Item 1. Business
Hanover Equipment Trust 2001A (the “Trust”) is a Delaware special purpose business trust which was formed in August 2001. The Trust was formed solely to: (i) issue the 8.5% senior secured notes due 2008 (the “Notes”), (ii) execute, deliver and perform the operating agreements to which it is a party, and (iii) use the proceeds of the Notes and the related equity certificates to purchase approximately $309 million of natural gas compression equipment from Hanover Compression Limited Partnership (“HCLP”) and certain of its subsidiaries. The equity funding, issuance of the Notes and equipment purchase occurred on August 30, 2001. The Trust leased its natural gas compression equipment back to HCLP under a seven-year operating lease (the “Lease”). In addition to rental payments, HCLP is obligated to pay supplemental rent, costs, taxes, indemnities, and other amounts owing under the Lease. In
addition, HCLP is obligated to pay the underwriting, legal, accounting and other costs of the transactions for the Trust. General Electric Capital Corporation (“GE Capital”) holds the Trust’s equity certificate. The equity certificate represents a common undivided beneficial interest in the assets of the Trust with an aggregate liquidation amount equal to at least 3% of the total capital of the Trust. Because it is the sole equity certificate holder of the Trust, GE Capital is the owner of the Trust. However, GE Capital has no obligation to pay the principal or interest on the Notes. Although Hanover and its affiliates have had arms-length business dealings with GE Capital and its affiliates in the past and may do so in the future, none of these transactions have resulted in and are not expected to result in any material conflict of interest between GE Capital and the Trust.
Under the Lease, the Trust receives lease payments that are sufficient in amount to pay interest on the Notes, and to provide a yield to the equity certificate holder. After September 1, 2005, HCLP has an option to purchase a portion of the leased equipment from the Trust for an amount sufficient to repay the Notes associated with the purchased equipment in full. If HCLP does not exercise its option to purchase all the leased equipment at the end of the lease term, HCLP is required to use its best efforts to sell the remaining equipment on the Trust’s behalf. In such event, at the end of the lease term, HCLP is required to make a final rent payment equal to approximately $102.8 million, plus the proceeds from the sale of the leased equipment. All of these amounts will be applied to repay the Notes. If the final rent payment and the proceeds from the sale of the leased equipment are insufficient to pay the Notes in full, HCLP will be liable for an assessment of additional rent with respect to actual excess wear and tear of the leased equipment, as determined by an independent appraisal procedure. If the sale option is exercised, the final rent payment, sale proceeds and the assessment of additional rent may not be sufficient for the Trust to repay the Notes in full. To the extent the final rent payment and the proceeds from the sale of leased equipment exceed the amounts required to pay the Notes, the excess will be used first to repay contributed capital to the equity certificate holder and the balance, if any, will thereafter be returned to HCLP. Hanover Compressor Company (“Hanover”) has guaranteed HCLP’s obligations under the Lease.
The Trust’s obligations under the Notes are jointly and severally guaranteed, unconditionally and on a senior subordinated basis, by Hanover and HCLP for an amount up to 77.33% of the aggregate principal balance of Notes outstanding, which is equal to the final rent payment under the Lease. If there is no event of default under the Lease and HCLP does not purchase the leased equipment, neither Hanover nor HCLP has any obligation to pay the other 22.67% of the aggregate principal balance of Notes outstanding, and the holders of Notes will be dependent upon the final rent payment, the proceeds of the sale of leased equipment and the assessment of additional rent, if any, to repay the outstanding principal balance of the Notes in full. The value of the leased equipment may decline prior to the end of the lease term due to market and economic conditions, the supply of similar types of equipment, the availability of buyers and the condition of the leased equipment, among other factors. If there is an event of default under the Lease, Hanover and HCLP guarantee, jointly and severally, on a senior subordinated basis, all of the Trust’s obligations under the Notes.
In February 2007, Hanover entered into an Agreement and Plan Merger with Universal Compression Holdings, Inc., a Delaware corporation (“Universal”), Iliad Holdings, Inc., a Delaware corporation (“Iliad”), Hector Sub, Inc., a Delaware corporation (“Hanover Merger Sub”), and Ulysses Sub, Inc., a Delaware corporation (“Universal Merger Sub”). Iliad is a newly formed, wholly owned direct subsidiary of Universal, and Hanover Merger Sub and Universal Merger Sub are direct wholly owned subsidiaries of Iliad. If the transactions contemplated by the merger agreement are consummated, Hanover and Universal will become direct wholly owned subsidiaries of Iliad, and the stockholders of Hanover and Universal will become stockholders of Iliad. Consummation of the proposed merger is subject to certain conditions that are set forth in the merger agreement including regulatory approval. If the proposed merger closes, each holder of the Notes will have the right to require the Trust to repurchase the Notes at a price of 101% of the principal amount of the Notes plus accrued and unpaid interest. Pursuant to the Lease, HCLP would be required to purchase the amount of equipment necessary to generate sufficient proceeds for the Trust to purchase the respective Notes and prepay a proportionate amount of equity certificates. For more information about the terms of the merger agreement, see Hanover’s Annual Report on Form 10-K for the year ended December 31, 2006.
In addition, Hanover and Universal have each made customary representations, warranties and covenants in the merger agreement, including, among others, covenants to conduct their businesses in the ordinary course between the execution of the merger agreement and the consummation of the mergers and covenants not to engage in certain kinds of transactions during that period. Hanover has agreed with Universal to certain exceptions to the limitations contained in these covenants, including (1) permitting Hanover to redeem or partially redeem from time to time their 7.25% Convertible Junior Subordinated Debentures due 2029 and (2) commencing on September 1, 2007, permitting Hanover to repurchase in the open market up to $100 million aggregate principal amount of Hanover’s outstanding 4.75% Convertible Senior Notes due 2008, subject to certain limitations. In addition, Hanover and Universal have made certain additional customary covenants to one another, including, among others, covenants, subject to certain exceptions, (A) not to solicit proposals relating to alternative business combination transactions, (B) not to enter into discussions concerning, or provide confidential information in connection with, alternative business combination transactions, (C) to cause stockholder meetings to be held to consider approval of the mergers and the other transactions contemplated by the merger agreement and (D) for their respective Boards of Directors to recommend adoption of the merger agreement by their respective stockholders.
In February 2003, the Trust completed a registered offering pursuant to a registration statement on Form S-4 to exchange its 8.5% senior secured notes due 2008 (the “new notes”) for all of its outstanding 8.5% senior secured notes due 2008 (the “old notes”). The exchange offer provided that holders of the old notes would receive $1,000 principal amount of new notes for each $1,000 principal amount of old notes exchanged. The terms of the new notes are identical to the terms of the old notes except that the new notes are freely transferable under the Securities Act of 1933 and do not have any exchange or registration rights. In March 2003, the exchange offer was completed and all of the old notes were exchanged for new notes. Because the dates of these financial statements relate to periods prior to and after the exchange, when we refer to the “Notes” in the notes to financial statements, we are referring collectively to the old notes and the new notes, unless otherwise indicated.
The Trust conducts its business pursuant to the terms of its trust agreement. The Trust exists for the exclusive purposes of:
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issuing the old notes and the new notes;
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issuing the equity certificates to the equity certificate holder;
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investing the gross proceeds of the old notes and the equity certificates in the leased equipment;
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entering into the Lease, a participation agreement and other ancillary agreements relating to the financing of the leased equipment (collectively, the “Operative Agreements”);
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distributing payments received under the Lease to the holders of the old notes or the new notes, as the case may be, and the equity certificates; and
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engaging in only those other activities necessary or incidental to such purposes.
Pursuant to the trust agreement, the equity certificate holder authorized the trustee of the Trust to execute and deliver each of the Operative Agreements to which the Trust is a party and to take such other actions as required by each of such Operative Agreements. The Trust holds all legal right and title in and to the leased equipment, the equity certificate holder contributions, the proceeds of the old notes, the Operative Agreements and any other property or payment of any kind (collectively, the “Trust Estate”) for the use and benefit of the equity certificate holder.
The Trust does not have officers or directors. The trustee of the Trust has a duty to protect and conserve the Trust Estate for the use and benefit of the equity certificate holder, subject to the provisions of the Operative Agreements. Subject to the terms of the trust agreement, the Operative Agreements and applicable law, the trustee of the Trust acts on behalf of the Trust solely as authorized and directed by the equity certificate holder. The trustee may not otherwise manage or control the Trust Estate. The trustee is indemnified by the equity certificate holder for any liabilities or expenses that may be imposed on it arising out of or relating to the Trust Estate, the administration of the Trust Estate, the Operative Agreements or the leased equipment. The equity certificate holder has the right to appoint, remove or replace the trustee. Amendments to the trust agreement must be approved in writing by a party (including, if applicable, the indenture trustee) who would be adversely affected thereby. The trust agreement and the Trust will terminate and the Trust Estate will be distributed, subject to the provisions of the Operative Agreements, to the equity certificate holder upon the sale of all property constituting the Trust Estate or after thirty years. In addition, at any time after six months from the date on which the Lease is no longer in effect, the trustee of the Trust may terminate the trust agreement and the Trust at its option and convey the Trust Estate to the equity certificate holder.
Financing
To fund the purchase of the leased equipment from HCLP, the Trust issued $300 million aggregate principal amount of Notes and raised $9.3 million in equity from the Trust’s equity certificate holder. Interest accrues on the Notes at the rate of 8.50% per year, payable semi-annually in arrears on March 1 and September 1 of each year. The Notes mature on September 1, 2008. Return on the equity certificate accrues at the Eurodollar rate or the prime rate, plus a spread in each case of 7.95% per year, payable quarterly on March 1, June 1, September 1 and December 1 of each year.
During September 2005, we sold to HCLP a portion of the natural gas compression equipment that they were leasing from us under the seven year operating lease for $172.2 million. We used the proceeds to redeem $167.0 million of the 8.5% senior secured notes due 2008 and to repay $5.2 million of the equity certificates. In connection with the redemption, we were required to pay $7.3 million for the premium to call the Notes. The $7.3 million of costs related to the call premium have been classified as debt extinguishment costs on the accompanying condensed consolidated statements of operations. The $7.3 million reimbursement for debt extinguishment costs we received from HCLP has been classified as rental revenue (supplemental rent) on the accompanying condensed consolidated statements of operations. As of December 31, 2006, there was approximately $137.1 million of natural gas compression equipment remaining under our seven year operating lease with HCLP.
A schedule reflecting the dates and amounts payable on the Notes and the equity certificate is set forth below. All amounts under the Notes are payable to the trustee, Wilmington Trust Company, who remits the payments to U.S. Bank, the indenture trustee. All amounts under the equity certificate are payable to the equity certificate holder.
Industry
Natural Gas Compression Overview
Typically, compression is required at several intervals of the natural gas production cycle: at the wellhead, at the gathering lines, into and out of gas processing facilities, into and out of storage and throughout the transportation systems.
Over the life of an oil or gas well, natural reservoir pressure and deliverability typically decline as reserves are produced. As the natural reservoir pressure of the well declines below the line pressure of the gas gathering or pipeline system used to transport the gas to market, gas no longer flows naturally into the pipeline. It is at this time that compression equipment is applied to economically boost the well’s production levels and allow gas to be brought to market.
In addition to such wellhead and gas field gathering activities, natural gas compressors are used in a number of other applications, most of which are intended to enhance the productivity of oil and gas wells, gas transportation lines and processing plants. Compressors are used to increase the efficiency of a low capacity gas field by providing a central compression point from which the gas can be removed and injected into a pipeline for transmission to facilities for further processing. As gas is transported through a pipeline, compression equipment is applied to allow the gas to continue to flow in the pipeline to its destination. Additionally, compressors are used to re-inject associated gas to lift liquid hydrocarbons and thereby increase the rate of crude oil production from oil and gas wells. Furthermore, compression enables gas to be stored in underground storage reservoirs for subsequent extraction during periods of peak demand. Finally, compressors are often used in combination with oil and gas production and processing equipment to process and refine oil and gas into higher value added and more marketable energy sources, as well as used in connection with compressed natural gas vehicle fueling facilities providing an alternative to gasoline.
Changing well and pipeline pressures and conditions over the life of a well often require producers to reconfigure or change their compressor units to optimize the well production or pipeline efficiency. Due to the technical nature of the equipment, a dedicated local parts inventory, a diversified fleet of natural gas compressors and a highly trained staff of field service personnel are necessary to perform such functions in the most economic manner.
Natural gas compressor fabrication involves the design, fabrication and sale of compressors to meet the unique specifications dictated by the well pressure, production characteristics and the particular applications for which compression is sought. Compressor fabrication is essentially an assembly operation in which an engine, compressor, control panel, cooler and necessary piping are attached to a frame called a “skid.” A fabricator typically purchases the various compressor components from third-party manufacturers, but employs its own engineers and labor force to design and fabricate compressor packages.
In order to meet customers’ needs, gas compressor fabricators typically offer a variety of services to their customers, including:
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engineering, fabrication and assembly of the compressor package;
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installation and testing of the package;
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ongoing performance review to assess the need for a change in compression; and
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periodic maintenance and replacement parts supply.
Our Equipment
The Trust’s compression equipment includes approximately 327 units representing approximately 287,000 of horsepower.
Customers
In the fiscal years ended December 31, 2006, 2005 and 2004, our single customer, HCLP, accounted for 100% of our total rental revenues. HCLP’s customer base consists of U.S. and international companies engaged in all aspects of the oil and gas industry, including major integrated oil and gas companies, large and small independent producers, national oil and gas companies, natural gas processors, gatherers and pipelines.
Environmental and Other Regulations
Under the Lease, HCLP indemnifies the Trust for all losses or liabilities it may suffer as a result of the failure to comply with applicable environmental laws, including requirements pertaining to necessary permits such as air permits. The Trust has no environmental losses or liabilities as of December 31, 2006.
Employees and Labor Relations
As of December 31, 2006, the Trust had no employees, officers or directors.
Available Information
Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and the amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available at the website of the Securities and Exchange Commission, which can be found at http://www.sec.gov. You may also read and copy any document we file with the SEC at its public reference facilities at 100 F Street, N.E., Washington, D.C. 20549. You can obtain copies of the documents at prescribed rates by writing to the Public Reference Section of the SEC at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference facilities.
Item 1A.
Item 1A. Risk Factors
The assets and source of revenue available to repay the Notes, satisfy the claims of holders of the Notes and provide a yield to the equity certificate holder are limited, as we have no assets other than our interests in the equipment, and no source of revenue other than the payments under the Lease and the Hanover guarantee.
The Notes are our obligations and are secured only by a perfected first priority security interest in the equipment and an assignment of the Lease and the Hanover guarantee to the trustee for the Notes. The Notes are not obligations of Hanover or HCLP. The holders of the Notes and the trustee under the indenture will have recourse only against us, the collateral for the benefit of the holders of the Notes, and Hanover and HCLP to the extent of the Hanover guarantee. If HCLP defaults under the Lease and Hanover and HCLP default under the Hanover guarantee, we may not be able to perform our obligations under the indenture or pay a yield to the equity certificate holder.
The business and performance of HCLP and Hanover are subject to a variety of risks. These risks are described in Item 1A. Risk Factors of Hanover’s annual report on Form 10-K for the year ended December 31, 2006 and are incorporated herein by reference and filed as Exhibit 99.1 to this report.
Obligations under the Hanover guarantee are subordinated to Hanover’s and HCLP’s senior indebtedness as well as all indebtedness and other liabilities of Hanover’s and HCLP’s subsidiaries.
While the Notes are our senior secured obligations, the Hanover guarantee ranks behind all of Hanover’s and HCLP’s existing and future senior indebtedness. Moreover, the obligations of Hanover and HCLP under the Hanover guarantee will be structurally subordinated to all indebtedness and other liabilities of Hanover’s and HCLP’s respective subsidiaries. Hanover’s and HCLP’s senior indebtedness include obligations under their bank credit facility. Their bank credit facility is secured by liens on the inventory, equipment and certain other property of Hanover and its domestic subsidiaries, and a pledge of 66% of the equity interests in Hanover’s foreign subsidiaries.
As of December 31, 2006, Hanover had approximately $1,145 million in outstanding indebtedness, guarantees and letters of credit that were senior to its obligations under the Hanover guarantee. As of December 31, 2006, HCLP had approximately $228 million in outstanding indebtedness and letters of credit that was senior to its obligations under the Lease and the Hanover guarantee of the Notes.
As a result of the subordinated nature of the Hanover guarantee, upon any distribution to any of the creditors of Hanover or HCLP, as the case may be, in a bankruptcy, liquidation or reorganization or similar proceeding relating to Hanover or HCLP or their respective properties, the holders of senior indebtedness of Hanover or HCLP, as the case may be, will be entitled to be paid in full in cash before any payment may be made with respect to the Hanover guarantee.
Events of default under the indenture differ in certain respects from the events of default under the Lease. Unless there is an event
of default under the Lease, we would have recourse under the Hanover guarantee only up to the maximum amount of 77.33% of the aggregate principal balance of notes outstanding, which is equal to the final rent payment under the Lease. As of December 31, 2006, unless there is an event of default under the Lease, we would have recourse under the Hanover guarantee only to the extent of approximately $103 million. As a result, we may not be able to perform our obligations under the indenture.
No payments may be made under the Hanover guarantee if there is a default in payment on senior indebtedness of Hanover or HCLP or the maturity of such senior indebtedness is accelerated. In addition, during the continuance of certain defaults under certain senior indebtedness of Hanover or HCLP, Hanover or HCLP, as the case may be, will not be permitted to make payments under the Hanover guarantee for a payment blockage period of up to 179 of 360 consecutive days. In the event that we are unable to pay the Notes, the holders of the Notes would have no recourse under the Hanover guarantee during any such payment blockage period. Furthermore, despite the fact that the Notes are secured by the equipment, any remedies exercisable against such collateral will also be blocked during such period.
Hanover’s proposed merger with Universal is subject to the receipt of consents and approvals from various government entities that may impose conditions on, jeopardize or delay completion of the merger or reduce the anticipated benefits of the merger.
In February 2007, Hanover announced that it had entered into an agreement to merge with Universal. Completion of the merger is conditioned upon, among other events, the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, which we refer to as the HSR Act, and the expiration or termination of any mandatory waiting period under applicable non-U.S. antitrust laws, where the failure to observe that waiting period would be reasonably likely to have a material adverse effect on the combined company after the merger.
Hanover and Universal may not be able to obtain the required consents, orders, approvals and clearances. Moreover, if they are obtained, they may impose conditions on, or require divestitures relating to operations or assets of, Hanover or Universal. The merger agreement requires Hanover and Universal to satisfy any conditions or divestiture requirements imposed upon them unless the conditions or divestitures would be reasonably likely to have a material adverse effect on the combined company after the merger. A substantial delay in obtaining any required approvals or the imposition of any unfavorable conditions or divestitures in connection with the receipt of any required approvals may jeopardize or delay completion of the merger or reduce the anticipated benefits of the merger.
While the merger is pending, Hanover will be subject to business uncertainties and contractual restrictions that could adversely affect Hanover’s business.
Uncertainty about the effect of the merger on employees, customers and suppliers may have an adverse effect on Hanover and, consequently, on the combined new company. Although Hanover has indicated that it intends to take steps to reduce any adverse effects, these uncertainties may impair Hanover’s ability to attract, retain and motivate key personnel until the merger is consummated and for a period of time thereafter, and could cause customers, suppliers and others who deal with Hanover to seek to change existing business relationships with Hanover. Employee retention may be particularly challenging for Hanover during the pendency of the merger because employees may experience uncertainty about their future roles with the combined company. If, despite Hanover’s retention efforts, employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with the combined company, the combined company’s business could be seriously harmed. In addition, the merger agreement restricts Hanover, without Universal’s consent and subject to certain exceptions, from making certain acquisitions and taking other specified actions until the merger occurs or the merger agreement terminates. These restrictions may prevent Hanover from pursuing otherwise attractive business opportunities and making other changes to Hanover’s business that may arise prior to completion of the merger or termination of the merger agreement.
Failure to complete the merger could negatively impact Hanover’s stock price and Hanover’s future business and financial results because of, among other things, the disruption that would occur as a result of uncertainties relating to a failure to complete the merger.
Although Hanover and Universal have agreed to use their reasonable best efforts to obtain stockholder approval of the merger, the stockholders of both Hanover and Universal may not approve the merger. In addition, Hanover and Universal may not receive the required consents, orders, approvals and clearances to complete the merger or satisfy the other conditions to the completion of the merger. If the merger is not completed for any reason, Hanover could be subject to several risks, including a break up fee and having had the focus of Hanover’s management directed toward the merger and integration planning instead of on Hanover’s core business and other opportunities that could have been beneficial to Hanover. In addition, Hanover would not realize any of the expected benefits of having completed the merger. Hanover has incurred and will continue to incur substantial financial advisory, legal and other expenses associated with the merger even if it does not close.
If the merger is not completed, the price of Hanover’s common stock may decline to the extent that the current market price of that stock reflects a market assumption that the merger will be completed and that the related benefits and synergies will be realized, or as a result of the market’s perceptions that the merger was not consummated due to an adverse change in Hanover’s business. In addition, Hanover’s business may be harmed, and the price of Hanover’s common stock may decline as a result, to the extent that customers, suppliers and others believe that Hanover cannot compete in the marketplace as effectively without the merger or otherwise remain uncertain about Hanover’s future prospects in the absence of the merger. Similarly, current and prospective employees may experience uncertainty about the future of Hanover if the merger is not completed, and the loss of those employees could adversely affect Hanover. If the merger is not completed, Hanover may not be able to attract and retain key management, marketing and technical personnel due to uncertainty about the future of Hanover, which could harm Hanover’s businesses and results. The realization of any of these risks may materially adversely affect Hanover’s business, financial results, financial condition and its stock price.
If at the end of the Lease term, HCLP fails to purchase the equipment, then HCLP is required to pay an amount equal to the final rent payment with respect to the Lease plus the proceeds, if any, from the sale of the equipment. This amount may be less than the amount due on the Notes.
Hanover and HCLP are obligated under the Hanover guarantee to guarantee payment in full on the Notes only upon the occurrence of an event of default under the Lease, which would include, among other things, the failure to make any rent payments (including the final rent payment) or properly insure or maintain the equipment. If, by the end of the term of the Lease, HCLP does not exercise its option to purchase the equipment and instead exercises its option to pay the final rent payment in full, sell the equipment, and apply the proceeds from the sale to repay the remainder of the Notes, no event of default under the Lease will have occurred. If the proceeds from the sale of the equipment under the Lease are less than $133 million, the principal amount currently outstanding under the Notes (as such amount may be reduced from time to time upon purchases of equipment under the Lease by HCLP in accordance with the terms of the Lease) and therefore insufficient to pay the remainder of the Notes, the holders of the Notes will incur a loss and neither Hanover nor HCLP will be required to compensate for any such shortfall.
The value of the equipment securing the Notes may not be sufficient to cover the obligations owed to holders of the Notes under the Notes.
The Notes are secured by collateral consisting of a perfected first priority security interest in the equipment, and an assignment of the Lease and the Hanover guarantee to the trustee for the Notes. If there is a payment default under the Lease or the Hanover guarantee such that HCLP and Hanover do not have sufficient cash and capital resources available to pay their obligations, holders of the Notes will have to look to the value that can be realized from the equipment with respect to the notes.
The value of the equipment may decline prior to the end of the term of the Lease due to market and economic conditions, the supply of similar types of equipment, the availability of buyers at the end of the Lease term and the condition of the equipment, among other factors. There is no amortization or sinking fund to cover the principal payment of the Notes. Hanover and HCLP have no experience selling leased equipment at the end of the term of an operating lease like the Lease and the proceeds realized upon a future sale of any of the equipment may be less than an appraised value of the equipment. Except for our rights under the Lease and the Hanover guarantees, we have no recourse to the assets of Hanover or HCLP to pay the amounts owed on the Notes. If the remedies after default are exercised under the Lease and the Hanover guarantee, the proceeds realized upon any such exercise of remedies may not be sufficient to satisfy in full amounts owing on the Notes.
There are some limitations on the right to amend the participation agreement and the other operative agreements and to accelerate payments under the Lease and to foreclose on the equipment.
During a workout or bankruptcy proceeding, the consent of our equity certificate holder may be required to amend, supplement, waive or modify provisions of the Lease, the participation agreement, the indenture and each other operative agreement that is material to such equity certificate holder, if such amendment, waiver, supplement or modification would materially adversely affect the equity certificate holder.
Events of default under the indenture are different in some ways from the events of default under the Lease. Accordingly, even though the trustee under the indenture will be entitled to accelerate the Notes if there is an event of default under the indenture, we, as lessor under the Lease, would not be entitled to accelerate the lease payments or exercise any of its other remedies under the Lease unless there was an event of default under the Lease. If a default occurs under the indenture without a corresponding default under the Lease, then we would have no source of repayment of the Notes upon acceleration of the Notes by the trustee. Further, unless there is
an event of default under the Lease, the holders of the Notes will have recourse under the Hanover guarantee only up to the maximum amount of 77.33% of the aggregate principal balance of notes outstanding, which is equal to the final rent payment under the Lease. As of December 31, 2006, unless there is an event of default under the Lease, we would have recourse under the Hanover guarantee only to the extent of approximately $103 million. As a result, we may not be able to perform our obligations under the indenture.
If HCLP declares bankruptcy, our rights against HCLP and Hanover may be limited.
The right to exercise remedies against HCLP in a bankruptcy proceeding would be stayed, including the right to proceed against the equipment and HCLP under the Lease and Hanover guarantee, and may be stayed against Hanover under the Hanover guarantee. In addition, in the event of a HCLP bankruptcy, (i) distributions, if any, payable with respect to any claim under the Lease may not be sufficient to result in a repayment of the Notes, and (ii) if, after obtaining bankruptcy court approval, we are permitted to foreclose or otherwise sell the equipment during a bankruptcy of HCLP, we may not realize sufficient value to cause the Notes to be repaid.
In addition to the risks discussed above with respect to bankruptcy of HCLP, if we declare bankruptcy, your rights against us may be limited.
If we were the subject of a bankruptcy petition, the right to exercise virtually all remedies against us would be stayed, including the right to proceed against the collateral held by the collateral agent securing the Notes. A bankruptcy court may recharacterize the Lease as a secured financing incurred by HCLP and therefore restrict your ability to realize on the equipment in order to satisfy the obligation under the Notes. In addition, the bankruptcy court could permit the use or disposition of payments made under the Lease for purposes other than making payments on the Notes and could reduce the amount or modify the timing of payments due under the Notes or the Lease, including by rejecting the Lease.
Other creditors may have prior liens on the collateral that could reduce or eliminate the amount of collateral securing the Notes.
In general, the priority of the liens on a particular item of collateral securing the Lease is determined by the time that the security interest in that item of collateral is perfected. Creditors such as purchase money lenders may be entitled to a prior claim to someone, such as the collateral agent, even if that person has previously perfected a security interest in the collateral. Furthermore, liens such as landlords’, warehousemen’s and materialmen’s liens and tax liens may by law have priority over the liens granted for your benefit in the collateral.
We do not believe there are any material prior liens on the collateral securing claims of anyone that is not a party to the Lease. However, additional prior claims may arise by law and a bankruptcy or other court may refuse, on equitable or other grounds, to enforce the terms of the Lease and the participation agreement against the other creditors party to those agreements. If this were to happen, the claims of the other creditors against the collateral could be prior to yours.
Item 1B.
Item 1B. Unresolved Staff Comments
None
Item 2.
Item 2. Properties
None
Item 3.
Item 3. Legal Proceedings
From time to time, the Trust may be involved in litigation relating to claims arising out of its operations or in the normal course of business. The Trust is not currently involved in any material litigation or proceeding and is not aware of any such litigation or proceeding threatened against it.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None
PART II
Item 5.
Item 5. Market for Registrants’ Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
There is currently no established market for the equity certificates. Hanover Equipment Trust 2001A is a trust with one equity certificate holder. We pay a return to our equity certificate holder each quarter as described under “Business.”
In February 2003, the Trust filed a registration statement on Form S-4 offering to exchange its registered 8.50% senior secured notes due 2008 for all of its outstanding 8.50% senior secured notes due 2008. The exchange offer provides that holders of the old notes will receive $1,000 principal amount of applicable new notes for each $1,000 principal amount of old notes exchanged. The terms of the new notes are identical to the terms of the applicable old notes except that the new notes are freely transferable under the Securities Act of 1933 and do not have any exchange or registration rights. In March 2003, the exchange offer was completed.
Item 6.
Item 6. Selected Financial Data
SELECTED HISTORICAL FINANCIAL DATA OF HANOVER EQUIPMENT TRUST 2001A
In the table below, we have presented certain financial data for the Trust. The historical financial data was derived from the Trust’s audited financial statements as of and for the years ended December 31, 2006, 2005, 2004, 2003 and 2002. The Trust was organized under the laws of the State of Delaware and commenced business on August 2, 2001 solely for the purpose of (1) issuing the old notes and the new notes, (2) executing, delivering and performing the Operative Agreements to which it is a party and (3) using the proceeds from the issuance of the old notes and the other financing transactions to purchase the leased equipment.
The information in this section should be read along with the Trust’s financial statements, accompanying notes and other financial information included elsewhere in this report.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
General
The Trust was formed in August 2001 for the purpose of purchasing natural gas compression equipment and leasing that equipment to HCLP under the Lease. The Trust funded the equipment purchase through the issuance of its 8.50% senior secured notes due 2008 and an equity investment from the equity certificate holder.
In August 2001, the Trust purchased approximately $309 million of gas compression equipment to be leased to HCLP in connection with the Lease. The Trust issued $300 million of 8.50% senior secured notes and raised $9.3 million in equity from the Trust’s equity certificate holder to finance the purchase of the gas compression equipment.
In February 2003, the Trust filed a registration statement on Form S-4 offering to exchange its registered new notes for all of its outstanding old notes. The exchange offer provided that holders of the old notes would receive $1,000 principal amount of new notes for each $1,000 principal amount of old notes exchanged. The terms of the new notes are identical to the terms of the old notes except that the new notes are freely transferable under the Securities Act of 1933 and do not have any exchange or registration rights. The exchange offer was completed in March 2003.
During September 2005, we sold to HCLP a portion of the natural gas compression equipment that they were leasing from us under the seven year operating lease for $172.2 million. We used the proceeds to redeem $167.0 million of the 8.5% senior secured notes due 2008 and to repay $5.2 million of the equity certificates. In connection with the redemption, we were required to pay $7.3 million for the premium to call the Notes. The $7.3 million of costs related to the call premium for the year ended December 31, 2005 have been classified as debt extinguishment costs on the accompanying condensed consolidated statements of operations. The $7.3 million reimbursement for debt extinguishment costs we received from HCLP has been classified as rental revenue (supplemental rent) on the accompanying condensed consolidated statements of operations for the year ended December 31, 2005. As of December 31, 2006, there was approximately $137.1 million of natural gas compression equipment remaining under our seven year operating lease with HCLP.
Critical Accounting Policies and Estimates
The financial statements of the Trust are significantly affected by its basis of accounting and estimates related to its equipment that are summarized below.
Revenue Recognition
Revenue from compression equipment rentals is recorded when earned over the period of the seven-year operating lease that began on August 30, 2001. Rental revenues are based on the current rental rates and estimated supplemental rent payable by HCLP under the Lease. (See Note 4 to the Financial Statements.)
Concentrations of Credit Risk
Financial instruments that potentially subject the Trust to concentrations of credit risk consist of cash, cash equivalents and accounts receivable. The Trust’s management believes that the credit risk in temporary cash investments that it has with financial institutions is minimal. Trade accounts receivable are due from HCLP and are due on a short-term basis. The Trust does not obtain collateral for receivables. The recorded assets, obligations and operations of the Trust could be adversely affected if the Trust’s relationship with and/or the financial position of Hanover and/or HCLP is adversely affected.
Rental Equipment
Rental equipment consists of domestic gas compression equipment and is recorded at cost. Due to the terms of the Lease (see Note 4 to the Financial Statements) and the expected residual value of the equipment at the end of the Lease, management of the Trust believes that the Trust will recover the original cost of the equipment at the end of the Lease. As such, the Trust is not depreciating the rental equipment. If this estimate were to change, the Trust would be required to record depreciation expense.
Long-Lived Assets
The Trust reviews for the impairment of long-lived assets, including rental equipment and the Trust’s interest in the residual value
of the equipment, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss exists when estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. The impairment loss recognized represents the excess of the asset’s carrying value as compared to its estimated fair market value. Adverse changes in market conditions could result in the inability to recover the carrying value of the Trust’s equipment, thereby possibly requiring an impairment charge in the future.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2006 COMPARED TO YEAR ENDED DECEMBER 31, 2005
Revenues
The Trust’s rental revenues decreased by $17,923,000, or approximately 60%, to $11,933,000 during the year ended December 31, 2006 from $29,856,000 during the year ended December 31, 2005. The Trust’s rental revenue is based primarily on the interest accrued on the Notes and the yield payable to the equity certificate holder. The decrease in rental revenues is primarily due to the decrease in interest accrued on the Notes as a result of the early redemption of $167,000,000 of Notes during September 2005. Rental revenue for the year ended December 31, 2005 included the reimbursement (supplemental rent) of $7,318,000 for call premiums paid on the early redemption of $167,000,000 of the Notes. The interest rate on the Notes is fixed at 8.50% and the amount of interest accrued was $11,305,000 and $21,556,000 for the years ended December 31, 2006 and 2005. The yield to the equity certificate holder was $544,000 for the year ended December 31, 2006 and $884,000 for the year ended December 31, 2005. The yield payable on the equity certificates will vary depending upon the certificate holder yield rate (13.3% as of December 31, 2006 and 12.2% as of December 31, 2005). The certificate holder yield rate is calculated using the Eurodollar rate or, in certain circumstances, the prime rate, plus a spread in each case of 7.95% per year.
In addition, the Trust received additional rents to reimburse it, as required under the Lease, for its operating expenses. These additional rents amounted to $84,000 for the year ended December 31, 2006 and $98,000 for the year ended December 31, 2005.
Expenses
Interest expense decreased by $10,251,000, or approximately 48%, to $11,305,000 during the year ended December 31, 2006 from $21,556,000 during the year ended December 31, 2005. The decrease resulted primarily from reduced interest expense as the result of the early redemption of $167,000,000 of the Notes in September 2005.
Debt extinguishment costs for the year ended December 31, 2006 and 2005 was zero and $7,318,000, respectively. Debt extinguishment costs in 2005 resulted from the call premium paid in connection with the partial redemption and repayment of our 8.5% senior secured notes due 2008.
Operating expenses decreased by $14,000, or approximately 14%, to $84,000 during the year ended December 31, 2006 from $98,000 during the year ended December 31, 2005. The decrease resulted from reduced professional fees during the year ended December 31, 2006 as compared to the year ended December 31, 2005.
YEAR ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004
Revenues
The Trust’s rental revenues increased by $3,350,000, or approximately 13%, to $29,856,000 during the year ended December 31, 2005 from $26,506,000 during the year ended December 31, 2004. The increase in rental revenues resulted from reimbursement (supplemental rent) of $7,318,000 for call premiums paid on the early redemption of $167,000,000 of the Notes in September 2005 and an increase in the yield rate paid to the equity certificate holder. The increase in rental revenues was partially offset by a decrease in interest accrued on the Notes as a result of the early redemption of $167,000,000 of the Notes and a decrease in reimbursements for operating expenses.
The Trust’s rental revenue is based primarily on the interest accrued on the Notes and the yield payable to the equity certificate holder. The interest rate on the Notes is fixed at 8.50% and the amount of interest accrued was $21,556,000 and $25,500,000 for the years ended December 31, 2005 and 2004. The yield to the equity certificate holder was $884,000 for the year ended December 31, 2005 and $886,000 for the year ended December 31, 2004. The yield payable on the equity certificates will vary depending upon the certificate holder yield rate (12.2% as of December 31, 2005 and 10.2% as of December 31, 2004). The certificate holder yield rate is
calculated using the Eurodollar rate or, in certain circumstances, the prime rate, plus a spread in each case of 7.95% per year.
In addition, the Trust received additional rents to reimburse it, as required under the Lease, for its operating expenses. These additional rents amounted to $98,000 for the year ended December 31, 2005 and $120,000 for the year ended December 31, 2004.
Expenses
Interest expense decreased by $3,944,000, or approximately 15%, to $21,556,000 during the year ended December 31, 2005 from $25,500,000 during the year ended December 31, 2004. The decrease resulted primarily from reduced interest expense as the result of the early redemption of $167,000,000 of the Notes in September 2005.
Debt extinguishment costs for the year ended December 31, 2005 were $7,318,000 as a result of the call premium paid in connection with the partial redemption and repayment of our 8.5% senior secured notes due 2008.
Operating expenses decreased by $22,000, or approximately 18%, to $98,000 during the year ended December 31, 2005 from $120,000 during the year ended December 31, 2004. The decrease resulted from reduced professional fees during the year ended December 31, 2005 as compared to the year ended December 31, 2004.
LIQUIDITY AND CAPITAL RESOURCES
Under the triple net lease terms on the leased equipment, all of the costs of maintaining and financing the leased equipment are borne by HCLP, as the lessee. The Trust believes that it has adequate capital resources for the nature of its business and that the funds provided by operations will be sufficient to satisfy its obligations. Because the Trust is limiting activities to the ownership, financing and leasing of equipment under the Lease, the Trust does not believe it will have any need to obtain additional debt or equity financing for its current operations.
The Trust’s cash and cash equivalents balance at December 31, 2006 and 2005 was $0. Operating activities for the year ended December 31, 2006 provided $574,000 of cash, which was used for the payment of the yield due on the equity certificates.
During September 2005, we sold to HCLP a portion of the natural gas compression equipment that they were leasing from us under the seven year operating lease for $172.2 million. We used the proceeds to redeem $167.0 million of the 8.5% senior secured notes due 2008 and to repay $5.2 million of the equity certificates. In connection with the redemption, we were required to pay $7.3 million for the premium to call the Notes. As of December 31, 2006, there were approximately $137.1 million of natural gas compression equipment remaining under our seven year operating lease with HCLP.
The Notes are obligations of the Trust and are collateralized by all of the equipment, rents and supplemental rents covered by the Lease. In addition, the Trust’s obligations under the Notes are jointly and severally guaranteed, unconditionally and on a senior subordinated basis, by Hanover, the ultimate parent company of HCLP, and HCLP for an amount up to 77.33% of the aggregate principal balance of Notes outstanding, which is equal to the final rent payment under the Lease. If there is an event of default under the Lease, Hanover and HCLP guarantee, jointly and severally, on a senior subordinated basis, all of the Trust’s obligations under the Notes. Hanover unconditionally guarantees on a senior subordinated basis all of HCLP’s obligations under the Lease. The obligations of HCLP under the Lease are subordinated in right of payment to all existing and future senior indebtedness of HCLP. The obligations of Hanover and HCLP under the guarantee are subordinated in right of payment to all existing and future senior indebtedness of such guarantor. Each guarantee ranks equally in right of payment with all senior subordinated debt and senior to all subordinated debt of such guarantor. The estimated fair market value of the Notes was approximately $134 million and $138 million at December 31, 2006 and 2005, respectively.
All payments that are received by the Trust under the Lease or guarantee will be applied first to the amounts due under the Notes. The payment of principal, premium, if any, and interest on the Notes are senior in right of payment to the payment in full of amounts due under the equity certificates.
The Trust did not have the right to redeem the Notes until September 1, 2005. After September 1, 2006, the Trust may redeem the Notes, in whole or in part, if the Trust pays the redemption prices indicated below
The Trust is not affiliated with Hanover or HCLP. The indenture and participation agreement governing the Notes contain covenants that restrict the Trust’s ability to, among other things: incur liens, incur additional indebtedness, enter into any other transactions, make investments, liquidate, and engage in non-related lines of business. In addition, the indenture and participation agreement governing the Notes contain covenants that limit Hanover’s and HCLP’s ability to engage in certain activities and transactions.
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2005, the Financial Accounting Standards Board (“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 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 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.
SEASONAL FLUCTUATIONS
The Trust’s results of operations have not reflected any material seasonal tendencies since inception.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Not Applicable.
Item 8.
Item 8. Financial Statements and Supplementary Data
The following documents are filed as part of this report:
1. Financial Statements
• Report of Independent Registered Public Accounting Firm
• Balance Sheets
• Statements of Operations
• Statements of Cash Flows
• Statements of Certificate Holder’s Equity
• Notes to Financial Statements
2. Financial Statement Schedules
All schedules have been omitted because they are not required under the relevant instructions.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A.
Item 9A. Controls and Procedures
The Trustee has carried out an evaluation of the effectiveness of the design and operation of the Trust’s disclosure controls and procedures as of the end of the fiscal year ended December 31, 2006. Based upon that evaluation, the Trustee concluded that the Trust’s disclosure controls and procedures are effective. The Trustee, in making these determinations, has relied to the extent reasonable on information provided by Hanover and HCLP. No changes in the Trust’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter ended December 31, 2006 that have materially affected, or are reasonably likely to materially affect, the Trust’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None
PART III
Item 10.
Item 10. Directors and Executive Officers of Hanover Equipment Trust 2001A
Hanover Equipment Trust 2001A is a Delaware special purpose business trust formed in August 2001 and is governed by the terms of its Trust Agreement and managed by its Trustee, Wilmington Trust Company. As such, there are no directors, executive officers or employees of the Trust. The Trust has not adopted a code of ethics that applies to officers because it has no such officers.
Item 11.
Item 11. Executive Compensation
Hanover Equipment Trust 2001A is a business trust, has no employees and is managed by its Trustee, Wilmington Trust Company. The Trustee receives an annual fee of $16,500 for its services as such. In addition, U.S. Bank serves as the indenture trustee and receives an annual fee of $10,000 for its services.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The sole equity certificate holder of Hanover Equipment Trust 2001A is General Electric Capital Corporation (“GE Capital”).
The Trust does not maintain any equity-based compensation plans.
Item 13.
Item 13. Certain Relationships and Related Transactions
None
Item 14.
Item 14. Principal Accountant Fees and Services
The aggregate fees PricewaterhouseCoopers LLP billed for professional services in 2006 and 2005 were:
Audit Fees are fees billed by PricewaterhouseCoopers LLP for professional services for the audit of the Trust’s financial statements included in the Trust’s Annual Report on Form 10-K and review of the Trust’s financial statements included in Quarterly Reports on Form 10-Q’s. The Trustee approved all services provided to the Trust by PricewaterhouseCoopers LLP. The Trustee has no pre-approval policy. The Trust does not have an audit committee.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) The following documents are filed as part of this report:
1. Financial Statements
• Report of Independent Registered Public Accounting Firm
• Balance Sheets
• Statements of Operations
• Statements of Cash Flows
• Statements of Certificate Holder’s Equity
• Notes to Financial Statements
2. Financial Statement Schedules
All schedules have been omitted because they are not required under the relevant instructions.
3. Exhibits:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Hanover Equipment Trust 2001A
By: Wilmington Trust Company, not in its individual
capacity but solely as Trustee
for the Hanover Equipment Trust 2001A
/s/ DAVID A. VANASKEY, JR.
Name: David A. Vanaskey, Jr.
Title: Vice President
Date: March 27, 2007
Note: Because the Registrant is a trust without officers, directors or employees, only the signature of an officer of the trustee of the Registrant is available and has been provided above.
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO
SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES
PURSUANT TO SECTION 12 OF THE ACT
The Registrant has not sent to security holders any annual report covering the Registrant’s last fiscal year or any proxy statements, form of proxy or other proxy soliciting material with respect to any annual or special meeting of security holders.
Report of Independent Registered Public Accounting Firm
To the Trustee and the Equity Certificate Holder of
Hanover Equipment Trust 2001A:
In our opinion, the financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Hanover Equipment Trust 2001A at December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Trust’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Houston, Texas
March 20, 2007
HANOVER EQUIPMENT TRUST 2001A
BALANCE SHEETS
(in thousands)
The accompanying notes are an integral part of these financial statements.
HANOVER EQUIPMENT TRUST 2001A
STATEMENTS OF OPERATIONS
(in thousands)
The accompanying notes are an integral part of these financial statements.
HANOVER EQUIPMENT TRUST 2001A
STATEMENTS OF CASH FLOWS
(in thousands)
The accompanying notes are an integral part of these financial statements.
HANOVER EQUIPMENT TRUST 2001A
STATEMENTS OF CERTIFICATE HOLDER’S EQUITY
(in thousands)
The accompanying notes are an integral part of these financial statements.
HANOVER EQUIPMENT TRUST 2001A
NOTES TO FINANCIAL STATEMENTS
1. Basis of Presentation
Hanover Equipment Trust 2001A (the “Registrant”, “Trust”, “we”, “us” or “our”) is a Delaware special purpose business trust which was formed in August 2001. The Trust was formed solely to: (i) issue the 8.5% senior secured notes due 2008 (the “Notes”) (see Note 2), (ii) execute, deliver and perform the operating agreements to which it is a party, and (iii) use the proceeds of the Notes and the related equity certificates to purchase approximately $309 million of natural gas compression equipment from Hanover Compression Limited Partnership (“HCLP”) and certain of its subsidiaries. The equity funding, issuance of the Notes and equipment purchase occurred on August 30, 2001. The Trust leased its natural gas compression equipment back to HCLP under a seven-year operating lease (the “Lease”). In addition to rental payments, HCLP is obligated to pay supplemental rent, costs, taxes, indemnities, and other amounts owing under the Lease. In addition, HCLP is obligated to pay the underwriting, legal, accounting and other costs of the transactions for the Trust. In February 2003, the Trust completed a registered offering pursuant to a registration statement on Form S-4 to exchange its 8.5% senior secured notes due 2008 (the “new notes”) for all of its outstanding 8.5% senior secured notes due 2008 (the “old notes”). The exchange offer provided that holders of the old notes would receive $1,000 principal amount of new notes for each $1,000 principal amount of old notes exchanged. The terms of the new notes are identical to the terms of the old notes except that the new notes are freely transferable under the Securities Act of 1933 and do not have any exchange or registration rights. In March 2003, the exchange offer was completed and all of the old notes were exchanged for new notes. When we refer to the “Notes” in these notes to financial statements, we are referring collectively to the old notes and the new notes, unless otherwise indicated.
In February 2007, Hanover Compressor Company (“Hanover”), the ultimate parent company of HCLP, entered into an Agreement and Plan Merger with Universal Compression Holdings, Inc. Consummation of the proposed merger is subject to certain conditions that are set forth in the merger agreement including regulatory approval. If the proposed merger closes, each holder of the Notes will have the right to require the Trust to repurchase the Notes at a price of 101% of the principal amount of the Notes plus accrued and unpaid interest. Pursuant to the Lease, HCLP would be required to purchase the amount of equipment necessary to generate sufficient proceeds for the Trust to purchase the respective Notes and prepay a proportionate amount of equity certificates. For more information about the terms of the merger agreement, see Hanover’s Annual Report on Form 10-K for the year ended December 31, 2006.
Use of Estimates in the Financial Statements
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets, liabilities, revenues and expenses, as well as the disclosures of contingent assets and liabilities. Because of the inherent uncertainties in this process, actual future results could differ from those expected at the reporting date. Management believes that its estimates are reasonable.
Cash and Cash Equivalents
The Trust considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.
Revenue Recognition
Revenue from compression equipment rentals is recorded when earned over the period of the seven-year Lease that began on August 30, 2001. Rental revenues are based on the current rental rates and estimated supplemental rent payable by HCLP under the Lease. (See Note 4.)
Concentrations of Credit Risk
Financial instruments that potentially subject the Trust to concentrations of credit risk consist of cash, cash equivalents and accounts receivable. The Trust’s management believes that the credit risk in temporary cash investments that it has with financial institutions is minimal. Trade accounts receivable are due from HCLP, are due on a short-term basis and are guaranteed by Hanover. The Trust does not obtain collateral for receivables. The recorded assets, obligations and operations of the Trust could be adversely affected if the Trust’s relationship with and/or the financial position of HCLP is adversely affected.
Rental Equipment
Rental equipment consists of domestic gas compression equipment and is recorded at cost. At the time of the initial sale of the old notes, an independent appraisal firm prepared an appraisal of the rental equipment as of August 16, 2001. Due to the terms of the Lease (See Note 4), the current fair market value of the Trust assets and based on the above-described appraisal, management of the Trust believes that the Trust will recover the original cost of the equipment at the end of the Lease. As such, the Trust is not depreciating the rental equipment.
Long-Lived Assets
The Trust reviews for the impairment of long-lived assets, including rental equipment and the Trust’s interest in the residual value of the equipment, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss exists when estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. The impairment loss recognized represents the excess of the asset’s carrying value as compared to its estimated fair market value.
Income Taxes
No provision has been made for federal or state income taxes because the parties will treat the Trust as a financing vehicle for income tax purposes. The Trust is not a business trust for tax purposes. To the extent the Trust is not considered a mere financing vehicle, then solely for income and franchise tax purposes, the Trust would be treated as a grantor trust. Each certificate holder will include in its gross income such certificate holder’s share of the Trust’s net income.
2. Notes Payable
Notes payable at December 31, 2006 and 2005 consisted of the following (in thousands):
Senior Secured Notes-fixed rate of 8.5% due September 1, 2008, interest payable semi-annually on March 1 and September 1
$ 133,000
During September 2005, we sold to HCLP a portion of the natural gas compression equipment that they were leasing from us under the seven year operating lease for $172.2 million. We used the proceeds to redeem $167.0 million of the 8.5% senior secured notes due 2008 and to repay $5.2 million of the equity certificates. In connection with the redemption, we were required to pay $7.3 million for the premium to call the Notes. The $7.3 million of costs related to the call premium have been classified as debt extinguishment costs on the accompanying condensed consolidated statements of operations for the year ended December 31, 2005. The $7.3 million reimbursement for debt extinguishment costs we received from HCLP has been classified as rental revenue (supplemental rent) on the accompanying condensed consolidated statements of operations for the year ended December 31, 2005. As of December 31, 2006, there was approximately $137.1 million of natural gas compression equipment remaining under our seven year operating lease with HCLP.
The Notes are obligations of the Trust and are collateralized by all of the equipment, rents and supplemental rents covered by the Lease. In addition, the Trust’s obligations under the Notes are jointly and severally guaranteed, unconditionally and on a senior subordinated basis, by Hanover, the ultimate parent company of HCLP, and HCLP for an amount up to 77.33% of the aggregate principal balance of Notes outstanding, which is equal to the final rent payment under the Lease. If there is an event of default under the Lease, Hanover and HCLP guarantee, jointly and severally, on a senior subordinated basis, all of the Trust’s obligations under the Notes. Hanover unconditionally guarantees on a senior subordinated basis all of HCLP’s obligations under the Lease. The obligations of HCLP under the Lease are subordinated in right of payment to all existing and future senior indebtedness of HCLP. The obligations of Hanover and HCLP under the guarantee are subordinated in right of payment to all existing and future senior indebtedness of such guarantor. Each guarantee ranks equally in right of payment with all senior subordinated debt and senior to all subordinated debt of such guarantor. The estimated fair market value of the Notes was approximately $134 million and $138 million at December 31, 2006 and 2005, respectively.
All payments that are received by the Trust under the Lease or the guarantee will be applied first to the amounts due under the Notes. The payment of principal, premium, if any, and interest on the Notes are senior in right of payment to the payment in full of amounts due under the equity certificates.
The Trust did not have the right to redeem the Notes until September 1, 2005. After September 1, 2006, the Trust may redeem the Notes, in whole or in part, if the Trust pays the redemption prices indicated below:
The Trust is not affiliated with Hanover or HCLP. The indenture and participation agreement governing the Notes contain covenants that restrict the Trust’s ability to, among other things: incur liens, incur additional indebtedness, enter into any other transactions, make investments, liquidate, and engage in non-related lines of business. In addition, the indenture and participation agreement governing the Notes contain covenants that limit Hanover’s and HCLP’s ability to engage in certain activities and transactions.
In February 2003, the Trust completed a registered offering pursuant to a registration statement on Form S-4 to exchange its 8.5% senior secured notes due 2008 for all of its outstanding old notes. The terms of the new notes are identical to the terms of the old notes except that the new notes are freely transferable under the Securities Act and do not have any exchange or registration rights.
3. Equity Certificates
The Trust raised approximately $9.3 million from equity certificates issued during the period from August 2, 2001 (inception) through December 31, 2001. The Trust’s equity certificates were issued to General Electric Capital Corporation (“GE Capital”). The original certificate holder assigned its interest to GE Capital and was repaid its capital contribution of $1 in August 2001. During September 2005 we redeemed $5.2 million of equity certificates. (See Note 2.) The equity certificate holder may receive a return of capital payments for its equity investment in the Trust, after full payment of the Notes. The Trust will make a quarterly payment (on the first day of March, June, September, and December; the first payment was made on March 1, 2002) to equity certificate holders equal to the certificate holder yield rate (13.3% and 12.2% as of December 31, 2006 and 2005, respectively) multiplied by the aggregate outstanding certificate holder contributions. As of December 31, 2006 and 2005, approximately $47,000 and $77,000, respectively, was payable to the certificate holder. Equity certificate capital repayment may be made using proceeds from sale of equipment to HCLP or, on the expiration date or earlier termination of the Lease, from the proceeds from the final rent payment and the sale of equipment. (See Note 4.)
4. Lease Transaction
The Trust’s equipment is rented to HCLP under a seven-year lease with the basic rent payments equal to the interest payable on the Notes and the yield payable to the equity certificate holder. In addition, HCLP will also pay supplemental rent in respect of all amounts which HCLP is obligated to pay, other than basic rent, under the Lease and participation agreement, including, but not limited to, operating costs of the Trust such as audit fees, legal fees, general administrative fees, certain taxes and indemnities.
The minimum rental payments to be received by the Trust under the Lease are estimated using interest rates and rental equipment balances applicable as of December 31, 2006, as follows (in thousands):
Prior to the stated maturity, HCLP may be required to purchase or shall have the option to purchase the equipment and terminate the Lease under certain conditions and after making the required payments as detailed in the Lease. Twelve months prior to the end of the Lease term, HCLP may (a) elect to purchase all of the equipment on the maturity date of the Notes, for an amount sufficient to repay the Notes, equity certificates and any other amounts owed under the Lease in full or (b) begin selling the equipment on behalf of the Trust. Upon the expiration of the Lease term, if HCLP has elected to sell the equipment on behalf of the Trust, HCLP is required to pay the Trust a final rent payment (the “Final Rent Payment”) of approximately $102.8 million as determined by and subject to limitations and adjustments as detailed in the Lease. The proceeds from the sale of equipment together with the Final Rent Payment will be applied to repay all amounts payable under the Notes. Any remaining proceeds will first be used to repay the unrecovered amount of the equity certificates and any excess will then be returned to HCLP. If the sale proceeds from the equipment together with the Final Rent Payment are less than the amount necessary to repay the Notes, HCLP will be liable for an assessment of additional rent with respect to excess wear and tear of such equipment as determined by an independent appraisal process and subject to limitations detailed in the Lease. The future minimum rental schedule above includes the future amounts HCLP is required to pay under the Lease exclusive of any Final Rent Payment or purchase option payment.
5. Commitments and Contingencies
In the ordinary course of business the Trust may be involved in various pending or threatened legal actions. The Trust is not currently involved in any material litigation or proceeding and is not aware of any such litigation or proceeding threatened against it. The Trust has no other commitments or contingent liabilities which, in the judgment of the Trustee, would result in losses that would materially affect the Trust’s financial position, operating results or cash flows.
6. Recent Accounting Pronouncements
In May 2005, the Financial Accounting Standards Board (“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 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 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.
HANOVER EQUIPMENT TRUST 2001A
SELECTED QUARTERLY UNAUDITED FINANCIAL DATA
The table below sets forth selected unaudited financial information for 2006 and 2005:
EXHIBIT INDEX