10-Q/A 1 d10qa.txt FORM 10-Q/A FOR THE PERIOD 9/30/2001 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________ TO __________ Commission File Number 1-13071 HANOVER COMPRESSOR COMPANY (Exact name of registrant as specified in its charter) Delaware 76-0625124 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 12001 North Houston Rosslyn Houston, Texas 77086 (Address of principal executive offices) (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 As of November 12, 2001 there were 79,084,551 shares of the Company's common stock $0.001 par value, outstanding. EXPLANATORY NOTE Hanover Compressor Company (the "Company") is filing this amendment to its Quarterly Report on Form 10-Q for the quarter ended September 30, 2001 in order to restate the Consolidated Financial Statements and make conforming revisions to "Management's Discussion and Analysis of Financial Condition and Results of Operations." In conjunction with a separate review of the Company's joint ventures and other transactions conducted by the Board of Directors in early 2002, the Company determined that restatement was appropriate. The net effect of this restatement for the three months ended September 30, 2001 was as follows: (i) a decrease in revenues of $17.5 million, from $298.8 million to $281.3 million; (ii) a decrease in income before taxes of $4.2 million, from $36.2 million to $32.0 million; (iii) a decrease in net income of $2.7 million, from $22.5 million to $19.8 million; and (iv) a decrease in earnings per common share of $0.04 basic and $0.03 diluted. The net effect of this restatement for the nine months ended September 30, 2001 was as follows: (i) a decrease in revenues of $25.1 million, from $781.6 million to $756.5 million; (ii) a decrease in income before taxes of $5.9 million, from $104.3 million to $98.4 million; (iii) a decrease in net income of $3.6 million, from $64.5 million to $60.9 million; and (iv) a decrease in earnings per common share of $0.05 basic and $0.05 diluted. The net effect of this restatement for the three months ended September 30, 2000 was as follows: (i) a decrease in revenues of $13.6 million, from $162.6 million to $149.0 million; (ii) a decrease in income before taxes of $4.8 million, from $25.0 million to $20.2 million; (iii) a decrease in net income of $3.0 million, from $15.4 million to $12.4 million; and (iv) a decrease in earnings per common share of $0.05 basic and $0.05 diluted. The net effect of this restatement for the nine months ended September 30, 2000 was as follows: (i) a decrease in revenues of $13.6 million, from $370.2 million to $356.6 million; (ii) a decrease in income before taxes of $4.8 million, from $62.7 million to $57.9 million; (iii) a decrease in net income of $3.0 million, from $39.3 million to $36.3 million; and (iv) a decrease in earnings per common share of $0.05 basic and $0.05 diluted. For additional detail of the transactions involved in the restatement and their impact on the Condensed Consolidated Financial Statements see Note 14 of the Notes to Condensed Consolidated Financial Statements. 2 HANOVER COMPRESSOR COMPANY CONDENSED CONSOLIDATED BALANCE SHEET (unaudited) (in thousands of dollars, except for par value and share amounts)
September 30, December 31, 2001 2000 ------------ ------------ (Restated) (Restated) ASSETS Current assets: Cash and cash equivalents $ 22,306 $ 45,484 Accounts receivable trade, net 301,373 223,022 Inventory 249,321 145,442 Costs and estimated earnings in excess of billings on uncompleted contracts 64,397 24,976 Prepaid taxes 32,066 19,948 Other current assets 27,356 12,384 ---------- ---------- Total current assets 696,819 471,256 Property, plant and equipment, net 1,009,269 573,596 Goodwill, net 199,683 141,973 Intangible and other assets 64,228 38,479 Investment in nonconsolidated affiliates 181,635 26,452 ---------- ---------- Total assets $2,151,634 $1,251,756 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt $ 5,607 $ 2,423 Short-term notes payable 10,073 Accounts payable, trade 108,717 88,651 Accrued liabilities 97,137 46,705 Advance billings 48,386 32,292 Billings on uncompleted contracts in excess of costs and estimated earnings 11,805 5,669 ---------- ---------- Total current liabilities 271,652 185,813 Long-term debt 434,709 110,935 Other liabilities 203,636 132,895 Deferred income taxes 128,533 103,405 ---------- ---------- Total liabilities 1,038,530 533,048 Commitments and contingencies (Note 12) Mandatorily redeemable convertible preferred securities 86,250 86,250 Common stockholders' equity: Common stock, $.001 par value; 200,000,000 shares authorized; 79,155,497 and 66,454,703 shares issued and outstanding, respectively 79 66 Additional paid-in capital 825,173 483,737 Notes receivable - employee stockholders (1,499) (1,531) Accumulated other comprehensive loss (8,393) (457) Retained earnings 212,211 151,360 Treasury stock - 75,739 common shares at cost (717) (717) ---------- ---------- Total common stockholders' equity 1,026,854 632,458 ---------- ---------- Total liabilities and common stockholders' equity $2,151,634 $1,251,756 ========== ==========
The accompanying notes are an integral part of these financial statements. 3 HANOVER COMPRESSOR COMPANY CONDENSED CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME (unaudited) (in thousands of dollars, except per share amounts)
Three Months Nine Months Ended September 30, Ended September 30, ------------------- ------------------- 2001 2000 2001 2000 ---- ---- ---- ---- (Restated) (Restated) (Restated) (Restated) Revenues and other: Rentals $104,995 $ 66,309 $275,120 $180,210 Parts, service and used equipment 67,658 28,743 168,017 64,293 Compressor fabrication 55,571 26,428 168,061 55,599 Production and processing equipment fabrication 50,363 25,634 135,760 46,745 Equity in income of non-consolidated affiliates 1,688 455 3,751 1,953 Other 1,035 1,391 5,811 7,801 -------- -------- -------- -------- 281,310 148,960 756,520 356,601 -------- -------- -------- -------- Expenses: Rentals 35,390 23,263 92,663 62,104 Parts, service and used equipment 47,835 17,951 111,878 42,202 Compressor fabrication 45,655 22,455 140,644 46,329 Production and processing equipment fabrication 39,831 20,546 107,809 36,964 Selling, general and administrative 24,212 14,467 68,593 34,481 Depreciation and amortization 25,498 14,179 62,482 36,830 Leasing expense 16,614 11,460 47,541 29,596 Interest expense 4,200 2,831 10,255 5,466 Distributions on mandatorily redeemable convertible preferred securities 1,593 1,593 4,780 4,776 Other 8,466 11,473 -------- -------- -------- -------- 249,294 128,745 658,118 298,748 -------- -------- -------- -------- Income before income taxes 32,016 20,215 98,402 57,853 Provision for income taxes 12,168 7,820 37,387 21,520 -------- -------- -------- -------- Net income before cumulative effect of accounting change 19,848 12,395 61,015 36,333 Cumulative effect of accounting change for derivative instruments, net of income tax (164) -------- -------- -------- -------- Net Income 19,848 12,395 60,851 36,333 Other comprehensive income (loss), net of tax: Adjustment to record changes in fair value of derivative financial instruments (8,675) (7,914) Foreign currency translation adjustment (6) 11 (22) (154) -------- -------- -------- -------- Comprehensive income $ 11,167 $ 12,406 $ 52,915 $ 36,179 ======== ======== ======== ======== Diluted net income per share: Net income before cumulative effect in accounting change $ 19,848 $ 12,395 $ 61,015 $ 36,333 Distributions on mandatorily redeemable convertible preferred securities, net of income tax 1,036 3,108 Cummulative effect of accounting change, net of income tax (164) -------- -------- -------- -------- Net income for purposes of computing diluted net income per share $ 20,884 $ 12,395 $ 63,959 $ 36,333 ======== ======== ======== ======== Weighted average common and common equivalent shares outstanding: Basic 73,194 63,966 70,098 60,324 -------- -------- -------- --------- Diluted 81,890 67,271 78,997 64,619 -------- -------- -------- --------- Earnings per common share: Basic $ 0.27 $ 0.19 $ 0.87 $ 0.60 -------- -------- -------- --------- Diluted $ 0.26 $ 0.18 $ 0.81 $ 0.56 -------- -------- -------- ---------
The accompanying notes are an integral part of these financial statements. 4 HANOVER COMPRESSOR COMPANY CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (unaudited) (in thousands of dollars)
Nine Months Ended September 30, ------------------------------- 2001 2000 ---- ---- (Restated) (Restated) Cash flows from operating activities: Net income $ 60,851 $ 36,333 Adjustments: Depreciation and amortization 62,482 36,830 Amortization of debt issuance costs and debt discount 1,475 479 Bad debt expense 1,608 840 Gain on sale of property, plant and equipment (4,157) (8,708) Equity in income of nonconsolidated affiliates (3,751) (1,953) Loss on derivative instruments 8,976 Deferred income taxes 22,746 5,998 Changes in assets and liabilities, excluding impact of business combinations: Accounts receivable (21,018) (28,014) Inventory (77,783) (34,814) Costs and estimated earnings in excess of billings on uncompleted contracts (33,284) (10,218) Accounts payable and other liabilities 9,822 25,171 Advance billings 16,094 2,749 Other (2,109) (4,442) --------- --------- Net cash provided by operating activities 41,952 20,251 --------- --------- Cash flows from investing activities: Capital expenditures (484,830) (207,827) Deferred leasing transaction costs (17,738) (2,660) Proceeds from sale of property, plant and equipment 582,557 218,660 Cash used for business combinations, net of cash acquired (377,537) (174,827) Cash used to acquire investments in nonconsolidated affiliates (6,514) (8,720) --------- --------- Net cash used in investing activities (304,062) (175,374) --------- --------- Cash flows from financing activities: Net borrowing (repayment) on revolving credit facility (17,500) 102,900 Repayment of long-term debt and short-term notes (14,920) (4,290) Issuance of convertible senior notes, net 185,332 - Issuance of common stock, net 83,850 59,400 Proceeds from warrant conversions and stock option exercises 2,174 2,774 Repayment of shareholder notes 32 1,669 --------- --------- Net cash provided by financing activities 238,968 162,453 --------- --------- Effect of exchange rate changes on cash and cash equivalents (36) (44) --------- --------- Net increase (decrease) in cash and cash equivalents (23,178) 7,286 Cash and cash equivalents at beginning of period 45,484 5,756 --------- --------- Cash and cash equivalents at end of period $ 22,306 $ 13,042 ========= ========= Acquisitions of businesses: Property, plant and equipment acquired $ 605,581 $ 190,521 Other assets acquired, net of cash acquired $ 247,510 $ 92,905 Goodwill $ 64,742 $ 106,777 Liabilities $ (64,264) $ (60,343) Debt issued $(215,305) $ Deferred taxes $ (6,802) $ (15,167) Common stock issued $(253,925) $(139,866)
The accompanying notes are an integral part of these financial statements. 5 HANOVER COMPRESSOR COMPANY Notes to Condensed Consolidated Financial Statements 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements of Hanover Compressor Company (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. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. It is the opinion of 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 the Company 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 the Company's Annual Report on Form 10-K for the year ended December 31, 2000. These interim results are not necessarily indicative of results for a full year. 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 30 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, net of accumulated depreciation is recorded in parts, service and used equipment expenses. Sales proceeds are recorded in parts, service and used equipment revenues. 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. Prior to July 1, 2001, compression equipment in the rental fleet was depreciated using the straight-line method over an estimated useful life that ranged from 4 to 25 years. Effective July 1, 2001, the Company changed its estimate of the useful life of certain compression equipment to range from 15 to 30 years. The effect of this change in estimate on the quarter ended September 30, 2001 was a decrease in depreciation expense of approximately $1.5 million and an increase in net income of approximately $0.9 million ($0.01 per share). The Company anticipates this change in estimated useful life will reduce future depreciation expense, based on the Company's current depreciable assets, by approximately $3 million per quarter. 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 and convertible securities. For the three months ended September 30, 2001 and 2000, common stock equivalents relating to options of 3,867,000 and 3,302,000, respectively, are included in diluted shares. For each of the three month periods, 4,000 warrants are included in diluted shares. For each of the three month ended September 30, 2001 4,825,000 mandatorily redeemable convertible preferred securities are included in diluted shares. Convertible senior notes were excluded from the diluted shares for the three-month periods presented as their effect would be anti-dilutive. Included in diluted shares are common stock equivalents relating to options of 4,071,000 and 3,927,000, and warrants of 4,000 and 368,000, for the nine months ended September 30, 2001 and 2000, respectively, and mandatorily redeemable convertible preferred securities of 4,825,000 for the nine months ended September 30, 2001. The mandatorily redeemable convertible preferred securities were excluded from the diluted shares for the nine months ended September 30, 2000 and the convertible senior notes were excluded from the diluted shares for all periods presented as their effects would be anti- dilutive. 6 Reclassifications Certain amounts in the prior years' financial statements have been reclassified to conform to the 2001 financial statement classification. These reclassifications have no impact on net income. 2. BUSINESS COMBINATIONS In March 2001, the Company purchased the OEC Compression Corporation ("OEC") in an all-stock transaction for approximately $100.7 million, including the payment of approximately $63.0 million of OEC indebtedness. The Company issued an aggregate of approximately 1,145,000 shares of common stock to stockholders of OEC. The acquisition was accounted for under the purchase method of accounting and is included in Hanover's financial statements commencing in April 2001. In August 2001, the Company acquired 100% of the issued and outstanding shares of the Production Operators Corporation natural gas compression business, ownership interests in certain joint venture projects in South America, and related assets ("POI") from Schlumberger for $761 million in cash, common stock and indebtedness, subject to certain post-closing adjustments pursuant to the purchase agreement (the "POI Acquisition"). Under the terms of the definitive agreement, Schlumberger received approximately $270 million in cash, $150 million in a long-term subordinated note and approximately 8,708,000 shares, or approximately 10% of the outstanding shares, of Hanover common stock which are required to be held by Schlumberger for at least three years following the closing date. The ultimate number of shares issued under the purchase agreement was determined based on the nominal value of $283 million divided by the 30 day average closing price of Hanover common stock as defined under the agreement and subject to a collar of $41.50 and $32.50. The estimated fair value of the stock issued was $212.5 million, based on the market value of the shares at the time the number of shares issued was determined reduced by an estimated 20% discount due to the restrictions on the stock's marketability. Additionally, under the terms of the agreement, the Company is required to pay $58 million upon the occurrence of certain events (see Note 12) relating to one of the joint ventures acquired by Hanover in the transaction. The purchase price was a negotiated amount between the Company and Schlumberger and the Company expects the acquisition to be accretive to earnings in future periods. The Company believes the purchase price represents the fair value of the POI business acquired based upon its assets, customer base, reputation, market position (domestic and international) and potential for long-term growth. The POI Acquisition was accounted for as a purchase and is included in Hanover's financial statements commencing on September 1, 2001. The Company recorded approximately $36 million in goodwill related to the acquisition which will not be amortized in accordance with the transition provisions of SFAS 142 (See Note 10). In addition, the Company recorded $18.3 million in estimated value of identifiable intangible assets. The purchase price is subject to certain post-closing adjustments and a contingent payment by Hanover to Schlumberger based on the realization of certain tax benefits by Hanover over the next 15 years. This final amount of goodwill and identifiable intangible assets could differ from the amount recorded upon completion of third party valuations of the acquired assets and any required purchase price adjustment under the agreement. The pro forma information set forth below assumes the acquisitions of OEC and POI completed in 2001, and the acquisitions of the Dresser-Rand Company's compression services division and Applied Process Solutions, Inc. ("APSI") completed in 2000 are accounted for as if the purchases had occurred at the beginning of 2000. The pro forma information is presented for informational purposed only and is not necessarily indicative of the results of operations that would have been achieved had the acquisitions been consummated at that time (in thousands, except per share amounts):
Three Months Ended September 30, Nine Months Ended September 30, -------------------------------- ------------------------------- 2001 2000 2001 2000 ---- ---- ---- ---- (Restated) (Restated) (Restated) (Restated) Revenue $307,477 $203,874 $865,933 $581,298 Net income before cumulative effect of accounting change * $ 17,579 $ 12,108 $ 58,929 $ 33,734 Earnings per common share--basic $ 0.22 $ 0.16 $ 0.75 $ 0.45 Earnings per common share--diluted $ 0.21 $ 0.15 $ 0.71 $ 0.43
* Net income (and per share amounts) include other expense of $2.8 million for the three and nine months ended September 30, 2001, respectively (see note 6). 7 3. INVENTORIES Inventory consisted of the following amounts (in thousands): September 30, December 31, 2001 2000 ---- ---- (Restated) (Restated) Parts and supplies.............................. $188,109 $93,308 Work in progress................................ 54,356 47,193 Finished goods.................................. 6,856 4,941 -------- -------- $249,321 $145,442 ======== ======== 4. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consisted of the following (in thousands): September 30, December 31, 2001 2000 ---- ---- (Restated) (Restated) Compression equipment and facilities... $1,016,844 $576,328 Land and buildings..................... 50,367 35,233 Transportation and shop equipment...... 60,114 44,202 Other.................................. 21,138 15,279 ---------- -------- 1,148,463 671,042 Accumulated depreciation............... (139,194) (97,446) ---------- -------- $1,009,269 $573,596 ========== ======== In August 2001, the Company exercised its purchase option under the 1998 operating lease for $200 million. The depreciable basis of the compressors purchased has been reduced by the deferred gain of approximately $42 million which was recorded at inception of the lease and previously included as an other liability on the Company's balance sheet (see note 8). 5. INVESTMENTS IN NONCONSOLIDATED AFFILIATES In connection with the POI Acquisition in August 2001, the Company acquired ownership interests in certain joint venture projects in South America. The investments in joint ventures are accounted for using the equity method of accounting as the Company has ability to exercise significant influence over each joint venture. The Company's preliminary estimate of the fair value of these long-term investments totals $147 million but could change subject to completion of the third party appraisal of the joint ventures. The Company's ownership interest and the location of each joint venture is as follows: Ownership Interest Location -------- -------- Wilpro - Pigap II 30.0% Venezuela Wilpro - El Furrial 33.3% Venezuela Simco 35.5% Venezuela 8 6. LONG-TERM DEBT Long-term debt consisted of the following (in thousands):
September 30, December 31, -------------- ------------- 2001 2000 ---- ---- Revolving credit facility $ 85,000 $102,500 4.75% convertible senior notes due 2008 192,000 Schlumberger note, interest at 8.5% 150,000 Real estate mortgage, interest at 7.5%, collateralized by certain land and buildings, payable through 2002. 3,667 4,000 Other, interest at various rates, collateralized by equipment and other assets, net of unamortized discount 9,649 6,858 ------- -------- 440,316 113,358 Less--current maturities (5,607) (2,423) -------- -------- $434,709 $110,935 ======== ========
The Company's credit agreement provides for a $200 million revolving credit facility that matures on December 17, 2002. Advances bear interest at the bank's prime or a negotiated rate (4.60% and 7.5% at September 30, 2001 and December 31, 2000, 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. In March 2001, the Company issued $192 million principal amount of 4.75% convertible senior notes due 2008 (see note 7). In connection with the POI Acquisition on August 31, 2001, the Company issued a $150 million subordinated acquisition note to Schlumberger, which matures December 15, 2005. Interest on the subordinated acquisition note accrues and is payable-in-kind at the rate of 8.5% annually for the first six months after issuance and periodically increases in increments of 1% to 2% per annum to a maximum interest rate 42 months after issuance of 15.5%. In the event of an event of default under the subordinated acquisition note, interest will accrue at a rate of 2% above the then applicable rate. The subordinated acquisition note is subordinated to all of the Company's indebtedness other than indebtedness to fund future acquisitions. In the event that the Company completes an offering of equity securities, the Company is required to apply the proceeds of the offering to repay amounts outstanding under the subordinated acquisition note as long as no default exists or would exist under our other indebtedness as a result of such payment. In August of 2001, the Company recorded in other expense a $2.8 million charge related to a bridge loan commitment fee associated with Hanover's recent acquisition of POI. Maturities of long-term debt at September 30, 2001 are (in thousands of dollars): 2001--$613; 2002--$90,423; 2003--1,364; 2004--$1,053; 2005--$150,871; 2006--$546 and $195,446 thereafter. 7. STOCK AND CONVERTIBLE SENIOR NOTES OFFERING In March 2001, the Company issued $192,000,000 principal amount of 4.75% convertible senior notes due 2008. The notes mature on March 15, 2008 and are first subject to call on March 15, 2004. The notes are convertible into shares of the Company's common stock at a conversion price of approximately $43.94 per share. The Company received approximately $185.3 million of proceeds from the sale, net of underwriting and offering costs. In March 2001, the Company completed a public offering of 2,500,000 newly issued shares of the Company's common stock. The Company realized approximately $83,850,000 of proceeds from the offering net of underwriting and offering costs. 8. LEASING TRANSACTION In August 2001 and in connection with the POI Acquisition, the Company completed two sale and lease back transactions involving certain compression equipment. Concurrent with the transactions, the Company exercised its purchase option under its 1998 operating lease for $200,000,000. Under one transaction, the Company received $309,300,000 proceeds from the sale of compression equipment. Under the second transaction, the Company received $257,750,000 for the sale of additional compression equipment. Both transactions are recorded as a sale and lease back of the equipment and are recorded as operating leases. Under the $309,300,000 transaction, the equipment was sold and leased back by the Company for a 7 year period and will continue to be deployed by the Company under its normal operating procedures. The agreement calls for semi-annual rental payments of approximately $12,750,000 in addition to quarterly rental payments of approximately $245,000. Under 9 the $257,750,000 transaction, the equipment was sold and leased back by the Company for a 10 year period and will continue to be deployed by the Company under its normal operating procedures. The agreement calls for semi-annual rental payments of approximately $10,938,000 in addition to quarterly rental payments of approximately $213,000. The Company has options to repurchase the equipment under certain conditions as defined by the lease agreement. The Company incurred transaction costs of approximately $17,700,000 related to the transactions. These costs are included in intangible and other assets and are being amortized over the respective lease terms. In October 2000, the Company completed a $172,589,000 sale and lease back of certain compression equipment. In March 2000, the Company entered into a separate $200,000,000 sale and lease back of certain compression equipment. Under the March agreement, the Company received $100,000,000 proceeds from the sale of compression equipment at closing and in August 2000, the Company completed the second half of the equipment lease and received an additional $100,000,000 for the sale of additional compression equipment. In June 1999 and in July 1998 the Company completed two other separate $200,000,000 sale and lease back transactions of certain compression equipment. Under the 2000 and 1999 lease 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 under the 2000 and 1999 leases at fair market value. The 2000 and 1999 lease agreements call for variable quarterly payments that fluctuate with the London Interbank Offering Rate. The following table summarizes the proceeds, net book value of equipment sold, deferred gain on equipment sale and the residual value guarantee for each equipment lease (in thousands of dollars): SALE NET BOOK DEFERRED RESIDUAL LEASES PROCEEDS VALUE GAIN VALUE GUARANTEE ------ -------- ----- ---- --------------- June 1999..................... $200,000 $166,356 $33,644 $166,000 March and August 2000......... 200,000 166,922 33,078 166,000 October 2000.................. 172,589 155,692 16,897 142,299 August 2001................... 567,050 541,911 25,139 407,000 All transactions are recorded as a sale and lease back of the equipment and the leases are treated as operating leases. The Company has substantial residual value guarantees under the lease agreements 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 under the terms of the lease agreements. Any gains on the sale of the equipment are deferred until the end of the respective lease terms. Should the Company not exercise its purchase options under the lease agreements, the deferred gains will be recognized to the extent they exceed any residual value guarantee payments and any other payments required under the lease agreements. Upon exercise of the purchase option under the 1998 operating lease, the Company reduced its depreciable basis by the gain of approximately $42 million previously deferred. The following future minimum lease payments are due under the leasing arrangements exclusive of any guarantee payments (in thousands): 2001 -- $21,458; 2002 -- $85,833; 2003 -- $85,833; 2004 -- $80,248; 2005 -- $63,474; 2006 -- $49,375. 9. ACCOUNTING FOR DERIVATIVES The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"), as amended by SFAS 137 and SFAS 138, effective January 1, 2001. SFAS 133 requires that all derivative instruments (including certain 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. Prior to 2001, the Company entered into two interest rate swaps which are outstanding at September 30, 2001 with notional amounts of $75,000,000 and $125,000,000 and strike rates of 5.51% and 5.56%, respectively. These swap transactions were to expire in July 2001, however, they were extended for an additional two years at the option of the counterparty. The difference paid or received on the swap transactions is recognized in leasing expense. These interest rate swaps expire in July 2003. On January 1, 2001, in accordance with the transition provisions of SFAS 133, the Company recorded an unrealized loss resulting from the cumulative effect of an accounting change in the statement of income of approximately $164,000 ($.00 per share), net of tax benefit of $89,000. During the three and nine months ended September 30, 2001, the Company recognized additional unrealized loss of $5.7 million and $8.7 million, respectively, related to the change in the fair value of these interest rate swaps in other expense in the statement of income because they did not meet the specific hedge criteria as a result of the counterparty option to extend the interest rate swaps. Further, management decided not to designate the interest rate swaps as hedges at the time they were extended by the counterparty. At September 30, 2001 the Company recorded a liability of $9 million related to these interest rate swaps in other liabilities. The fair value of these interest rate swaps will fluctuate with changes in interest rates over their remaining terms and these changes in fair value will be recorded in the statement of income. 10 During the second quarter of 2001, the Company entered into three additional interest rate swaps to convert variable lease payments under certain operating lease arrangements to fixed payments as follows: Lease Maturity Date Strike Rate Notional Amount ----- ------------- ----------- --------------- March 2000 3/11/2005 5.2550% $100,000,000 August 2000 3/11/2005 5.2725% $100,000,000 October 2000 10/26/2005 5.3975% $100,000,000 These three swaps, which the Company has 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 three months and nine months ended September 30, 2001, the Company recorded a $8.7 million and $7.9 million loss, net of tax in other comprehensive income and recorded a liability related to these swaps of $13 million in other liabilities. The counterparties to all of the Company's interest rate swap agreements consist of major international financial institutions. The Company continually monitors the credit quality of these financial institutions and does not expect non-performance by any counterparty 10. ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards("SFAS") No. 141, Business Combinations. The Statement is effective for all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001, or later. All business combinations in the scope of this statement are to be accounted for using one method, the purchase method. In June 2001, the FASB issued SFAS No.142, Goodwill and Other Intangible Assets. Under SFAS No.142, amortization of goodwill to earnings will be discontinued. However, goodwill will be reviewed for impairment annually or whenever events indicate impairment may have occurred. SFAS No.142 is effective for Hanover on January 1, 2002. However, under the transition provisions of SFAS 142, goodwill acquired in a business combination for which the acquisition date is after June 30, 2001, shall not be amortized. Since the acquisition of POI was consummated after June 30, 2001, the goodwill related to the POI acquisition will not be amortized. The goodwill related to business combinations completed before June 30, 2001 continues to be amortized since Hanover has not adopted SFAS 142. At September 30, 2001, Hanover has recorded approximately $222.3 million of goodwill, of which $181.3 million is required to be amortized, at an annual rate of approximately $9.6 million, under generally accepted accounting principles. The Company is currently evaluating the effect the implementation of SFAS No. 142 will have on its financial statements. In June 2001, the FASB issued SFAS No. 143, Accounting for Obligations Associated with the Retirement of Long-Lived Assets. SFAS 143 establishes the accounting standards for the recognition and measurement of an asset retirement obligation and its associated asset retirement cost. This statement is effective for Hanover effective January 1, 2003. The Company is presently evaluating the impact that the implementation of SFAS 143 will have on its financial statements. In October 2001, the Financial Accounting Standards Board issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS 144 addresses significant issues relating to the implementation of SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and to develop a single accounting model, based on the framework established in FAS 121, for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired. This statement is effective for Hanover effective January 1, 2002. The Company is presently evaluating the impact that the implementation of SFAS 144 will have on its financial statements. 11. RELATED PARTY TRANSACTIONS During the three months ended June 30, 2001, the Company sold approximately $16.1 million of inventory recorded in parts, service and used equipment revenue to a related party. At June 30, 2001, $14.5 million was recorded in accounts receivable-trade from this related party. The $16.1 million turbine was ultimately sold to a project that is utilizing the turbine in a contract with the California Department of Water and Resources. The Company received payment in full on the turbine in December 2001. However, since the Company is a participant in the project financing, it will not record a profit related to the sale of that turbine. See Note 13. In August 2001, the Company paid $4.7 million to GKH Partners, L.P., a major stockholder of the Company, as payment for services rendered in connection with the POI Acquisition. In March 2001, the Company advanced cash to Michael J. McGhan, the Company's Chief Executive Officer, in return for two promissory notes. The notes receivable totaled $2,200,000, bear interest at 4.88% per annum, and mature in April 2006. 11 The notes are secured with full recourse, by a deed of trust and security agreement on two parcels of land and all improvements and personal property located on the land. During the nine months ending September 30, 2001, the Company sold equipment totaling approximately $12,004,000 to an affiliate of Enron Capital and Trade Resources Corp ("Enron"). 12. COMMITMENTS AND CONTINGENCIES As part of the POI Acquisition, the Company is required to make a payment of $58 million due upon the completion of a refinancing of a South American joint venture acquired by Hanover. If the joint venture fails to execute the refinancing on or before December 31, 2002, Hanover will be obligated to either put its interest in such joint venture back to Schlumberger or make the joint venture payment using other funds. This obligation is recorded in other liabilities in the accompanying balance sheet. The purchase price is also subject to certain post-closing adjustments and a contingent payment by Hanover to Schlumberger based on the realization of certain tax benefits by Hanover over the next 15 years. In January 2001, the Company entered into a facilitation agreement with Bellili Energy SRL ("Bellili"), a fabrication company based in Italy. In connection with the agreement, the Company agreed to provide Bellili with project financing including necessary guarantees, bonding capacity and other collateral on an individual project basis. Under the agreement, Bellili must present each project to the Company which must be approved at the Company's sole discretion. At September 30, 2001, no amounts were outstanding under the facilitation agreement. Under a separate agreement with Bellili, the Company has guaranteed performance bonds on Bellili's behalf totaling approximately $9.3 million at September 30, 2001. 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, results of operations or cash flows. 13. REPORTABLE SEGMENTS The Company manages its business segments primarily on the type of product or service provided. The Company has five principal industry segments: Rentals-- Domestic; Rentals--International; Parts, Service and Used Equipment; Compressor Fabrication and Production and Processing Equipment Fabrication. The Rentals segments provide natural gas compression rental and maintenance services to meet specific customer requirements. Parts, Service and Used Equipment segment provides used equipment, both new and used parts directly to customers, as well as complete maintenance services for customer owned packages. The Compressor Fabrication Segment involves the design, fabrication and sale of natural gas compression units to meet unique customer specifications. The Production and Processing Equipment Fabrication Segment designs, fabricates and sells equipment utilized in the production of crude oil and natural gas. Prior periods have been restated to reflect the expansion in 2000 of the Parts, Service and Used Equipment segment. 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 mandatorily redeemable convertible preferred securities 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 and inter-segment sales. Inter-segment sales are accounted for at cost, except for compression fabrication equipment revenue which are accounted for on an arms length basis, and the sales and resulting profits 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. 12 The following table presents sales and other financial information by industry segment for the three and nine months ended September 30, 2001 and 2000 (in thousands).
(Restated) Three Months Ended September 30, 2001 Three Months Ended September 30, 2000 ------------------------------------------ ------------------------------------------ Sales to Sales to External Intersegment Total External Intersegment Total Business Segment Customers Sales Revenues Customers Sales Revenues ---------------- ------------------------------------------ ------------------------------------------ Domestic rentals $ 72,033 $ 72,033 $ 45,533 $ 45,533 International rentals 32,962 $ 711 33,673 20,776 $ 300 21,076 Parts service & used equipment 67,658 13,460 81,118 28,743 2,452 31,195 Compressor fabrication 55,571 12,991 68,562 26,428 21,187 47,615 Production equipment fabrication 50,363 2,531 52,894 25,634 25,634 Other 2,723 1,261 3,984 1,846 884 2,730 Eliminations (30,954) (30,954) (24,823) (24,823) ------------------------------------------ ------------------------------------------ Total consolidated revenues $281,310 $281,310 $148,960 $148,960 ========================================== ==========================================
(Restated) Nine Months Ended September 30, 2001 Nine Months Ended September 30, 2000 ------------------------------------------ ------------------------------------------ Sales to Sales to External Intersegment Total External Intersegment Total Business Segment Customers Sales Revenues Customers Sales Revenues ---------------- ------------------------------------------ ------------------------------------------ Domestic rentals $185,822 $185,822 $122,761 $ 122,761 International rentals 89,298 $ 2,845 92,143 57,449 $ 900 58,349 Parts service & used equipment 168,017 37,428 205,445 64,293 22,155 86,448 Compressor fabrication 168,061 49,713 217,774 55,599 73,490 129,089 Production equipment fabrication 135,760 4,763 140,523 46,745 1,747 48,492 Other 9,562 3,507 13,069 9,754 2,477 12,231 Eliminations (98,256) (98,256) (100,769) (100,769) ------------------------------------------ ------------------------------------------ Total consolidated revenues $756,520 $756,520 $356,601 $ 356,601 ========================================== ==========================================
(Restated) Gross Profit ---------------------------------------------------------------- Three Months Ended Nine Months Ended Identifiable Assets ------------------ ----------------- ------------------------------- September 30, September 30, September 30, September 30, September 30, September 30, Business Segment 2001 2000 2001 2000 2001 2000 ---------------- -------------------------------- ----------------------------- ------------------------------- Domestic rentals $ 46,144 $29,550 $122,485 $ 80,592 $1,205,951 $ 684,936 International rentals 23,461 13,496 59,972 37,514 481,946 174,027 Parts service & used equipment 19,823 10,792 56,139 22,091 79,110 24,037 Compressor fabrication 9,916 3,973 27,417 9,270 249,098 278,290 Production equipment fabrication 10,532 5,088 27,951 9,781 113,221 92,336 Other 2,723 1,846 9,562 9,754 22,308 13,042 -------------------------------- ----------------------------- ------------------------------- Total $112,599 $64,745 $303,526 $169,002 $2,151,634 $1,266,668 ================================ ============================= ===============================
13 14. RESTATEMENT The transactions involved in the restatement, which are detailed further below are: (i) the Cawthorne Channel project in Nigeria, initially conducted through the Hampton Roads joint venture; (ii) the Company's acquisition of two compressors in a non-monetary exchange transaction; (iii) a compressor sale transaction; (iv) a sale of a turbine engine; and (v) an increase in certain selling, general and administrative expenses as well as an increase in depreciation and amortization expense. The impact of the restatement is summarized in the table below: For the Three Months Ended September 30, 2001 ---------------------------------------------
Cawthorne Channel Acquisition Project in of Nigeria / Compressors Hampton In Sale of Roads Joint Non-Monetary Turbine As Filed Venture Exchange Engine Revenues: --------- ------- -------- ------- Rentals................................................. $104,995 Parts, service and used equipment....................... 84,608 ($16,950) Compressor fabrication.................................. 55,678 ($107) Production and processing equipment fabrication......... 50,363 Equity in income of non-consolidated affiliates......... 1,688 Other................................................... 1,467 (432) -------- ------- -------- --------- Total revenues.................................... 298,799 (107) (17,382) -------- ------- -------- --------- Expenses: Rentals................................................ 35,390 Parts, service and used equipment...................... 61,716 (13,881) Compressor fabrication.................................. 45,897 (242) Production and processing equipment fabrication........ 39,831 Selling, general and administrative.................... 23,706 Depreciation and amortization.......................... 24,998 ($20) Lease expense.......................................... 16,614 Interest expense....................................... 4,355 (155) Distributions on mandatorily redeemable convertible preferred Securities................................ 1,593 Other.................................................. 8,466 -------- ------- ------- --------- Total expenses................................... 262,566 (397) (20) (13,881) -------- ------- ------- --------- Income before income taxes............................... 36,233 290 20 (3,501) Provision for income taxes............................... 13,769 110 8 (1,330) -------- ------- ------- --------- Net income............................................... $ 22,464 $ 180 $ 12 ($2,171) ======== ======= ======= ========= Earnings per common share Basic $ 0.31 Diluted $ 0.29 Additional Selling, General and Administrative, Depreciation and Amortization Expenses Restated -------- -------- Revenues: Rentals............................................................... $104,995 Parts, service and used equipment..................................... 67,658 Compressor fabrication................................................ 55,571 Production and processing equipment fabrication....................... 50,363 Equity in income of non-consolidated affiliates....................... 1,688 Other................................................................. 1,035 ------- -------- Total revenues.................................................. 281,310 ------- -------- Expenses: Rentals............................................................... 35,390 Parts, service and used equipment..................................... 47,835 Compressor fabrication................................................ 45,655 Production and processing equipment fabrication....................... 39,831 Selling, general and administrative................................... $ 506 24,212 Depreciation and amortization......................................... 520 25,498 Lease expense......................................................... 16,614 Interest expense...................................................... 4,200 Distributions on mandatorily redeemable convertible preferred Securities......................................................... 1,593 Other................................................................. 8,466 ------- -------- Total expenses.................................................. 1,026 249,294 ------- -------- Income before income taxes.............................................. (1,026) 32,016 Provision for income taxes.............................................. (389) 12,168 ------- -------- Net income.............................................................. ($637) $ 19,848 ======= ======== Earnings per common share Basic $ 0.27 Diluted $ 0.26
14 For the Three Months Ended September 30, 2000 ---------------------------------------------
Cawthorne Channel Acquisition Project in of Nigeria / Compressors Hampton In Roads Joint Non-Monetary As Filed Venture Exchange Restated -------- ------- -------- -------- Revenues: Rentals ................................................................ $ 66,309 66,309 Parts, service and used equipment ...................................... 28,743 28,743 Compressor fabrication ................................................. 30,975 ($4,547) 26,428 Production and processing equipment fabrication ........................ 32,759 (7,125) 25,634 Equity in income of non-consolidated affiliates ........................ 455 455 Other .................................................................. 3,340 ($1,949) 1,391 -------- -------- -------- -------- Total revenues ....................................................... 162,581 (11,672) (1,949) 148,960 -------- -------- -------- -------- Expenses: Rentals ................................................................ 23,263 23,263 Parts, service and used equipment ...................................... 17,951 17,951 Compressor fabrication ................................................. 26,208 (3,753) 22,455 Production and processing equipment fabrication ........................ 25,520 (4,974) 20,546 Selling, general and administrative .................................... 14,467 14,467 Depreciation and amortization .......................................... 14,179 14,179 Lease expense .......................................................... 11,460 11,460 Interest expense ....................................................... 2,925 (94) 2,831 Distributions on mandatorily redeemable convertible preferred Securities ............................................................ 1,593 1,593 Other .................................................................. -------- -------- -------- -------- Total expenses ....................................................... 137,566 (8,821) 128,745 -------- -------- -------- -------- Income before income taxes ............................................... 25,015 (2,851) (1,949) 20,215 Provision for income taxes ............................................... 9,605 (1,061) (724) 7,820 -------- -------- -------- -------- Net income ............................................................... $ 15,410 $ (1,790) ($ 1,225) $ 12,395 -======= ======== ======== ======== Earnings per common share Basic $ 0.24 $ 0.19 Diluted $ 0.23 $ 0.18
15 For the Nine Months Ended September 30, 2001 --------------------------------------------
Cawthorne Acquisition Channel of Project in Compressors Nigeria / In Compressor Sale of Hampton Roads Non-Monetary Sale Turbine As Filed Joint Venture Exchange Transaction Engine ---------- ------------- -------- ----------- ------ Revenues: Rentals................................................. $ 275,120 Parts, service and used equipment....................... 189,063 $ 12,004 ($33,050) Compressor fabrication.................................. 168,168 ($107) Production and processing equipment fabrication......... 139,296 (3,536) Gain on change in interest in non-consolidated affiliate............................................. 3,751 Other................................................... 6,243 (432) --------- ---------- ---------- ----------- -------- Total revenues........................................ 781,641 (3,643) 12,004 (33,482) --------- ---------- ---------- ----------- -------- Expenses: Rentals................................................. 92,663 Parts, service and used equipment....................... 132,126 7,954 (28,202) Compressor fabrication.................................. 140,915 (271) Production and processing equipment fabrication......... 110,277 (2,468) Selling, general and administrative..................... 66,341 263 Depreciation and amortization........................... 60,926 ($60) Lease expense........................................... 47,541 Interest expense........................................ 10,318 (63) Distributions on mandatorily redeemable convertible preferred Securities............................................. 4,780 Other................................................... 11,473 --------- ---------- ---------- ----------- -------- Total expenses........................................ 677,360 (2,539) (60) 7,954 (28,202) --------- ---------- ---------- ----------- -------- Income before income taxes................................ 104,281 (1,104) 60 4,050 (5,280) Provision for income taxes................................ 39,620 (420) 23 1,539 (2,006) --------- ---------- ---------- ----------- -------- Net income before cumulative effect of accounting change................................................. 64,661 (684) 37 2,511 (3,274) Cumulative effect of accounting change, net income tax........................................... (164) --------- ---------- ---------- ----------- -------- Net income................................................ $ 64,497 ($684) $ 37 $ 2,511 ($3,274) ========= ========== ========== =========== ======== Earnings per common share Basic $ 0.92 Diluted $ 0.86 Additional Selling, General and Administrative, Depreciation and Amortization Expenses Restated ---------- ---------- Revenues: Rentals................................................ $ 275,120 Parts, service and used equipment...................... 168,017 Compressor fabrication................................. 168,061 Production and processing equipment fabrication........ 135,760 Gain on change in interest in non-consolidated affiliate............................................ 3,751 Other.................................................. 5,811 -------- ---------- Total revenues....................................... 756,520 -------- ---------- Expenses: Rentals................................................ 92,663 Parts, service and used equipment...................... 111,878 Compressor fabrication................................. 140,644 Production and processing equipment fabrication........ 107,809 Selling, general and administrative.................... 1,989 68,593 Depreciation and amortization.......................... 1,616 62,482 Lease expense.......................................... 47,541 Interest expense....................................... 10,255 Distributions on mandatorily redeemable convertible preferred Securities............................................ 4,780 Other.................................................. 11,473 -------- ---------- Total expenses....................................... (3,605) 658,118 ---------- Income before income taxes............................... (3,605) 98,402 Provision for income taxes............................... (1,369) 37,387 -------- ---------- Net income before cumulative effect of accounting change................................................ (2,236) 61,015 Cumulative effect of accounting change, net income tax.......................................... (164) -------- ---------- Net income............................................... ($2,236) $ 60,851 ======== ========== Earnings per common share Basic $ 0.87 Diluted $ 0.81
16 For the Nine Months Ended September 30, 2000 --------------------------------------------
Cawthorne Channel Acquisition Project in of Nigeria / Compressors Hampton In Roads Joint Non-Monetary As Filed Venture Exchange Restated -------- ------- -------- -------- Revenues: Rentals.................................................................. $180,210 $180,210 Parts, service and used equipment........................................ 64,293 64,293 Compressor fabrication................................................... 60,146 ($4,547) 55,599 Production and processing equipment fabrication.......................... 53,870 (7,125) 46,745 Equity in income of non-consolidated affiliates.......................... 1,953 1,953 Other.................................................................... 9,750 ($1,949) 7,801 -------- -------- --------- -------- Total revenues......................................................... 370,222 (11,672) (1,949) 356,601 -------- -------- --------- -------- Expenses: Rentals.................................................................. 62,104 62,104 Parts, service and used equipment........................................ 42,202 42,202 Compressor fabrication................................................... 50,082 (3,753) 46,329 Production and processing equipment fabrication.......................... 41,938 (4,974) 36,964 Selling, general and administrative...................................... 34,481 34,481 Depreciation and amortization............................................ 36,830 36,830 Lease expense............................................................ 29,596 29,596 Interest expense......................................................... 5,560 (94) 5,466 Distributions on mandatorily redeemable convertible preferred Securities.............................................................. 4,776 4,776 Other -------- -------- ---------- -------- Total expenses......................................................... 307,569 (8,821) 298,748 -------- -------- ---------- -------- Income before income taxes................................................. 62,653 (2,851) (1,949) 57,853 Provision for income taxes................................................. 23,305 (1,061) (724) 21,520 -------- -------- ---------- -------- Net income................................................................. $ 39,348 $ (1,790) ($1,225) $ 36,333 ======== ======== ========== ======== Earnings per common share Basic............................................................... $ 0.65 $ 0.60 Diluted............................................................. $ 0.61 $ 0.56
Cawthorne Channel Project in Nigeria / Hampton Roads Joint Venture ------------------------------------------------------------------ Cawthorne Channel is a project to build, own and operate barge-mounted gas compression and gas processing facilities to be stationed off the coast of Nigeria in performance of a contract between Global Energy and Refining Ltd ("Global") and Shell Petroleum Development Company of Nigeria Limited, the Nigerian operating unit of The Royal/Dutch Shell Group ("Shell"). The Company entered into a contract with Global in June 1999 to fabricate and lease the facilities to Global to fulfill the Shell contract. Subsequently, the Company acquired a 10% interest in Global. In September 2000, a joint venture known as Hampton Roads Shipping Investors II, L.L.C. ("Hampton Roads") was formed to own the gas processing facilities and lease them to Global. The Company purchased a 25% interest in Hampton Roads for $1,250,000 and entered into a turn-key construction contract with Hampton Roads to construct the facilities. The equipment, which had a sale price of $51 million, was to be used pursuant to a 10-year contract on behalf of Shell to commence September 30, 2001. In the first quarter of 2001, the scope of the project was reduced to $43 million and the contract term was extended to 15 years with a projected start date of September 2003. As the project has not yet started, the Company has recorded no income attributable to its equity ownership in the venture. The Company is constructing the equipment to be used in the gas compression and processing project with Shell under the turn-key construction contract with Hampton Roads and had accounted for this activity under the percentage of completion method of accounting. Based upon the evaluation of new information related to these transactions, the Company determined that it should not have recognized revenue for this activity during these periods. The restatement treats the project as if the Company had owned 100% of the project since inception by reversing revenue and related costs recognized under the percentage of completion method. In February 2002, the Company purchased the 75% interest in Hampton Roads that it did not own. The Company now owns 100% of the venture and will recognize the rental revenues pursuant to its contract with Global once startup begins. 17 Acquisition of Compressors In Non-Monetary Exchange --------------------------------------------------- In the third quarter of 2000, the Company entered into an acquisition of two compressors in a non-monetary exchange transaction with an independent oil and gas producer. In the transaction, the Company acquired the two compressors in exchange for certain gas reservoir rights that the Company had obtained in settlement of a payment default by one of its customers. The Company accounted for the transaction as an exchange of non-monetary assets and recorded $2.2 million in revenue and pre-tax income in 2000. Based upon the evaluation of new information related to this transaction, the Company has determined that it should not have recognized a gain on this transaction. The impact for the 2001 periods above is a reduction of depreciation expense. Compressor Sale Transaction --------------------------- The Company sold 33 gas compressors to a gas pipeline system then controlled by Enron for $12.0 million pursuant to invoices issued in December 2000. The Company recorded $4.1 million of pre-tax income from the transaction in the fourth quarter of 2000. In January 2001, the Company entered into an agreement with its customer to provide transition services and settle claims between the parties arising from the operation of the compressors prior to their sale. The agreement also provided for the issuance of a bill of sale. Upon further evaluation of the transaction, the Company has determined that it should have recognized the gain on this transaction when it issued the bill of sale in January 2001 rather then December 2000. Sale of Turbine Engine ---------------------- In the fourth quarter of 2000, the Company entered the non-oil field power generation market to take advantage of rising electricity demand and purchased used turbines to carry out this effort. Subsequently, the Company agreed to sell certain turbines on extended credit and recognized revenues and the related profits at the time of such transactions. The Company recorded $1.8 million of pre-tax income on a $16.1 million turbine sale in the second quarter of 2001 and recorded $3.1 million of pre-tax income on a $16.9 million turbine sale in the third quarter of 2001. Upon further evaluation of the transactions, the Company determined that revenue should have been recognized on these transactions at the time that collectibility of the sales price was reasonably assured. The $16.1 million turbine was ultimately sold to a project that is utilizing the turbine in a contract with the California Department of Water and Resources. The Company received payment in full on the turbine in December 2001. However, since the Company is a participant in the project financing, it will not record a profit related to the sale of that turbine. Selling, general and administrative expenses and depreciation and amortization ------------------------------------------------------------------------------ expense ------- After reviewing its selling, general and administrative expenses for 2001, the Company determined that certain expenses had been understated. As a result, the Company increased these expenses by $506,000 and $1,989,000 for the three and nine month periods ended September 30, 2001, respectively. Additionally, the Company understated depreciation and amortization expenses for the corresponding periods by $520,000 and 1,616,000, respectively. 18 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 document 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 the Company's compression and oil and gas production equipment, (4) new governmental safety, health and environmental regulations which could require significant capital expenditures by the Company, (5) inability to successfully integrate acquired businesses, including Production Operators Corporation ("POI") and (6) 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. GENERAL The Company is the global market leader in full service natural gas compression and a leading provider of service, financing, fabrication and equipment for contract natural gas handling applications. The Company provides this equipment on a rental, contract compression, maintenance and acquisition leaseback basis to natural gas production, processing and transportation companies that are increasingly seeking outsourcing solutions. Founded in 1990 and a public company since 1997, its customers include premier independent and major producers and distributors throughout the Western Hemisphere. In conjunction with the Company's maintenance business, the Company has developed its parts and service business to provide solutions to customers that own their own compression equipment but want to outsource their operations. The Company's compression services are complemented by its compressor and oil and gas production equipment fabrication operations and gas processing and treating, gas measurement and power generation services, which broaden the Company's customer relationships both domestically and internationally. The Company's products and services are essential to the production, gathering, processing, transportation and storage of natural gas and are provided primarily to independent and major producers and distributors of natural gas. As of September 30, 2001, the Company operated a fleet of 6,939 compression rental units with an aggregate capacity of approximately 3,487,000 horsepower. In March 2001, the Company purchased the OEC Compression Corporation("OEC") in an all-stock transaction for approximately $100.7 million, including the assumption of approximately $63.0 million of indebtedness of OEC. The acquisition was accounted for under the purchase method of accounting. In August 2001, the Company acquired the Production Operators Corporation natural gas compression business, ownership interests in certain joint venture projects in South America, and related assets ("POI") from Schlumberger for $761 million in cash, common stock and indebtedness, subject to certain post-closing adjustments pursuant to the purchase agreement (the "POI Acquisition"). The POI Acquisition was accounted for as a purchase and is included in Hanover's financial statements commencing on September 1, 2001. RESULTS OF OPERATIONS The following discussion has been updated to reflect the restated results of operations, see Note 14 in "Notes to Consolidated Financial Statements" for details regarding the restatement. THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2000 REVENUES The Company's total revenues increased by $132.3 million, or 89%, to $281.3 million during the three months ended September 30, 2001 from $149.0 million during the three months ended September 30, 2000. The increase in revenues resulted from growth in revenues and horsepower from the Company's natural gas compressor rental fleet, organic growth in the 19 Company's outsourcing businesses, which now include compression, gas treating, process measurement and power generation as well as growth due to business acquisitions completed in 2001 and 2000. Revenues from rentals increased by $38.7 million, or 58%, to $105.0 million during the three months ended September 30, 2001 from $66.3 million during the three months ended September 30, 2000. Domestic revenues from rentals increased by $26.5 million, or 58%, to $72.0 million during the three months ended September 30, 2001 from $45.5 million during the three months ended September 30, 2000. International rental revenues increased by $12.2 million, or 59%, to $33.0 million during the three months ended September 30, 2001 from $20.8 million during the three months ended September 30, 2000. The increase in both domestic and international rental revenue resulted from expansion of the Company's rental fleet and business acquisitions completed in 2001 and 2000. Subsequent to the acquisition of POI on August 31, 2001, rental revenues related to the POI business of $11.7 million were included in the Company's revenues for the period ended September 30, 2001. At September 30, 2001, the compressor rental fleet consisted of approximately 3,487,000 horsepower, a 66% increase over the 2,098,000 horsepower in the rental fleet at September 30, 2000. Domestic horsepower in the rental fleet increased by 60% to 2,740,000 horsepower at September 30, 2001 from approximately 1,714,000 horsepower at September 30, 2000. International horsepower increased by 95% to 747,000 horsepower at September 30, 2001 from approximately 384,000 horsepower at September 30, 2000. Revenue from parts, service and used equipment increased by $39.0 million, or 135% to $67.7 million during the three months ended September 30, 2001 from $28.7 million during the three months ended September 30, 2000. This increase is due in part to an increase in our marketing focus for this business segment as well as expansion of business activities through acquisitions. Revenues from compressor fabrication increased by $29.1 million, or 110%, to $55.6 million during the three months ended September 30, 2001 from $26.4 million during the three months ended September 30, 2000. This increase is due to the continued development of this product line and the acquisition of Dresser-Rand Company's compression service division beginning in September 2000. During the three months ended September 30, 2001, an aggregate of approximately 152,000 horsepower of compression equipment was fabricated compared to approximately 81,000 horsepower fabricated during the three months ended September 30, 2000. Revenues from production and processing equipment fabrication increased by $24.8 million, or 96%, to $50.4 million during the three months ended September 30, 2001 from $25.6 million during the three months ended September 30, 2000. The increase is due primarily to an improvement in market conditions in the process equipment business. Equity in earnings in subsidiaries increased $1.2 million, or 271%, to $1.7 million during the three months ended September 30, 2001, from $.5 million during the three months ended September 30, 2000. This increase is primarily due to the acquisition of POI which included interests in certain joint venture projects in South America. EXPENSES Operating expenses of the rental segments increased by $12.1 million, or 52%, to $35.4 million during the three months ended September 30, 2001 from $23.3 million during the three months ended September 30, 2000. The increase resulted primarily from the corresponding 58% increase in revenues from rentals over the corresponding period in 2000. The gross profit percentage from rentals was 66% during the three months ended September 30, 2001 and 65% during the three months ended September 30, 2000. The rentals gross profit percentage increase is primarily due to improved rental rates resulting from the increase in market demand for natural gas compression. Operating expenses of parts, service and used equipment increased by $29.9 million, or 166% to $47.8 million, which relates to the 135% increase in parts, service and used equipment revenue. The gross profit margin from parts, service and used equipment was 29% during the three months ended September 30, 2001 from 38% during the three months ended September 30, 2000. The gross margin in parts, service and used equipment was decreased by approximately 3% by a low margin installation project in Venezuela, which should be completed in the fourth quarter. Operating expenses of compressor fabrication increased by $23.2 million, or 103%, to $45.7 million during the three months ended September 30, 2001 from $22.5 million during the three months ended September 30, 2000 commensurate with the corresponding increase in compressor fabrication revenue. The gross profit margin on compression fabrication was 18% during the three months ended September 30, 2001 and 15% during the three months ended September 30, 2000. The increase in gross profit margin for compression fabrication was attributable to operating efficiencies realized on certain projects completed during the quarter which may not be achievable in future periods. The operating expenses attributable to production and processing equipment fabrication increased by $19.3 million, or 94%, to $39.8 million during the three months ended September 30, 2001 from $20.5 million during the three months ended September 30, 2000. The gross profit margin attributable to production and processing equipment fabrication was 21% during the three months ended September 30, 2001 and was 20% during the three months ended September 30, 2000. Selling, general and administrative expenses increased $9.7 million, or 67%, to $24.2 million during the three months ended September 30, 2001 from $14.5 million during the three months ended September 30, 2000. The increase is attributable to increased personnel and other administrative and selling expenses associated with increased activity in the Company's business segments as described above, as well as acquisitions during 2001 and 2000. 20 The Company believes that earnings before interest, leasing expense, distributions on mandatorily redeemable convertible preferred securities, income taxes, depreciation and amortization (EBITDA) is a standard measure of financial performance used for valuing companies in the compression industry. EBITDA is a useful common yardstick as it measures the capacity of companies to generate cash without reference to how they are capitalized, how they account for significant non-cash charges for depreciation and amortization associated with assets used in the business (the bulk of which are long-lived assets in the compression industry), or what their tax attributes may be. Additionally, since EBITDA is a basic source of funds not only for growth but to service indebtedness, lenders in both the private and public debt markets use EBITDA as a primary determinant of borrowing capacity. EBITDA for the three months ended September 30, 2001 increased 59% to $79.9 million from $50.3 million for the three months ended September 30, 2000. This increase was primarily due to the increase in the Company's revenues and gross profit which were explained above. EBITDA should not be considered in isolation from, or a substitute for, net income, cash flows from operating activities or other consolidated income or cash flow data prepared in accordance with generally accepted accounting principles. Depreciation and amortization increased by $11.3 million to $25.5 million during the three months ended September 30, 2001 compared to $14.2 million during the three months ended September 30, 2000. The increase in depreciation was due to the additions to the rental fleet which were partially offset by the sale of compressor equipment in the equipment leases in August 2000 and in August of 2001. In addition, the increase in depreciation expense was partially offset by the change in the depreciable lives of certain types of compression equipment. Prior to July 1, 2001, compression equipment in the rental fleet was depreciated using the straight-line method over an estimated useful life that ranged from 4 to 25 years. Effective July 1, 2001, the Company changed its estimate of the useful life of certain compression equipment from 15 to 30 years. The effect of this change in estimate on the quarter ended September 30, 2001 was a decrease in depreciation expense of approximately $1.5 million and an increase in net income of approximately $0.9 million ($0.01 per share). The Company anticipates this change in estimated useful life will reduce future depreciation expense, based on the Company's current depreciable assets, by approximately $3 million per quarter. The increase in amortization was due to the goodwill recorded from business acquisitions completed during 2001 and 2000. The Company incurred leasing expense of $16.6 million, during the three months ended September 30, 2001 compared to $11.5 million during the three months ended September 30, 2000. The increase of $5.1 million resulted from the additional equipment leases entered into in 2001 and 2000. Interest expense increased by $1.4 million to $4.2 million during the three months ended September 30, 2001 from $2.8 million for the three months ended September 30, 2000. The increase in interest expense is due to higher levels of outstanding debt which was partially offset by lower interest rates. Other expense during the three months ended September 30, 2001 was $8.5 million, which included a $2.8 million bridge loan commitment fee associated with Hanover's recent acquisition of POI and a $5.7 million non-cash charge from the recognition of an unrealized loss related to the change in fair value of the interest rate swaps as required under SFAS 133 (see note 9 to Condensed Consolidated Financial Statements). INCOME TAXES The provision for income taxes increased by $4.4 million, or 56%, to $12.2 million during the three months ended September 30, 2001 from $7.8 million during the three months ended September 30, 2000. The increase resulted primarily from the corresponding increase in income before income taxes. The average effective income tax rate during the three months ended September 30, 2001 and 2000 was 38%. NET INCOME Net income increased $7.4 million, or 60%, to $19.8 million during the three months ended September 30, 2001 from $12.4 million during the three months ended September 30, 2000 due to the increase in revenues and gross profits discussed above. NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2000 REVENUES The Company's total revenues increased by $399.9 million, or 112%, to $756.5 million during the nine months ended September 30, 2001 from $356.6 million during the nine months ended September 30, 2000. The increase in revenues resulted 21 from growth in revenues and horsepower from the Company's natural gas compressor rental fleet, organic growth in the Company's outsourcing businesses, which now include compression, gas treating, process measurement and power generation as well as growth due to business acquisitions completed in 2001 and 2000. Revenues from rentals increased by $94.9 million, or 53%, to $275.1 million during the nine months ended September 30, 2001 from $180.2 million during the nine months ended September 30, 2000. Domestic revenues from rentals increased by $63.0 million, or 51%, to $185.8 million during the nine months ended September 30, 2001 from $122.8 million during the nine months ended September 30, 2000. International rental revenues increased by $31.9 million, or 55%, to $89.3 million during the nine months ended September 30, 2001 from $57.4 million during the nine months ended September 30, 2000. The increase in both domestic and international rental revenue resulted from expansion of the Company's rental fleet and business acquisitions in 2001 and 2000. Revenue from parts, service and used equipment increased by $103.7 million, or 161% to $168.0 million during the nine months ended September 30, 2001 from $64.3 million during the nine months ended September 30, 2000. This increase is due in part to an increase in our marketing focus for this business segment, as well as expansion of business activities through acquisitions. Revenues from compressor fabrication increased by $112.5 million, or 202%, to $168.1 million during the nine months ended September 30, 2001 from $55.6 million during the nine months ended September 30, 2000. This increase is due to the acquisition of Dresser-Rand Company's compression service division beginning September 2000. During the nine months ended September 30, 2001, an aggregate of approximately 424,000 horsepower of compression equipment was fabricated compared to approximately 246,000 horsepower fabricated during the nine months ended September 30, 2000. Revenues from production and processing equipment fabrication increased by $89.1 million, or 190%, to $135.8 million during the nine months ended September 30, 2001 from $46.7 million during the nine months ended September 30, 2000. The increase is due primarily to the acquisition of APSI during June 2000 and an improvement in market conditions in the process equipment business compared to conditions which existed in the prior year. Equity in earnings in subsidiaries increased $1.8 million, or 92.1%, to $3.8 million during the nine months ended September 30, 2001, from $2.0 million during the nine months ended September 30, 2000. This increase is primarily due to acquisition of POI which included interests in certain joint venture projects in South America. EXPENSES Operating expenses of the rental segments increased by $30.6 million, or 49%, to $92.7 million during the nine months ended September 30, 2001 from $62.1 million during the nine months ended September 30, 2000. The increase resulted primarily from the corresponding 53% increase in revenues from rentals over the corresponding period in 2000. The gross profit percentage from rentals was 66% during the nine months ended September 30, 2001 and 2000. Operating expenses of parts, service and used equipment increased by $69.7 million, or 165% to $111.9 million, which relates to the 161% increase in parts, service and used equipment revenue. The gross profit margin from parts, service and used equipment was 33% during the nine months ended September 30, 2001 compared to 34% during the nine months ended September 30, 2000. The gross margin in parts, service and used equipment was decreased by approximately 1% by a low margin installation project in Venezuela which should be completed in the fourth quarter. Operating expenses of compressor fabrication increased by $94.3 million, or 204%, to $140.6 million during the nine months ended September 30, 2001 from $46.3 million during the nine months ended September 30, 2000 commensurate with the corresponding increase in compressor fabrication revenue. The gross profit margin on compression fabrication was 16% during the nine months ended September 30, 2001 and 17% during the nine months ended September 30, 2000. The decrease in gross profit margin for compression fabrication was attributable to the acquisition of the compression services division of Dresser- Rand Company, which has lower gross margins than the Company has historically experienced. The operating expenses attributable to production and processing equipment fabrication increased by $70.8 million, or 192%, to $107.8 million during the nine months ended September 30, 2001 from $37.0 million during the nine months ended September 30, 2000. The gross profit margin attributable to production and processing equipment fabrication was 21% during the nine months ended September 30, 2001 and 21% during the nine months ended September 30, 2000. Selling, general and administrative expenses increased $34.1 million, or 99%, to $68.6 million during the nine months ended September 30, 2001 from $34.5 million during the nine months ended September 30, 2000. The increase is attributable to increased personnel and other administrative and selling expenses associated with increased activity in the Company's business segments as described above as well as acquisitions during 2001 and 2000. The Company believes that earnings before interest, leasing expense, distributions on mandatorily redeemable convertible preferred securities, income taxes, depreciation and amortization (EBITDA) is a standard measure of financial performance used for valuing companies in the compression industry. EBITDA is a useful common yardstick as it measures the 22 capacity of companies to generate cash without reference to how they are capitalized, how they account for significant non-cash charges for depreciation and amortization associated with assets used in the business (the bulk of which are long-lived assets in the compression industry), or what their tax attributes may be. Additionally, since EBITDA is a basic source of funds not only for growth but to service indebtedness, lenders in both the private and public debt markets use EBITDA as a primary determinant of borrowing capacity. EBITDA for the nine months ended September 30, 2001 increased 66% to $223.5 million from $134.5 million for the nine months ended September 30, 2000 primarily due to the increase in the Company's rental revenue for reasons previously discussed. EBITDA should not be considered in isolation from, or a substitute for, net income, cash flows from operating activities or other consolidated income or cash flow data prepared in accordance with generally accepted accounting principles. Depreciation and amortization increased by $25.7 million to $62.5 million during the nine months ended September 30, 2001 compared to $36.8 million during the nine months ended September 30, 2000. The increase in depreciation was due to the additions to the rental fleet which were partially offset by the sale of compressor equipment in the equipment leases in March, August and October 2000 and in August 2001. The increase in amortization was due to the goodwill recorded from business acquisitions completed during 2001 and 2000. Effective July 1, 2001, the Company changed its estimate of the useful life of certain compression equipment from 15 to 30 years. The effect of this change in estimate on the nine months ended September 30, 2001 was a decrease in depreciation expense of approximately $1.5 million and an increase in net income of approximately $0.9 million ($0.01 per share). The Company anticipates this change in estimated useful life will reduce future depreciation expense, based on the Company's current depreciable assets, by approximately $3 million per quarter. The Company incurred leasing expense of $47.5 million during the nine months ended September 30, 2001 compared to $29.6 million during the nine months ended September 30, 2000. The increase of $17.9 million resulted from the additional equipment leases entered into in 2000 and 2001. Interest expense increased by $4.8 million to $10.3 million during the nine months ended September 30, 2001 from $5.5 million for the nine months ended September 30, 2000. The increase in interest expense is due to higher levels of outstanding debt which was partially offset by lower interest rate. Other expenses during the nine months ended September 30, 2001 was $11.5 million, which included a $2.8 million bridge loan commitment fee associated with Hanover's recent acquisition of POI and $8.7 million from the recognition of an unrealized loss related to the change in fair value of the interest rate swaps as required under SFAS 133 (see note 9 to Consolidated Financial Statements). INCOME TAXES The provision for income taxes increased by $15.9 million, or 74%, to $37.4 million during the nine months ended September 30, 2001 from $21.5 million during the nine months ended September 30, 2000. The increase resulted primarily from the corresponding increase in income before income taxes. The average effective income tax rates during the nine months ended September 30, 2001 and 2000 were 38% and 37%, respectively. The increase in the average effective income tax rate is due primarily to increased income in foreign tax jurisdictions. NET INCOME Net income increased $24.6 million, or 67%, to $60.9 million during the nine months ended September 30, 2001 from $36.3 million during the nine months ended September 30, 2000 due to the increase in revenues and gross profits discussed above. LIQUIDITY AND CAPITAL RESOURCES The Company's cash balance amounted to $22.3 million at September 30, 2001 compared to $45.5 million at December 31, 2000. Primary sources of cash during the nine months ended September 30, 2001 were net proceeds of $185.3 million from the issuance of 4.75% Convertible Senior Notes due 2008, $83.9 million through a public offering of 2,500,000 shares of common stock by the Company, $550 million from two sale-leaseback transactions and operating cash flows of $42.0 million. Principal uses of cash during the nine months ended September 30, 2001 were capital expenditures and business acquisitions of $662.4 million, the net repayment of the revolving credit facility of $17.5 million and $200.0 million to exercise an equipment purchase option under an existing operating lease. Working capital increased to $425.2 million at September 30, 2001 from $285.4 million at December 31, 2000, primarily as a result of increases in accounts receivables, inventories, costs in excess of billings and other current assets. The increase in the balances is due to an increased level of activity in the Company's lines of business over 2000 as well as from acquisitions. These 23 increases were partially offset by an increase in current liabilities. The amounts invested in property, plant and equipment during 2001 was $484.8 million which resulted in the addition of approximately 1,336,000 horsepower to the rental fleet. At September 30, 2001, the rental fleet consisted of 2,740,000 horsepower domestically and 747,000 in the international rental fleet. Current plans are to spend approximately $75 to $90 million during the remainder of 2001, 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, sale lease-back transactions and raising additional equity and issuing long term debt. As of September 30, 2001 the Company has approximately $94.5 million of credit capacity remaining on its $200 million Revolving credit facility (4.6% rate at September 30, 2001). The Company believes that cash flow from operations and borrowings under its existing $200 million Revolving credit facility will provide the Company with adequate capital resources to fund its estimated level of capital expenditures for the remainder of 2001. However, the Company is in the process of evaluating alternatives to replace its $200 million Revolving credit facility and to replace the note payable to Schlumberger. NEW ACCOUNTING PRONOUNCEMENTS In September 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations. The Statement is effective for all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001, or later. All business combinations in the scope of this statement are to be accounted for using one method, the purchase method. In June 2001, the FASB issued SFAS No.142, Goodwill and Other Intangible Assets. Under SFAS No.142, amortization of goodwill to earnings will be discontinued. However, goodwill will be reviewed for impairment annually or whenever events indicate impairment may have occurred. SFAS No.142 is effective for Hanover on January 1, 2002. However, under the transition provisions of SFAS 142, goodwill acquired in a business combination for which the acquisition date is after June 30, 2001, shall not be amortized. Since the acquisition of POI was consummated after June 30, 2001, the goodwill related to the POI acquisition will not be amortized. The goodwill related to business combinations completed before June 30, 2001 continues to be amortized in the pro forma combined condensed statements of operations since Hanover has not adopted SFAS 142. At September 30, 2001, Hanover has recorded approximately $222.3 million of goodwill, of which $181.3 million is required to be amortized, at an annual rate of approximately $9.6 million, under generally accepted accounting principles. The Company is current evaluating the effect the implementation of SFAS No. 142 will have on its financial statements. In June 2001, the FASB issued SFAS No. 143, Accounting for Obligations Associated with the Retirement of Long-Lived Assets. SFAS 143 establishes the accounting standards for the recognition and measurement of an asset retirement obligation and its associated asset retirement cost. This statement is effective for Hanover effective January 1, 2003. The Company is presently evaluating the impact that the implementation of SFAS 143 will have on its financial statements. In October 2001, the Financial Accounting Standards Board issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS 144 addresses significant issues relating to the implementation of SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and to develop a single accounting model, based on the framework established in SFAS 121, for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired. This statement is effective for Hanover effective January 1, 2002. The Company is presently evaluating the impact that the implementation of SFAS 144 will have on its financial statements. ITEM 3. 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 September 30, 2001, the fair market value of these interest rate swaps is approximately $22 million and this amount was recorded in other liabilities. 24 The Company is a party to five interest rate swaps to convert variable lease payments under certain lease arrangements to fixed payments as follows (in thousands): Company Pays Fair Value of the Swap Maturity Date Fixed Rate Notional Amount at September 30, 2001 ------------- ---------- --------------- --------------------- 7/20/2003 5.5100% $ 75,000 $(3,320) 7/20/2003 5.5600% $125,000 $(5,657) 3/11/2005 5.2550% $100,000 $(4,078) 3/11/2005 5.2725% $100,000 $(4,120) 10/26/2005 5.3975% $100,000 $(4,894) The Company is exposed to interest rate risk on borrowings under its floating rate revolving credit facility. At September 30, 2001, $85 million was outstanding bearing interest at a weighted average effective rate of 4.60% per annum. Assuming a hypothetical 10% increase in interest rates from those in effect at September 30, 2001, the increase in annual interest expense for advances under this facility would be approximately $391 thousand. At September 30, 2001, the Company is exposed to variable rental rates on the equipment leases it entered into in September 1999 and October 2000. Assuming a hypothetical 10% increase in interest rates from those in effect at quarter end; the increase in annual leasing expense on these equipment leases would be approximately $1.5 million. The Company does not currently use derivative financial instruments to mitigate foreign currency risk. 25 Part II. Other Information Item 6: Exhibits and reports on Form 8-K (a) Exhibits Exhibit ------- Number Description ------ ----------- 10.64 Lease dated as of August 31, 2001 between Hanover Equipment Trust 2001A and the Hanover Compression Limited Partnership (2)[10.64] 10.65 Guarantee dated as of August 31, 2001 and made by Hanover Compressor Company, Hanover Compression Limited Partnership and certain subsidiaries (2)[10.65] 10.66 Participation Agreement dated as of August 31, 2001 among the Hanover Compression Limited Partnership, the Hanover Equipment Trust 2001A and General Electric Capital Corporation (2)[10.66] 10.67 Security Agreement dated as of August 31, 2001 made by the Hanover Equipment Trust 2001A in favor Wilmington Trust FSB as agent (2)[10.67] 10.68 Assignment of Leases, Rents and Guarantee from Hanover Equipment Trust 2001A to Wilmington Trust FSB dated as of August 31, 2001 (2)[10.68] 10.69 Indenture for the 8.50% Senior Secured Notes due 2008, dated as of August 30, 2001, among Hanover Equipment Trust 2001A, as issuer, Hanover Compression Limited Partnership and certain subsidiaries, as guarantors, and Wilmington Trust FSB, as Trustee (2)[10.69] 10.70 Lease dated as of August 31, 2001 between Hanover Equipment Trust 2001B and the Hanover Compression Limited Partnership (2)[10.70] 10.71 Guarantee dated as of August 31, 2001 and made by Hanover Compressor Company, Hanover Compression Limited Partnership. and certain subsidiaries (2)[10.71] 10.72 Participation Agreement dated as of August 31, 2001 among the Hanover Compression Limited Partnership, the Hanover Equipment Trust 2001B and General Electric Capital Corporation (2)[10.72] 10.73 Security Agreement dated as of August 31, 2001 made by the Hanover Equipment Trust 2001B in favor Wilmington Trust FSB as agent (2)[10.73] 10.74 Assignment of Leases, Rents and Guarantee from Hanover Equipment Trust 2001B to Wilmington Trust FSB dated as of August 31, 2001 (2)[10.74] 10.75 Indenture for the 8.75% Senior Secured Notes due 2011, dated as of August 30, 2001, among Hanover Equipment Trust 2001B, as issuer, Hanover Compression Limited Partnership and certain subsidiaries, as guarantors, and Wilmington Trust FSB, as Trustee (2)[10.75] 10.76 Amendment dated as of August 31, 2001 to Purchase Agreement among Schlumberger Oilfield Holdings Limited, Schlumberger Surenco S.A., Camco International Inc., Hanover Compressor Company and Hanover Compression Limited Partnership (1) [99.3] 10.77 Most Favored Supplier and Alliance Agreement dated August 31, 2001 among Schlumberger Oilfield Holdings Limited, Schlumberger Technology Corporation and Hanover Compression Limited Partnership (1) [99.4] 10.78 Lock-Up, Standstill and Registration Rights Agreement dated as of August 31, 2001 by and among Schlumberger Technology Corporation, Camco International, Inc., Schlumberger Oilfield Holdings Ltd., Schlumberger Surenco S.A. Operational Services, Inc. and Hanover Compressor Company (1) [99.5] (1) Such exhibit previously filed as an exhibit to the Company's Current Report on Form 8-K dated September 14, 2001, under the exhibit number indicated in brackets [_], and is incorporated by reference. * Filed herewith. (2) Such exhibit previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the third quarter of 2001, under the exhibit number indicated in brackets [ ], and is incorporated by reference. 26 (b) Reports submitted on Form 8-K: 1. A report on Form 8-K was filed on August 8, 2001, which reported under the caption "Item 5 - Other Events" that the Company had announced a private offering by Hanover Equipment Trust 2001A of $300 million of senior secured notes. 2. A report on Form 8-K was filed on August 9, 2001, which reported under the caption "Item 5 - Other Events" that on June 27, 2001, Hanover had signed a definitive agreement to acquire Production Operators Corporation and related assets and in connection with the acquisition, the following financial statements were attached to the report: (a) The audited historical combined balance sheet of the Gas Compression Business of Schlumberger Limited at December 31, 2001 and 1999 and combined statements of operations, cash flows and owner's net investment for the years then ended and (b) Pro forma combined condensed financial statements for Hanover Compressor Company (unaudited). 3. A report on Form 8-K was filed on August 9, 2001, which reported under the caption "Item 5 - Other Events" Hanover Compressor Company's financial results for the second quarter of 2001. This report included a consolidated statement of income for the Company for the three and six-month periods ended June 30, 2001 and 2000. 4. A report on Form 8-K was filed on August 17, 2001, which reported under the caption "Item 5 - Other Events" that the Company had announced terms of the private offerings by Hanover Equipment Trust 2001A and Hanover Equipment Trust 2001B of senior secured notes totaling $550 million. 5. A report on Form 8-K was filed on September 4, 2001, which reported under the caption "Item 5 - Other Events" that the Company had completed two sale-leaseback transactions totaling $550 million. 6. A report on Form 8-K was filed on September 4, 2001, which reported under the caption "Item 5 - Other Events" that the Company had completed its previously announced acquisition from Schlumberger Limited of the Production Operators Corporation natural gas compression business, ownership interests in certain joint venture projects in South America, and related assets for $761 million. 7. A report on Form 8-K was filed on September 14, 2001, which reported under the caption "Item 2 -Acquisition Or Disposition Of Assets" that on August 31, 2001, the Company had completed its acquisition from Schlumberger Ltd. of the Production Operators Corporation natural gas compression business, ownership interests in certain joint ventures and related assets. The report also reported under "Item 7--Financial Statements and Exhibits" that it was impracticable to provide the audited historical financial statements of the business acquired or to provide the required pro forma financial information of Hanover Compressor Company for the acquisition and that the required information would be filed no later than 60 days after the date of the report. All other items specified by Part II of this report are inapplicable and have been omitted. 27 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HANOVER COMPRESSOR COMPANY Date: April 15, 2002 By: /s/ Michael J. McGhan --------------------- Michael J. McGhan President and Chief Executive Officer Date: April 15, 2002 By: /s/ John E. Jackson ------------------- John E. Jackson Chief Financial Officer 28