2.4 million in current deferred income taxes and $23.3 million in non-current deferred tax liability, against our net U.S. deferred tax assets. See Note 13 in “Notes to the Consolidated Financial Statements” in our annual report on Form 10-K for the fiscal year end December 31, 2003 for further information regarding our tax valuation allowances.

16. SUBSEQUENT EVENTS

On November 2, 2004, we sold the compression rental assets of our Canadian subsidiary, Hanover Canada Corporation, to Universal Compression Canada, a subsidiary of Universal Compression Holdings, Inc., for approximately $56.9 million. Additionally, we have agreed to sell our ownership interest in Collicutt Energy Services Ltd. (“CES”) for approximately $2.6 million to an entity owned by Steven Collicutt. Hanover owns approximately 2.6 million shares in CES and this transaction is anticipated to close prior to year-end 2004. As of September 30, 2004, these assets were carried on our Condensed Consolidated Balance Sheet at approximately $59.6 million including $57.9 million of fixed assets. For the nine months ended September 30, 2004, we reported approximately $4.6 million in income before tax from these assets. The results of these operations will be reported as discontinued operations.

During October 2004, we sold an asset held for sale related to our discontinued power generation business for approximately $7.5 million and expect to realize a gain of approximately $0.7 million. This asset was sold to a subsidiary of The Wood Group. The Wood Group owns 49.5% of the Simco/Harwat Consortium, a joint venture gas compression project in Venezuela in which we hold a 35.5% ownership interest.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain matters discussed in this Quarterly Report on Form 10-Q are “forward-looking statements” intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements can generally be identified as such because the context of the statement will include words such as we “believe”, “anticipate”, “expect”, “estimate” or words of similar import. Similarly, statements that describe Hanover’s future plans, objectives or goals or future revenues or other future financial metrics are also forward-looking statements. Such forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those anticipated as of the date of this report. These risks and uncertainties include:

•

our inability to renew our short-term leases of equipment with our customers so as to fully recoup our cost of the equipment;

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a prolonged substantial reduction in oil and natural gas prices, which could cause a decline in the demand for our compression and oil and natural gas production equipment;

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reduced profit margins or the loss of market share resulting from competition or the introduction of competing technologies by other companies;

•

legislative changes or changes in economic or political conditions in the countries in which we do business;

•

the inherent risks associated with our operations, such as equipment defects, malfunctions and failures and natural disasters;

•

our inability to implement certain business objectives, such as:

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integrating acquired businesses,

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implementing our new enterprise resource planning systems,

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generating sufficient cash,

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accessing the capital markets,

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refinancing existing or incurring additional indebtedness to fund our business, and

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executing our exit and sale strategy with respect to assets classified on our balance sheet as discontinued operations and held for sale;

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governmental safety, health, environmental and other regulations, which could require us to make significant expenditures; and

•

our inability to comply with covenants in our debt agreements and the decreased financial flexibility associated with our substantial debt.

Other factors besides those described in this Form 10-Q could also affect our actual results. You should not unduly rely on the forward-looking statements contained in this Form 10-Q, which speak only as of the date of this Form 10-Q. Except as otherwise required by law, we undertake no obligation to publicly revise any forward-looking statement to reflect

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circumstances or events after the date of this Form 10-Q or to reflect the occurrence of unanticipated events. You should, however, review the factors and risks we describe in our Annual Report on Form 10-K for the year ended December 31, 2003 and the reports we file from time to time with the SEC after the date of this Form 10-Q. All forward-looking statements attributable to Hanover are expressly qualified in their entirety by this cautionary statement.

GENERAL

Hanover Compressor Company, a Delaware corporation, (“we”, “Hanover”, or the “Company”) together with its subsidiaries, is a global market leader in the full service natural gas compression business and is also a leading provider of service, fabrication and equipment for oil and natural gas processing and transportation applications. We sell and rent this equipment and provide complete operation and maintenance services, including run-time guarantees, for both customer-owned equipment and our fleet of rental equipment. Hanover was founded as a Delaware corporation in 1990, and has been a public company since 1997. Our customers include both major and independent oil and gas producers and distributors as well as national oil and gas companies in the countries in which we operate. Our maintenance business, together with our parts and service business, provides solutions to customers that own their own compression and surface production and processing equipment, but want to outsource their operations. We also fabricate compressor and oil and gas production and processing equipment and provide gas processing and treating and oilfield power generation services, primarily to our domestic and international customers as a complement to our compression services. In addition, through our subsidiary, Belleli Energy S.r.l. (“Belleli”), we provide engineering, procurement and construction services primarily related to the manufacturing of heavy wall reactors for refineries and construction of desalination plants, primarily for use in Europe and the Middle East.

Substantially all of our assets and operations are owned or conducted by our wholly owned subsidiary, Hanover Compression Limited Partnership (“HCLP”).

OVERVIEW

Our revenue and other income for the three months ended September 30, 2004 was $322.5 million compared to $275.2 million for the three months ended September 30, 2003. Net loss for the three months ended September 30, 2004 was $5.3 million, or $0.06 per share, compared with a net loss of $145.4 million, or $1.79 per share, for the three months ended September 30, 2003. The relative improvement in our operating results was primarily due the inclusion in the three months ended September 30, 2003 of a cumulative effect of accounting change of $133.7 million ($86.9 million net of tax), the write-down of certain non-core assets as discontinued operations of $16.3 million ($10.6 million after tax), impairments recorded for rental fleet assets to be sold or scrapped of $14.4 million ($9.8 million after tax) and a $35.5 million goodwill impairment charge associated with Belleli. In addition, our provision for income taxes for the three months ended September 30, 2004 did not include a full tax benefit for our estimate of anticipated U.S. losses. Based on a 35% federal U.S. tax rate, we estimate that our tax expense was approximately $4.7 million higher because of our current tax position in the United States. This expense is discussed in greater detail under “Income Taxes” below.

Our revenue and other income for the nine months ended September 30, 2004 was $893.5 million compared to $825.2 million for the nine months ended September 30, 2003. Net loss for the nine months ended September 30, 2004 was $23.8 million, or $0.28 per share, compared with a net loss of $171.8 million, or $2.12 per share, for the nine months ended September 30, 2003. The improvement in our operating results was primarily the result of the inclusion in the nine months ended September 30, 2003 of the charges taken in the third quarter of 2003 discussed above and a $40.3 million ($26.2 million after tax) provision for the estimated settlement cost of the securities-related litigation recorded in the first quarter of 2003. The improvement during 2004 also reflects approximately $8.5 million in additional depreciation expense related to the adoption of FIN 46 that was recorded during the nine months ended September 30, 2004. In addition, our provision for income taxes for the nine months ended September 30, 2004 did not include a full tax benefit for our estimate of anticipated U.S. losses. Based on a 35% federal U.S. tax rate, we estimate that our tax expense was approximately $18.8 million higher because of our current tax position in the United States. This expense is discussed in greater detail

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under “Income Taxes” below.

During the nine months ended September 30, 2004, our domestic and international rental operations experienced an improvement in revenues, which we attribute to stronger market conditions. However, our domestic rental business gross margin was lower than we anticipated and was impacted by poor performance primarily at one of our domestic geographic business units. We are working to improve these gross margins. In addition, during the nine months ended September 30, 2004, we achieved an improvement in backlog in both the compression and production and processing fabrication lines of business. Our parts, service and used equipment business segment benefited from strong international service and installation revenue and gross profit, but our base parts and service revenue was lower than anticipated. While this business started to pick up in the third quarter of 2004, we believe that we experienced lower revenue in the first half of this year due to delays in maintenance by our customers because of the strong gas price environment, particularly in North America.

Our third quarter 2004 reported utilization declined by approximately 2% compared to the reported utilization for the second quarter of 2004. This was primarily due to a correction we made in July 2004 as we refined our procedures used to calculate horsepower for utilization percentages, and discovered that some units were previously double counted in this calculation. As a result, we believe that our actual utilization percentage from second quarter 2004 to third quarter 2004 did not significantly change. We believe that our utilization percentage is a helpful measure in understanding our long-term trends relating to our rental fleet, but utilization statistics should not be considered as an alternative to reported financial information presented in accordance with generally accepted accounting principles, and may not be comparably calculated from one company to another.

Total compression horsepower at September 30, 2004 was approximately 3,483,000, consisting of approximately 2,569,000 horsepower in the United States and approximately 914,000 horsepower internationally. We estimate that our total compression horsepower utilization rate in September, 2004 was approximately 82%, compared to utilization of approximately 81% in December 2003 and approximately 80% in September, 2003. Domestic and international utilization in September 2004 was approximately 76% and 96%, respectively, compared to approximately 76% and 94%, respectively, in December 2003, and approximately 75% and 94%, respectively, in September 2003.

At September 30, 2004, Hanover’s total third-party fabrication backlog, excluding Belleli, was approximately $115 million compared to approximately $46 million at December 31, 2003 and $61 million at September 30, 2003. Backlog for Belleli at September 30, 2004 was approximately $143 million, compared to approximately $107 million at December 31, 2003 and $66 million at September 30, 2003. The compressor and accessory fabrication backlog was approximately $43 million at September 30, 2004, compared to approximately $28 million at December 31, 2003 and $29 million at September 30, 2003. The backlog for production and processing equipment fabrication, excluding Belleli, was approximately $72 million at September 30, 2004, compared to approximately $18 million at December 31, 2003 and $32 million at September 30, 2003.

Industry Conditions

The North American rig count increased by 5% to 1,513 at September 30, 2004 from 1,441 at September 30, 2003, and the twelve-month rolling average North American rig count increased by 16% to 1,521 at September 30, 2004 from 1,307 at September 30, 2003. In addition, the twelve-month rolling average New York Mercantile Exchange wellhead natural gas price increased to $5.51 per Mcf at September 30, 2004 from $5.24 per Mcf at September 30, 2003. During the nine months ended September 30, 2004, we experienced an 8% increase in revenues and other income as a result of an improvement in market conditions and our focus on improving our sales success ratio on new bid opportunities.

Facility Consolidation

We had previously announced our plan to reduce our U.S. headcount by approximately 500 employees worldwide and to close four fabrication facilities. During the year ended December 31, 2002, we accrued approximately $2.7 million in employee separation costs related to the reduction in workforce. During the year ended December 31, 2003, we paid approximately $2.0 million in employee separation costs, implemented further cost saving initiatives and closed two facilities in addition to the four fabrication facilities we closed pursuant to our original reduction plan. During the first nine months of 2004, we paid an additional $0.7 million in employee separation costs related to the completion of these activities. From December 31, 2002 to September 30, 2004, our U.S. workforce has decreased by approximately 700 employees.

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U.S. Tax Position

As a result of recent operating losses, we were in a net deferred tax asset position (for U.S. income tax purposes) for the first time in 2003. Due to our recent domestic tax losses, we could not reach the conclusion that it was “more likely than not” that certain of our U.S. deferred tax assets will be realized in the near future. Accordingly, for 2003 we provided a $25.7 million deferred tax valuation allowance against our net U.S. deferred tax asset. We will be required to record additional valuation allowances if our domestic deferred tax asset position is increased and the “more likely than not” criteria of SFAS 109 continues to not be met. If we are required to record additional valuation allowances, our effective tax rate will be above the statutory rate. Our preliminary analysis leads us to believe that we will likely be required to record additional valuation allowances in 2004, and we may be required to record additional valuation allowances in future periods.

Canada Asset Sale

On November 2, 2004, we sold the compression rental assets of our Canadian subsidiary, Hanover Canada Corporation, to Universal Compression Canada, a subsidiary of Universal Compression Holdings, Inc., for approximately $56.9 million. Additionally, we have agreed to sell our ownership interest in Collicutt Energy Services Ltd. (“CES”) for approximately $2.6 million to an entity owned by Steven Collicutt. Hanover owns approximately 2.6 million shares in CES and this transaction is anticipated to close prior to year-end 2004. As of September 30, 2004, these assets were carried on our Condensed Consolidated Balance Sheet at approximately $59.6 million including $57.9 million of fixed assets. For the nine months ended September 30, 2004, we reported approximately $4.6 million in income before tax from these assets. The results of these operations will be reported as discontinued operations.

RESULTS OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2003

Summary of Business Segment Results

Domestic Rentals
(in thousands)

Domestic rental revenue increased during the three months ended September 30, 2004, compared to the three months ended September 30, 2003, due primarily to improvement in market conditions. Gross profit and gross margin for the three months ended September 30, 2004 decreased compared to the three months ended September 30, 2003, due to increased maintenance and repair expense primarily at one of our three domestic

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geographic business units. We are working to improve this business unit’s results. The decrease in margin at this business unit decreased our overall domestic rental margin by approximately 4%.

International Rentals
(in thousands)

During the three months ended September 30, 2004 international rental revenue and gross profit increased, compared to the three months ended September 30, 2003, primarily due to increased compression and processing plant rental activity in Argentina, Brazil, Mexico and Venezuela. Gross margin for the three months ended September 30, 2004 increased when compared to the three months ended September 30, 2003, primarily due to operating efficiencies achieved as a result of the increase in sales without requiring a corresponding increase in operating expenses.

Parts, Service and Used Equipment
(in thousands)

Parts, service and used equipment revenue for the three months ended September 30, 2004 was higher than the three months ended September 30, 2003 due primarily to increased demand resulting from stronger industry conditions. Gross profit and gross margin for the three months ended September 30, 2004 was higher than the results for the three months ended September 30, 2003 primarily due to a high margin sale of a gas plant. For the three months ended September 30, 2004, parts and service revenue was $36.7 million with a gross margin of 23%, compared to $29.7 million and 33%, respectively, for the three months ended September 30, 2003. The decrease in margins was primarily due to a decrease in margins by our domestic parts and service business, which has not performed as anticipated and, thus, we are working to improve its results. Used rental equipment and installation sales revenue in the three months ended September 30, 2004 was $14.2 million with a gross margin of 43%, compared to $15.9 million with a 3% gross margin for the three months ended September 30, 2003. Our used rental equipment and installation sales and gross margins vary significantly from period to period and are dependent on the exercise of purchase options on rental equipment by customers and the start-up of new projects by customers.

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Compression and Accessory Fabrication
(in thousands)