To fight Shady Hanz, you must be playing as Xoda. After defeating Sailorman in Stage 5, the floor explodes and you drop down. Instead of heading right as you normally would for the rest of the level, jump over the barrels on your left. Here you will find a hidden picture of Lori from the first game. Look at it for a few seconds, then head back right. After jumping back over the barrels, the ground will explode and you will be dropped down onto a theatrical stage. There will be a short introductory scene, and then fight with Shady Hanz will begin.