Exterran Energy Solutions (EXLP) 10-Q 2006 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-Q

(MARK ONE)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006

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

FOR THE TRANSITION PERIOD FROM                    TO                    .

Commission File No. 1-31934

Hanover Compression Limited Partnership

(Exact name of registrant as specified in its charter)

Delaware (State or Other Jurisdiction of Incorporation or Organization)	75-2344249 (I.R.S. Employer Identification No.)
12001 North Houston Rosslyn, Houston, Texas (Address of principal executive offices)	77086 (Zip Code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filero     Accelerated filero     Non-accelerated filerþ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

As of the filing date, no common equity securities of Hanover Compression Limited Partnership (the “Registrant”) were held by non-affiliates of the Registrant. The Registrant is owned 99% by Hanover HL, LLC (“Hanover HL”), as limited partner, and 1% by Hanover Compression General Holdings, LLC (“Hanover General”), as general partner. Hanover HL is an indirect wholly-owned subsidiary of Hanover Compressor Company (File No. 1-13071). Hanover General is a direct wholly-owned subsidiary of Hanover Compressor Company.

The registrant meets the conditions set forth in General Instructions (H)(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q with the reduced disclosure format. Part II, Items 2, 3, 4, and Part I, Item 3, have been omitted in accordance with Instruction (H)(2)(b) and (c), respectively.

TABLE OF CONTENTS

	Page
PART I. FINANCIAL INFORMATION		3
Item 1. Financial Statements		3
Condensed Consolidated Balance Sheets		3
Condensed Consolidated Statements of Operations		4
Condensed Consolidated Statements of Comprehensive Income (Loss)		5
Condensed Consolidated Statements of Cash Flows		6
Notes to Condensed Consolidated Financial Statements		8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 4. Controls and Procedures		36
PART II. OTHER INFORMATION		36
Item 1. Legal Proceedings		36
Item 1A. Risk Factors		36
Item 6: Exhibits		37
SIGNATURES		38
Certification of CEO pursuant to Section 302
Certification of CFO pursuant to Section 302
Certification of CEO pursuant to Section 906
Certification of CFO pursuant to Section 906

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

HANOVER COMPRESSION LIMITED PARTNERSHIP

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)

	September 30,		December 31,
	2006		2005
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	55,111	$	48,233
Accounts receivable, net of allowance of $5,223 and $4,751, respectively		298,535		243,672
Inventory, net		317,652		251,069
Costs and estimated earnings in excess of billings on uncompleted contracts		79,968		99,166
Prepaid taxes		10,028		8,194
Current deferred income taxes		21,786		15,097
Assets held for sale		2,020		2,020
Prepaid expenses		51,768		20,002
Other current assets		24,893		25,576
Total current assets		861,761		713,029
Property, plant and equipment, net		1,843,996		1,823,100
Goodwill, net		181,098		184,364
Intangible and other assets		49,884		55,130
Investments in non-consolidated affiliates		91,850		90,741
Total assets	$	3,028,589	$	2,866,364
LIABILITIES AND PARTNERS’ EQUITY
Current liabilities:
Short-term debt	$	11,157	$	4,080
Current maturities of long-term debt		641		1,309
Accounts payable, trade		110,939		92,980
Accrued liabilities		143,598		125,884
Advance billings		145,715		89,513
Liabilities held for sale		878		878
Billings on uncompleted contracts in excess of costs and estimated earnings		83,271		35,126
Total current liabilities		496,199		349,770
Long-term debt		452,222		431,442
Due to general partner		684,620		763,867
Other liabilities		44,631		38,976
Deferred income taxes		93,414		81,358
Total liabilities		1,771,086		1,665,413
Commitments and contingencies (Note 9)
Minority interest		11,991		11,873
Partners’ equity:
Partners’ capital		1,232,441		1,173,864
Accumulated other comprehensive income		13,071		15,214
Total partners’ equity		1,245,512		1,189,078
Total liabilities and partners’ equity	$	3,028,589	$	2,866,364

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

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HANOVER COMPRESSION LIMITED PARTNERSHIP

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands of dollars)
(unaudited)

	Three Months Ended September 30,					Nine Months Ended September 30,
	2006		2005			2006			2005
Revenues and other income:
U.S. rentals	$	98,030	$	87,703		$	282,746		$	262,548
International rentals		63,792		58,208			193,818			167,644
Parts, service and used equipment		47,951		74,027			152,959			157,995
Compressor and accessory fabrication		90,141		51,798			214,960			125,414
Production and processing equipment fabrication		115,890		90,312			298,162			284,180
Equity in income of non-consolidated affiliates		6,313		6,027			17,391			15,759
Gain on sale of business and other income		1,677		1,781			42,246			2,744
		423,794		369,856			1,202,282			1,016,284
Expenses:
U.S. rentals		39,557		35,503			114,377			102,563
International rentals		25,528		19,284			70,551			53,930
Parts, service and used equipment		37,894		55,865			124,017			117,140
Compressor and accessory fabrication		74,371		44,418			179,546			110,622
Production and processing equipment fabrication		97,675		83,146			255,841			254,700
Selling, general and administrative		50,913		45,442			148,751			131,509
Foreign currency translation		905		1,083			(2,828	)		6,309
Other		—		133			1,204			526
Debt extinguishment costs		—		7,318			5,902			7,318
Depreciation and amortization		45,074		47,302			129,653			137,758
Interest expense		24,929		30,739			78,109			93,594
		396,846		370,233			1,105,123			1,015,969
Income (loss) from continuing operations before income taxes and minority interest		26,948		(377	)		97,159			315
Provision for (benefit from) income taxes		6,079		(3,345	)		24,864			559
Income (loss) from continuing operations before minority interest		20,869		2,968			72,295			(244	)
Minority interest, net of taxes		93		—			—			—
Income (loss) from continuing operations		20,962		2,968			72,295			(244	)
Income (loss) from discontinued operations, net of tax		570		(214	)		368			(706	)
Gain (loss) from sales of discontinued operations, net of tax		—		48			63			(156	)
Income (loss) before cumulative effect of accounting changes		21,532		2,802			72,726			(1,106	)
Cumulative effect of accounting changes, net of tax		—		—			370			—
Net income (loss)	$	21,532	$	2,802		$	73,096		$	(1,106	)

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

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HANOVER COMPRESSION LIMITED PARTNERSHIP

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

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006			2005
Net income (loss)	$	21,532	$	2,802	$	73,096		$	(1,106	)
Other comprehensive income (loss):
Change in fair value of derivative financial instruments, net of tax		—		—		—			609
Foreign currency translation adjustment		1,793		1,900		(2,143	)		(2,157	)
Comprehensive income (loss)	$	23,325	$	4,702	$	70,953		$	(2,654	)

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

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HANOVER COMPRESSION LIMITED PARTNERSHIP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
(unaudited)

	Nine Months Ended
	September 30,
	2006			2005
Cash flows from operating activities:
Net income (loss)	$	73,096		$	(1,106	)
Adjustments:
Depreciation and amortization		129,653			137,758
(Income) loss related to discontinued operations, net of tax		(431	)		862
Cumulative effect of accounting changes, net of tax		(370	)		—
Bad debt expense		3,169			1,568
Gain on sale of property, plant and equipment		(11,282	)		(9,736	)
Equity in income of non-consolidated affiliates, net of dividends received		(1,125	)		2,924
Loss on derivative instruments		—			416
(Gain) loss on remeasurement of intercompany balances		(1,858	)		10,968
Net realized gain on trading securities		(2,208	)		—
Zero coupon subordinated notes accreted interest paid by refinancing		(86,084	)		—
Gain on sale of business		(28,476	)		(188	)
Stock compensation expense		6,543			4,059
Pay-in-kind interest on zero coupon subordinated notes		6,282			17,185
Sales of trading securities, net		2,208			—
Deferred income taxes		5,145			(8,614	)
Changes in assets and liabilities, excluding business combinations:
Accounts receivable and notes		(50,189	)		(43,835	)
Inventory		(69,325	)		(35,956	)
Costs and estimated earnings versus billings on uncompleted contracts		69,820			(41,694	)
Prepaid and other current assets		(38,526	)		(5,942	)
Accounts payable and other liabilities		30,756			21,151
Advance billings		56,091			27,508
Other		(5,020	)		2,055
Net cash provided by continuing operations		87,869			79,383
Net cash provided by (used in) discontinued operations		431			(376	)
Net cash provided by operating activities		88,300			79,007
Cash flows from investing activities:
Capital expenditures		(173,172	)		(103,155	)
Proceeds from sale of property, plant and equipment		23,473			38,028
Proceeds from sale of business		52,125			2,500
Cash used for business acquisitions		—			(3,426	)
Cash used to acquire investments in and advances to non-consolidated affiliates		—			(500	)
Net cash used in continuing operations		(97,574	)		(66,553	)
Net cash provided by discontinued operations		—			220
Net cash used in investing activities		(97,574	)		(66,333	)
Cash flows from financing activities:
Borrowings on revolving credit facilities		161,500			120,000
Repayments on revolving credit facilities		(140,500	)		(79,000	)
Borrowings from general partner, senior notes due 2013		150,000			—
Payments for debt issue costs		(3,832	)		—
Partners’ contribution (distribution), net		(9,214	)		170,112
Proceeds (repayments) of other debt, net		5,994			(1,421	)

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

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	Nine Months Ended
	September 30,
	2006			2005
Stock-based compensation excess tax benefit		1,213			—
Repayment to general partner, zero coupon subordinated notes principal		(150,000	)		—
Payments of 2000B equipment lease obligations		—			(57,589	)
Payments of 2001A equipment lease obligations		—			(172,177	)
Net cash provided by (used in) continuing operations		15,161			(20,075	)
Net cash used in discontinued operations		—			—
Net cash provided by (used in) financing activities		15,161			(20,075	)
Effect of exchange rate changes on cash and equivalents		991			(835	)
Net increase (decrease) in cash and cash equivalents		6,878			(8,236	)
Cash and cash equivalents at beginning of period		48,233			38,076
Cash and cash equivalents at end of period	$	55,111		$	29,840

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

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HANOVER COMPRESSION LIMITED PARTNERSHIP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of Hanover Compression Limited Partnership (“HCLP”, “we”, “us”, “our” or the “Company”) included herein have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America are not required in these interim financial statements and have been condensed or omitted. It is the opinion of our management that the information furnished includes all adjustments, consisting only of normal recurring adjustments, which are necessary to present fairly the financial position, results of operations, and cash flows of HCLP for the periods indicated. The financial statement information included herein should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005. These interim results are not necessarily indicative of results for a full year.

Reclassifications

Certain amounts in the prior period’s financial statements have been reclassified to conform to the 2006 financial statement classification. These reclassifications have no impact on our consolidated results of operations, cash flows or financial position.

2. STOCK OPTIONS AND STOCK-BASED COMPENSATION

We are an indirect wholly-owned subsidiary of Hanover Compressor Company (“Hanover”). Certain of our employees participate in stock incentive plans that provide for the granting of options to purchase shares of Hanover common stock and grants of Hanover restricted common stock.

In December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123(R)”). This standard addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS 123(R) eliminates the ability to account for share-based compensation transactions using the intrinsic value method under Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), and generally requires instead that such transactions be accounted for using a fair value based method. SFAS 123(R) is effective as of the first interim or annual reporting period that begins after June 15, 2005. However, on April 14, 2005, the Securities and Exchange Commission announced that the effective date of SFAS 123(R) would be changed to the first annual reporting period that begins after June 15, 2005. We adopted the provisions of SFAS 123(R) on January 1, 2006.

Prior to January 1, 2006, we measured compensation expense for Hanover’s stock-based employee compensation plans using the intrinsic value method, which follows the recognition and measurement principles of APB No. 25, as permitted by FASB Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”).

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123(R) using the modified prospective transition method. Under that transition method, compensation cost recognized during the nine months ended September 30, 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value, and (b) compensation cost for any share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value. In accordance with the modified prospective transition method, results for prior periods have not been restated. For the nine months ended September 30, 2006 and 2005, stock-based compensation expense of $6.5 million and $4.1 million, respectively, was recognized and included in the accompanying unaudited Condensed Consolidated Statements of Operations. The total income tax benefit recorded in parnters’ equity for share-based compensation arrangements was $1.7 million and zero for the nine-month periods ended September 30, 2006 and 2005, respectively.

On January 1, 2006, we recorded the cumulative effect of the change in accounting related to our adoption of SFAS 123(R) of $0.4 million (net of tax of $0) which relates to the requirement to estimate forfeitures on restricted stock awards.

8

Prior to the adoption of SFAS 123(R), we recorded an entry to other assets and contributed capital within partners’ equity when Hanover’s restricted stock was granted to HCLP employees. Due to the adoption of SFAS 123(R) on January 1, 2006, we reclassified $13.2 million from partners’ equity and other assets related to unearned compensation.

Prior to the adoption of SFAS 123(R), we presented all tax benefits of deductions resulting from the exercise of Hanover’s stock options as operating cash flows in our Consolidated Statements of Cash Flows. SFAS 123(R) requires the cash flows from the tax benefits of tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. There were $1.2 million excess tax benefits classified as a financing cash inflow in the accompanying Consolidated Statement of Cash Flows for the nine months ended September 30, 2006 that would have been classified as an operating cash inflow prior to our adoption of SFAS 123(R).

As of January 1, 2006, we adopted SFAS 123(R) thereby eliminating pro forma disclosure for periods following such adoption. For purposes of this pro forma disclosure, the value of options is estimated using a Black-Scholes option valuation model and amortized to expense over the options’ vesting periods. Had we used the fair value based accounting method for stock-based compensation expense described by SFAS 123(R) for the three months and nine months ended September 30, 2005, our net income (loss) for the three months and nine months ended September 30, 2005 would have been as set forth in the table below (in thousands).

	Three Months			Nine Months
	Ended			Ended
	September 30, 2005			September 30, 2005
Net income (loss), before stock-based compensation for employees	$	2,802		$	(1,106	)
Add back: Stock-based compensation expense for employees previously determined under intrinsic value method, net of tax effect		1,836			4,059
Deduct: Stock-based employee compensation expense for employees determined under the fair value method, net of tax		(2,297	)		(5,846	)
Net income (loss), after effect of stock-based compensation for employees	$	2,341		$	(2,893	)

Incentive Plans

Hanover has employee stock incentive plans that provide for the granting of restricted stock and options to purchase common shares to HCLP employees. During the second quarter of 2006, Hanover’s stockholders approved the Hanover Compressor Company 2006 Stock Incentive Plan (the “Plan”). Upon adoption of the new Plan, Hanover’s Board of Directors determined to terminate the authority to make future grants under all previously existing equity compensation plans. At September 30, 2006, approximately 4.9 million shares were available for grant in future periods under Hanover’s Plan. The stock incentive plans provide for various long-term incentive awards, which include stock options, performance shares and restricted stock awards.

In July 2006, Hanover’s Board of Directors approved grants of awards under the 2006 Long-term Incentive Awards Program to certain HCLP employees, including our executive officers, as part of an incentive compensation program. The grants included, in the aggregate, approximately 0.5 million shares of Hanover restricted stock or stock-settled restricted stock units, 0.3 million shares (at target) of performance vested Hanover restricted stock or stock-settled restricted stock units, and cash awards that vest over a period of three years of approximately $1.3 million. A description of long-term stock-based incentive awards and related activity within each is provided below.

Stock Options

Prior to the adoption of SFAS 123(R), and in accordance with APB No. 25, no stock-based compensation cost was reflected in net income for grants of stock options to employees because the stock options were granted with an exercise price equal to the fair market value of the stock on the date of grant. Options granted typically vest over a three to four year period and are exercisable over a ten-year period. For footnote disclosures under SFAS No. 123, the fair value of each option award was estimated on the date of grant using a Black-Scholes option valuation model. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by employees who receive equity awards.

No stock options have been granted after January 1, 2006 following the adoption of SFAS 123(R). For future stock option grants, we currently plan to use the Black-Scholes valuation model to calculate the fair value of each stock option award and we will follow the provisions of SFAS 123(R). The Company will use historical data and other pertinent information to estimate the expected volatility for the term of new options and the outstanding period of the option. The risk free interest rate will be based on the U.S. Treasury yield curve in effect at the time of grant.

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Upon the adoption of SFAS 123(R), unvested options granted prior to the date of adoption are being amortized to expense ratably over the remaining vesting period. For options granted after the date of adoption, the fair value will be amortized to expense ratably over the vesting period.

The following is a summary of Hanover’s stock option activity for the nine months ended September 30, 2006 (in thousands, except per share data and years):

						Weighted
						Average
				Weighted		Remaining
				Average Exercise		Contractual		Aggregate
	Shares			Price per Share		Life (in years)		Intrinsic Value
Outstanding at December 31, 2005		3,021		$	11.77
Granted		—		$	—
Exercised		(442	)	$	10.46
Forfeited		(112	)	$	12.24
Outstanding at September 30, 2006		2,467		$	11.97		4.8	$	15,652
Exercisable at September 30, 2006		2,019		$	12.05		4.1	$	12,690

The following table summarizes significant ranges of Hanover’s stock options outstanding and exercisable as of September 30, 2006 (in thousands, except per share data and years):

	Options Outstanding						Options Exercisable
			Weighted
			Average		Weighted				Weighted
			Remaining		Average				Average
			Contractual		Exercise				Exercise
Range of exercise prices	Shares		Life (in years)		Price		Shares		Price
$7.51–10.00		901		2.2	$	9.76		854	$	9.75
$10.01–12.50		941		7.1	$	11.76		547	$	11.74
$12.51–15.00		496		5.2	$	14.44		489	$	14.46
$15.01–17.50		75		5.5	$	17.25		75	$	17.25
$17.51–20.00		21		5.4	$	18.95		21	$	18.95
$22.51–25.00		33		4.8	$	25.00		33	$	25.00
		2,467						2,019

A summary of the status of Hanover’s unvested stock options granted to HCLP employees as of September 30, 2006 and changes during the nine months ended September 30, 2006 is presented below (shares in thousands):

				Weighted-Average
				Grant Date
	Shares			Fair Value
Unvested stock options:
Unvested at December 31, 2005		914		$	5.31
Granted		—		$	—
Vested		(402	)	$	5.58
Forfeited		(64	)	$	5.24
Unvested at September 30, 2006		448		$	5.03

As of September 30, 2006, there was approximately $1.8 million of unrecognized compensation cost related to unvested options. Such cost is expected to be recognized over a weighted-average period of 1.4 years. Total compensation expense for stock options was $0.4 million and $1.4 million, respectively, for the three and nine month periods ended September 30, 2006. The total intrinsic value of options exercised during the three and nine month periods ended September 30, 2006 was $0.4 million and $3.3 million, respectively.

Restricted Stock Awards

For grants of restricted stock and stock-settled restricted stock units, we recognize compensation expense over the vesting period equal to the fair value of the restricted stock at the date of grant. The weighted-average fair value of Hanover restricted stock awards granted to HCLP employees during the three and nine month periods ended September 30, 2006 was $16.32. The weighted-average fair value

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of Hanover restricted stock awards granted to HCLP employees during the three and nine month periods ended September 30, 2005 was $11.98 and $11.96, respectively.

For restricted stock and stock-settled restricted stock units that vest based on performance, we record an estimate of the compensation expense to be expensed over the vesting period related to these grants. The compensation expense recognized in our statements of operations is adjusted for changes in our estimate of the number of performance stock that will vest. After the adoption of SFAS 123(R), performance stock awards are expensed based on the original grant date value of the awards. During the three and nine months ended September 30, 2006, 0.3 million shares (at target) of Hanover performance stock awards were granted to HCLP employees. Based on the Company’s performance, the ultimate amount of shares that will vest can range from 0% to 200% of target. No performance stock awards were granted during the nine months ended September 30, 2005.

A summary of the status of the Hanover’s unvested restricted stock awards (including performance stock) granted to HCLP employees as of September 30, 2006 and changes during the nine months ended September 30, 2006 are presented below (shares in thousands):

				Weighted-
				Average
				Grant Date
	Shares			Fair Value
Unvested restricted stock awards:
Unvested at December 31, 2005		1,280		$	11.80
Granted		764		$	16.32
Vested		(355	)	$	11.97
Forfeited		(119	)	$	11.73
Change in expected vesting of performance awards		48		$	11.39
Unvested at September 30, 2006		1,618		$	13.89

As of September 30, 2006, there was approximately $16.9 million of total unrecognized compensation cost related to unvested restricted stock awards (including performance shares). Such cost is expected to be recognized over a weighted-average period of 2.0 years. Total compensation expense for restricted stock awards was $2.0 million and $1.8 million for the three months ended September 30, 2006 and 2005, respectively. Total compensation expense for restricted stock awards was $5.1 million and $4.1 million for the nine months ended September 30, 2006 and 2005, respectively. The total fair value of restricted stock awards vested in the three and nine month periods ended September 30, 2006 was $3.7 million and $4.3 million, respectively.

3. INVENTORY

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

	September 30,		December 31,
	2006		2005
Parts and supplies	$	138,162	$	135,310
Work in progress		168,902		105,405
Finished goods		10,588		10,354
	$	317,652	$	251,069

As of September 30, 2006 and December 31, 2005, we had inventory reserves of approximately $11.7 million and $11.8 million, respectively.

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4. PROPERTY, PLANT AND EQUIPMENT

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

	September 30,			December 31,
	2006			2005
Compression equipment, facilities and other rental assets	$	2,539,882		$	2,441,119
Land and buildings		97,987			87,604
Transportation and shop equipment		84,361			77,507
Other		56,644			53,824
		2,778,874			2,660,054
Accumulated depreciation		(934,878	)		(836,954	)
	$	1,843,996		$	1,823,100

As of September 30, 2006, the compression assets owned by entities that lease equipment to us but, pursuant to our adoption of FIN 46, are included in property, plant and equipment in our consolidated financial statements, had a net book value of approximately $342.3 million, including improvements made to these assets after the sale leaseback transactions.

5. INVESTMENTS IN NON-CONSOLIDATED AFFILIATES

Investments in affiliates that are not controlled by HCLP but where we have the ability to exercise significant influence over the operations are accounted for using the equity method. Our share of net income or losses of these affiliates is reflected in the Consolidated Statements of Operations as “Equity in income of non-consolidated affiliates”. Our primary equity method investments are comprised of entities that own, operate, service and maintain compression and other related facilities.

Our ownership interest and location of each equity method investee at September 30, 2006 is as follows:

	Ownership
	Interest			Location	Type of Business
PIGAP II		30.0	%	Venezuela	Gas Compression Plant
El Furrial		33.3	%	Venezuela	Gas Compression Plant
Simco/Harwat Consortium		35.5	%	Venezuela	Water Injection Plant

Summarized combined earnings information for these entities consisted of the following amounts (on a 100% basis, in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006		2005
Revenues	$	51,692	$	51,894	$	151,441	$	148,198
Operating income		25,991		27,369		74,700		74,914
Net income		16,053		13,783		37,200		40,925

6. DEBT

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

	September 30,			December 31,
	2006			2005
Bank credit facility due November 2010	$	69,000		$	48,000
2001A equipment lease notes, interest at 8.5%, due September 2008		133,000			133,000
2001B equipment lease notes, interest at 8.75%, due September 2011		250,000			250,000
Other, interest at various rates, collateralized by equipment and other assets, net of unamortized discount		863			1,751
		452,863			432,751
Less-current maturities		(641	)		(1,309	)
Long-term debt	$	452,222		$	431,442

As of September 30, 2006, we had $69.0 million in outstanding borrowings under our bank credit facility. Outstanding amounts under our bank credit facility bore interest at a weighted average rate of 7.1% and 6.1% at September 30, 2006 and December 31, 2005,

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respectively. As of September 30, 2006, we also had approximately $164.9 million in letters of credit outstanding under our bank credit facility. Our bank credit facility permits us to incur indebtedness, subject to covenant limitations, up to a $450 million credit limit, plus, in addition to certain other indebtedness, an additional (a) $50 million in unsecured indebtedness, (b) $100 million of indebtedness of international subsidiaries and (c) $35 million of secured purchase money indebtedness. Additional borrowings of up to $216.1 million were available under that facility as of September 30, 2006.

As of September 30, 2006, HCLP and Hanover were in compliance with all covenants and other requirements set forth in our bank credit facility, the indentures and agreements related to our compression equipment lease obligations and the indentures and agreements relating to our other long-term debt. A default under our bank credit facility or a default under certain of the various indentures and agreements would in some situations trigger cross-default provisions under our bank credit facility or the indentures and agreements relating to certain of our other debt obligations. Such defaults would have a material adverse effect on our liquidity, financial position and operations.

While all of the agreements related to our long-term debt do not contain the same financial covenants, the indentures and the agreements related to our compression equipment lease obligations for our 2001A and 2001B sale leaseback transactions, Hanover’s 8.625% Senior Notes due 2010, Hanover’s 7.5% Senior Notes due 2013 and Hanover’s 9.0% Senior Notes due 2014 permit us at a minimum, (1) to incur indebtedness, at any time, of up to $400 million under our bank credit facility, plus an additional $75 million in unsecured indebtedness, (2) to incur additional indebtedness so long as, after incurring such indebtedness, Hanover’s ratio of the sum of consolidated net income before interest expense, income taxes, depreciation expense, amortization of intangibles, certain other non-cash charges and rental expense to total fixed charges (all as defined and adjusted by the agreements governing such obligations), or Hanover’s “coverage ratio,” is greater than 2.25 to 1.0, and no default or event of default has occurred or would occur as a consequence of incurring such additional indebtedness and the application of the proceeds thereof and (3) to incur certain purchase money and similar obligations. The indentures and agreements for our 2001A and 2001B compression equipment lease obligations, Hanover’s 8.625% Senior Notes due 2010, Hanover’s 7.5% Senior Notes due 2013 and Hanover’s 9.0% Senior Notes due 2014 define indebtedness to include the present value of our rental obligations under sale leaseback transactions and under facilities similar to our compression equipment operating leases. As of September 30, 2006, Hanover’s coverage ratio exceeded 2.25 to 1.0, and therefore as of such date it would allow us to incur a limited amount of indebtedness in addition to our bank credit facility and the additional $75 million in unsecured indebtedness and certain other permitted indebtedness, including certain refinancing of indebtedness allowed by such bank credit facility.

7. DUE TO GENERAL PARTNER

We have entered into four promissory notes in favor of our general partner. Under these notes, we promised to pay to the order of our general partner: (a) such amounts as are equal to the amounts which are due by Hanover to the holders of Hanover’s $200 million 8.625% Senior Notes due 2010 (the “8.625% Senior Notes”) and all costs incurred by Hanover in connection with the issuance of the 8.625% Senior Notes or any amendment or modification thereof, (b) such amounts as are equal to the amounts which are due by Hanover, excluding the conversion features, to the holders of Hanover’s $143.8 million 4.75% Convertible Senior Notes due 2014 (the “4.75% Convertible Notes”) and all costs incurred by Hanover in connection with the issuance of the 4.75% Convertible Notes or any amendment or modification thereof, (c) such amounts as are equal to the amounts which are due by Hanover to the holders of Hanover’s $200 million 9.0% Senior Notes due 2014 (the “9.0% Senior Notes”) and all costs incurred by Hanover in connection with the issuance of the 9.0% Senior Notes or any amendment or modification thereof, and (d) such amounts as are equal to the amounts which are due by Hanover to the holders of Hanover’s $150 million 7.5% Senior Notes due 2013 (the “7.5% Senior Notes”) and all costs incurred by Hanover in connection with the issuance of the 7.5% Senior Notes or any amendment or modification thereof. The notes described in (a) and (b) above are dated December 15, 2003, the note described in (c) above is dated June 1, 2004 and the note described in (d) above is dated March 31, 2006. Such amounts are due from HCLP to its general partner at the same time or times as such amounts must be paid by Hanover. Our general partner has also entered into four promissory notes in favor of Hanover with the same general terms as the obligations which we have to our general partner under the notes described in (a), (b), (c) and (d) above. The promissory note to our general partner that has the same general terms as Hanover’s 11% Zero Coupon Subordinated Notes was redeemed in March 2006 in connection with the repayment of the 11% Zero Coupon Subordinated Notes by Hanover in March 2006.

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Obligations to our general partner that have the same general terms as the Hanover notes payable consisted of the following (in thousands):

	September 30,			December 31,
	2006			2005
4.75% senior notes due 2014	$	143,750		$	143,750
8.625% senior notes due 2010		200,000			200,000
9.0% senior notes due 2014		200,000			200,000
11% zero coupon subordinated notes due March 2007		—			229,803
7.5% senior notes due 2013		150,000			—
Fair value adjustment — fixed to floating interest rate swaps		(9,130	)		(9,686	)
	$	684,620		$	763,867

7.5% Senior Notes due 2013

In March 2006, Hanover completed a public offering of $150 million aggregate principal amount of 7.5% Senior Notes due 2013. Hanover used the net proceeds from the offering of $146.6 million, together with borrowings under our bank credit facility, to redeem their 11% Zero Coupon Subordinated Notes due March 31, 2007. In connection with the redemption, we expensed $5.9 million related to the call premium. Hanover paid approximately $242 million to redeem their 11% Zero Coupon Subordinated Notes, including the call premium. The offering and sale of the 7.5% Senior Notes were made pursuant to an automatic shelf registration statement on Form S-3 filed with the Securities and Exchange Commission. Hanover may redeem up to 35% of the 7.5% Senior Notes using the proceeds of certain equity offerings completed before April 15, 2009 at a redemption price of 107.5% of the principal amount, plus accrued and unpaid interest to the redemption date. In addition, Hanover may redeem some or all of the 7.5% Senior Notes at any time on or after April 15, 2010 at certain redemption prices together with accrued interest, if any, to the date of redemption.

The 7.5% Senior Notes are general unsecured senior obligations of Hanover and rank equally in right of payment with all of Hanover’s other senior debt. The 7.5% Senior Notes are effectively subordinated to all existing and future liabilities of Hanover’s subsidiaries that do not guarantee the 7.5% Senior Notes. The 7.5% Senior Notes are guaranteed on a senior subordinated basis by us. The 7.5% Senior Notes rank equally in right of payment with Hanover’s 8.625% Senior Notes and Hanover’s 9.0% Senior Notes and the guarantee of the 7.5% Senior Notes by us ranks equally in right of payment with the guarantee of Hanover’s 8.625% Senior Notes and Hanover’s 9.0% Senior Notes by us. The indenture under which the 7.5% Senior Notes were issued contains various financial covenants which limit, among other things, Hanover and HCLP’s ability to incur additional indebtedness or sell assets.

8. ACCOUNTING FOR DERIVATIVES

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

In March 2004, we entered into two interest rate swaps, which we designated as fair value hedges, to hedge the risk of changes in fair value of our note to our general partner that has the same general terms as Hanover’s 8.625% Senior Notes due 2010 resulting from changes in interest rates. These interest rate swaps, under which we receive fixed payments and make floating payments, result in the conversion of the hedged obligation into floating rate debt. For derivative instruments designated as fair value hedges, the gain or loss is recognized in earnings in the period of change together with the gain or loss on the hedged item attributable to the risk being hedged. The following table summarizes, by individual hedge instrument, these interest rate swaps as of September 30, 2006 (dollars in thousands):

							Fair Value of
		Fixed Rate to be			Notional		Swap at
Floating Rate to be Paid	Maturity Date	Received			Amount		September 30, 2006
Six Month LIBOR +4.72%	December 15, 2010		8.625	%	$	100,000	$	(4,687	)
Six Month LIBOR +4.64%	December 15, 2010		8.625	%	$	100,000	$	(4,443	)

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As of September 30, 2006, a total of approximately $1.6 million in accrued liabilities, $7.5 million in long-term liabilities and a $9.1 million reduction of debt due to our general partner was recorded with respect to the fair value adjustment related to these two swaps. We estimate the effective floating rate, which is determined in arrears pursuant to the terms of the swap, to be paid at the time of settlement. As of September 30, 2006, we estimated that the effective rate for the six-month period ending in December 2006 would be approximately 9.9%.

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

9. COMMITMENTS AND CONTINGENCIES

HCLP has issued the following guarantees that are not recorded on our accompanying balance sheet (dollars in thousands):

			Maximum Potential
			Undiscounted
			Payments as of
	Term		September 30, 2006
Performance guarantees through letters of credit		2006-2010	$	155,490
Standby letters of credit		2006-2007		13,739
Commercial letters of credit		2006-2007		15,833
Bid bonds and performance bonds		2006-2011		125,564
			$	310,626

We have issued guarantees to third parties to ensure performance of our obligations, some of which may be fulfilled by third parties. In addition, in December 2003, June 2004 and March 2006, Hanover issued $200.0 million aggregate principal amount of its 8.625% Senior Notes, issued $200.0 million aggregate principal amount of its 9.0% Senior Notes, issued $150.0 million aggregate principal amount of its 7.5% Senior Notes, respectively, which we fully and unconditionally guaranteed on a senior subordinated basis.

Hanover has guaranteed the amount included below, which is a percentage of the total debt of this non-consolidated affiliate equal to our ownership percentage in such affiliate. If these guarantees by Hanover are ever called, we may have to advance funds to Hanover to cover its obligation under these guarantees (dollars in thousands).

			Maximum Potential
			Undiscounted
			Payments as of
	Term		September 30, 2006
Indebtedness of non-consolidated affiliates:
Simco/Harwat Consortium		2009	$	4,999
El Furrial		2013		29,019
			$	34,018

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

We are substantially self-insured for worker’s compensation, employer’s liability, auto liability, general liability, property damage/loss, and employee group health claims in view of the relatively high per-incident deductibles we absorb under our insurance arrangements for these risks. Losses are estimated and accrued based upon known facts, historical trends and industry averages.

We are involved in a project called the Cawthorne Channel Project in Nigeria, a project in which Global Gas and Refining Ltd., a Nigerian entity (“Global”) has contracted with an affiliate of The Royal/Dutch Group (“Shell”) to process gas from some of Shell’s Nigerian oil and gas fields. Pursuant to a contract between Hanover and Global, we rent and operate barge-mounted gas compression and gas processing facilities stationed in a Nigerian coastal waterway. We completed the building of the required barge-mounted facilities and our portion of the project was declared commercial by Global in November 2005. The contract runs for a ten-year period which commenced when the project was declared commercial, subject to a purchase option, by Global, that is exercisable for the remainder of the term of the contract. Under the terms of a series of contracts between Global and Hanover, Shell, and several other counterparties, respectively, Global is primarily responsible for the overall project.

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In the first nine months of 2006, violence and local unrest significantly increased in Nigeria. As a result of these events, Global declared Force Majeure with respect to the Cawthorne Channel Project. Global’s actions followed a declaration of Force Majeure by Shell under its contract with Global. We have notified Global that we dispute their declaration of Force Majeure and that we believed local conditions did not relieve Global’s obligations to make monthly rental payments or monthly operations and maintenance fee payments to us under our contract with Global. The Cawthorne Channel Project was brought back on-line in April 2006 and operated through early June 2006.

In early June and again in October 2006, the area experienced unrest and violence and gas delivery from Shell to the Project was stopped in June 2006. The Project did not receive any gas from Shell during the third quarter and Shell has not completed repairs on its gathering system. As a result, the Cawthorne Channel Project has not operated since early June 2006.

During the three and nine month periods ended September 30, 2006, we recognized $0 million and $7.3 million, respectively, of revenues related to the Cawthorne Channel Project and we have received approximately $2.6 million in payments during 2006. Even though we believe we are entitled to rents from Global, irrespective of whether Shell has declared Force Majeure, and have invoiced Global for rents, collectibility is not reasonably assured due to uncertainty regarding when the Project’s operations will restart and Global’s dependence on gas production by the Cawthorne Channel Project to pay its rents to us. Therefore, we did not recognize any revenue related to the Cawthorne Channel Project in the third quarter of 2006. Once the Cawthorne Channel Project goes back on-line, we will determine how much revenue to recognize for the period it is on-line. Based on current long-term expectations of future run-time, we believe we will recover all of our receivables and our full investment in the Cawthorne Channel Project over the term of the contract.

This project and our other projects in Nigeria are subject to numerous risks and uncertainties associated with operating in Nigeria. Such risks include, among other things, political, social and economic instability, civil uprisings, riots, terrorism, kidnapping, the taking of property without fair compensation and governmental actions that may restrict payments or the movement of funds or result in the deprivation of contract rights. Any of these risks including risks arising from the recent increase in violence and local unrest, could adversely impact any of our operations in Nigeria, and could affect the timing and decrease the amount of revenue we may realize from our investments in Nigeria. If Shell does not provide gas to the project or if Shell were to terminate its contract with Global for any reason or if we were to terminate our involvement in the Cawthorne Channel Project, we would be required to find an alternative use for the barge facility which could result in a write-down of our investment and receivables related to this project. At September 30, 2006, we had net assets of approximately $75.3 million related to projects in Nigeria, a majority of which is related to our investment and accounts receivable for the Cawthorne Channel Project.

Additionally, due to the environment in Nigeria, Global’s capitalization level, inexperience with projects of a similar nature and lack of a successful track record with respect to this project and other factors, there is no assurance that Global can satisfy its obligations under its various contracts, including its contract with Hanover.

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

10. RELATED—PARTY TRANSACTIONS

Ted Collins, Jr., one of Hanover’s Directors, owns 100% of Azalea Partners, which owns approximately 15% of Energy Transfer Group, LLC (“ETG”). In the first quarter of 2006, we entered into an agreement to be ETG’s exclusive manufacturer of Dual Drive compressors and to provide marketing services for ETG. During the nine months ended September 30, 2006 and 2005, we recorded revenue of approximately $34.8 million and $14.5 million, respectively, related to sales to ETG. As of September 30, 2006 and December 31, 2005, we had receivable balances due from ETG of $7.3 million and $1.1 million, respectively. In addition, HCLP and ETG are co-owners of a power generation facility in Venezuela. Under the agreement of co-ownership, each party is responsible for its obligations as a co-owner. In addition, HCLP is the designated manager of the facility. As manager, HCLP received revenues related to the facility and distributed to ETG its net share of the operating cash flow of $0.5 million for both of the nine month periods ended September 30, 2006 and 2005.

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11. RECENT ACCOUNTING PRONOUNCEMENTS

In May 2003, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (��SFAS 150”). SFAS 150 changes the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. SFAS 150 requires that those instruments be classified as liabilities in statements of financial position. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective for interim periods beginning after June 15, 2004. On November 7, 2003, the FASB issued Staff Position 150-3 that delayed the effective date for certain types of financial instruments. The adoption of the guidance currently provided in SFAS 150 did not have a material effect on our consolidated results of operations or cash flow. However, upon further guidance from the FASB, we may be required to classify as debt approximately $12.0 million in sale leaseback obligations that, as of September 30, 2006, were reported as “Minority interest” on our consolidated balance sheet pursuant to FIN 46.

These minority interest obligations represent the equity of the entities that lease compression equipment to us. In accordance with the provisions of our compression equipment lease obligations, the equity certificate holders are entitled to quarterly or semi-annual yield payments on the aggregate outstanding equity certificates. As of September 30, 2006, the yield rates on the outstanding equity certificates ranged from 13.3% to 13.7%. Equity certificate holders may receive a return of capital payment upon termination of the lease or our purchase of the leased compression equipment after full payment of all debt obligations of the entities that lease compression equipment to us. At September 30, 2006, the carrying value of the minority interest obligations approximated the fair market value of assets that would be required to be transferred to redeem the minority interest obligations.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs — an Amendment of ARB No. 43, Chapter 4” (“SFAS 151”). This standard provides clarification that abnormal amounts of idle facility expense, freight, handling costs, and spoilage should be recognized as current-period charges. Additionally, this standard requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this standard are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS 151 did not have a material effect on our consolidated results of operations, cash flows or financial position.

In December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123(R)”). This standard addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS 123(R) eliminates the ability to account for share-based compensation transactions using the intrinsic value method under Accounting Principles Board (APB) Opinion No. 25,Accounting for Stock Issued to Employees,and generally requires instead that such transactions be accounted for using a fair-value-based method. SFAS 123(R) is effective as of the first interim or annual reporting period that begins after June 15, 2005. However, on April 14, 2005, the Securities and Exchange Commission announced that the effective date of SFAS 123(R) would be changed to the first annual reporting period that begins after June 15, 2005. The adoption of SFAS 123(R) did not have a material impact on our financial position or cash flows, but impacted our results of operations. See Note 2 for a discussion of the impact of the adoption of SFAS 123(R).

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 153, “Exchange of Nonmonetary Assets, an amendment of APB Opinion No. 29” (“SFAS 153”). SFAS 153 is based on the principle that exchange of nonmonetary assets should be measured based on the fair market value of the assets exchanged. SFAS 153 eliminates the exception of nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. SFAS 153 is effective for nonmonetary asset exchanges in fiscal periods beginning after June 15, 2005. The adoption of SFAS 153 did not have a material impact on our consolidated results of operations, cash flows or financial position.

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

In February 2006, the FASB issued Statement of Financial Accounting Standards No. 155, “Accounting for Certain Hybrid Instruments — an amendment of FASB Statements No. 133 and 140” (“SFAS 155”). SFAS 155 (a) permits fair value remeasurement

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for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, (b) clarifies which interest-only strips and principal-only strips are not subject to the requirements of FASB No. 133, (c) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, (d) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and (e) amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. We are currently evaluating the provisions of SFAS 155 and do not believe that our adoption will have a material impact on our consolidated results of operations, cash flows or financial position.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). This interpretation is effective for fiscal years beginning after December 15, 2006. This interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with FASB Statement No. 109,Accounting for Income Taxes. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We are currently evaluating the provisions of FIN 48.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 provides a single definition of fair value, establishes a framework for measuring fair value and requires additional disclosures about the use of fair value to measure assets and liabilities. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the provisions of SFAS 157.

12. REPORTABLE SEGMENTS

We manage our business segments primarily based upon the type of product or service provided. We have six principal industry segments: U.S. Rentals; International Rentals; Parts, Service and Used Equipment; Compressor and Accessory Fabrication; Production and Processing — Belleli; and Production and Processing — Surface Equipment Fabrication. The U.S. and International Rentals segments primarily provide natural gas compression and production and processing equipment rental and maintenance services to meet specific customer requirements on HCLP-owned assets. The Parts, Service and Used Equipment segment provides a full range of services to support the surface production needs of customers from installation and normal maintenance and services to full operation of a customer’s owned assets and surface equipment as well as sales of used equipment. The Compressor and Accessory Fabrication segment involves the design, fabrication and sale of natural gas compression units and accessories to meet unique customer specifications. The Production and Processing — Surface Equipment Fabrication segment designs, fabricates and sells equipment used in the production and treating of crude oil and natural gas. The Production and Processing — Belleli segment provides engineering, procurement and construction services primarily related to the manufacturing of heavy wall reactors for refineries and construction of desalinization plants and tank farms. During 2005, we determined that the Production and Processing — Belleli segment should become a separate reportable segment from our Production and Processing — Surface Equipment Fabrication reportable segment due to differing long term economic characteristics. We have adjusted prior periods to conform to the current presentation.

We evaluate the performance of our segments based on segment gross profit. Segment gross profit for each segment includes direct revenues and operating expenses. Costs excluded from segment gross profit include selling, general and administrative, depreciation and amortization, interest, foreign currency translation, provision for cost of litigation settlement, goodwill impairment, other expenses and income taxes. Amounts defined as “Other income” include equity in income of non-consolidated affiliates, gain on sales of a business and corporate related items primarily related to cash management activities. Revenues include sales to external customers. We do not include intersegment sales when we evaluate the performance of our segments. Our chief executive officer does not review asset information by segment.

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The following tables present sales and other financial information by industry segment for the three months ended September 30, 2006 and 2005.

									Production and						Total
					Parts,		Compressor		Processing						revenues
					service and		and		Surface						and
	U.S.		International		used		accessory		equipment				Other		other
	rentals		rentals		equipment		fabrication		fabrication		Belleli		income		income
							(in thousands)
September 30, 2006:
Revenue from external customers	$	98,030	$	63,792	$	47,951	$	90,141	$	50,776	$	65,114	$	7,990	$	423,794
Gross profit		58,473		38,264		10,057		15,770		10,471		7,744		7,990		148,769
September 30, 2005:
Revenue from external customers	$	87,703	$	58,208	$	74,027	$	51,798	$	43,421	$	46,891	$	7,808	$	369,856
Gross profit		52,200		38,924		18,162		7,380		4,000		3,166		7,808		131,640

The following tables present sales and other financial information by industry segment for the nine months ended September 30, 2006 and 2005.

									Production and						Total
					Parts,		Compressor		Processing						revenues
					service and		and		Surface						and
	U.S.		International		used		accessory		equipment				Other		other
	rentals		rentals		equipment		fabrication		fabrication		Belleli		income		income
							(in thousands)
September 30, 2006:
Revenue from external customers	$	282,746	$	193,818	$	152,959	$	214,960	$	133,992	$	164,170	$	59,637	$	1,202,282
Gross profit		168,369		123,267		28,942		35,414		24,888		17,433		59,637		457,950
September 30, 2005:
Revenue from external customers	$	262,548	$	167,644	$	157,995	$	125,414	$	145,051	$	139,129	$	18,503	$	1,016,284
Gross profit		159,985		113,714		40,855		14,792		18,778		10,702		18,503		377,329

13. ASSETS HELD FOR SALE AND DISPOSITIONS

In February 2006, we sold our U.S. amine treating rental assets to Crosstex Energy Services L.P. (“Crosstex”) for approximately $51.5 million and recorded a pre-tax gain of $28.4 million that is included in gain on sale of business and other income in the attached condensed consolidated statement of operations. Our U.S. amine treating rental assets had revenues of approximately $7.6 million in 2005. Because we leased back from Crosstex one of the facilities sold in this transaction, approximately $3.3 million of additional gain was deferred into future periods. We also entered into a three-year strategic alliance with Crosstex. The disposal of these assets did not meet the criteria established for recognition as discontinued operations under SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (“SFAS 144”).

During the first quarter of 2006, Hanover’s Board of Directors approved management’s plan to dispose of the assets used in our fabrication facility in Canada, which was part of our Production and Processing- Surface Equipment Fabrication segment. These assets were sold in May 2006 as part of management’s plan to improve overall operating efficiency in this line of business. The Canadian assets were sold for approximately $10.1 million and we recorded a pre-tax gain of approximately $8.0 million as a result of the transaction in gain on sale of business and other income in the attached condensed consolidated statement of operations. The disposal of these assets did not meet the criteria established for recognition as discontinued operations under SFAS 144.

During the fourth quarter of 2002, Hanover’s Board of Directors approved management’s plan to dispose of our non-oilfield power generation projects, which were part of our U.S. rental business, and certain used equipment businesses, which were part of our parts and service business. These disposals met the criteria established for recognition as discontinued operations under SFAS 144. SFAS 144 specifically requires that such amounts must represent a component of a business comprised of operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. These businesses are reflected as discontinued operations in our consolidated statements of operations.

Due to changes in market conditions, we have made valuation adjustments and the disposal plan for a small piece of our original non-oilfield power generation business was not completed as of September 30, 2006. We are continuing to actively market this asset. The remaining asset is expected to be sold within the next three to six months and the asset and liabilities are reflected as held-for-sale on our condensed consolidated balance sheet.

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

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2006		2005			2006		2005
Revenues and other:
U.S. rentals	$	—	$	250		$	15	$	320
Other		776		74			776		79
		776		324			791		399
Expenses:
U.S. rentals		48		274			182		657
Selling, general and administrative		1		101			84		280
Foreign currency translation		—		—			—		5
Interest expense		—		163			—		163
		49		538			266		1,105
Income (loss) from discontinued operations before income taxes		727		(214	)		525		(706	)
Provision for income taxes		157		—			157		—
Income (loss) from discontinued operations	$	570	$	(214	)	$	368	$	(706	)

Summary balance sheet data for assets held for sale (in thousands):

	September 30,			December 31,
	2006			2005
Current asset	$	2,020		$	2,020
Current liabilities		(878	)		(878	)
Net assets held for sale	$	1,142		$	1,142

14. INCOME TAXES

During the three months ended September 30, 2006, we recorded a net tax provision of $6.1 million compared to a net tax benefit of $3.3 million for the three months ended September 30, 2005. Our effective tax rate for the three months ended September 30, 2006 was 23%, compared to 887% for the three months ended September 30, 2005. During the nine months ended September 30, 2006, we recorded a net tax provision of $24.9 million compared to $0.6 million for the nine months ended September 30, 2005. Our effective tax rate for the nine months ended September 30, 2006 was 26%, compared to 177% for the nine months ended September 30, 2005. The change in the effective tax rates was primarily due to our current U.S. tax position and the change in the weight of our U.S. income (loss), including the gain on the sale of our U.S. amine treating business that was recorded in the first quarter of 2006, compared to total income (loss) and the impact of change in loss jurisdictions. During the nine months ended September 30, 2006, we recorded pre-tax income in the U.S. and therefore were able to realize the benefit from net operating loss carryforwards and capital loss carryforwards that previously we had provided a valuation allowance against. Our tax provision for the nine months ended September 30, 2006 includes approximately $3.0 million in deferred tax expense related to the enactment of the Texas Margins tax described below. Our provision for the three and nine months ended September 30, 2005 was impacted by a $3.1 million valuation allowance against U.K. deferred tax assets for which we could not come to the conclusion that realization is more likely than not.

On May 18, 2006, the Governor of Texas signed into law House Bill 3 (“HB-3”) which modifies the existing Texas franchise tax law. The modified franchise tax will be computed by subtracting either costs of goods sold or compensation expense, as defined in HB-3, from gross revenue to arrive at a gross margin. The resulting gross margin will be taxed at a one percent tax rate. HB-3 has also expanded the definition of tax paying entities to include limited partnerships and thereby now subjecting us to a new state tax expense. HB-3 becomes effective for activities occurring on or after January 1, 2007. We believe that this tax should still be accounted for as an income tax, following the provisions of SFAS 109, because it has the characteristics of an income tax. Accordingly, a deferred tax liability of $3.0 million was established for future liabilities under this new tax in the nine months ended September 30, 2006.

Due to our cumulative U.S. tax losses, we can not reach the conclusion that it is “more likely than not” that certain of our U.S. deferred tax assets will be realized in the future. In addition, we have recorded valuation allowances for certain international jurisdictions. If we are required to record and/or release additional valuation allowances in the United States or any other jurisdiction, our effective tax rate will be impacted, perhaps substantially, compared to the statutory rate.

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Pursuant to Section 382 of the Internal Revenue Code of 1986, as amended (“IRC”) , the annual utilization of our net operating loss carryforward may be limited if there is a 50 percentage point change in ownership of Hanover within a three-year period by certain stockholders owning 5% or more of Hanover’s stock. We do not believe that a 50 percentage point change in ownership has occurred during the three year period ended September 30, 2006. It is possible that subsequent transactions involving Hanover’s capital stock could result in such a limitation.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Special Note Regarding Forward-Looking Statements

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

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

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

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

• changes in economic or political conditions in the countries in which we do business, including civil uprisings, riots, terrorism, kidnappings, the taking of property without fair compensation and legislative changes;

• changes in currency exchange rates;

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

• our inability to implement certain business objectives, such as:

• international expansion, including our ability to timely and cost-effectively execute projects in new international operating environments,

• integrating acquired businesses,

• generating sufficient cash,

• accessing the capital markets, and

• refinancing existing or incurring additional indebtedness to fund our business;

• risks associated with any significant failure or malfunction of our enterprise resource planning system;

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

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

Other factors in addition to those described in this Form 10-Q could also affect our actual results. You should carefully consider the risks and uncertainties described above and those described in this Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in evaluating our forward-looking statements.

You should not unduly rely on these forward-looking statements, which speak only as of the date of this Form 10-Q. Except as required by law, we undertake no obligation to publicly revise any forward-looking statement to reflect circumstances or events after the date of this Form 10-Q or to reflect the occurrence of unanticipated events. You should, however, review the factors and risks we describe in our Annual Report on Form 10-K for the year ended December 31, 2005 and the reports we file from time to time with the

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SEC after the date of this Form 10-Q. All forward-looking statements attributable to us are expressly qualified in their entirety by this cautionary statement.

GENERAL

Hanover Compression Limited Partnership, a Delaware corporation (“we”, “us”, “our”, “HCLP”, or the “Company”), is a Delaware limited partnership and an indirect wholly-owned subsidiary of Hanover Compressor Company (File No. 1-13071) (“Hanover”). We, together with our subsidiaries, are a global market leader in the full service natural gas compression business and are also a leading provider of service, fabrication and equipment for oil and natural gas production, processing and transportation applications. We sell and rent this equipment and provide complete operation and maintenance services, including run-time guarantees, for both customer-owned equipment and our fleet of rental equipment. HCLP was founded as a Delaware corporation in 1990, and reorganized as a Delaware limited partnership in 2000. Our customers include both major and independent oil and gas producers and distributors as well as national oil and gas companies in the countries in which we operate. Our maintenance business, together with our parts and service business, provides solutions to customers that own their own compression and surface production and processing equipment, but want to outsource their operations. We also fabricate compressor and oil and gas production and processing equipment and provide gas processing and treating, and oilfield power generation services, primarily to our U.S. and international customers as a complement to our compression services. In addition, through our subsidiary, Belleli Energy S.r.l. (“Belleli”), we provide engineering, procurement and construction services primarily related to the manufacturing of heavy wall reactors for refineries and construction of desalinization plants and tank farms, primarily for use in Europe and the Middle East.

OVERVIEW

Our revenue and other income for the third quarter 2006 was $423.8 million compared to third quarter 2005 revenue and other income of $369.9 million. Net income for the third quarter 2006 was $21.5 million compared to net income of $2.8 million in the third quarter 2005. Our revenue and net income increased due to improved market conditions and our focus on improving sales and margins.

Our revenue and other income for the nine months ended September 30, 2006 was $1,202.3 million compared to revenue and other income of $1,016.3 million for the nine months ended September 30, 2005. Net income for the nine months ended September 30, 2006 was $73.1 million compared with a net loss of $1.1 million for the nine months ended September 30, 2005. Our revenue and net income increased due to improved market conditions and our focus on improving sales and margins. In addition, results for the nine months ended September 30, 2006 benefited from a pre-tax gain of $28.4 million on the sale of our U.S. amine treating business in the first quarter of 2006 and an $8.0 million pre-tax gain on the sale of our fabrication facilities in Canada during the second quarter of 2006. Results for the nine months ended September 30, 2006 were also impacted by debt extinguishment costs of $5.9 million related to the call premium when Hanover repaid thier 11% Zero Coupon Subordinated Notes due March 31, 2007 in the first quarter of 2006.

Total compression horsepower at September 30, 2006 was approximately 3,337,000, consisting of approximately 2,444,000 horsepower in the United States and approximately 893,000 horsepower internationally.

At September 30, 2006, our total third-party fabrication backlog was approximately $688.8 million compared to approximately $373.1 million at December 31, 2005 and $394.8 million at September 30, 2005. Our compressor and accessory fabrication backlog was approximately $192.4 million at September 30, 2006, compared to approximately $85.4 million at December 31, 2005 and $95.6 million at September 30, 2005. Our backlog for production and processing equipment fabrication was approximately $496.4 million at September 30, 2006, compared to approximately $287.7 million at December 31, 2005 and $299.2 million at September 30, 2005.

Industry Conditions

The North American rig count increased by 12% to 2,185 at September 30, 2006 from 1,949 at September 30, 2005, and the twelve-month rolling average North American rig count increased by 20% to 2,090 at September 30, 2006 from 1,743 at September 30, 2005. In addition, the twelve-month rolling average U.S. wellhead natural gas price increased to $7.45 per Mcf at September 30, 2006 from $6.44 per Mcf at September 30, 2005. Despite the increase in natural gas prices and the recent increase in the rig count, U.S. natural gas production levels have not significantly changed. Recently, we have not experienced significant growth in U.S. rentals of equipment, which we believe is primarily the result of (i) the lack of immediate availability of compression equipment in the configuration currently in demand by our customers, and (ii) an increase in the purchase of compression equipment by oil and gas companies that have available capital. However, improved market conditions have led to improved pricing and demand for compression equipment in the U.S. market. In response, we have converted one of our facilities to refurbish approximately 200,000 horsepower of idle U.S. compression assets so we can deploy these units in both our U.S. and international rental businesses. To date,

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the compression units from the first phase of this project have primarily been deployed on international projects; but, we expect that this program, along with the addition of new rental units, will increase our available U.S. horsepower over the next twelve months.

U.S. Tax Position

Due to our cumulative U.S. tax losses, we can not reach the conclusion that it is “more likely than not” that certain of our U.S. deferred tax assets will be realized in the future. During the nine months ended September 30, 2006, we recorded pre-tax income in the U.S. and therefore were able to realize the benefit from net operating loss carryforwards and capital loss carryforwards that previously we had provided a valuation allowance against. If we are required to record and/or release additional valuation allowances in the United States or any other jurisdiction, our effective tax rate will be impacted, perhaps substantially, compared to the statutory rate.

RESULTS OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2005

Summary of Business Line Results

U.S. Rentals
(in thousands)

	Three months ended
	September 30,						Increase
	2006			2005			(Decrease)
Revenue	$	98,030		$	87,703			12	%
Operating expense		39,557			35,503			11	%
Gross profit	$	58,473		$	52,200			12	%
Gross margin		60	%		60	%		0	%

U.S. rental revenue and gross profit increased during the three months ended September 30, 2006, compared to the three months ended September 30, 2005, due primarily to an improvement in market conditions that has led to an improvement in pricing and an increase in contracted horsepower. Gross margin for the three months ended September 30, 2006 benefited from price increases, but was offset by higher repair and maintenance expenses and the impact of recording increased incentive compensation expenses of approximately $1.1 million, including the impact of the adoption of SFAS 123(R).

International Rentals
(in thousands)

	Three months ended
	September 30,						Increase
	2006			2005			(Decrease)
Revenue	$	63,792		$	58,208			10	%
Operating expense		25,528			19,284			32	%
Gross profit	$	38,264		$	38,924			(2	)%
Gross margin		60	%		67	%		(7	)%

During the three months ended September 30, 2006, international rental revenue increased, compared to the three months ended September 30, 2005, primarily due to increased rental activity in Venezuela, Mexico, Argentina and Brazil. Gross profit and gross margin decreased primarily due to higher repair and maintenance costs in Venezuela, Argentina and Mexico and increased costs in Nigeria. Additionally, we were not able to recognize approximately $5.4 million of revenues related to projects in Nigeria (of which $4.2 million related to the Cawthorne Channel Project) that were off-line due to the unrest in that area and the resulting uncertainty related to the collection of the associated receivables during the third quarter of 2006. Although we were not able to recognize these revenues, we have recognized the expenses incurred associated with these projects in Nigeria. This impacted gross margins by approximately 3%.

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Parts, Service and Used Equipment
(in thousands)

	Three months ended
	September 30,						Increase
	2006			2005			(Decrease)
Revenue	$	47,951		$	74,027			(35	)%
Operating expense		37,894			55,865			(32	)%
Gross profit	$	10,057		$	18,162			(45	)%
Gross margin		21	%		25	%		(4	)%

Parts, service and used equipment revenue for the three months ended September 30, 2006 were lower than the three months ended September 30, 2005 primarily due to a decrease in used rental equipment sales. Gross profit and gross margin for the three months ended September 30, 2006 were lower than the three months ended September 30, 2005 primarily due to reduced margins on used rental equipment sales and installation sales. Parts, service and used equipment revenue includes two business components: (1) parts and service and (2) used rental equipment and installation sales. For the three months ended September 30, 2006, parts and service revenue was $43.7 million with a gross margin of 24%, compared to $40.7 million and 25%, respectively, for the three months ended September 30, 2005. Used rental equipment and installation sales revenue for the three months ended September 30, 2006 was $4.2 million with a gross margin of (6)%, compared to $33.3 million with a 24% gross margin for the three months ended September 30, 2005. Our used rental equipment and installation sales revenue and gross margins vary significantly from period to period and are dependent on the exercise of purchase options on rental equipment by customers and installation sales associated with the start-up of new projects by customers.

Compressor and Accessory Fabrication
(in thousands)

	Three months ended
	September 30,						Increase
	2006			2005			(Decrease)
Revenue	$	90,141		$	51,798			74	%
Operating expense		74,371			44,418			67	%
Gross profit	$	15,770		$	7,380			114	%
Gross margin		17	%		14	%		3	%

For the three months ended September 30, 2006, compressor and accessory fabrication revenue, gross profit and gross margin increased, compared to the three months ended September 30, 2005, primarily due to improved market conditions that led to higher sales levels and improved pricing. As of September 30, 2006, we had compressor fabrication backlog of $192.4 million compared to $95.6 million at September 30, 2005.

Production and Processing Equipment Fabrication
(in thousands)

	Three months ended
	September 30,						Increase
	2006			2005			(Decrease)
Revenue	$	115,890		$	90,312			28	%
Operating expense		97,675			83,146			17	%
Gross profit	$	18,215		$	7,166			154	%
Gross margin		16	%		8	%		8	%

Production and processing equipment fabrication revenue, gross profit and gross margin for the three months ended September 30, 2006 were higher than for the three months ended September 30, 2005, primarily due to an improvement in market conditions that led to an increase in awarded sales, improved pricing and an improvement in operating efficiencies. Margins for the three months ended September 30, 2005 were also impacted by poor performance on a number of jobs. As of September 30, 2006, we had a production and processing equipment fabrication backlog of $496.4 million compared to $299.2 million at September 30, 2005, including Belleli’s backlog of $454.0 million and $203.1 million at September 30, 2006 and 2005, respectively.

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Belleli’s revenue and gross profit increased during the three months ended September 30, 2006 compared to the same period in 2005 due to improved market conditions. During the three months ended September 30, 2006, Belleli’s revenue increased $18.2 million to $65.1 million and Belleli’s gross profit increased $4.6 million to $7.7 million compared to the same period in 2005.

Expenses

Selling, general, and administrative expense (“SG&A”) for the three months ended September 30, 2006 was $50.9 million, compared to $45.4 million during the three months ended September 30, 2005. The increase in SG&A expense is primarily due to increased incentive compensation expenses, including the impact of our adoption of SFAS 123(R), and other costs associated with the increase in business activity. As a percentage of revenues and other income, SG&A for both the three months ended September 30, 2006 and September 30, 2005 was 12%.

Depreciation and amortization expense for the three months ended September 30, 2006 decreased to $45.1 million, compared to $47.3 million for the three months ended September 30, 2005. Depreciation and amortization decreased during the three months ended September 30, 2006 as compared to the three months ended September 30, 2005 primarily due to reduced amortization of deferred financing costs. Depreciation and amortization expense for the three months ended September 30, 2005 included a write-off of $2.5 million of unamortized debt issuance costs related to the partial redemption and repayment of our 2001A compression equipment lease obligations.

The decrease in our interest expense was primarily due to debt repayments since September 30, 2005 including the redemption of our promissory note to our general partner that had the same general terms as Hanover’s 11% Zero Coupon Subordinated Notes due 2013. Hanover redeemed its 11% Zero Coupon Subordinated Notes in March 2006 using proceeds from its public offering of $150 million 7.5% Senior Notes due 2013 and borrowings under the bank credit facility.

Foreign currency translation for the three months ended September 30, 2006 and 2005 was a loss of $0.9 million and $1.1 million, respectively. For the three months ended September 30, 2006, foreign currency translation included a $0.3 million gain related to the re-measurement of our international subsidiaries’ dollar denominated inter-company debt. For the three months ended September 30, 2005, foreign currency translation included a $2.1 million loss related to the re-measurement of our international subsidiaries’ dollar denominated inter-company debt, primarily for our subsidiary in Canada.

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

	Three Months Ended
	September 30,
	2006			2005
Canada	$	(61	)	$	(1,447	)
Argentina		(73	)		(112	)
Venezuela		6			304
Italy		(637	)		(273	)
All other countries		(140	)		445
Exchange gain (loss)	$	(905	)	$	(1,083	)

The impact of foreign exchange on our statements of operations will depend on the amount of our net asset and liability positions exposed to currency fluctuations in future periods.

Income Taxes

During the three months ended September 30, 2006, we recorded a net tax provision of $6.1 million compared to a net tax benefit of $3.3 million for the three months ended September 30, 2005. Our effective tax rate for the three months ended September 30, 2006 was 23%, compared to 887% for the three months ended September 30, 2005. The change in the effective tax rate was primarily due to our current U.S. tax position and the change in the weight of our U.S. income (loss), including the gain on the sale of our U.S. amine treating business that was recorded in the first quarter of 2006, compared to total income (loss) and the impact of change in loss jurisdictions. During the three months ended September 30, 2006, we recorded pre-tax income in the U.S. and therefore were able to realize the benefit from net operating loss carryforwards and capital loss carryforwards that previously we had provided a valuation allowance against. Our provision for the three months ended September 30, 2005 was impacted by a $3.1 million valuation allowance against U.K. deferred tax assets for which we could not come to the conclusion that realization is more likely than not.

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Due to our cumulative U.S. tax losses, we can not reach the conclusion that it is “more likely than not” that certain of our U.S. deferred tax assets will be realized in the future. In addition, we have recorded valuation allowances for certain international jurisdictions. If we are required to record and/or release additional valuation allowances in the United States or any other jurisdiction, our effective tax rate will be impacted, perhaps substantially, compared to the statutory rate.

NINE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2005

Summary of Business Line Results

U.S. Rentals
(in thousands)

	Nine months ended
	September 30,						Increase
	2006			2005			(Decrease)
Revenue	$	282,746		$	262,548			8	%
Operating expense		114,377			102,563			12	%
Gross profit	$	168,369		$	159,985			5	%
Gross margin		60	%		61	%		(1	)%

U.S. rental revenue and gross profit increased during the nine months ended September 30, 2006, compared to the nine months ended September 30, 2005, due primarily to an improvement in market conditions that has led to an improvement in pricing and an increase in contracted horsepower. Gross margin for the nine months ended September 30, 2006 decreased compared to the nine months ended September 30, 2005, primarily due to $3.0 million of higher expenses related to our program to refurbish approximately 200,000 horsepower of idle U.S. compression equipment and the impact of recording increased incentive compensation expenses of approximately $2.8 million, including the impact of the adoption of SFAS 123(R), partially offset by price increases.

International Rentals
(in thousands)

	Nine months ended
	September 30,						Increase
	2006			2005			(Decrease)
Revenue	$	193,818		$	167,644			16	%
Operating expense		70,551			53,930			31	%
Gross profit	$	123,267		$	113,714			8	%
Gross margin		64	%		68	%		(4	)%

During the nine months ended September 30, 2006, international rental revenue and gross profit increased, compared to the nine months ended September 30, 2005, primarily due to increased rental activity in Venezuela, Mexico and Nigeria. Gross margin decreased primarily due to increased labor costs in Argentina and reduced margins in Brazil and Mexico. Additionally, we did not recognize approximately $6.3 million of revenues related to projects in Nigeria (of which $5.1 million related to the Cawthorne Channel Project) that were off-line due to the unrest in that area and the resulting uncertainty related to the collection of the associated receivables during the nine months ended September 30, 2006. Although we were not able to recognize these revenues, we have recognized the expenses incurred associated with these projects in Nigeria. This impacted gross margins by approximately 1%.

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Parts, Service and Used Equipment
(in thousands)

	Nine months ended
	September 30,						Increase
	2006			2005			(Decrease)
Revenue	$	152,959		$	157,995			(3	)%
Operating expense		124,017			117,140			6	%
Gross profit	$	28,942		$	40,855			(29	)%
Gross margin		19	%		26	%		(7	)%

Parts, service and used equipment revenue for the nine months ended September 30, 2006 were lower than the nine months ended September 30, 2005 primarily due to a decrease in used rental equipment sales. Gross margin for the nine months ended September 30, 2006 decreased due to lower margins on used equipment sales and installation sales. Parts, service and used equipment revenue includes two business components: (1) parts and service and (2) used rental equipment and installation sales. For the nine months ended September 30, 2006, parts and service revenue was $128.6 million with a gross margin of 23%, compared to $110.5 million and 26%, respectively, for the nine months ended September 30, 2005. Used rental equipment and installation sales revenue for the nine months ended September 30, 2006 was $24.4 million with a gross margin of (4)%, compared to $47.5 million with a 25% gross margin for the nine months ended September 30, 2005. Used rental equipment and installation gross margin was negatively impacted by approximately $3.0 million of cost overruns on installation jobs in the first quarter of 2006. Our used rental equipment and installation sales revenue and gross margins vary significantly from period to period and are dependent on the exercise of purchase options on rental equipment by customers and installation sales associated with the start-up of new projects by customers.

Compressor and Accessory Fabrication
(in thousands)

	Nine months ended
	September 30,						Increase
	2006			2005			(Decrease)
Revenue	$	214,960		$	125,414			71	%
Operating expense		179,546			110,622			62	%
Gross profit	$	35,414		$	14,792			139	%
Gross margin		16	%		12	%		4	%

For the nine months ended September 30, 2006, compressor and accessory fabrication revenue, gross profit and gross margin increased primarily due to improved market conditions that led to higher sales levels and better pricing. As of September 30, 2006, we had compressor fabrication backlog of $192.4 million compared to $95.6 million at September 30, 2005.

Production and Processing Equipment Fabrication
(in thousands)

	Nine months ended
	September 30,						Increase
	2006			2005			(Decrease)
Revenue	$	298,162		$	284,180			5	%
Operating expense		255,841			254,700			0	%
Gross profit	$	42,321		$	29,480			44	%
Gross margin		14	%		10	%		4	%

Production and processing equipment fabrication revenue for the nine months ended September 30, 2006 was higher than for the nine months ended September 30, 2005, primarily due to an improvement in market conditions that led to an increase in awarded sales, improved pricing and an improvement in operating efficiencies. Gross margins improved due to improved market conditions and poor performance on a few jobs in the first nine months of 2005. As of September 30, 2006, we had a production and processing equipment fabrication backlog of $496.4 million compared to $299.2 million at September 30, 2005, including Belleli’s backlog of $454.0 million and $203.1 million at September 30, 2006 and 2005, respectively.

Belleli’s revenue and gross profit increased during the nine months ended September 30, 2006 compared to the same period in 2005 due to improved market conditions. During the nine months ended September 30, 2006, Belleli’s revenue increased $25.0 million to $164.2 million and Belleli’s gross profit increased $6.7 million to $17.4 million compared to the same period in 2005.

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Gain on sale of business and other income

Gain on sale of business and other income for the nine months ended September 30, 2006 increased to $42.2 million, compared to $2.7 million for the nine months ended September 30, 2005. The increase was primarily due to a pre-tax gain of $28.4 million on the sale of our U.S. amine treating business in the first quarter of 2006 and an $8.0 million pre-tax gain on the sale of assets used in our fabrication facility in Canada during the second quarter of 2006.

Expenses

SG&A for the nine months ended September 30, 2006 was $148.8 million, compared to $131.5 million for the nine months ended September 30, 2005. The increase in SG&A expense is primarily due to increased compensation expenses, including the impact of our adoption of SFAS 123(R), and other costs associated with the increase in business activity. As a percentage of revenues and other income, SG&A for the nine months ended September 30, 2006 and September 30, 2005 was 12% and 13%, respectively.

Depreciation and amortization expense for the nine months ended September 30, 2006 decreased to $129.7 million, compared to $137.8 million for the nine months ended September 30, 2005. Depreciation and amortization decreased during the nine months ended September 30, 2006 as compared to the nine months ended September 30, 2005 primarily due to reduced amortization of deferred financing costs and reduced amortization related to installation costs that were fully amortized. Depreciation and amortization expense for the nine months ended September 30, 2005 included a write-off of $2.5 million of unamortized debt issuance costs related to the partial redemption and repayment of our 2001A compression equipment lease obligations.

Other expense for the nine months ended September 30, 2006 increased to $1.2 million, compared to $0.5 million for the nine months ended September 30, 2005. We recorded a $1.2 million charge to other expense in the second quarter of 2006 related to the write-down of a pre-acquisition receivable for Belleli to our estimated net realizable value.

The decrease in our interest expense was primarily due to debt repayments since September 30, 2005 and the redemption in March 2006 of our promissory note to our general partner that had the same general terms as Hanover’s 11% Zero Coupon Subordinated Notes due 2013. Hanover redeemed its 11% Zero Coupon Subordinated Notes in March 2006 using proceeds from its public offering of $150 million 7.5% Senior Notes due 2013 and borrowings under the bank credit facility.

Foreign currency translation for the nine months ended September 30, 2006 was a gain of $2.8 million, compared to a loss of $6.3 million for the nine months ended September 30, 2005. The increase in foreign exchange gain is primarily due to the strengthening of the Euro against the U.S. Dollar for the nine months ended September 30, 2006 as compared to the strengthening of the U.S. Dollar against the Euro for the nine months ended September 30, 2005. For the nine months ended September 30, 2006 and 2005, foreign currency translation included a $1.9 million gain and an $11.0 million loss, respectively, related to the re-measurement of our international subsidiaries’ dollar denominated inter-company debt, primarily for our subsidiary in Italy. During the nine months ended September 30, 2005, we recorded the impact of the change in the fixed exchange rate made by the Venezuelan government.

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

	Nine Months Ended
	September 30,
	2006			2005
Canada	$	(1,078	)	$	(1,252	)
Argentina		(1,020	)		362
Venezuela		581			3,453
Italy		3,617			(9,165	)
All other countries		728			293
Exchange gain/(loss)	$	2,828		$	(6,309	)

The impact of foreign exchange on our statements of operations will depend on the amount of our net asset and liability positions exposed to currency fluctuations in future periods.

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Income Taxes

During the nine months ended September 30, 2006, we recorded a net tax provision of $24.9 million compared to $0.6 million for the nine months ended September 30, 2005. Our effective tax rate for the nine months ended September 30, 2006 was 26%, compared to 177% for the nine months ended September 30, 2005. The change in the effective tax rate was primarily due to our current U.S. tax position and the change in the weight of our U.S. income (loss), including the gain on the sale of our U.S. amine treating business that was recorded in the first quarter of 2006, compared to total income (loss) and the impact of change in loss jurisdictions. During the nine months ended September 30, 2006, we recorded pre-tax income in the U.S. and therefore were able to realize the benefit from net operating loss carryforwards and capital loss carryforwards that previously we had provided a valuation allowance against. Our tax provision for the nine months ended September 30, 2006 includes approximately $3.0 million in deferred tax expense related to the enactment of the Texas Margins tax. Our provision for the nine months ended September 30, 2005 was impacted by a $3.1 million valuation allowance against U.K. deferred tax assets for which we could not come to the conclusion that realization is more likely than not.

Due to our cumulative U.S. tax losses, we can not reach the conclusion that it is “more likely than not” that certain of our U.S. deferred tax assets will be realized in the future. In addition, we have recorded valuation allowances for certain international jurisdictions. If we are required to record and/or release additional valuation allowances in the United States or any other jurisdictions, our effective tax rate will be impacted, perhaps substantially, compared to the statutory rate.

Cumulative Effect of Accounting Change, Net of Tax

On January 1, 2006, we recorded the cumulative effect of change in accounting related to our adoption of SFAS 123(R) of $0.4 million (net of tax of $0) which relates to the requirement to estimate forfeitures on restricted stock awards.

LIQUIDITY AND CAPITAL RESOURCES

Our unrestricted cash balance was $55.1 million at September 30, 2006 compared to $48.2 million at December 31, 2005. Working capital increased to $365.6 million at September 30, 2006 from $363.3 million at December 31, 2005. The increase in working capital was primarily attributable to an increase in accounts receivable and inventory, substantially offset by an increase in advance billings and billings on uncompleted contracts in excess of costs and estimated earnings.

Our cash flow from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows, are summarized in the table below (dollars in thousands):

	Nine Months Ended
	September 30,
	2006			2005
Net cash provided by (used in) continuing operations:
Operating activities	$	87,869		$	79,383
Investing activities		(97,574	)		(66,553	)
Financing activities		15,161			(20,075	)
Effect of exchange rate changes on cash and cash equivalents		991			(835	)
Net cash provided by (used in) discontinued operations		431			(156	)
Net change in cash and cash equivalents	$	6,878		$	(8,236	)

The increase in cash provided by operating activities for the nine months ended September 30, 2006 as compared to the nine months ended September 30, 2005 was primarily due to cash generated from improved operating performance. The increase was substantially offset by the payment of $86.1 million of accreted interest from August 31, 2001 to March 31, 2006 on our note to our general partner that had the same general terms as Hanover’s 11% Zero Coupon Subordinated Notes, which Hanover redeemed in the second quarter of 2006. The accreted interest was previously included in the outstanding balance of our note to our general partner that had the same general terms as Hanover’s 11% Zero Coupon Subordinated Notes.

The increase in cash used in investing activities during the nine months ended September 30, 2006 as compared to the nine months ended September 30, 2005 was primarily attributable to a $70.0 million increase in net capital expenditures during the nine months ended September 30, 2006. The increase in cash used in investing activities was partially offset by proceeds received from the sales of our amine treating business in the first quarter of 2006 and our Canadian fabrication assets in the second quarter of 2006.

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The increase in cash provided by financing activities was primarily due to the use of our bank credit facility for a portion of the redemption of our note to our general partner that had the same general terms as Hanover’s 11% Zero Coupon Subordinated Notes, including the payment of accreted interest.

We may carry out new customer projects through rental fleet additions and other related capital expenditures. We generally invest funds necessary to make these rental fleet additions when our idle equipment cannot economically fulfill a project’s requirements and the new equipment expenditure is matched with long-term contracts whose expected economic terms exceed our return on capital targets. We currently plan to spend approximately $225 million to $250 million on net capital expenditures during 2006 including (1) rental equipment fleet additions and (2) approximately $65 million to $75 million on equipment maintenance capital. Projected maintenance capital for 2006 includes the cost of our program to refurbish approximately 200,000 horsepower of idle U.S. compression equipment. In addition, our purchase order commitments as of September 30, 2006 are approximately $337 million. Other than the increase in purchase commitments and the refinancing completed in March 2006 which is discussed below, subsequent to December 31, 2005, there have been no other significant changes to our obligations to make future payments under existing contracts.

Historically, we have funded our capital requirements with a combination of internally generated cash flow, borrowings under a bank credit facility, sale leaseback transactions, capital contributions and advances from Hanover and issuing long-term debt.

As part of our business, we are a party to various financial guarantees, performance guarantees and other contractual commitments to extend guarantees of credit and other assistance to various subsidiaries, investees and other third parties. To varying degrees, these guarantees involve elements of performance and credit risk, which are not included on our consolidated balance sheet. The possibility of our having to honor our contingencies is largely dependent upon future operations of various subsidiaries, investees and other third parties, or the occurrence of certain future events. We would record a reserve for these guarantees if events occurred that required that one be established.

In March 2006, Hanover completed a public offering of $150 million aggregate principal amount of 7.5% Senior Notes due 2013, which we have guaranteed on a senior subordinated basis. Hanover used the net proceeds from the offering of $146.6 million, together with borrowings under our bank credit facility, to redeem Hanover’s 11% Zero Coupon Subordinated Notes due March 31, 2007. In connection with the redemption, we expensed $5.9 million related to the call premium. Hanover paid approximately $242 million to redeem its 11% Zero Coupon Subordinated Notes, including the call premium. The offering and sale of the 7.5% Senior Notes were made pursuant to an automatic shelf registration statement on Form S-3 filed with the Securities and Exchange Commission. Hanover may redeem up to 35% of the 7.5% Senior Notes using the proceeds of certain equity offerings completed before April 15, 2009 at a redemption price of 107.5% of the principal amount, plus accrued and unpaid interest to the redemption date. In addition, Hanover may redeem some or all of the 7.5% Senior Notes at any time on or after April 15, 2010 at certain redemption prices together with accrued interest, if any, to the date of redemption.

Our bank credit facility provides for a $450 million revolving credit in which U.S. dollar-denominated advances bear interest at our option, at (a) the greater of the Administrative Agent’s prime rate or the federal funds effective rate plus 0.50% (“ABR”), or (b) the Eurodollar rate (“LIBOR”), in each case plus an applicable margin ranging from 0.375% to 1.5%, with respect to ABR loans, and 1.375% to 2.5%, with respect to LIBOR loans, in each case depending on Hanover’s consolidated leverage ratio. Euro-denominated advances bear interest at the Eurocurrency rate, plus an applicable margin ranging from 1.375% to 2.5%, depending on Hanover’s consolidated leverage ratio. A commitment fee ranging from 0.375% to 0.5%, depending on Hanover’s consolidated leverage ratio, times the average daily amount of the available commitment under the bank credit facility is payable quarterly to the lenders participating in the bank credit facility.

As of September 30, 2006, HCLP and Hanover were in compliance with all covenants and other requirements set forth in our bank credit facility, the indentures and agreements related to our compression equipment lease obligations and the indentures and agreements relating to our other long-term debt. While there is no assurance, we believe based on our current projections for 2006 that HCLP and Hanover will be in compliance with the financial covenants in these agreements. A default under our bank credit facility or a default under certain of the various indentures and agreements would in some situations trigger cross-default provisions under our bank credit facility or the indentures and agreements relating to certain of our other debt obligations. Such defaults would have a material adverse effect on our liquidity, financial position and operations.

As of September 30, 2006, we had $69.0 million of outstanding borrowings and $164.9 million of outstanding letters of credit under our bank credit facility, resulting in $216.1 million of additional capacity under such bank credit facility at September 30, 2006. We expect that our bank credit facility and cash flow from operations will provide us adequate capital resources to fund our estimated

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level of capital expenditures for the short term. Our bank credit facility permits us to incur indebtedness, subject to covenant limitations, up to a $450 million credit limit, plus, in addition to certain other indebtedness, an additional (a) $50 million in unsecured indebtedness, (b) $100 million of indebtedness of international subsidiaries and (c) $35 million of secured purchase money indebtedness.

While all of the agreements related to our long-term debt do not contain the same financial covenants, the indentures and the agreements related to our compression equipment lease obligations for our 2001A and 2001B sale leaseback transactions, Hanover’s 8.625% Senior Notes due 2010, Hanover’s 7.5% Senior Notes due 2013 and Hanover’s 9.0% Senior Notes due 2014 permit us at a minimum, (1) to incur indebtedness, at any time, of up to $400 million under our bank credit facility, plus an additional $75 million in unsecured indebtedness, (2) to incur additional indebtedness so long as, after incurring such indebtedness, Hanover’s ratio of the sum of consolidated net income before interest expense, income taxes, depreciation expense, amortization of intangibles, certain other non-cash charges and rental expense to total fixed charges (all as defined and adjusted by the agreements governing such obligations), or Hanover’s “coverage ratio,” is greater than 2.25 to 1.0, and no default or event of default has occurred or would occur as a consequence of incurring such additional indebtedness and the application of the proceeds thereof and (3) to incur certain purchase money and similar obligations. The indentures and agreements for our 2001A and 2001B compression equipment lease obligations, Hanover’s 8.625% Senior Notes due 2010, Hanover’s 7.5% Senior Notes due 2013 and Hanover’s 9.0% Senior Notes due 2014 define indebtedness to include the present value of our rental obligations under sale leaseback transactions and under facilities similar to our compression equipment operating leases. As of September 30, 2006, Hanover’s coverage ratio exceeded 2.25 to 1.0, and therefore as of such date it would allow us to incur a limited amount of indebtedness in addition to our bank credit facility and the additional $75 million in unsecured indebtedness and certain other permitted indebtedness, including certain refinancing of indebtedness allowed by such bank credit facility.

In September 2006, Moody’s Investors Service, Inc. (“Moody’s”) announced the implementation of its new Probability-of-Default (PD) and Loss-Given-Default (LGD) rating methodologies for the U.S. and Canadian oilfield service and refining and marketing sectors. As of September 30, 2006, Hanover’s credit ratings as assigned by Moody’s and Standard & Poor’s Ratings Services (“Standard & Poor’s”) were:

			Standard
	Moody’s		& Poor’s
Outlook		Positive		Stable
Senior implied rating		B1		BB-
Liquidity rating		SGL-3		—
2001A equipment lease notes, interest at 8.5%, due September 2008		Ba3, LGD 3		B+
2001B equipment lease notes, interest at 8.75%, due September 2011		Ba3, LGD 3		B+
4.75% convertible senior notes due 2008		B3, LGD 5		B
4.75% convertible senior notes due 2014		B3, LGD 5		B
8.625% senior notes due 2010		B2, LGD 4		B
9.0% senior notes due 2014		B2, LGD 4		B
7.5% senior notes due 2013		B2, LGD 4		B
7.25% convertible subordinated notes due 2029*		B3, LGD 6		B-

* Rating is on the Mandatorily Redeemable Convertible Preferred Securities issued by Hanover Compressor Capital Trust, a trust sponsored by Hanover.

Neither Hanover nor HCLP have any credit rating downgrade provisions in their respective debt agreements or the agreements related to their compression equipment lease obligations that would accelerate their maturity dates. However, a downgrade in Hanover’s credit rating could materially and adversely affect Hanover’s and HCLP’s ability to renew existing, or obtain access to new, credit facilities in the future and could increase the cost of such facilities. Should this occur, we might seek alternative sources of funding. In addition, our significant leverage puts us at greater risk of default under one or more of our existing debt agreements if we experience an adverse change to our financial condition or results of operations. Our ability to reduce our leverage depends upon market and economic conditions, as well as our ability to execute liquidity-enhancing transactions such as sales of non-core assets or Hanover equity securities.

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

In March 2004, we entered into two interest rate swaps, which we designated as fair value hedges, to hedge the risk of changes in fair value of our note to our general partner that has the same general terms as Hanover’s 8.625% Senior Notes due 2010 resulting from changes in interest rates. These interest rate swaps, under which we receive fixed payments and make floating payments, result in the conversion of the hedged obligation into floating rate debt. For derivative instruments designated as fair value hedges, the gain or loss is recognized in earnings in the period of change together with the gain or loss on the hedged item attributable to the risk being hedged. The following table summarizes, by individual hedge instrument, these interest rate swaps as of September 30, 2006 (dollars in thousands):

							Fair Value of
		Fixed Rate to be					Swap at
Floating Rate to be Paid	Maturity Date	Received			Notional Amount		September 30, 2006
Six Month LIBOR +4.72%	December 15, 2010		8.625	%	$	100,000	$	(4,687	)
Six Month LIBOR +4.64%	December 15, 2010		8.625	%	$	100,000	$	(4,443	)

As of September 30, 2006, a total of approximately $1.6 million in accrued liabilities, $7.5 million in long-term liabilities and a $9.1 million reduction of debt due to our general partner was recorded with respect to the fair value adjustment related to these two swaps. We estimate the effective floating rate, which is determined in arrears pursuant to the terms of the swap, to be paid at the time of settlement. As of September 30, 2006, we estimated that the effective rate for the six-month period ending in December 2006 would be approximately 9.9%.

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

International Operations. We have significant operations that expose us to currency risk in Argentina and Venezuela. As a result, adverse political conditions and fluctuations in currency exchange rates could materially and adversely affect our business. To mitigate that risk, the majority of our existing contracts provide that we receive payment in, or based on, U.S. dollars rather than Argentine pesos and Venezuelan bolivars, thus reducing our exposure to fluctuations in their value.

In February 2003, the Venezuelan government fixed the exchange rate to 1,600 bolivars for each U.S. dollar. In February 2004 and March 2005, the Venezuelan government devalued the currency to 1,920 bolivars and 2,148 bolivars, respectively, for each U.S. dollar. The impact of the devaluation on our results will depend upon the amount of our assets (primarily working capital) exposed to currency fluctuation in Venezuela in future periods.

For the nine months ended September 30, 2006, our Argentine operations represented approximately 4% of our revenue and 6% of our gross profit. For the nine months ended September 30, 2006, our Venezuelan operations represented approximately 9% of our revenue and 15% of our gross profit. At September 30, 2006, we had approximately $14.2 million and $23.4 million in accounts receivable related to our Argentine and Venezuelan operations, respectively.

The economic situation in Argentina and Venezuela is subject to change. To the extent that the situation deteriorates, exchange controls continue in place and the value of the peso and bolivar against the dollar is reduced further, our results of operations in Argentina and Venezuela could be materially and adversely affected which could result in reductions in our net income.

Foreign currency translation for the nine month ended September 30, 2006 was a gain of $2.8 million, compared to a loss of $6.3 million for the nine months ended September 30, 2005. The increase in foreign exchange gain is primarily due to strengthening of the Euro against the U.S. Dollar for the nine months ended September 30, 2006 as compared to the strengthening of the U.S. Dollar against the Euro for the nine months ended September 30, 2005. During the nine months ended September 30, 2005, we recorded the impact of the change in the fixed exchange rate made by the Venezuelan government.

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

	Nine Months Ended
	September 30,
	2006			2005
Canada	$	(1,078	)	$	(1,252	)
Argentina		(1,020	)		362
Venezuela		581			3,453
Italy		3,617			(9,165	)
All other countries		728			293
Exchange gain/(loss)	$	2,828		$	(6,309	)

The impact of foreign exchange on our statements of operations will depend on the amount of our net asset and liability positions exposed to currency fluctuations in future periods.

We are involved in a project called the Cawthorne Channel Project in Nigeria, a project in which Global Gas and Refining Ltd., a Nigerian entity (“Global”) has contracted with an affiliate of The Royal/Dutch Group (“Shell”) to process gas from some of Shell’s Nigerian oil and gas fields. Pursuant to a contract between Hanover and Global, we rent and operate barge-mounted gas compression and gas processing facilities stationed in a Nigerian coastal waterway. We completed the building of the required barge-mounted facilities and our portion of the project was declared commercial by Global in November 2005. The contract runs for a ten-year period which commenced when the project was declared commercial, subject to a purchase option, by Global, that is exercisable for the remainder of the term of the contract. Under the terms of a series of contracts between Global and Hanover, Shell, and several other counterparties, respectively, Global is primarily responsible for the overall project.

In the first nine months of 2006, violence and local unrest significantly increased in Nigeria. As a result of these events, Global declared Force Majeure with respect to the Cawthorne Channel Project. Global’s actions followed a declaration of Force Majeure by Shell under its contract with Global. We have notified Global that we dispute their declaration of Force Majeure and that we believed local conditions did not relieve Global’s obligations to make monthly rental payments or monthly operations and maintenance fee payments to us under our contract with Global. The Cawthorne Channel Project was brought back on-line in April 2006 and operated through early June 2006.

In early June and again in October 2006, the area experienced unrest and violence and gas delivery from Shell to the Project was stopped in June 2006. The Project did not receive any gas from Shell during the third quarter and Shell has not completed repairs on its gathering system. As a result, the Cawthorne Channel Project has not operated since early June 2006.

During the three and nine month periods ended September 30, 2006, we recognized $0 million and $7.3 million, respectively, of revenues related to the Cawthorne Channel Project and we have received approximately $2.6 million in payments during 2006. Even though we believe we are entitled to rents from Global, irrespective of whether Shell has declared Force Majeure, and have invoiced Global for rents, collectibility is not reasonably assured due to uncertainty regarding when the Project’s operations will restart and Global’s dependence on gas production by the Cawthorne Channel Project to pay its rents to us. Therefore, we did not recognize any revenue related to the Cawthorne Channel Project in the third quarter of 2006. Once the Cawthorne Channel Project goes back on-line, we will determine how much revenue to recognize for the period it is on-line. Based on current long-term expectations of future run-time, we believe we will recover all of our receivables and our full investment in the Cawthorne Channel Project over the term of the contract.

This project and our other projects in Nigeria are subject to numerous risks and uncertainties associated with operating in Nigeria. Such risks include, among other things, political, social and economic instability, civil uprisings, riots, terrorism, kidnapping, the taking of property without fair compensation and governmental actions that may restrict payments or the movement of funds or result in the deprivation of contract rights. Any of these risks including risks arising from the recent increase in violence and local unrest, could adversely impact any of our operations in Nigeria, and could affect the timing and decrease the amount of revenue we may realize from our investments in Nigeria. If Shell does not provide gas to the project or if Shell were to terminate its contract with Global for any reason or if we were to terminate our involvement in the Cawthorne Channel Project, we would be required to find an alternative use for the barge facility which could result in a write-down of our investment and receivables related to this project. At September 30, 2006, we had net assets of approximately $75.3 million related to projects in Nigeria, a majority of which is related to our investment and accounts receivable for the Cawthorne Channel Project.

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Additionally, due to the environment in Nigeria, Global’s capitalization level, inexperience with projects of a similar nature and lack of a successful track record with respect to this project and other factors, there is no assurance that Global can satisfy its obligations under its various contracts, including its contract with Hanover.

NEW ACCOUNTING PRONOUNCEMENTS

In May 2003, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS 150 changes the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. SFAS 150 requires that those instruments be classified as liabilities in statements of financial position. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective for interim periods beginning after June 15, 2004. On November 7, 2003, the FASB issued Staff Position 150-3 that delayed the effective date for certain types of financial instruments. The adoption of the guidance currently provided in SFAS 150 did not have a material effect on our consolidated results of operations or cash flow. However, upon further guidance from the FASB, we may be required to classify as debt approximately $12.0 million in sale leaseback obligations that, as of September 30, 2006, were reported as “Minority interest” on our consolidated balance sheet pursuant to FIN 46.

These minority interest obligations represent the equity of the entities that lease compression equipment to us. In accordance with the provisions of our compression equipment lease obligations, the equity certificate holders are entitled to quarterly or semi-annual yield payments on the aggregate outstanding equity certificates. As of September 30, 2006, the yield rates on the outstanding equity certificates ranged from 13.3% to 13.7%. Equity certificate holders may receive a return of capital payment upon termination of the lease or our purchase of the leased compression equipment after full payment of all debt obligations of the entities that lease compression equipment to us. At September 30, 2006, the carrying value of the minority interest obligations approximated the fair market value of assets that would be required to be transferred to redeem the minority interest obligations.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs — an Amendment of ARB No. 43, Chapter 4” (“SFAS 151”). This standard provides clarification that abnormal amounts of idle facility expense, freight, handling costs, and spoilage should be recognized as current-period charges. Additionally, this standard requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this standard are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS 151 did not have a material effect on our consolidated results of operations, cash flows or financial position.

In December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123(R)”). This standard addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS 123(R) eliminates the ability to account for share-based compensation transactions using the intrinsic value method under Accounting Principles Board (APB) Opinion No. 25,Accounting for Stock Issued to Employees,and generally requires instead that such transactions be accounted for using a fair-value-based method. SFAS 123(R) is effective as of the first interim or annual reporting period that begins after June 15, 2005. However, on April 14, 2005, the Securities and Exchange Commission announced that the effective date of SFAS 123(R) would be changed to the first annual reporting period that begins after June 15, 2005. The adoption of SFAS 123(R) did not have a material impact on our financial position or cash flows, but impacted our results of operations. See Note 2 for a discussion of the impact of the adoption of SFAS 123(R).

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 153, “Exchange of Nonmonetary Assets, an amendment of APB Opinion No. 29” (“SFAS 153”). SFAS 153 is based on the principle that exchange of nonmonetary assets should be measured based on the fair market value of the assets exchanged. SFAS 153 eliminates the exception of nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. SFAS 153 is effective for nonmonetary asset exchanges in fiscal periods beginning after June 15, 2005. The adoption of SFAS 153 did not have a material impact on our consolidated results of operations, cash flows or financial position.

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”). SFAS 154 requires retrospective application for reporting a change in accounting principle in the absence of explicit transition requirements specific to newly adopted accounting principles, unless impracticable. Corrections of errors will continue to be reported under SFAS 154 by restating prior periods as of the beginning of the first period presented. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years

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beginning after December 15, 2005. The adoption of SFAS 154 did not have a material impact on our consolidated results of operations, cash flows or financial position.

In February 2006, the FASB issued Statement of Financial Accounting Standards No. 155, “Accounting for Certain Hybrid Instruments — an amendment of FASB Statements No. 133 and 140” (“SFAS 155”). SFAS 155 (a) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, (b) clarifies which interest-only strips and principal-only strips are not subject to the requirements of FASB No. 133, (c) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, (d) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and (e) amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. We are currently evaluating the provisions of SFAS 155 and do not believe that our adoption will have a material impact on our consolidated results of operations, cash flows or financial position.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). This interpretation is effective for fiscal years beginning after December 15, 2006. This interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with FASB Statement No. 109,Accounting for Income Taxes. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We are currently evaluating the provisions of FIN 48.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 provides a single definition of fair value, establishes a framework for measuring fair value and requires additional disclosures about the use of fair value to measure assets and liabilities. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the provisions of SFAS 157.

Item 4. Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Our principal executive officer and principal financial officer evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934) as of September 30, 2006. Based on the evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting during our third quarter of fiscal 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

There have been no material changes in our risk factors that were previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005.

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Item 6: Exhibits

(a) Exhibits

10.1	2006 Long Term Cash Incentive Plan (incorporated by reference to Exhibit 10.1 to Hanover Compressor Company’s Current Report on Form 8-K filed with the SEC on July 27, 2006)
10.2	Form of Award Notice Time Vested Restricted Stock (incorporated by reference to Exhibit 10.2 to Hanover Compressor Company’s Current Report on Form 8-K filed with the SEC on July 27, 2006)
10.3	Form of Award Notice Time Vested Restricted Stock Units (stock settled) (incorporated by reference to Exhibit 10.3 to Hanover Compressor Company’s Current Report on Form 8-K filed with the SEC on July 27, 2006)
10.4	Form of Award Notice Performance Vested Restricted Stock (incorporated by reference to Exhibit 10.4 to Hanover Compressor Company’s Current Report on Form 8-K filed with the SEC on July 27, 2006)
10.5	Form of Award Notice Performance Vested Restricted Stock Units (stock settled) (incorporated by reference to Exhibit 10.5 to Hanover Compressor Company’s Current Report on Form 8-K filed with the SEC on July 27, 2006)
10.6	Form of Award Notice Cash Incentive Plan (incorporated by reference to Exhibit 10.6 to Hanover Compressor Company’s Current Report on Form 8-K filed with the SEC on July 27, 2006)
10.7	Schedule of Compensation for Non-Employee Directors (incorporated by reference to Exhibit 10.8 to Hanover Compressor Company’s Current Report on Form 8-K filed with the SEC on July 27, 2006)
31.1	Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
31.2	Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *
32.1	Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**
32.2	Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**

*	Filed herewith.
**	Furnished herewith.

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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 COMPRESSION LIMITED PARTNERSHIP

Date: November 9, 2006

By:	/s/ JOHN E. JACKSON
	John E. Jackson
	President and Chief Executive Officer

Date: November 9, 2006

By:	/s/ LEE E. BECKELMAN
	Lee E. Beckelman
	Senior Vice President and Chief Financial Officer

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EXHIBIT INDEX

10.1	2006 Long Term Cash Incentive Plan (incorporated by reference to Exhibit 10.1 to Hanover Compressor Company’s Current Report on Form 8-K filed with the SEC on July 27, 2006)
10.2	Form of Award Notice Time Vested Restricted Stock (incorporated by reference to Exhibit 10.2 to Hanover Compressor Company’s Current Report on Form 8-K filed with the SEC on July 27, 2006)
10.3	Form of Award Notice Time Vested Restricted Stock Units (stock settled) (incorporated by reference to Exhibit 10.3 to Hanover Compressor Company’s Current Report on Form 8-K filed with the SEC on July 27, 2006)
10.4	Form of Award Notice Performance Vested Restricted Stock (incorporated by reference to Exhibit 10.4 to Hanover Compressor Company’s Current Report on Form 8-K filed with the SEC on July 27, 2006)
10.5	Form of Award Notice Performance Vested Restricted Stock Units (stock settled) (incorporated by reference to Exhibit 10.5 to Hanover Compressor Company’s Current Report on Form 8-K filed with the SEC on July 27, 2006)
10.6	Form of Award Notice Cash Incentive Plan (incorporated by reference to Exhibit 10.6 to Hanover Compressor Company’s Current Report on Form 8-K filed with the SEC on July 27, 2006)
10.7	Schedule of Compensation for Non-Employee Directors (incorporated by reference to Exhibit 10.8 to Hanover Compressor Company’s Current Report on Form 8-K filed with the SEC on July 27, 2006)
31.1	Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
31.2	Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
32.1	Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**
32.2	Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**

*	Filed herewith.
**	Furnished herewith.

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