**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-K**

 

| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE                            SECURITIES EXCHANGE                            ACT OF 1934 |
|---|--------------------------------------------------------------------------------------------------------------------------------------------|

**                           For the fiscal year ended****September 30,            2007**

 

| 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 Number**000-33215**

 

**CASPIAN SERVICES, INC.**

(Exact name of registrant as specified in its charter)

 

| **Nevada**                               |   | **87-0617371**      |
|------------------------------------------|--------|---------------------|
| (State or other jurisdiction of          |   | (I.R.S. Employer    |
| incorporation or organization)           |   | Identification No.) |
|                                     |   |                |
| **257 East 200 South, Suite 340**        |   |                |
| **Salt Lake City, Utah**                 |   | **84101**           |
| (Address of principal executive offices) |   | (Zip Code)          |

 

**(801) 746-3700**

(Registrant’s telephone number, including area code)

 

**Securities registered pursuant to Section 12(b) of the Exchange Act:            None**

 

**Securities registered pursuant to 12(g) of the Exchange Act: Common,            $.001 par value**

 

Indicate by check mark if the registrant is a well-known seasoned            issuer, as defined in Rule 405 of the Securities Act.

o  Yes  x  No

 

Indicate by check mark if the registrant is not required to file reports            pursuant to Section 13 or Section 15(d) of the Exchange Act from their obligations            under those Sections.

o  Yes  x  No

 

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.

x  Yes  o  No

 

Indicate by check mark if disclosure of delinquent filers pursuant to            Item 405 of Regulation S-K is not contained herein, and will not be contained, to the            best of registrant’s knowledge, in definitive proxy or information statements            incorporated by reference in Part III of this Form 10-K or any amendment to this Form            10-K.

o

 

| Indicate by check mark whether the registrant is a large                            accelerated filed, an accelerated filer, or non-accelerated                            filer. |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Large            accelerated FileroAccelerated            FileroNon-accelerated Filerx

 

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

o  Yes  x  No

 

The            aggregate market value of the voting stock held by non-affiliates of the registrant as            of March 31, 2007 was $70,931,701 based upon the closing stock price of $3.70 (the            closing price on March 30, 2007) per share as reported on the Over-the-Counter Bulletin            Board.

 

As            of January 11, 2008, the registrant had 50,492,060 shares of common stock, par value            $0.001, issued and outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE: None

 

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**Table of Contents**

 

|     |                                                                                                 | Page   |
|----------|------------------------------------------------------------------------------------------------------|--------|
|     | **PART I**                                                                                           |   |
|     |                                                                                                 |   |
| Item 1.  | Business                                                                                             | 3      |
|     |                                                                                                 |   |
| Item 1A. | Risk Factors                                                                                         | 18     |
|     |                                                                                                 |   |
| Item 1B. | Unresolved Staff Comments                                                                            | 21     |
|     |                                                                                                 |   |
| Item 2.  | Properties                                                                                           | 21     |
|     |                                                                                                 |   |
| Item 3.  | Legal Proceedings                                                                                    | 22     |
|     |                                                                                                 |   |
| Item 4.  | Submission of Matters to a Vote of Security                            Holders                       | 23     |
|     |                                                                                                 |   |
|     | **PART II**                                                                                          |   |
|     |                                                                                                 |   |
| Item 5.  | Market for Registrant’s Common Equity Related                            Stockholder Matters   |   |
|     | and Issuer Purchases of Equity Securities                                                            | 23     |
|     |                                                                                                 |   |
| Item 6.  | Selected Financial Data                                                                              | 26     |
|     |                                                                                                 |   |
| Item 7.  | Management’s Discussion and Analysis of Financial                            Condition         |   |
|     | and Results of Operations                                                                            | 27     |
|     |                                                                                                 |   |
| Item 7A. | Quantitative and Qualitative Disclosures About Market                            Risk                | 41     |
|     |                                                                                                 |   |
| Item 8.  | Financial Statements and Supplementary Data                                                          | 41     |
|     |                                                                                                 |   |
| Item 9.  | Changes in and Disagreements with Accountants on                            Accounting               |   |
|     | and Financial Disclosure                                                                             | 42     |
|     |                                                                                                 |   |
| Item 9A. | Controls and Procedures                                                                              | 42     |
|     |                                                                                                 |   |
| Item 9B. | Other Information                                                                                    | 42     |
|     |                                                                                                 |   |
|     | **PART III**                                                                                         |   |
|     |                                                                                                 |   |
| Item 10. | Directors, Executive Officers and Corporate                            Governance                    | 42     |
|     |                                                                                                 |   |
| Item 11. | Executive Compensation                                                                               | 48     |
|     |                                                                                                 |   |
| Item 12. | Security Ownership of Certain Beneficial Owners                            and                       |   |
|     | Management and Related Stockholder Matters                                                           | 61     |
|     |                                                                                                 |   |
| Item 13. | Certain Relationships and Related Transactions, and                            Director Independence | 63     |
|     |                                                                                                 |   |
| Item 14. | Principal Accounting Fees and Services                                                               | 65     |
|     |                                                                                                 |   |
| Item 15. | Exhibits, Financial Statement Schedules                                                              | 66     |
|     |                                                                                                 |   |
|     | SIGNATURES                                                                                           | 67     |

 

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**CASPIAN SERVICES, INC.**

 

*Unless otherwise indicated by the context, references herein to the            “Company”, “CSI”, “we”, our” or            “us” means Caspian Services, Inc, a Nevada corporation, and its corporate            subsidiaries and predecessors.*

 

**Forward Looking Statements**

             

Certain statements contained herein including, but not limited to those            relating to our negotiations for future charters and work contracts including future            potential revenue, future expenses, changes in the composition of our vessel fleet,            future growth of our vessel fleet, plans for development of the marine base, our            ability to obtain future governmental approvals, expansion of our operations, future            equipment acquisitions, our ability to generate additional work, future demand for oil            and gas, future commodity price environment, forecasts of the quantity and            recoverability of oil and gas reserves in the Kazakhstan sector of the Caspian Sea,            managing our asset base, integration of new technology into operations, credit            facilities, future capital expenditures and working capital, sufficiency of future            working capital, borrowings and capital resources and liquidity, projected cash flows            from operations, expectations of timing, satisfaction of contingencies, the impact of            any change in accounting policies on our financial statements, future acquisitions,            management’s assessment of internal control over financial reporting, financial            results, opportunities, growth, business plans and strategy and other statements that            are not historical facts contained in this report are forward-looking statements. When            used in this document, words like            “*believe*,”            “*expect*,”            “*project*,”            “*intend*,”            “*estimate*,”            “*budget*,”            “*plan*,”            “*forecast*,”            “*predict*,”            “*may*,”            “*will*,”            “*could*,”            “*should*,” or            “*anticipates*” and            similar expressions or the negative thereof, or other variations thereon, or comparable            terminology, or by discussions of strategy that involve risk and uncertainties. Such            statements involve known and unknown risks, uncertainties, and other factors that may            cause our actual results, performance or achievements or the industry to be materially            different from any future results, performance or achievements expressed or implied by            such forward-looking statements. Such factors include, but are not limited to, market            factors, market prices (including regional basis differentials) of natural gas and oil,            results for future drilling and marketing activity, future production and costs,            unsettled political conditions, civil unrest and governmental actions, foreign currency            fluctuations, and environmental and labor laws and other factors detailed herein. Given            these uncertainties, prospective investors are cautioned not to place undue reliance on            such forward-looking statements. These forward-looking statements are based on current            expectations, and we assume no obligation to update this information. We undertake no            obligation to publicly update or revise any forward-looking statement, whether as a            result of new information, future events or otherwise.

 

**Item            1. Description of Business**

 

**Company History**

 

Caspian Services, Inc. was incorporated under the laws of the state of            Nevada on July 14, 1998. On February 28, 2002 we entered into an Agreement and Plan of            Reorganization whereby we acquired all of the issued and outstanding shares of Caspian            Services Group Limited, (“Caspian”) in exchange for 27,089,700

             

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To enhance the range of oilfield services we provide to our clients, in            May 2004 we acquired 100% of the outstanding interests in Tat-Arka LLP            (“TatArka”) and a 50% non-controlling interest in Kazmorgeophysica CJSC            (“Kazmorgeophysica”). In September 2005 we increased our ownership interest            in Kazmorgeophysica to 51%. Through TatArka and Kazmorgeophysica, we are able to offer            onshore, transition zone and marine seismic data acquisition and processing services to            oil and gas exploration companies.

 

In July 2005 we changed the Company’s name from EMPS Corporation            to Caspian Services, Inc., to better reflect the nature of our business in providing a            range of oilfield services in the Caspian Sea region of western Kazakhstan.

 

**Recent Developments**

             

In July 2007, Veritas Caspian LLP, a joint venture between            Kazmorgeophysica and CGG Veritas (formerly Veritas DGC Ltd), began the second season            work program for the seismic data library project in the Kazakh sector of the Caspian            Sea. The 2007 work program was successfully completed in November 2007. The 2008 work            plan is currently under discussion with the Ministry of Energy and Mineral Resources of            the Republic of Kazakhstan.

 

In July 2007 we mobilized to the Caspian Sea our first dedicated shallow            water seismic source vessel. This boat is 36 meters long and has a new seismic source            and related equipment capable of emitting a large air-gun energy source at high            pressure. The vessel has accommodations for 14 people and endurance in excess of 10            days, which makes the vessel extremely practical and easy to support.

 

In May 2007 we mobilized to the Caspian Sea two additional shallow water            vessels to accompany the Caspian Maria to operate on a geophysical survey conducted by            RXT for Agip KCO on the Kashagan field. RXT is a specialized geophysical acquisition            company. The vessel’s open deck areas were configured with special cable handling            and energy source equipment.

 

We continue with development plans for our marine base in Bautino Bay.            We had anticipated construction to begin in October 2006. However, as a result of            prolongedfunding negotiations, and taking into consideration            winter weather conditions in Bautino Bay, we commenced construction in late November            2007, with final completion expected by November 2009. We anticipate the cost to            construct the marine base will be approximately $71.8 million. We plan to achieve            this funding through a combination of debt financing in the

             

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Balykshi LLP, a wholly-owned subsidiary of our wholly-owned subsidiary            Caspian Real Estate has entered into a loan agreement with the European Bank for            Reconstruction and Development (“EBRD”) in the amount of $32 million. We            are currently negotiating a number of agreements underlying the loan agreement,            including an Agreement on Mortgage of Immovable Property, an Agreement on Pledge of            Bank Accounts, and Agreement on Pledge of Movable Property, a Deed of Assignment of            Contracts, a Deed of Assignment of Insurances, a Deed of Financial and Performance            Guarantee, a Participation Interest Pledge Agreement, a Share Retention Deed and a            Subordination Agreement.

 

In June 2007 we also entered into an investment agreement with EBRD            under which EBRD has agreed to make an equity investment in the marine base in the            amount of $10 million in exchange for a 22% equity interest in Balykshi LLP. We are            currently negotiating a number of agreements underlying the investment agreement,            including a Put Option Agreement and a Shareholders Agreement.

 

A pre-condition to funding of the EBRD loan and of the other potential            financing transactions discussed herein is the requirement that we must first fund            Balykshi with $29.8 million for the marine base project. We raised net proceeds of            approximately $24 million through a private placement of Units of our securities in            July 2007. We plan to fund the balance of our commitment with funds from additional            fund raising, improved profitability and a smaller 2008 investment in our vessel            division. Before the loan and investment agreements fund, we must also finalize and            execute the agreements underlying the loan and investment agreements.

 

Currently our common stock is traded on the OTC Bulletin Board in the            United States under the symbol CSSV. In 2006, we had decided to seek a listing on AIM,            the junior exchange of the London Stock Exchange. We made significant progress in            meeting the listing requirements of AIM but decided to postpone this project as the            economic climate became unfavorable for new companies looking to float. We instead            targeted potential investors more directly through a private placement. The majority of            these funds will be used to develop our marine base.

 

**Our            Business**

 

We provide a broad range of oilfield services in western Kazakhstan and            the Caspian Sea. Our business focuses on three principal areas – Offshore Marine            Serviceswhich are provided by our fleet of vessels; Geophysical            Services and Infrastructure Development, including water desalinization. We have three            wholly-owned subsidiaries, all of which are British Virgin Island companies, Caspian            Services Group Limited, Caspian Geophysics Limited and Caspian Real Estate Limited.            Caspian is responsible for overseeing the offshore marine services provided by our            vessel fleet. Caspian Geophysics is responsible for overseeing our geophysical services            operations. Caspian Real Estate oversees our infrastructure development efforts. The            following diagram sets forth our subsidiaries and our percentage ownership interest in            each entity:

             

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**Kazakhstan**

             

Until 1991, Kazakhstan was one of 15 independent republics that            comprised the former Soviet Union. It has chosen to align with Russia and 12 of the            former republics in the Commonwealth of Independent States (“CIS”), a union            of economic and political cooperation. Upon independence, Kazakhstan embarked on a            course of political and monetary reforms that has resulted in the development of a            market economy. Kazakhstan’s economic prospects are strong mainly due to            continued strength in world oil prices and major oil finds in the Caspian Sea region as            well as the continued development of oil production and export capabilities.

 

Kazakhstan rests upon a large hydrocarbon basin. This basin is estimated            to contain approximately 26 billion barrels of oil in place and two trillion proven            cubic meters of gas in place. Kazakhstan produces an average of 1.3 million barrels of            oil per day (“bopd”), which is expected to increase to as much as 3.5            million bopd by 2015.

             

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The Pre-Caspian and Pre-Salt Basins have hosted several large            world-class discoveries including the Tengiz, Karachaganak and Kashagan fields. Many            major western oil & gas exploration and production companies and national oil            companies operate in Kazakhstan.

             

*Petroleum Industry in Kazakhstan* 

 

Kazakhstan is an area of significant investment activity for the            international oil and gas industry. Kazakhstan’s proven reserves rank among the            top 15 countries in the world with over 180 producing oil fields and up to 26 billion            barrels of reserves. In 2006, oil production was approximately 1.43 million bopd, of            which nearly 1.14 million bopd was exported.

 

The entire former Soviet Union region has seen significant foreign            investment and strategic alliances for exploration, acquisition and development of oil            and gas reserves. Between 2003 and 2015, approximately 20.6 billion USD is expected to            be invested in Kazakhstan’s offshore oil industry. To date, a significant            percentage of the investment in Kazakhstan has been focused in the oil, gas and mineral            industries. This includes investment in the development of the Tengiz field, which has            an estimated 6-9 billion barrels of reserves, the Karachaganak field, with an estimated            8-9 billion barrels of oil and gas condensate reserves and the Kashagan field with 7-9            billion barrels of recoverable reserves.

 

The oil industry in Kazakhstan has been codified in the Law of            Petroleum, which sets out the conduct of the oil and gas industry and the roles of            participants, both private and governmental. The industry is regulated by the Ministry            of Energy and Mineral Resources, which administers all contracts, licenses and            investment programs.

 

**Offshore Marine Services Industry**

 

Our fleet customers employ our vessels to provide services to support            their oil and gas exploration activities, particularly in connection with seismic work,            and in the construction of necessary infrastructure to pursue development and            production of successful exploration projects. This industry employs various types of            vessels, referred to broadly as offshore support vessels that are used to transport            materials, supplies and personnel.

 

The Offshore Marine Services industry is directly impacted by the level            of activity in worldwide offshore oil and natural gas exploration, development and            production, which, in turn, is impacted by trends in oil and natural gas prices. Oil            and natural gas prices are affected by a host of geopolitical and economic forces,            including the fundamental principles of supply and demand. Each of the major worldwide            geophysical offshore oil and gas production regions has unique characteristics that            influence the economics of exploration and production and consequently the market for            vessels in support of these activities. While there is some vessel interchangeability            betweengeographic regions, barriers such as mobilization costs,            environmental sensitivity, seasonality and vessel design suitability restrict migration            of vessels between regions. The effect of these restrictions on vessel migration has            segmented various regions into separate markets.

             

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**Vessel Fleet**

 

Our vessel fleet has grown to fourteen specialized shallow draft vessels            designed for use in the shallow waters of the north Caspian Sea. We operate our fleet            through our subsidiary, Caspian. Of the fourteen vessels in our fleet, we own eight. We            operate the other six vessels pursuant to agreement with Rederij Waterweg bv, the Dutch            shipping company that owns the vessels.

 

Our fleet is time chartered to oil and natural gas exploration and            production companies working in the Kazakh sector of the Caspian Sea. Our customers            charter our vessels and hire us to provide all necessary staffing and support for safe            and efficient operation. Vessel operating expenses are typically our responsibility            except that its customer generally provides for port fees and consumables such as            water, fuel, lubricants and anti-freeze. In return for providing time-chartered            services, we are paid a daily rate of hire. We also provide additional support services            for our accommodations vessels.

 

Listed below are the five vessel classes we operate along with a            description of the type of vessels categorized in each class, the services the            respective vessels perform and the number of vessels in each class we            operate.

 

***Supply Vessels.***Included in this            class are towing supply vessels and supply vessels. This vessel class is chartered to            customers for use in transporting supplies and equipment from shore bases to offshore            projects. Supply vessels, have large cargo handling capabilities, serve drilling and            production facilities and support offshore construction and maintenance work. We have            one supply vessel in our fleet.

 

***Seismic Source and Survey/Utility Vessels.***Seismic source and survey/utility vessels are chartered to customers for            use in performing offshore geological and seismic studies. Our seismic source vessel is            equipped with specialized seismic source and related equipment capable of emitting a            large air-gun energy source at high pressure. These vessels may also have            accommodations and multiple day endurance. We currently have one seismic source vessel            and two survey/utility vessels.

             

***Anchor HandlingMulticats and Support Vessel Tugs.***This is our largest category of vessels, with seven such vessels in our            fleet. Both of these type of vessels are used to tow floating drilling rigs; assist in            the docking of tankers; tow barges; assist pipe laying, cable laying and construction            barges; as well as setting anchors for positioning and mooring drilling rigs, and are            used in a variety of other commercial towing operations, including towing barges            carrying a variety of bulk cargoes and containerized cargo.

 

***Accommodations Vessels.***We currently            have one accommodations barge and one accommodations vessel in our fleet. These vessels            are chartered to customers to provide offshore living quarters to personnel. These            vessels also offer food services and laundry and related services. One of our vessels            also has a heli-deck. Our accommodationsvessels have combined            capacity to house up to 123 client personnel and 32 crew members.

             

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***Crewboats***. Crewboats are chartered            to customers for use in transporting personnel and small quantities of supplies from            shore bases to offshore drilling rigs, platforms and other installations more quickly            than other vessels. We currently have one crewboat in our            fleet.

 

As future demand and funding justify, we will continue to expand our            fleet. However, there are no assurances, that there will be sufficient demand in the            market to justify expanding our fleet or the services we can offer. Similarly, even if            there is sufficient demand, there is no guarantee that we will have sufficient funds or            be able to obtain sufficient funding to finance such expansion.

 

As part of our strategic plan, we are developing a marine base in the            port of Bautino. The base will be the home port for the Caspian fleet, as well as a            service and mooring facility for other vessel operators. A feasibility study, including            an environmental impact assessment, seabed survey and engineering design works has been            approved by the applicable Kazakh regulatory authorities. Final design and construction            approvals for the first phase of works have been received, including earth works,            breakwater and dredging. As discussed above, we have arranged debt and equity financing            with the EBRD to partially fund the construction costs for the marine base facility.            Construction on the site commenced in late November 2007, with the site earth            works.

 

During fiscal 2007, 93% of our vessel revenue came from three clients:            Veritas Caspian – 44%, Saipem – 28% and RXT – 21%.

 

Five of our vessels were on contract to Veritas Caspian. Veritas Caspian            has the exclusive rights from the Ministry of Energy and Mineral Resources to acquire            seismic data over the entire open acreage of the Kazakh sector of the Caspian Sea. The            second year of this multi-year project proved successful with the full 1460 km 2D            seismic data being completed. Detailed planning is now well underway for the 2008 work            season, which will begin in April.

 

During fiscal 2007, we also had five vessels on charter to Saipem, SpA            for the second season of a minimum two season contract. Saipem have exercised their            option to extend the contract into a third year.

 

During fiscal 2007, we also had three vessels on contract to Reservoir            Exploration Technology ASA (“RXT”) to operate on a geophysical survey            conducted by RXT for Agip Kazakhstan North Caspian Operating Company N.V., (“Agip            KCO”) on the Kashagan field. Agip KCO is the operator of the Kashagan and            Kalamkas fields that lie in the northeastern sector of the Caspian Sea. Agip KCO            operates the fields on behalf of a consortium of international oil            companies.

With the exception of one supply vessel, for which we are currently            analyzing various options, all of our vessels are under contract for the 2008 work            season. We anticipate 100% utilization of our fleet for the full 2008 work season. Our            order book for 2008 includes Saipem, Veritas Caspian and Fugro KazProjects.

             

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Because our fleet is chartered to a limited number of customers, the            loss of any one of these customers could adversely impact our financial condition and            results of operations. Given the strong demand for vessels in the Kazakh sector of the            Caspian Sea during the past two work seasons, however, we believe such impact would be            short-term in nature and would be mitigated by the likelihood that, given current            market conditions, any released vessels could be contracted out to new customer fairly            quickly. Should market demand for vessels soften, however, a loss of any of our major            customers could have a more lasting detrimental effect upon our financial condition and            results of operations.

 

Caspian’s competition varies from small regional companies to            large international corporations and competition is intense. Currently, Caspian has            only one local Kazakh competitor. Caspian does have to compete with many larger foreign            companies operating in the Kazakh sector of the Caspian Sea. Offsetting its small size            relative to some of its competition, Caspian believes it has an advantage over its            competition because of its extensive experience operating vessels in the Caspian Sea            and conducting business within and complying with the laws and regulations of the            Republic of Kazakhstan. In addition, Caspian has developed strong relationships with            government authorities and other local companies. Based on its local regulatory            compliance and business reputation Caspian has been able to differentiate itself from            its competitors.

 

**Geophysical Services**

 

Through our subsidiary Caspian Geophysics, we provide onshore,            transition zone and marine seismic data acquisition services to both the national oil            company and independent oil and gas exploration and development companies operating in            Kazakhstan and the Caspian Sea.

Geophysical seismic surveys have been the primary tool or method of oil            and gas exploration for over fifty years. Geophysical seismic surveying refers to the            making, processing and interpreting of measurements of the physical properties of the            earth for the purpose of gathering data.

 

|   | Oil companies utilize                            geophysical services in the following ways: |
|--------|----------------------------------------------------------------------------------------------|

 

|   | **•** | To identify new areas of potential sources of                            hydrocarbons termed “reservoirs.” |
|--------|------------|------------------------------------------------------------------------------------------------------------------------|

|   | **•** | To determine the size and structure of                            reservoirs. |
|--------|------------|-------------------------------------------------------------------------------|

|   | **•** | To characterize reservoirs and optimize their                            development. |
|--------|------------|---------------------------------------------------------------------------------------|

             

The aim of a 2D seismic survey is to provide a series of vertical inline            and crossline graphical slices of the earth that are used to identify and determine the            size of a hydrocarbon reservoir. A 3D survey, utilizing a very dense grid of data,            provides acontinuous volume (100% coverage) of high-quality            subsurface data. Both the structural and stratigraphic elements are continuously            represented at a resolution not attainable in 2D surveys.

Oil and gas exploration companies typically contract for geophysical            services in one of two ways. First, they contract directly with the geophysical service            provider. Under this format, once the survey is completed the client owns the data that            is recorded. In the industry, this is termed “proprietary” work. Contracts            for this type of

             

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“Non-proprietary”, “multi-client”, or            “speculative” seismic surveys are the second contracting method geophysical            service companies may offer. When performing services on this basis, the data is            actually acquired by the geophysical service company for its own account. The            geophysical service company then licenses that data to a number of clients. The high            cost involved in obtaining geophysical data on a proprietary basis has prompted many            clients to license data on a multi-client basis.

 

The geophysical industry is highly technical and the requirements and            demands on acquisition and processing are continually evolving as clients seek to            answer questions and understand more about their reservoirs using seismic data            sets.

 

We intend to invest in the latest available technology to allow us to            offer the kinds of solutions our clients require, both in terms of capacity; as the            area develops its licensing of new acreage, and in terms of technology; as the            reservoirs themselves develop and require more detailed data acquisition and            analysis.

 

Caspian Geophysics provides geophysical services through its two            subsidiaries: TatArka LLP, a wholly-owned subsidiary; and Kazmorgeophysica, CJSC, a 51%            owned subsidiary.

 

|   | *TatArka LLP* |
|--------|---------------|

 

TatArka provides 2D and 3D land seismic data acquisition services to            companies engaged in onshore oil and gas exploration in the Republic of Kazakhstan.            TatArka provides these services under project specific partnerships with other local            service providers as required by the Republic of Kazakhstan. TatArka has held a general            state license to conduct geophysical works since September 4, 2001.

 

Land seismic data acquisition requires that our surveying crews mark and            position with GPS the location for deployment of recording (geophones) and seismic            source equipment. The recording crews use either explosives or mechanical vibrators to            produceacoustic sound waves (termed “shooting”). The            recording system synchronizes the shooting and captures the seismic signal via the            geophones.

 

In comparative terms, the acquisition of onshore seismic data requires            considerably less effort, and is less complex, than the acquisition of offshore seismic            data. As a result, onshore seismic data acquisition services are far less expensive            than offshore services.    

             

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The onshore seismic market in Kazakhstan is comparably mature and is            dominated by four local companies: Kazakhstancaspishelf, Azimut, SIF Dank and            TatArka.

 

|   | *Kazmorgeophysica CJSC* |
|--------|-------------------------|

 

We own a 51% controlling interest in Kazmorgeophysica. Kazmorgeophysica            provides 2D and 3D transition zone and marine seismic data acquisition services to oil            and gas exploration companies operating in the Kazakhstan sector of the Caspian Sea.            Kazmorgeophysica has held a general state license to conduct geophysical works since            May 29, 2002.

 

In contrast to the onshore seismic market, the marine seismic market in            Kazakhstan is still developing. The first modern marine seismic survey in the            Kazakhstan sector of the Caspian Sea was conducted between 1994 and 1996. Since that            time, only a small number of marine or transition zone surveys have been conducted. We            believe this is primarily due to the limited number of entities currently holding            exploration licenses in Kazakhstan. In early 2004, the government of Kazakhstan            announced the first round of licensing for new offshore blocks in the Kazakhstan sector            of the Caspian Sea. We expect that the release of additional new license blocks will            attract significant interest from the international oil and gas community. We also            anticipate that a direct result of the release of new license blocks will be a            significant increase in demand for marine and transition zone seismic data acquisition            services as well as additional demand for our vessel fleet.

 

The complexity of modern marine seismic data collection methods in the            environmentally sensitive, shallow waters of the north Caspian Sea, and the associated            cost, has meant that only large international exploration companies with advanced            technology and sufficient capital have been capable of providing marine seismic            services in Kazakhstan. We believe this trend will change as more local companies gain            access to the technology and methodologies used and as they obtain sufficient capital            to acquire the necessary equipment and vessels to provide these services. Additionally,            under the current laws of Kazakhstan, to provide marine seismic services the service            provider must meet the country’s local content requirements, either through local            ownership or by partnership. The 49% owner of Kazmorgeophysica is 100% owned by Kazakh            interests, which satisfies the local content requirement and gives Kazmorgeophysica an            advantage over its international competitors.

 

Kazmorgeophysica currently competes with two local companies,            Kazakhstancaspishelf and Uzhmaorgeologia and three international firms, Westerngeco,            CGG Veritas and PGS. As discussed above, the international firms are required to            tenderwith a local partner to satisfy the local content            requirements of Kazakhstan.

 

As oil and gas exploration companies often require both onshore and            offshore seismic data acquisition services, TatArka and Kazmorgeophysica often contract            with each other to provide services for their respective customers.

 

Kazmorgeophysica owns a 50% equity interest in Veritas Caspian LLP.            Veritas Caspian contracted with the Ministry of Energy and Mineral Resources of the            Republic of Kazakhstan in January 2006 to acquire seismic data, on an exclusive basis,            over all the open acreage in Kazakhstan’s sector of the Caspian Sea. This project            is referred to herein as the “State Geophysical Survey of the Republic of            Kazakhstan.”

             

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We believe this project is a significant step forward for the Republic            of Kazakhstan in its efforts to develop its offshore Caspian Sea hydrocarbon deposits.            The 2007 work program centered on the Chagala block which is located just south of the            massive Kashagan discovery and just west of the equally large onshore Tengiz field, the            Medina block south west of Kalamkas and acreage to the north west of Kashagan. In            total, 1,461 kilometers of 2D seismic data was acquired in the second year of the            project. Veritas Caspian is currently in discussions with the Ministry of Energy of the            Republic of Kazakhstan regarding its 2008 work plan.

 

The combination of existing high quality seismic data packages and            licensing rounds has proven very successful in a number of locations around the globe            in ensuring maximum revenues from license blocks for the State while providing a            transparent and efficient system of tenders for oil companies. As the project moves            forward and Veritas Caspian begins to market the seismic data collected on behalf of            the Government of the Republic of Kazakhstan, we will begin to realize revenues            generated through the sale of the seismic data we are gathering in connection with the            State Geophysical Survey.

 

**Infrastructure Development**

 

|   | *Water Desalinization* |
|--------|------------------------|

 

|   | **Bauta JSCI** |
|--------|----------------|

 

Through our subsidiary Caspian Real Estate Ltd. we own a 56% interest in            Bauta JSCI (“Bauta”), a joint venture that operates a water desalinization            plant in the Port of Bautino. At the desalinization plant, Bauta purifies drinking            water for sale in bulk and in bottles. Bauta provides bulk water to the local community            at cost under an infrastructure agreement with the local government and provides water            to oilfield camps in the region. Agip KCO is the largest buyer of bulk water from the            plant. Bauta also bottles and sells water in five liter and one-and-a half liter            bottles. As much of the demand for drinking water comes from oilfield camps, water            sales, like vessel operations, are seasonal, with most sales occurring during the work            season. The bottled water is primarily sold to the surrounding oil field camps, the            local municipality and other businesses in the region.

 

|   | *Water Treatment* |
|--------|-------------------|

 

|   | **Pact Caspian Engineering FZC and Pact Engineering KZ                            LLP** |
|--------|-----------------------------------------------------------------------------------------|

 

Caspian Real Estate Ltd. currently owns a 50% interest in Pact Caspian            Engineering FZC (“Pact Caspian”). Through its wholly-owned subsidiary Pact            Engineering KZ LLP (“Pact Engineering”), Pact Caspian markets and sells in            Kazakhstan water and wastewater treatment systems manufactured by Pact Engineering FZC.            Pact Caspian has just started to actively market these systems in Kazakhstan. To date            no sales have been made.

             

13

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|   | *Atash Marine Base* |
|--------|---------------------|

 

In connection with our plans to build a major marine supply and support            base in the port of Bautino, on November 16, 2005, through Caspian Real Estate, we            acquired a five hectare (approximately 12 acre) parcel of undeveloped real property            located in the port of Bautino near the Atashi Village. To acquire the real property,            Caspian Real Estate acquired a 100% ownership interest in Balykshi LLP, the entity in            which the property was held by its previous owners. In 2005, we completed an offshore            sea bed sampling survey, environmental impact assessment study, preliminary jetty and            shore site facility engineering design works and a feasibility study. These studies and            surveys were all reviewed and approved by the relevant Kazakh authorities. In 2006, our            Environmental and Social Impact Assessment and marine base design received final            approval from the Ministry of Environmental Protection of the Republic of Kazakhstan.            In November 2007, we received construction approvals for the first phase of works,            including earth works, break water and dredging.

 

We expect the cost to build the marine base will be approximately $71.8            million. We plan to fund these costs through a combination of debt financing in the            amount of $32 million and cash equity financing in the amount of $39.8 million of            which $10.1has already been contributed by us for the initial feasibility            studies, preliminary construction costs and materials. We also contributed the land for            the project through the acquisition of Balykshi LLP.

 

In December 2006, Balykshi LLP entered into a loan agreement with EBRD            in the amount of $24 million. In June 2007 a first amendment to the loan agreement with            EBRD was signed increasing the loan amount to $32 million.

 

In June 2007 we also entered into an investment agreement with EBRD            under which EBRD has agreed to make an equity investment in the marine base in the            amount of $10 million in exchange for a 22% equity interest in Balykshi LLP.

 

The balance of $29.8 million less already contributed costs will be            provided to Balykshi from the Company. In July 2007 we raised net proceeds of            approximately $24 million. These funds will primarily be used to meet our $29.8 million            contributed capital requirement.

             

Funding of the loan and equity financing between EBRD and Balykshi, is            contingent upon the Company first providing $29.8 million in funding to Balykshi to            fund marine base development. Our failure to provide the $29.8 million would result in            Balykshi not receiving the necessary funding to meet its current capital expenditure            plans for the marine base, which would directly and materially impact our ability to            move forward with the full construction of the marine base facility.

 

Construction commenced in late November 2007. We expect the initial            phase of the marine base facilities, including dredging, breakwater, wharf front and            general site area to be completed and operational            by December 2008, with final completion of the base occurring by November            2009.

             

14

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Through the marine base we will offer a full range of services, not only            to our own fleet, but also to other vessel fleet operators in the region, as well as,            to the large multi-national oil companies engaged in exploration in the            region.

 

Currently there are approximately 135 vessels and barges supporting the            Agip KCO development of the Kashagan field. This number is expected to grow            significantly over the next few years as pipeline laying, pile and flares, hookup and            commissioning of projects commence. The number of operating personnel requiring support            offshore is expected to reach approximately 4,000 in the short term.

 

Bautino Bay, where the Atash Marine Base will be located, is            approximately 1.8 km across from east to west and “open” to the Caspian Sea            to the north. A public road, public electricity and landline telephone utility            infrastructure run parallel to the property. No other utility infrastructure (water,            sewage, heating, etc.) exists in the vicinity of the property.

 

|   | Once completed, we plan to offer the following offshore                            facilities and services: |
|--------|-------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Service jetty and moorings |
|--------|------------|----------------------------|

|   | **•** | Loading and off-loading facilities |
|--------|------------|------------------------------------|

|   | **•** | Vessel lifting facilities |
|--------|------------|---------------------------|

|   | **•** | Breakwater protection |
|--------|------------|-----------------------|

|   | **•** | Long-term berths |
|--------|------------|------------------|

|   | **•** | Crew transfer berth |
|--------|------------|---------------------|

|   | **•** | Main wharf area |
|--------|------------|-----------------|

             

We also plan to offer the following onshore facilities and services at            the marine base:

 

|   | **•** | Marine maintenance facilities |
|--------|------------|-------------------------------|

|   | **•** | Warehousing |
|--------|------------|-------------|

|   | **•** | Base offices |
|--------|------------|--------------|

|   | **•** | Transit lounge |
|--------|------------|----------------|

|   | **•** | Fully integrated marine base command and control                            facilities |
|--------|------------|----------------------------------------------------------------------------------------|

|   | **•** | Fully integrated fuel distribution system and storage                            facilities |
|--------|------------|---------------------------------------------------------------------------------------------|

|   | **•** | Fully integrated water distribution system and storage                            facilities |
|--------|------------|----------------------------------------------------------------------------------------------|

|   | **•** | Oily water collection and storage facilities |
|--------|------------|----------------------------------------------|

|   | **•** | Weighbridge facilities |
|--------|------------|------------------------|

|   | **•** | Electrical power supply and distribution                            system |
|--------|------------|----------------------------------------------------------------------------|

|   | **•** | Back-up electrical power generation                            facilities |
|--------|------------|---------------------------------------------------------------------------|

|   | **•** | Security system |
|--------|------------|-----------------|

|   | **•** | Fire-fighting system |
|--------|------------|----------------------|

|   | **•** | Lay-down storage area |
|--------|------------|-----------------------|

 

15

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Fuel bunkering, water export, material loading and off-loading and            vessel hauling/repairs at the slipway are expected to generate a significant percentage            of revenues during the operating season (mid March through mid November). Long-term            berthing and vessel hauling/maintenance is expected to generate the bulk of revenue            during the off-season (mid November to mid March).

 

**Safety and Risk Management**

 

We are committed to ensuring the safety of our operations. Management            regularly communicates with our personnel to promote safety and instill safe work            habits through company media and safety review sessions. We also regularly conduct            safety training meetings for our seaman and staff personnel. We dedicate personnel and            resources to ensure safe operations and regulatory compliance. We employ safety            personnel who are responsible for administering our safety programs.

 

The operation of any marine vessel involves an inherent risk of            catastrophic marine disaster, adverse weather conditions, mechanical failure,            collisions, and property losses to the vessel and business interruption due to            political action. Any such event may result in a reduction in revenues or increased            costs.

 

The worldwide threat of terrorist activity and other acts of war, or            hostility, have increased the risk of political, economic and social instability. It is            possible that acts of terrorism may be directed against the United States domestically            or abroad and such acts of terrorism could be directed against properties and personnel            of U.S.-owned companies such as ours. The resulting economic, political and social            uncertainties, including the potential for future terrorist acts and war, could cause            the premiums charged for our insurance coverage to increase. To date, the company has            not experienced any property losses as a result of terrorism, political instability or            war.

 

Management believes that the Company’s insurance coverage is            adequate. We have not experienced a loss in excess of insurance policy limits; however,            there is no assurance that our liability coverage will be adequate to cover all            potential claims that may arise. While we believe that we should be able to maintain            adequate insurance in the future at rates considered commercially acceptable, we cannot            guarantee such with the current level of uncertainty in the insurance            market.

 

**Industry Conditions, Competition and Customers**

 

Our operations are materially dependent upon the levels of activity in            offshore crude oil and natural gas exploration, development and production in the north            Caspian Sea. Such activity levels are affected by the trends in worldwide crude oil and            natural gas prices that are ultimately influenced by the supply and demand relationship            for these natural resources.

             

16

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The principal competitive factors for the offshore marine services            industry are suitability and availability of equipment, price and quality of service.            As noted above, we have numerous competitors in all areas in which we operate, so the            business environment is highly competitive.

 

Our principal customers are major oil and natural gas exploration,            development and production companies or subcontractors of such companies. As noted            above our three largest customers accounted for 93% of our vessel revenues during the            fiscal year ended September 30, 2007 and Agip KCO purchases the majority of the water            we produce. We consider our operations to be dependent, at least in the short-term, on            Agip KCO and its subcontractors.

 

**Environmental Compliance**

 

During the ordinary course of business our operations are subject to a            wide variety of environmental laws and regulations. Compliance with existing            governmental regulations that have been enacted or adopted regulating the discharge of            materials into the environment, or otherwise relating to the protection of the            environment, has not had, nor is expected to have, a material effect on the company. We            are proactive in establishing policies and operating procedures for safeguarding the            environment against any environmentally hazardous material aboard its vessels and at            shore base locations. In addition, we have established operating policies that are            intended to increase awareness of actions that may harm the environment.

 

**Seasonality**

 

As discussed herein, due to weather conditions in the north Caspian Sea,            demand for our vessel fleet, desalinized water and transition zone and marine seismic            data acquisition services is seasonal and is subject to prevailing weather conditions            in the region. Typically, significant demand for these services begins in late March or            early April and continues until late November. Our business volume, however, is more            dependent on oil and natural gas prices and the global supply and demand conditions for            our services than any seasonal variations.

 

**Employees**

 

The Company and its subsidiaries currently employ approximately 560 full            time employees. We hire our employees under local labor contracts complying with the            governing law of the Republic of Kazakhstan.

 

Under local labor laws, all labor contracts that do not expire or are            not terminated before one year are automatically (by law) extended for an undefined            period. This makes it more difficult to terminate existing employees. We have managed            to maintain turnover of our work force at a low level. With ongoing labor market            monitoring, we believe that future new labor requirements can be satisfied and there is            no significant risk of a labor shortage.

 

We provide voluntary and mandatory offshore training and support            qualification growth of our employees. In addition there are legislative requirements            to provide a certain number of local employees per year with formal outside training.            We continue to satisfy these local labor market protective measures.

             

17

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We believe we have satisfactory relations with our employees. To date,            neither our operations, nor the operations of any of our subsidiaries, have been            interrupted by strikes or work stoppages.

 

**Reports to Security Holders**

 

We file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q,            Current Reports on Form 8-K and other items with the Securities and Exchange Commission            (SEC). We provide free access to all of these SEC filings, as soon as reasonably            practicable after filing, on our Internet web site located atwww.caspianservicesinc.com. In addition, the public may read and copy any documents we file with            the SEC at the SEC’s Public Reference Room at 100 F Street N.E., Washington, DC            20549. The public may obtain information on the operation of the Public Reference Room            by calling the SEC at 1-800-SEC-0330. The SEC maintains its Internet sitewww.sec.gov, which            contains reports, proxy and information statements and other information regarding            issuers like Caspian Services.

 

**Item 1A.**  **Risk Factors**

 

**Business Risks**

 

*Slower than Anticipated Growth of the            Market*. Our revenues are dependent upon demand for our            services. If oil and gas exploration and development activities expand at slower than            anticipated rates, or if one of our primary clients curtails its activities for any            reason, our results of operations and financial condition could be negatively impacted            by the reduction in available work and/or a reduction in pricing if supply of services            exceeds market demand.

             

*Failure to Obtain Sufficient Funding to Fund Construction of our            Marine Base*. Funding of the loan and equity financing            between EBRD and Balykshi, is contingent upon the Company first providing $29.8 million            in funding to Balykshi to fund marine base development. We do not currently have            sufficient funds to satisfy this commitment and anticipate the need to seek additional            funding to cover the shortfall. Our failure to provide the $29.8 million would result            in Balykshi not receiving the necessary funding to meet its current capital expenditure            plans for the marine base, which would directly and materially impact our ability to            move forward with the full construction of the marine base facility. We currently have            no firm commitment from any party to provide us the additional funding we need and            there is no guarantee we will be able to obtain additional funding on reasonable terms,            or at all.

             

*Cost Overruns or Time Delays in Completing Construction of the            Marine Base*. While we will seek to include penalty            provisions in our construction contracts designed to ensure construction of the marine            base within our budget and projected timelines, we cannot completely protect ourselves            against cost overruns and time delays in the construction process. If the cost overruns            or time delays were significant, such could result in

             

18

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us having to seek additional funding, diverting funds from other            projects to complete the marine base, or possibly in our being unable to complete the            marine base. Moreover, delays in completion of the marine base within the projected            timelines could result in material deviations from projected marine base revenues and            operating expenses discussed elsewhere in this Memorandum. Such delays could impact our            projected results of operations and financial condition.

*Marine Base Revenue and Expense Estimates may Differ Materially            from Actual Results*. Our forward-looking statements            regarding projected marine base revenue and operating expenses are based on assumptions            and expectations. While we have utilized our best efforts and the market information            available to us in formulating these projections, we have not previously constructed or            operated a marine base and some of our assumptions and expectations could be incorrect.            Depending upon how significantly our projections vary from actual results, our results            of operations and financial condition could be adversely affected. We would, therefore,            caution you to perform your own independent evaluation of our projections and the            viability of our marine base before making an investment in our securities.

             

*Oil and Gas Prices are Highly            Volatile*. Commodity prices for crude oil and natural gas            are highly volatile. Prices are sensitive to the supply/demand relationship for the            respective natural resources. High demand for crude oil and natural gas and/or low            inventory levels for the resources as well as any perceptions about future supply            interruptions can cause commodity prices for crude oil and natural gas to rise, while            generally, low demand for natural resources and/or increases in crude oil and natural            gas supplies cause commodity prices for the respective natural resources to            decrease.

 

Factors that affect the supply of crude oil and natural gas include but            are not limited to the following: the Organization of Petroleum Exporting            Countries’ (“OPEC”) ability to control crude oil production levels            and pricing as well as the level of production by non-OPEC countries; political and            economic uncertainties; advances in exploration and development technology; worldwide            demand for natural resources; and governmental restrictions placed on exploration and            production of natural resources.

 

*Changes in Level of Capital Spending by our            Customers*. Our principal customers are oil and natural            gas exploration, development and production companies. Our results of operations are            dependent on the level of capital spending by the energy industry. The energy            industry’s level of capital spending is substantially related to the prevailing            commodity price of natural gas and crude oil. Low commodity prices have the potential            to reduce the amount of crude oil and natural gas that our customers can explore for,            develop and produce economically. When this market dynamic occurs, it is expected that            our customers will generally reduce their capital spending budgets for offshore            drilling, exploration and development until commodity prices for natural resources            increase to levels that can support increases in production and development and sustain            growth.

 

*Competition*. The oilfield services            industry is highly competitive. Competition in Kazakhstan and Central Asia includes            other local and multi-national companies. We will have to compete for additional            customers with these companies who in some cases may have greater financial resources            and larger technical staff than we do.

             

19

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*Liquidity of Common Stock*. Our            common stock has limited trading volume on the Over-the-Counter Bulletin Board and is            not listed on a national exchange. Moreover, a significant percentage of the            outstanding common stock is “restricted” and therefore subject to the            resale restrictions set forth in Rule 144 of the rules and regulations promulgated by            the SEC under the Securities Act. These factors could adversely affect the liquidity,            trading volume, price and transferability of our common stock.

 

**Foreign Operations**

 

In recent years, the Republic of Kazakhstan has undergone substantial            political and economic change. As an emerging market, Kazakhstan is still developing            the business infrastructure that generally exists in more mature free market economies.            As a result, operations carried out in Kazakhstan can involve risks that are not            typically associated with developed markets. Instability in the market reform process            could subject us to unpredictable changes in the basic business environment in which we            currently operate. Therefore, we face risks inherent in conducting business            internationally, such as:

 

|   | **•** | foreign currency exchange fluctuations or imposition of                            currency exchange |
|--------|------------|------------------------------------------------------------------------------------------------------|

|   | controls; |
|--------|-----------|

|   | **•** | legal and governmental regulatory                            requirements; |
|--------|------------|----------------------------------------------------------------------------|

|   | **•** | disruption of tenders resulting from disputes with                            governmental authorities; |
|--------|------------|---------------------------------------------------------------------------------------------------------|

|   | **•** | potential vessel seizure or nationalization of                            assets; |
|--------|------------|-----------------------------------------------------------------------------------|

|   | **•** | import-export quotas or other trade barriers; |
|--------|------------|-----------------------------------------------|

|   | **•** | difficulties in collecting accounts receivable and                            longer collection periods; |
|--------|------------|----------------------------------------------------------------------------------------------------------|

|   | **•** | political and economic instability; |
|--------|------------|-------------------------------------|

|   | **•** | difficulties and costs of staffing and managing                            international operations; and |
|--------|------------|----------------------------------------------------------------------------------------------------------|

|   | **•** | language and cultural differences. |
|--------|------------|------------------------------------|

 

Any of these factors could adversely affect our operations and            consequently their operating results and financial condition. At this time, management            is unable to estimate what, if any, changes may occur or the resulting effect of any            such changes on our financial condition or future results of operations.

 

We also face the potential risk of changing and potentially unfavorable            tax treatment and currency law violations. Legislation and regulations regarding            taxation, foreign currency transactions and licensing of foreign currency loans in the            Republic of Kazakhstan continue to evolve as the central government manages the            transformation from a command to a market-oriented economy. The legislation and            regulations are not always clearly written and their interpretation is subject to the            opinions of local tax inspectors. Instances of inconsistent opinions between local,            regional and national tax authorities are not unusual.

 

The current regime of penalties and interest related to reported and            discovered violations of Kazakhstan’s laws, decrees and related regulations can            be severe. Penalties include confiscation of the amounts

             

20

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at            issue for currency law violations, as well as fines of generally 100% of the taxes            unpaid. Interest is assessable at rates of generally 0.06% per day. As a result,            penalties and interest can result in amounts that are multiples of any unreported            taxes.

 

Despite the political stability in Kazakhstan, relative to the other            countries in the region, our operations and financial condition may be adversely            affected by Kazakh political developments, including the application of existing and            future legislation and tax regulations.

 

**Environmental Regulations**

 

We must comply with extensive government regulation in the form of            international conventions, federal and state laws and regulations in jurisdictions            where its vessels operate and/or are registered. These conventions, laws and            regulations govern matters of environmental protection, worker health and safety, and            the manning, construction and operation of vessels. Moreover, the International            Maritime Organization recently made the regulations of the International Safety            Management (“ISM”) Code mandatory. All of our vessels now comply fully with            these international standards. The ISM Code provides an international standard for the            safe management and operation of ships, pollution prevention and certain crew and            vessel certifications. The risks of incurring substantial compliance costs, liabilities            and penalties for non-compliance are inherent in offshore maritime operations.            Compliance with environmental, health and safety laws and regulations increases our            cost of doing business. Additionally, environmental, health and safety laws change            frequently. Therefore, we may be unable to predict the future costs or other future            impact of environmental, health and safety laws on its operations. There is no            assurance that we can avoid significant costs, liabilities and penalties imposed as a            result of environmental regulation in the future.

             

**Item 1B.**  **Unresolved Staff Comments**

 

|   | None. |
|--------|-------|

 

**Item            2. Description of Property**

 

Our principal executive offices are located at, 29/6 Satpaev Ave, Rakhat            Palace Hotel, 9th Floor, Almaty, 050040, Republic of Kazakhstan. We also maintain            executive offices at 257 East 200 South, Suite 340, Salt Lake City, Utah 84111 and an            office in Aktau, Kazakhstan. We lease these spaces. The office in Almaty is leased for            a term ending in March 2008. The monthly rent is $13,294. The office in Salt Lake City            is leased for a term ending in February 2009. The monthly rent is currently $3,695, and            increases each year at a rate of 3%. Our office lease in Aktau expires in December 2007            and we intend to renew this lease. Our current rental rate in Kazakh Tenge equivalent            to about $20,000 per month.

             

As is the norm in locations such as Almaty and Aktau, we rent apartments            for the exclusive use of our employees posted there. We have nine apartments on a            revolving annual lease that usually renews each year in January. Total rent for the            nine apartments in Kazakh Tenge is equivalent to about $18,000 per month.

             

21

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We believe the facilities we lease are in good, serviceable condition            and are adequate for our needs.

             

Through Bauta, we own a 56% interest in a water desalinization plant.            The Bauta facility consists of production and administrative buildings, two 500 meter            capacity desalinization units, filtration systems, bulk storage tanks, production            lines, packaging equipment and warehouse space.

             

                           The Bauta facility is not subject to any mortgage or lien.

 

As disclosed above in Item 1. Description of Business in November 2005,            through Caspian Real Estate, we acquired a five hectare parcel of undeveloped real            property. We own this property free of any mortgages or liens. The property forms the            basis for our marine base facility and will be expanded, through dredging and land            reclamation, to approximately 11 hectares in size upon completion of phase one of the            project. The cost of the property has been included in the roughly $14.5 million            figured disclosed as our investment to date in the marine base facility.

             

We acquire interests in real property to support our operations. We are            not engaged in the business of acquiring real estate for investment            purposes.

             

**Item            3. Legal Proceedings**

 

Currently we are involved in a judicial appeal in Kazakhstan as a result            of the Customs Committee of the Ministry of Finance of the Republic of Kazakhstan            challenging the claims of a number of Agip KCO contractors, including the Company, to            an exemption from customs VAT for certain goods provided to Agip KCO under various            contracts dating back to 2002. Based on the lower court’s decision issued in            October 2007 the initial claimed VAT of $0.6 million was decreased to $0.2 million. At            the request of Agip KCO we appealed this ruling. We lost on that appeal. Agip KCO has            acknowledged to us in writing that under the terms of our contracts with Agip KCO that            it is obliged to pay the customs VAT. We have formally requested indemnification from            Agip KCO and are awaiting their response. In November 2007 the lower court issued a            second decision where it upheld the initial imposition of $0.1 million in VAT and            penalties related to the Agip KCO contract. We also appealed this decision. The appeal            is now pending and, depending on the outcome, the matter will be further referred to            Agip KCO for indemnity. Therefore, we anticipate we will incur no liability if the            customs VAT is imposed. Throughout these matters, Agip KCO has paid our legal expenses.            We have incurred no legal or court fees in connection with this matter.

             

If customs VAT is owed, we could be subject to fines and penalties            totaling up to as much as 100% of the tax obligation. Our understanding is that Agip            KCO will also indemnify us against any fines and penalties but, until this point is            specifically agreed to in writing, we have accrued $0.2 million toward any possible            payment.

             

22

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**Item            4. Submission of Matters to a Vote of Security Holders**

 

No matters were submitted to a vote of security holders and there were            no changes in our board of directors during the quarter ended September 30,            2007.

 

**PART II**

 

**Item 5.**  **Market for Registrant’s Common Equity, Related Stockholder            Matters and Issuer Purchases of Equity Market for our Common Stock**

             

Our shares are currently traded on the Over-the-Counter Bulletin Board            (“OTCBB”) under the symbol “CSSV.” The following table presents            the high and low bid prices for the fiscal years ended September 30, 2007 and 2006. The            published high and low bid quotations were furnished to us by Pink Sheets, LLC. These            quotations represent prices between dealers and do not include retail markup, markdown            or commissions and may not represent actual transactions.

             

|                                 |   | High   |   | Low    |
|--------------------------------------|--------|--------|--------|--------|
|                                 |   |   |   |   |
| Fiscal year ended September 30, 2007 |   |   |   |   |
|                                 |   |   |   |   |
| Fourth quarter                       |   | $ 2.95 |   | $ 2.65 |
| Third quarter                        |   | $ 3.60 |   | $ 2.80 |
| Second quarter                       |   | $ 4.00 |   | $ 3.10 |
| First quarter                        |   | $ 4.50 |   | $ 3.50 |
|                                 |   |   |   |   |
| Fiscal year ended September 30, 2006 |   |   |   |   |
|                                 |   |   |   |   |
| Fourth quarter                       |   | $ 5.05 |   | $ 4.05 |
| Third quarter                        |   | $ 5.25 |   | $ 4.55 |
| Second quarter                       |   | $ 5.00 |   | $ 3.25 |
| First quarter                        |   | $ 4.80 |   | $ 3.00 |

             

**Record Holders**

 

As of January 11, 2008 we had approximately 196 shareholders of record            holding 50,492,060 shares of our common stock. The number of record holders was            determined from the records of our transfer agent and does not include beneficial            owners of common stock whose shares are held in the names of various security brokers,            dealers, and registered clearing agencies.

 

**Dividend Policy**

 

We have not declared or paid a cash dividend on our common stock during            the past two fiscal years. Our ability to pay dividends is subject to limitations            imposed by Nevada law. Under Nevada law, dividends may be paid to the extent that a            corporation’s assets exceed it liabilities and it is able to pay its debts as            they become due in the usual course of business. At the present time, our board of            directors does not anticipate paying any dividends in the foreseeable future; rather,            the board of directors intends to retain earnings that could be distributed, if any, to            fund operations, expansion and development of our business.

             

23

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**Securities for Issuance Under Equity Compensation            Plans**

 

As of January 11, 2008 shares of our common stock were subject to            issuance upon the exercise of outstanding options or warrants as set forth            below.

 

| Plan category

                                                                                                                          | Number of securitiesto be issued uponexercise ofoutstanding options,warrants and rights

(a) | Weighted-averageexercise price ofoutstandingoptions, warrantsand rights

(b) | Number of securitiesremaining available for futureissuance under equitycompensation plans (excludingsecurities reflected in columns (a))

(c) |
|-----------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------|------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------|
| Equity compensation  plans approved by  security holders                                                                  | 1,000,000                                                                                    | $3.00                                                                        | -0-                                                                                                                                           |
| Equity compensation  plans not approved  by security holders                                                              | 846,068                                                                                      | $3.91                                                                        | -0-                                                                                                                                           |
|  

                                            **Total** | 1,846,068                                                                                    | $3.42                                                                        | -0-                                                                                                                                           |

 

Our board of directors adopted and our shareholders approved the EMPS            Corporation 2002 Stock Option Plan (the “Plan”) allowing us to offer key            employees, officers, directors, consultants and advisors, an opportunity to acquire a            proprietary interest in the Company. The various types of incentive awards which may be            provided under the Stock Option Plan will enable us to respond to changes in            compensation practices, tax laws, accounting regulations and the size and diversity of            our business.

 

On December 31, 2004, we granted options to purchase 100,000 shares each            to two employees. The options have an exercise price of $3.00 per share. These options            are fully vested. 100,000 options expire in September 2009 and 100,000 expire in            September 2010.

 

On August 1, 2005, options to purchase up to an aggregate of 800,000            shares of our common stock were granted to certain of our officers, directors,            employees and consultants as follows:

 

| Name               |   | # of Shares underlying Options |
|--------------------|--------|--------------------------------|
|               |   |                           |
| Marat Cherdabayev  |   | 100,000                        |
| Laird Garrard      |   | 220,000                        |
| Alexey Kotov       |   | 100,000                        |
| Mirgali Kunayev    |   | 110,000                        |
| Yevgeniy Kurguzkin |   | 110,000                        |
| James Passin       |   | 25,000                         |
| Paul Roberts       |   | 110,000                        |
| Valery Tolkachev   |   | 25,000                         |

 

24

----

The options vested one year from the date of grant and expire ten years            from the date of grant. The options have an exercise price of $3.00 per            share.

 

On August 3, 2007 we granted a placement agent warrant to Aton            Securities, Inc. for services rendered as our agent in connection with a private            placement completed by us in July2007. The placement agent            warrant grants Aton the right to purchase up to 692,333 shares of our common stock at            an exercise price of $4.00 per share. The placement agent warrant expires on August 2,            2009. The placement agent warrant provides for adjustments to the number of shares            and/or the price per share to protect the holder against dilution and in the event of            mergers, reorganizations and similar events.

             

Pursuant to the terms of their respective employment agreements John            Scott, our Chief Operating Officer, Terrance Powell, our Vice President of Investor            Relations, and Arjan Goris, the Managing Director of our wholly owned subsidiary            Caspian Services Group Ltd. were entitled to receive mandatory stock option grants on            the first anniversary of the effective date of their employment agreements, which were            March 20, 2007, January 11, 2007 and March 1, 2007, respectively. The option grants,            however, were not made on the respective anniversary dates. The primary reason for the            delay in making the mandatory stock option grants has been the ongoing discussion            between management, the board of directors and Messrs. Scott, Powell and Goris            regarding the possibility of revising their respective employment agreements to provide            for restricted stock grants rather than stock options. Because the parties have been            unable to reach an agreement on this issue, and with the mutual agreement of all            parties, on January 10, 2008, the board of directors awarded mandatory stock option            grants to Messrs. Scott, Powell and Goris. Following is additional information            regarding the stock option grants.

 

| Name            |   | # of Sharesunderlying Options |   | Exercise Priceper Share |   | Expiration Date                           |
|-----------------|--------|-------------------------------|--------|-------------------------|--------|-------------------------------------------|
|            |   |                          |   |                    |   |                                      |
| John Scott      |   | 53,730                        |   | $3.35                   |   | March 20,                            2015 |
| Terrance Powell |   | 48,780                        |   | $3.69                   |   | January 11, 2015                          |
| Arjan Goris     |   | 51,225                        |   | $3.51                   |   | March 1, 2015                             |

 

The options granted to Mr. Scott will vest: i) one third on March            20, 2008, ii) one third on March 20, 2009, and iii) the final third on March 20, 2010.            The options granted to Mr. Powell vest as follows: i) one third on January 11,            2008, ii) one third on January 11, 2009, and iii) the final third on January 11, 2010.            The options granted to Mr. Goris will vest: i) one third on March 1, 2008, ii) one            third on March 1, 2009, and iii) the final third on March 1, 2010.

             

25

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**Recent Sales of Unregistered Securities**

 

As noted in the preceding paragraph on January 10, 2008 we granted stock            options to purchase shares of our common stock to John Scott, Terrance Powell and Arjan            Goris. For details regarding the options please see the preceding paragraph. As            Messrs. Scott, Powell and Goris are non-U.S. persons residing in Kazakhstan, these            options were granted pursuant to Regulation S under the Securities Act.

 

Except as disclosed herein and in our Current Report on Form 8-K we            filed with the Securities and Exchange Commission on August 2, 2007, we sold no equity            securities, which were not registered under the Securities Act of 1933 during the            quarter the quarter ended September 30, 2007.

 

**Issuer Repurchases**

 

We did not make any repurchases of our equity securities during the year            ended September 30,2007.

 

**Item 6.**  **Selected Financial Data**

 

The selected consolidated financial information set forth below is            derived from our consolidated balance sheets and statements of operations as of and for            the years ended September 30, 2007 and 2006, the nine months ended September 30, 2005            and the years ended December 31, 2004 and 2003. The data set forth below should be read            in conjunction with “Management’s Discussion and Analysis of Financial            Condition and Results of Operations” and the consolidated financial statements            and related notes thereto included in this Annual Report.

 

|                                                                                      |  

                             

**For the****years ended****September 30,** |   |  

                             

**For the nine****months ended****September 30,** |  

                             

                              |  

                             

**For the****years ended****December 31,** |
|-------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------|----------------------------------------------------------------------------------------|
|                                                                                      | **2007**                                                                                |   | **2006**                                                                                      |                                                                           | **2005**                                                                               |   | **2004** |   | **2003** |
| **Consolidated Statements of**  **Operations                            Data:** |                                                                                    |   |                                                                                          |                                                                           |                                                                                   |   |   |   |   |
|                                                                                      |                                                                                    |   |                                                                                          |                                                                           |                                                                                   |   |   |   |   |
| Vessel revenues                                                                           | $  24,441                                                                     |   | $  14,444                                                                      |                                                                           | $   6,026                                                               |   | $    7,441  |   | $    9,701  |
| Geophysical services revenue                                                              | 38,896                                                                                  |   | 27,350                                                                                   |                                                                           | 11,778                                                                                 |   | 6,161  |   | -  |
| Product sales                                                                             | 1,556                                                                                   |   | 1,249                                                                                    |                                                                           | 858                                                                                    |   | 960  |   | 833  |
| Total revenues                                                                            | 64,893                                                                                  |   | 43,043                                                                                   |                                                                           | 18,662                                                                                 |   | 14,562  |   | 10,534  |
| Vessel operating costs                                                                    | 18,509                                                                                  |   | 13,366                                                                                   |                                                                           | 4,258                                                                                  |   | 5,867  |   | 5,119  |
| Geophysical costs of revenues                                                             | 17,058                                                                                  |   | 13,982                                                                                   |                                                                           | 4,182                                                                                  |   | 2,661  |   | -  |
| Cost of product sold                                                                      | 898                                                                                     |   | 647                                                                                      |                                                                           | 299                                                                                    |   | 327  |   | 418  |
| Depreciation                                                                              | 6,619                                                                                   |   | 3,330                                                                                    |                                                                           | 1,320                                                                                  |   | 1,055  |   | 789  |
| General and administrative                                                                | 12,127                                                                                  |   | 10,162                                                                                   |                                                                           | 5,520                                                                                  |   | 3,577  |   | 2,021  |
| Total operating expenses                                                                  | 55,211                                                                                  |   | 41,487                                                                                   |                                                                           | 15,579                                                                                 |   | 13,487  |   | 8,347  |
| Income from operations                                                                    | 9,682                                                                                   |   | 1,556                                                                                    |                                                                           | 3,083                                                                                  |   | 1,075  |   | 2,187  |
| Net income (loss)                                                                         | 9,465                                                                                   |   | (1,700)                                                                                       |                                                                           | 1,351                                                                                  |   | (195) |   | (192) |
| Basic income (loss) per common share                                                      | 0.22                                                                                    |   | (0.04)                                                                                        |                                                                           | 0.04                                                                                   |   | (0.01) |   | (0.01) |
| Diluted income/(loss) per common share                                                    | 0.22                                                                                    |   | (0.04)                                                                                        |                                                                           | 0.04                                                                                   |   |   |   |   |
|                                                                                      |                                                                                    |   |                                                                                          |                                                                           |                                                                                   |   |   |   |   |
|                                                                                      | **As of September 30,**                                                                 |   | **As of December 31,**                                                                        |
|                                                                                      | **2007**                                                                                |   | **2006**                                                                                      |                                                                           | **2005**                                                                               |   | **2004** |   | **2003** |
| **Balance Sheet Data:**                                                                   |                                                                                    |   |                                                                                          |                                                                           |                                                                                   |   |   |   |   |
|                                                                                      |                                                                                    |   |                                                                                          |                                                                           |                                                                                   |   |   |   |   |
| Total current assets                                                                      | $  42,220                                                                     |   | $  23,950                                                                           |                                                                           | $   12,536                                                              |   | $   7,297 |   | $   2,557 |
| Vessels, equipment and property, net                                                      | 45,481                                                                                  |   | 33,064                                                                                        |                                                                           | 20,711                                                                                 |   | 12,490 |   | 8,965 |
| Total assets                                                                              | 92,663                                                                                  |   | 61,650                                                                                        |                                                                           | 38,058                                                                                 |   | 25,198 |   | 12,366 |
| Total current liabilities                                                                 | 11,896                                                                                  |   | 17,347                                                                                        |                                                                           | 8,146                                                                                  |   | 14,230 |   | 9,208 |
| Total liabilities                                                                         | 13,739                                                                                  |   | 18,743                                                                                        |                                                                           | 8,146                                                                                  |   | 18,648 |   | 9,208 |
| Total shareholders’ equity                                                          | 75,191                                                                                  |   | 39,616                                                                                        |                                                                           | 27,470                                                                                 |   | 4,394 |   | 1,196 |
|                                                                                           |                                                                                         |        |                                                                                               |                                                                                |                                                                                        |  |  |  |  |  |  |  |  |

 

26

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**Item 7.**  **Management’s Discussion and Analysis of Results of            Operations**

 

This discussion summarizes the significant factors affecting our            consolidated operating results, financial condition, liquidity and capital resources            during the fiscal years ended September 30, 2007 and 2006 and the nine months ended            September 30, 2005. During our 2005 fiscal year our shareholders approved a change in            our fiscal year end from December 31 to September 30. For this reason, the financial            information presented in this report for our 2005 fiscal year present only the nine            month period from January 1, 2005 to September 30, 2005. This discussion should be read            in conjunction with the consolidated financial statements and footnotes to the            consolidated financial statements included in this annual report.

 

All dollar amounts stated in this Item 6 are presented in thousands            unless stated otherwise.

 

**2007            Summary**

             

In fiscal 2007 we experienced a 51% increase in total revenue as            compared to the year ended September 30, 2006. This was in line with our projections            and reflected a similar pattern of growth from 2005. Our income from operations during            fiscal 2007 was $9,682, an increase of 522%. We realized a net income of $9,465 or            $0.22 per share compared to a net loss of ($1,700) or ($0.04) per share during 2006.            The increase in revenue is the result of robust growth in both our vessels and            geophysical divisions. Total operating expenses rose by only 33% and our operating            margin increased from 3.6% to 14.9%. Better margins were obtained because our            infrastructure was substantially completed in 2006, allowing fixed costs to be            contained, and because increased investment allowed us to perform work in-house, rather            than subcontracting the work.

 

In the geophysical services sector, with the purchase of new equipment            we were able to field two new crews for a full year, reducing our subcontracting costs            and substantially improving our margins. We have increased our capacity in the            geophysical services sector with new recording systems and other large plant and            equipment. This trend will continue as we seek to purchase our own additional marine            craft and recording equipment to support these operations.

 

Vessel operating revenue improved as several new multi-year contracts            signed in 2006 allowed our fleet to be almost fully utilized. The only negative factors            were; i) a vessel damaged at the end of the 2006 season which took substantially longer            to repair than had been anticipated; and ii) a new vessel which was delivered late and            which had a number of teething problems. Had these vessels been available on time, the            vessel division would have made a profit. The fixed costs of the new Aktau office can            now be fully covered and additional vessels should lead to strong profit            growth.

 

We continue with development plans for the marine base in Bautino Bay.            Construction commenced in November 2007. We expect the initial phase of the marine base            facilities, including dredging, breakwater, wharf front and general site area to be            completed and functional by December 2008 with final completion of the base            occurring by November 2009. Anticipated cost to construct the marine base is            approximately $71,810. We plan to achieve this funding through a combination of debt            financing in the amount of $32,000 and cash equity financing in the amount of            $39,810 of which $10,120 has already been contributed by us for            the initial feasibility studies, preliminary construction costs andmaterials. We also contributed the land for the project through our            acquisition of Balykshi LLP.

             

27

----

 

In December 2006, Balykshi LLP entered into a loan agreement with EBRD            in the amount of $24,000 and in June 2007 the first amendment to the loan            agreement with EBRD was signed increasing the loan amount to $32,000. In June 2007 we            also entered into an investment agreement with EBRD under which EBRD has agreed to make            an equity investment in the marine base in the amount of $10,0000 in exchange for a 22%            equity interest in Balykshi LLP.

 

The balance of $29,800 less already contributed costs will be provided            by us to Balykshi. We raised net proceeds of approximately $24,000 through a private            placement of units of our securities in July 2007. Most of these funds will be applied            toward this $29.8 million commitment. The balance will be funded from additional fund            raising, improved profitability and a smaller investment in our vessel division for            2008.

             

In February 2007 Balykshi entered into short-term loan agreement with            Halyk Bank for $2,000. The loan was fully repaid in August 2007. The purpose of the            loan was to pay for marine base construction costs.

 

During the years ended September 30, 2007 and 2006 the Company incurred            construction costs of $8,011 and $1,115, respectively.

 

|   | *Comparison of the fiscal year ended September 30,                            2007 and September 30, 2006* |
|--------|------------------------------------------------------------------------------------------------------------|

 

In fiscal 2007, we operated four business segments: Vessel Operations,            Geophysical Services, Infrastructure Development and Corporate Administration. The            following discussion and analysis of results of operations should be read in            conjunction with the Consolidated Financial Statements.

             

28

----

 

| (Stated in thousands)           |
|---------------------------------|
|                            |   | Year ended |   | Year ended |   |   |
|                            |   | September 30,2007 |   | September 30,2006 |   | %Change |
|                            |   |   |   |   |   |   |   |   |
| VESSEL OPERATIONS               |   |   |   |   |   |   |   |   |
| Operating Revenue               |   | $ | 24,441  |   | $ | 14,444  |   | 69%  |
| Pretax Operating Loss1          |   | $ | (732) |   | $ | (3,178) |   | (77%) |
|                            |   |   |   |   |   |   |   |   |
| GEOPHYSICAL SERVICES            |   |   |   |   |   |   |   |   |
| Operating Revenue               |   | $ | 38,896  |   | $ | 27,350  |   | 42%  |
| Pretax Operating Income1        |   | $ | 13,878  |   | $ | 5,640  |   | 146%  |
|                            |   |   |   |   |   |   |   |   |
| INFRASTRUCTURE DEVELOPMENT      |   |   |   |   |   |   |   |   |
| Operating Revenue               |   | $ | 1,556  |   | $ | 1,249  |   | 25%  |
| Pretax Operating Income/(Loss)1 |   | $ | 2,529  |   | $ | (282) |   | (997%) |
|                            |   |   |   |   |   |   |   |   |
| CORPORATE ADMINISTRATION        |   |   |   |   |   |   |   |   |
| Operating Revenue               |   | $ | -  |   | $ | -  |   | n/a   |
| Pretax Operating Loss1          |   | $ | (778) |   | $ | (535) |   | 45%  |
|                            |   |   |   |   |   |   |   |   |

 

_________________________

1  Pretax segment income represents income before taxes            and minority interest.

 

**Revenue**

 

Total revenue for the fiscal year ended September 30, 2007 was $64,893            compared to $43,043 for 2006. This increase was largely the result of increased            activity in the geophysical services sector, where the delivery of additional equipment            allowed us to field additional operating crews, and increases in both the size and            utilization rate of our vessel fleet during fiscal 2007.

 

Vessel revenue of $24,441 in fiscal 2007 was 69% higher than in 2006,            due to improved utilization of our fleet, more vessels and increased charter rates. The            figure would have been higher if two vessels had been available on time.

 

In fiscal 2007 geophysical service revenue was $38,896 or 42% higher            than in 2006. This significant increase is the result of strong demand, coupled with            the benefits of high investment in 2006. The increased crews and equipment led to            additional payroll and depreciation charges but they were more than offset by savings            in subcontracting and the generation of strong revenues. We were effectively able to            increase revenues without increasing costs during fiscal 2007.

 

Infrastructure revenue in fiscal 2007 of $1,556 increased 25% compared            to 2006, due to demand for water arising from increased activity in the port of            Bautino. Revenue from product sales less cost of product sold in fiscal 2007 was $658            compared to $602 during the 2006, as we continued our efforts to improve efficiency,            profitability and revenue at our water desalinization plant.

 

The corporate administration segment of our business refers primarily to            the administration of our affairs in the United States and includes marketing services            provided by that segment to the other segments of our operations. Corporate            administration generated a pretax operating loss of $778 during the fiscal year ended            September 30, 2007 compared to a pretax operating loss of $535 during 2006.

             

29

----

 

|   | *Vessel Operations* |
|--------|---------------------|

 

The exploration and production season in the north Caspian Sea where our            vessels operate, usually ends in November and does not commence again until March or            April. Therefore, revenue and operating income from vessel operations typically            decreases during our first fiscal quarter and is at its lowest level during the second            fiscal quarter of each fiscal year.

 

Vessel revenues are affected by utilization and day rates. We            experienced an increase in revenue from vessel operations during the 2007 fiscal year,            as compared to 2006. This increase was largely attributable to improved vessel            utilization rates, an increased number of vessels in our fleet and improving day rates.            We mobilized an additional three vessels to the Caspian Sea during fiscal 2007. In 2008            we expect to mobilize one more vessel. This will bring the total number of vessels in            our fleet to fifteen.

We expect the trend of increasing demand to continue in the upcoming            year. We already have an almost full order book for 2008. Only one vessel remains to be            allocated and we are currently investigating several options for contract during 2008.            Based on charters in place, current negotiations and anticipated increased exploration            and production activities in the Caspian Sea, we expect revenues and income from vessel            operations to increase in fiscal 2008 as compared to fiscal 2007.

 

Vessel operating costs of $18,509 during the fiscal year ended September            30, 2007 were 38% higher than in 2006. This increase is primarily volume related and            has risen less quickly than revenues, leading to better margins. Some of our vessel            operating costs are attributable to the vessels we operate under our agreement with            Rederij Waterweg. Pursuant to that agreement we pay a day rate to Rederij Waterweg for            the vessels they own, that we operate. Currently, six of the vessels in our fleet are            owned by Rederij Waterweg. While they cost us more to operate than our own vessels we            are willing to operate these vessels at a reduced profit margin to gain access to            Rederij Waterweg’s large shallow draft fleet. This relationship makes it possible            for us to meet demand without incurring the significant expense of purchasing            additional vessels. Because of the growth of our fleet, and as a result of inflation,            we also realized increases in operational costs and costs for general supplies            including consumables such as fuel.

 

During December 2006, we entered into a contract with Reservoir            Exploration Technology ASA, a specialized seismic acquisition company, to provide three            shallow draft vessels as survey vessels for an offshore marine seismic acquisition            program over the Kashagan oilfield in the north Caspian Sea. We provided one vessel            from our fleet to fulfill the contract. The remaining two vessels were new additions to            our fleet through our leasing agreement with Rederij Waterweg. This contract is now            complete.

 

We plan to purchase and mobilize to the Caspian Sea a dedicated shallow            water cable laying barge. This vessel will be contracted out to Saipem as part of their            work commitment on the Kashagan field.

 

As a result of this anticipated addition to our fleet, we expect that            vessel operating costs will continue to increase in fiscal 2008.

             

30

----

             

*Geophysical Services*

             

We also experienced a significant increase in revenue from geophysical            services during the 2007 fiscal year, as revenue increased $11,546 or 42% compared to            the 2006 fiscal year.

 

As a result of new contracts, TatArka’s business grew            significantly during fiscal 2007, with revenue increasing from $20,078 to $28,664. To            take advantage of this ongoing strong demand for geophysical services, in 2006 we            purchased additional equipment to allow us to field extra operational crews. We were            able to operate with additional crews for the entire 2007 fiscal year.

With the anticipated increase in proprietary exploration activities in            the Caspian Sea region in 2008 and the rights of Veritas Caspian to conduct            non-proprietary surveys, we anticipate revenue from geophysical services will continue            to increase in the upcoming 2008 fiscal year.

 

Geophysical operating costs also increased during the 2007 fiscal year            from $13,982 to $17,058. Kazmorgeophysica costs increased $5,341 to $8,536 but            TatArka’s costs decreased $1,805 to $8,696, resulting in an overall increase in            geophysical operating costs of $3,076. As discussed above, this is primarily due to            higher payroll costs and depreciation as we increased crews and equipment, but there            were much higher savings in subcontracting costs as we performed the work in-house. The            result was higher revenues and lower costs.

 

With the anticipated exploration activities in the Caspian Sea region in            2008, we expect revenues to increase. Costs of providing geophysical services should            increase in line with inflation as compared to costs experienced during the 2007 fiscal            year. Unlike our vessel operations, TatArka can provide onshore geophysical research            services throughout the year. Because Kazmorgeophysica provides marine and transition            zone geophysical services, its operations are more seasonal.

 

|   | *Infrastructure Development* |
|--------|------------------------------|

 

During fiscal 2007, revenue from water desalinization increased 25%            compared to fiscal 2006. Revenue from water sales, less the cost of water sales            increased to $658 in fiscal 2007 compared to $602 in fiscal 2006. This is the result of            increased demand for water arising from more activity in the port of Bautino. Increased            costs related to production of water are mainly due to higher payroll costs and costs            of chemicals and electricity. However, gross margin in percentage decreased from 48% in            2006 to 42% in 2007. This decrease is mainly attributable to increased cost of            materials as we switched suppliers of plastic forms for water bottles to ensure timely            delivery and increased utility costs, due to higher tariffs in 2007. As much of our            water sales are made to exploration and production camps operating in the Caspian Sea            region, much like our vessel operations, demand for water is directly affected by oil            and gas exploration and production in the region. With the anticipated increases in            exploration and production activities in the region, we anticipate increased revenue            and income from water desalinization in 2008.

             

31

----

             

*Corporate Administration*

             

During the fiscal year ended September 30, 2007, net loss from corporate            administration was $778 compared to $535 during the fiscal year ended September 30,            2006. This increase in net loss is due to increased office rental cost, travel and            communication costs.

 

**Consolidated Results**

 

|   | *General and Administrative                            Expenses* |
|--------|------------------------------------------------------------------|

 

General and administrative expenses increased $1,965, or 19% during            fiscal 2007 compared to the fiscal 2006. A primary contributing factor to this increase            in general and administrative expense is improved infrastructure, including the new            Aktau office being operational for the full year. Additionally, we hired new key            personnel in 2007 which resulted in higher payroll, travel and insurance costs. Our            infrastructure is now substantially in place for the expected increase in            revenues.

While we anticipate general and administrative expenses for the upcoming            year will continue to rise as we continue to expand our operations, we do not expect            them to increase significantly.

 

|   | *Interest Expense* |
|--------|--------------------|

 

Interest expense decreased 55% to $130 during fiscal 2007, compared to            fiscal 2006. This is the result of the decreased debt load we carried during 2007            compared to 2006. We expect interest expense will increase in future periods as we            access funds under the loan agreement with EBRD for the construction of the marine            base.

 

*Other Income*

 

The significant increase in other income of $4,583 is primarily due to            the sale of our interest in Bautino Development Company, realizing a profit of $3,000.            Our seismic companies were also able to rent equipment and sell consumables to third            parties. The sale of our interest in Bautino Development Company was a one-time event            that we do not expect to recur. Therefore we expect other income to return to more            traditional levels during our 2008 fiscal year.

 

|   | *Comparison of the fiscal year ended September 30,                            2006 and the nine months ended* |
|--------|---------------------------------------------------------------------------------------------------------------|

*September 30, 2005*

 

In fiscal 2006, we operated four business segments: Vessel Operations,            Geophysical Services, Infrastructure Development and Corporate Administration. The            following discussion and analysis of results of operations should be read in            conjunction with the Consolidated Financial Statements.

             

32

----

 

| (Stated in thousands)           |
|---------------------------------|
|                            |   | Twelve monthsended |   | Nine monthsended |   |   |
|                            |   | September 30,2006 |   | September 30,2005 |   | %Change |
|                            |   |   |   |   |   |   |   |   |
| VESSEL OPERATIONS               |   |   |   |   |   |   |   |   |
| Operating Revenue               |   | $ | 14,444  |   | $ | 6,026  |   | 140%  |
| Pretax Operating Loss1          |   | $ | (3,178) |   | $ | (1,969) |   | 61%  |
|                            |   |   |   |   |   |   |   |   |
| GEOPHYSICAL SERVICES            |   |   |   |   |   |   |   |   |
| Operating Revenue               |   | $ | 27,350  |   | $ | 11,778  |   | 132%  |
| Pretax Operating Income1        |   | $ | 5,640  |   | $ | 3,734  |   | (51%) |
|                            |   |   |   |   |   |   |   |   |
| INFRASTRUCTURE DEVELOPMENT      |   |   |   |   |   |   |   |   |
| Operating Revenue               |   | $ | 1,249  |   | $ | 858  |   | 46%  |
| Pretax Operating Income/(Loss)1 |   | $ | (282) |   | $ | (189) |   | 49%  |
|                            |   |   |   |   |   |   |   |   |
| CORPORATE ADMINISTRATION        |   |   |   |   |   |   |   |   |
| Operating Revenue               |   | $ | -  |   | $ | -  |   | n/a   |
| Pretax Operating Income/(Loss)1 |   | $ | (535) |   | $ | (225) |   | 138%  |

 

_________________________

1  Pretax segment income represents            income before taxes and minority interest.

**Revenue**

 

Total revenue for the fiscal year ended September 30, 2006 was $43,043            compared to $18,662 for the 2005 transition period. This increase in total revenue was            largely the result of increased activity in the geophysical services sector where the            delivery of additional equipment allowed us to field additional operating crews and due            to increases in both the size and utilization rate of our vessel fleet during fiscal            2006. Another contributing factor was the consolidation of the financial results of            Kazmorgeophysica which had geophysical service revenue of $7,327 in fiscal            2006.

 

Vessel revenue of $14,444 in fiscal 2006 was 140% higher compared to the            2005 transition period due to improved utilization of our fleet during fiscal 2006            resulting from the commencement of the Saipem, Agip KCO and Veritas Caspian contracts            and a corresponding increase in the number of vessels in our fleet.

 

In fiscal 2006 geophysical service revenue was $27,350 or 132% higher            than during the 2005 transition period. This significant increase was primarily the            result of an increase in our geophysical services business during fiscal 2006 coupled            with the consolidation of Kazmorgeophysica’s results of operations during the            2006 fiscal year. Geophysical revenue less geophysical costs of revenue totaled $13,368            in fiscal 2006 compared to $7,596 during the 2005 transition period, a 76% increase.            During the 2006 fiscal year we invested in additional new equipment to allow us to            continue to meet the growing demand in Kazakhstan and the Kazakh sector of the Caspian            Sea for geophysical services.

 

Infrastructure revenue in fiscal 2006 of $1,249 increased 46% compared            to the 2005 transition period due to increased demand for water arising from increased            activity in the port of Bautino. Revenue from product sales less cost of product sold            in fiscal 2006 was $602 compared to $559 during the 2005 transition period, as we            continued our efforts to improve efficiency, profitability and revenue at our water            desalinization plant.

             

33

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Corporate Administration generated a pretax operating loss of $535            during the fiscal year ended September 30, 2006 compared to a pretax operating loss of            $225 during the 2005 transition period.

 

|   | *Vessel Operations* |
|--------|---------------------|

 

We experienced an increase in revenue from vessel operations during the            2006 fiscal year, as compared to the 2005 transition period. This increase was largely            attributable to improved vessel utilization rates, an increased number of vessels in            our fleet and improving day rates. We mobilized an additional four vessels to the            Caspian Sea during fiscal 2006

 

We expected the trend of increasing demand to continue in the upcoming            year and this proved to be the case. We already had a full order book for            2007.

Vessel operating costs of $13,366 during the fiscal year ended September            30, 2006 were $9,108 or 214% higher compared to the nine month 2005 transition period.            This increase was the result of several factors. A disproportionate percentage of our            vessel operating costs were attributable to the vessels we operated under our agreement            with Rederij Waterweg. Because of the growth of our fleet, and as a result of            inflation, we also realized increases in operational costs and costs for general            supplies including consumables such as fuel. During fiscal 2006, we also sold our            under-utilized shallow draft supply vessel, the Caspian Yelena. As a result, we            realized one-time extraordinary costs associated with the sale, including            demobilization and drydocking costs. During the early part of 2006, we had fewer            vessels earning winter standby rates, as compared to the 2005 transition period, while            we continued to incur costs associated with those vessels.

 

During December 2006, we entered into a contract with Reservoir            Exploration Technology ASA, a specialized seismic acquisition company, to provide three            shallow draft vessels as survey vessels for an offshore marine seismic acquisition            program over the Kashagan oilfield in the North Caspian Sea. We were to provide one            vessel from our current fleet to fulfill the contract. The remaining two vessels were            to be new additions to our fleet, through our leasing agreement with Rederij Waterweg.            The contract was for an initial period of one year, with options for up to three            additional one-year terms.

 

In addition to the above, we planned to purchase and mobilize to the            Caspian Sea a dedicated shallow water survey/support vessel. This vessel was to be            contracted out to Veritas Caspian to assist with the “State Geophysical Survey of            the Republic of Kazakhstan” project. The vessel was to be fitted out with            purpose-built seismic acquisition source equipment.

 

*Geophysical Services*

 

We also experienced a significant increase in revenue from geophysical            services during the 2006 fiscal year, as revenue increased $15,572 or 132% compared to            the 2005 transition period.

             

34

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As a result of new contracts, TatArka’s business grew            significantly during fiscal 2006 with revenue increasing from $8,300 to $20,078. To            take advantage of this ongoing strong demand for geophysical services, we purchased            additional equipment to allow us to field extra operational crews.

 

With the anticipated increase in proprietary exploration activities in            the Caspian Sea region in 2006 and the rights of Veritas Caspian to conduct            non-proprietary surveys, we anticipated revenue and costs from geophysical services to            continue to increase in 2007 fiscal year and this assessment was accurate.

 

Another factor that contributed to the increase in revenue from            geophysical services was the consolidation of the results of operations of            Kazmorgeophysica with our own in fiscal 2006. Because we did not acquire the            controlling interest in Kazmorgeophysica until the end of September 2005, we could not            consolidate Kazmorgeophysica’s results of operations with our own during the 2005            transition period. During fiscal 2006, Kazmorgeophysica realized revenue of            $7,327.

             

Geophysical costs of revenues also increased substantially during the            2006 fiscal year. During the 2005 transition period geophysical costs of revenues was            $4,182. By comparison, during fiscal 2006 Kazmorgeophysica realized costs of revenue of            $3,481 and TatArka’s cost of revenue increased $6,319 to $10,501, resulting in an            overall increase in geophysical costs of revenue of $9,800. As discussed above, this            increase was attributable to several factors, including the consolidation of            Kazmorgeophysica’s results of operations, increased payroll expenses as a result            of increasing the number of our field crews from two during the 2005 transition period            to four in fiscal 2006 and we increased VAT expense resulting from greater material and            services costs.

 

|   | *Infrastructure Development* |
|--------|------------------------------|

 

During fiscal 2006, revenue from water desalinization increased 46%            compared to the 2005 transition period. Revenue from water sales, less the cost of            water sales increased to $602 in fiscal 2006 compared to $559 during the 2005            transition period. This was the result of increased demand for water arising from            increased activity in the port of Bautino. The increase in operating expenses is            partially attributable to the acquisition of Balykshi. Increased costs related to            production of water were mainly due to increased payroll costs and costs of chemicals            and electricity. As much of our water sales are made to exploration and production            camps operating in the Caspian Sea region, much like our vessel operations, demand for            water is directly affected by oil and gas exploration and production in the region. We            anticipated increased revenue and income from water desalinization in 2007.

             

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*Corporate Administration*

 

During the fiscal year ended September 30, 2006, net loss from corporate            administration was $535 compared to $225 during the 2005 transition period. This            increase in net loss was mainly due to increased compensation and payroll            expenses.

 

**Consolidated Results**

 

|   | *General and Administrative                            Expenses* |
|--------|------------------------------------------------------------------|

 

General and administrative expenses increased $4,642, or 84% during            fiscal 2006 compared to the 2005 transition period. A primary contributing factor to            this increase in general and administrative expense was the consolidation of            Kazmorgeophysica’s general and administrative expenses, which amounted to $2,021            during fiscal 2006. Additionally we hired some new key personnel in 2006 which resulted            in increased payroll and travel costs. Insurance cost also increased due to increased            personnel.

 

While we anticipated general and administrative expenses for the            upcoming year to rise as we continued to expand our operations, we did not expect            general and administrative expenses to increase at such a dramatic rate. This            expectation was confirmed.

|   | *Interest Expense* |
|--------|--------------------|

 

Interest expense decreased 53% to $288 during fiscal 2006, compared to            the 2005 transition period. The decrease in interest expense was primarily due to the            fact that we fully repaid finance lease obligations as of June 30, 2006 arising from            acquisition of seismic equipment.

             

*Other Income*

             

The significant increase in Other Income of $443 was primarily due to            the sale of the Caspian Yelena to an unrelated third party for net proceeds of $1,868.            The vessel had a book value of $1,489. We recognized a gain on the sale of the vessel            in the amount of $379.

 

**Cash            Flow**

 

We typically realize decreasing cash flows during our first fiscal            quarter and limited cash flow during our second fiscal quarter as weather conditions in            the north Caspian Sea region dictate when oil and gas exploration and development work            can be undertaken. Usually, the work season commences in late March or early April and            continues until the Caspian Sea ices over in November. As a result, other than TatArka,            which can continue to provide some onshore geophysical services between November and            March and the receipt of winter standby rates on vessels, we generate very little            revenue from November to March each year.

 

The following table provides an overview of our cash flow during the            fiscal years ended September 30, 2007 and 2006 and the nine months ended September 30,            2005.

             

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|                                                 |   | For the fiscal years                            ended September 30, |   | For the nine                            months ended                         |
|------------------------------------------------------|--------|---------------------------------------------------------------------|--------|------------------------------------------------------------------------------|
|                                                 |   | 2007                                                                |   | 2006                                                                         |   | September 30, 2005 |
|                                                 |   |                                                                |   |                                                                         |   |   |
| Net cash provided by operating  activities |   | $       6,723               |   | $           590  |   | $        1,423  |
| Net cash used in investing  activities     |   | (18,169)                                                            |   | (11,336)                                                                     |   | (8,151) |
| Net cash provided by financing  activities |   | 24,734                                                         |   | 11,236                                                                  |   | 8,967  |
| Effect of exchange rate changes  on cash   |   | (676)                                                               |   | (232)                                                                        |   | 2  |
|                                                 |   |                                                                |   |                                                                         |   |   |
| Net change in cash                                   |   | $     12,612                          |   | $         258              |   | $      2,241  |

 

In fiscal 2007 net cash provided by operating activities was $6,723,            compared to net cash provided by operating activities of $590 in fiscal 2006. This            change in cash flow from operating activities is the result of net income of $9,465 in            fiscal 2007, compared to $1,700 net loss from operations in fiscal 2006. There was a            $3,289 increase in depreciation and amortization arising from our investments in            vessels and additional seismic equipment. These benefits were partially offset by            increases in receivables linked to the strong revenue growth, but net cash from            operating activities still improved by $6,133.

In fiscal 2007 we invested $17,226 in the acquisition of vessels and            equipment, requiring additional external financing. These purchases were partially            funded by $26,339 from private placements of our equity securities during fiscal 2007            and fiscal 2006. We also borrowed $217 from unrelated parties. Of the funds we raised            in financing activities, $467 was used to repay short-term debts to related parties and            $1,381 was used to repay notes payable.

 

**Summary of Material Contractual Commitments**

 

| **(Stated in                            thousands)**   |
|--------------------------------------------------------|
|                                                   |   | **Payment Period** |
| **Contractual                            Commitments** |   | **Total** |   | **Less than****1 year** |   | **2-3 years** |   | **4-5 years** |   | **After****5 years** |
| Long-Term Debt                                         |   | $        680 |   | $      680 |   | $        — |   | $    — |   | $    — |
| Vessel Operating                            Leases     |   | 8,484 |   | 6,424 |   | 2,060 |   | — |   | — |
| Operating                            Leases            |   | 2,847 |   | 2,847 |   | — |   | — |   | — |
| **Total**                                              |   | $   12,011 |   | $   9,951 |   | $   2,060 |   | $    — |   | $    — |

 

**Financing**

 

In December 2006, Balykshi LLP entered into a loan agreement with EBRD            in the amount of $24,000 and in June 2007 the first amendment to the loan            agreement with EBRD was signed increasing the loan amount to $32,000.

 

In June 2007 the Company also entered into an investment agreement with            EBRD under which EBRD has agreed to make an equity investment in the marine base in the            amount of $10,000 in exchange for a 22% equity interest in Balykshi LLP.

             

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In February 2007 Balykshi entered into short-term loan agreement with            Halyk Bank for $2,000. The loan was fully repaid in August 2007. The purpose of the            loan was to pay for marine base construction costs.

 

During the 2007 fiscal year, Bauta borrowed $26 from a local bank and            repaid $11. The notes are collateralized by equipment and inventory and bear interest            at 18%. Bauta will pay an additional $15 until December 2008.

 

During the year ended September 30, 2007, KMG borrowed $223 from            institutions other than banks. The notes bear interest at 0% and will be repaid in            December 31, 2007.

 

During the 2006 fiscal year, TatArka borrowed $2,580 from two local            banks. The notes are collateralized by equipment and bear interest at 14%. Through 2007            fiscal year $590 was repaid. TatArka will pay an additional $442 until March            2008.

 

In July 2007, the Company completed a private placement of Units raising            net proceeds of $24,041. The Units offered in the private placement consisted of three            shares of common stock and a redeemable warrant to purchase an additional share of            common stock at an exercise price of $4.00. The warrant contained in each Unit is            immediately exercisable and has a three-year term. The price per Unit was $9.00. The            funds raised in the offering were used to fund development of the Company’s            marine base and to acquire vessels and seismic equipment.

             

**Off-Balance Sheet Financing Arrangements**

 

|   | There are no off-balance sheet financing                            arrangements. |
|--------|-----------------------------------------------------------------------------------|

 

**New            Accounting Standards**

 

In December 2007, the FASB issued SFAS No. 141(R)            “Business Combinations” (“SFAS 141(R)”) and            SFAS No. 160, “Non-controlling Interests in Consolidated Financial            Statement” (“SFAS 160”). SFAS 141(R) requires the acquiring            entity in a business combination to record all assets acquired and liabilities assumed            at their respective acquisition-date fair values and changes other practices under            FAS 141, some of which could have a material impact on how the Company accounts            for business combinations. SFAS 141(R) also requires additional disclosure of            information surrounding a business combination, such that users of the entity’s            financial statements can fully understand the nature and financial impact of the            business combination. SFAS 160 requires entities to report non-controlling            (minority) interests in subsidiaries as equity in the consolidated financial            statements. The Company is required to adopt SFAS 141(R) and SFAS 160            simultaneously in the fiscal year beginning October 1, 2009. The provisions of            SFAS 141(R) will only impact the Company if the Company is party to a business            combination after the pronouncement has been adopted. The Company is currently            evaluating the effects, if any, that SFAS 160 may have on the Company’s            financial statements.

 

In February 2007, the FASB issued SFAS No. 159, “The            Fair Value Option for Financial Assets and Financial Liabilities — Including            an amendment of FASB Statement No. 115” (“SFAS 159”).            SFAS 159

             

38

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During September 2006, the FASB issued SFAS 157, “Fair Value            Measurements” (“SFAS 157”), which provides enhanced guidance for            using fair value to measure assets and liabilities. The standard applies whenever other            standards require (or permit) assets or liabilities to be measured at fair value. The            standard does not expand the use of fair value in any new circumstances. SFAS 157            is effective for financial statements issued for fiscal years beginning after            November 15, 2007, and interim periods within those fiscal years. This standard is            effective in the Company’s financial statements beginning October 1, 2008. The            Company is currently evaluating the effects, if any, that this pronouncement may have            on the Company’s financial statements.

 

During June 2006, the FASB issued FASB Interpretation No. 48,            “Accounting for Uncertainty in Income Taxes — an interpretation of            FASB Statement No. 109” (“FIN 48”), which clarifies the            accounting for uncertainty in income taxes. FIN 48 prescribes a recognitionthreshold and measurement attribute for the financial statement            recognition and measurement of a tax position taken or expected to be taken in a tax            return. FIN 48 also provides guidance on derecognition, classification, interest            and penalties, accounting in interim periods, disclosure and transition. FIN 48 is            effective for fiscal years beginning after December 15, 2006. The Company is            required to adopt the provisions of FIN 48 in the fiscal year beginning            October 1, 2007. The Company is currently evaluating the effects, if any, that            this pronouncement may have on the Company’s financial statements.

 

**Critical Accounting Policies and Estimates**

 

The preparation of financial statements in accordance with accounting            standards generally accepted in the United States requires management to make estimates            and assumptions that affect both the recorded values of assets and liabilities at the            date of the financial statements and the revenues recognized and expenses incurred            during the reporting period. Our estimates and assumptions affect its recognition of            deferred expenses, bad debts, income taxes, the carrying value of its long-lived assets            and its provision for certain contingencies. We evaluate the reasonableness of these            estimates and assumptions continually based on a combination of historical information            and other information that comes to its attention that may vary its outlook for the            future. Actual results may differ from these estimates under different            assumptions.

 

We suggest that the Summary of Significant Accounting Policies, as            described in Note 1 of Notes to Consolidated Financial Statements, be read in            conjunction with this Management’s Discussion and Analysis of Financial Condition            and Results of Operations. We believe the critical accounting policies that most impact            our consolidated financial statements are described below.

             

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***Revenue Recognition***— Vessel            revenues are derived from time charter contracts of its vessels on a rate-per-day of            service basis; therefore, vessel revenues are recognized on a daily basis throughout            the contract period. These time charter contracts are generally on a term basis,            ranging from three months to three years. The base rate of hire for a contract is            generally a fixed rate, provided, however, that term contracts often include clauses to            recover specific additional costs, and mobilization and demobilization            costs.

 

Geophysical service revenue is recognized when services are rendered and            payment is reasonably assured. Direct costs are charged to each contract as incurred            along with an allocated amount of indirect costs for the specific period of service.            Losses on contracts are recognized during the period in which the loss first becomes            probable and reasonably estimated.

 

Product sales revenue is recorded upon delivery or shipment of bulk or            bottled water to the customer.

 

***Receivables***— In the normal            course of business, we extend credit to our customers on a short-term basis. Our            principal customers are major oil and natural gas exploration, development and            production companies or companies providing services to such companies. Although credit            risks associated with our customers are considered minimal, we routinely review our            accounts receivable balances and make adequate provisions for doubtful            accounts.

***Impairment of Long-Lived Assets and Long-Lived Assets to be            Disposed Of***— Long-lived assets are reviewed for            impairment whenever events or changes in circumstances indicate that the carrying            amount of an asset may not be recoverable. Recoverability of assets to be held and used            is measured by comparison of the carrying amount of an asset to future net cash flows            expected to be generated by the asset. If such assets are considered to be impaired,            the impairment to be recognized is measured by the amount that the carrying amount of            the assets exceeds the fair value of the assets. Assets to be disposed of are reported            at the lower of the carrying amount or fair value less costs to sell. At September 30,            2007, we reviewed our long-lived assets and determined no impairment was            necessary.

 

***Income Taxes —***Deferred tax            assets and liabilities are recognized for the future tax consequences attributable to            differences in the balances of existing assets and liabilities on our financial            statements and our respective tax bases and attributable to operating loss carry            forwards. Deferred taxes are computed at the enacted tax rates for the periods when            such amounts are expected to be realized or settled. Because of differences which            result in calculation of income under accounting principles generally accepted in the            United States of America, and income calculated under Kazakh income tax regulations it            is possible for operations to result in local taxable income while reflecting operating            losses in the accompanying consolidated financial statements.

 

***Drydocking Costs***—            Caspian’s vessels must be periodically drydocked and pass certain inspections to            maintain their operating classification, as mandated by certain maritime regulations.            Costs incurred to drydock the vessels for certification are deferred and amortized over            the period to the next certification drydocking,

             

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**Effects of Inflation**

 

Day-to-day operating costs are generally affected by inflation. However,            because the energy services industry requires specialized goods and services, general            economic inflationary trends may not affect our operating costs. The major impact on            operating costs is the level of offshore exploration, development and production            spending by energy exploration and production companies. As spending increases, prices            of goods and services used by the energy industry and the energy services industry will            increase. Future increases in vessel day rates may shield us from the inflationary            effects on operating costs.

             

**Item 7A. Qualitative and Quantitative Disclosures About Market            Risk**

 

Our primary market risks are fluctuations in commodity prices, in that            they affect the operations of our customers, and foreign currency exchange            rates.

**Commodity Price Risk**

 

Our revenues, profitability and future growth depend substantially on            prevailing prices for crude oil. As oil prices decrease demand for our services and            correspondingly our cash flows may decrease. Historically, crude oil prices have been            subject to significant volatility in response to changes in supply, market uncertainty            and a variety of other factors beyond our control. Crude oil prices are likely to            continue to be volatile and this volatility makes it difficult to predict future oil            price movements with any certainty. Declines in oil prices could reduce our revenues,            and could also reduce the amount of oil that we can produce economically. As a result,            this could have a material adverse effect on our business, financial condition and            results of operations.

 

**Foreign Currency Risk**

 

To the extent that business transactions in Kazakhstan are denominated            in the Kazakh Tenge we are exposed to transaction gains and losses that could result            from fluctuations in the U.S. Dollar—Kazakh Tenge exchange rate. Some of our            expenditure, particularly capital expenditure, can be in Euros. We attempt to offset            the currency risk by negotiating some contract revenues in Euros. We do not engage in            hedging transactions to protect us from such risk.

 

**Item 8. Financial Statements and Supplementary Data**

             

The consolidated financial statements and supplementary data required by            this item are included at page F-1 herein.

             

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**Item 9. Changes in and Disagreements with Accountants on Accounting            and Financial Disclosure**

 

|   | None. |
|--------|-------|

 

**Item 9A. Controls and Procedures**

 

*Evaluation of Disclosure Controls and Procedures*

 

We maintain disclosure controls and procedures, as such term is defined            in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as            amended (the “Exchange Act”), that are designed to provide reasonable            assurance that information required to be disclosed by us in the reports that we file            or submit under the Exchange Act is recorded, processed, summarized and reported within            the time periods specified in the SEC rules and forms, and that such information            is accumulated and communicated to our management, including our principal executive            officer and principal financial officer, as appropriate, to allow timely decisions            regarding required financial disclosures. Because of inherent limitations, our            disclosure controls and procedures, no matter how well designed and operated, can            provide only reasonable, and not absolute, assurance that the objectives of such            disclosure controls and procedures are met.

As of the end of the period covered by this Report we conducted an            evaluation, under the supervision and with the participation of our management,            including our principal executive officer and principal financial officer, of the            effectiveness of the design and operation of our disclosure controls and procedures            pursuant to Exchange Act Rules 13a-15(b) and 15d-15(b). Based on this            evaluation, our principal executive officer and principal financial officer concluded            that our disclosure controls and procedures were effective as of September 30,            2007.

             

*Changes in Internal Control over Financial Reporting*

             

There were no changes in our internal controls over financial reporting            during the quarter ended September 30, 2007 that materially affected, or are reasonably            likely to materially affect, our internal control over financial reporting.

 

**Item            9B. Other Information**

 

|   | None. |
|--------|-------|

----

 

**PART III**

 

**Item            10. Directors, Executive Officers and Corporate Governance**

 

The following table sets forth our directors, executive officers,            promoters and control persons, their ages, and all offices and positions they hold.            Directors are elected for a period of one year and thereafter serve until their            successor is duly elected by the stockholders and qualified. Officers and other            employees serve at the will of the Board of Directors.

 

| Name of Director | Age    | Positions with the Company         | Term Served as Director |
|------------------|--------|------------------------------------|-------------------------|
|             |   |                               |                    |
| Laird Garrard    | 43     | Chief Executive Officer and        |                    |
|             |   | President                          |                    |
|             |   |                               |                    |
| John Scott       | 39     | Chief Operating Officer            |                    |
|             |   |                               |                    |
| John Baile       | 53     | Chief Financial Officer            |                    |
|             |   |                               |                    |
| Mirgali Kunayev  | 50     | Chairman of the Board of Directors | Since July 2002         |
|             |   |                               |                    |
| James Passin     | 36     | Director                           | Since January 2005      |
|             |   |                               |                    |
| Paul Roberts     | 51     | Director                           | Since July 2002         |
|             |   |                               |                    |
| Valery Tolkachev | 40     | Director                           | Since January 2005      |

 

            The            above individuals serve as our executive officers and/or directors. A brief description            of their background and business experience follows:

 

**Laird Garrard, Chief Executive Officer and            President**. In addition to his duties with the Company,            Mr. Garrard serves as a Vice President and Director of Caspian Services Group            Limited. Mr. Garrard joined Caspian in August 2002. From July 1999 to July 2002,            Mr. Garrard was the Eastern Hemisphere Financial Manager, for PGS Onshore, Inc., a            company specializing in oilfield services. At PGS Onshore, Mr. Garrard was            primarily responsible as the regional financial manager for Africa, the Middle East and            Central Asia. Prior to joining PGS Onshore, Mr. Garrard was employed with Western            Geophysical from 1990 to July 1999. During his time at Western Geophysical,            Mr. Garrard held a number of overseas accounting management positions including            from 1994 to 1999 the position of Financial Controller Kazakhstan. As Financial            Controller he was responsible for all aspects of finance and administration. From 1983            to 1987, Mr. Garrard worked in Somalia for Resource Management and Research, a            company specializing in land use surveys. Initially employed as a field research            assistant, Mr. Garrard was promoted to Project Manager in 1986. Mr. Garrard            earned a Bachelor of Arts degree in Business Administration from Westminster            University, London, England in 1990. Mr. Garrard is not a director or nominee in            any SEC reporting company.

             

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**John Scott, Chief Operating Officer**. Prior            to joining the Company in 2006, Mr. Scott had been employed with WesternGeco, a            subsidiary of Schlumberger Ltd., since 2000. From 2000-2003 he served as the Operations            Manager for WesternGeco in Kazakhstan, where he oversaw operations in Kazakhstan,            Turkmenistan and Azerbijan. From 2003 to 2005 he served as the WesternGeco Marine            Business Development Manager for the Greater Caspian Region. From 2005-2006            Mr. Scott was Marine Business Development Manager for WesternGeco for the Middle            East and North Africa. Mr. Scott graduated from the University of East London with            a Bachelor of Science degree in Surveying and Mapping Services in 1992. Mr. Scott            is not a director or nominee in any SEC reporting company.

             

**John Baile, Chief Financial Officer**. Mr            Baile joined Caspian Services Inc in January 2007. From 2000 to 2006 he was Asia /            Pacific Finance Director for Dogi International Fabrics, based in the Philippines and            also with responsibility for factories in China and Thailand. Prior to that he had            worked in Portugal, France and Morocco. He has a degree in French and Spanish from the            University of Liverpool and became a Fellow of the Institute of Chartered Accountants            in England and Wales in 1990. Mr. Baile is not a director or nominee in any SEC            reporting company.

 

**Mirgali Kunayev, Chairman of the Board of            Directors**. Mr. Kunayev served as Chief Executive Officer            and President of the Company from July of 2002 through May of 2005. Mr. Kunayev            has been a Vice President for Caspian Services Group Limited since 2000.            Mr. Kunayev’s primary responsibilities include marine oil operations            support, construction of infrastructure within the Caspian region and negotiation of            service contracts. From 1998 to 2000, Mr. Kunayev was the President of OJSC            Kazakhstancaspishelf. During that time he worked collaboratively on the international            project JNOC-KazakhOil with geophysical companies including, JGI, Schlumberger, Western            Geophysical and PGS. From 1995 to 1998, Mr. Kunayev served as President of            International Geophysics, Ltd. He was primarily responsible to oversee            geological-geophysical operations and exploratory drilling. In January 2002,            Mr. Kunayev earned a Ph.D. under the discipline of Geological and Mineralogical            Science from the Moscow Geological University in Moscow, Russia and he has been an            Academician of the Russian Academy of Natural Science since April of 2006.            Mr. Kunayev is not a director or nominee in any other SEC reporting            company.

             

**James Passin, Director**. In July 1999,            Mr. Passin joined Firebird Management, LLC, as a portfolio manager. In 2000, he            co-founded FGS Advisors, LLC, which is an investment advisor to Firebird Global Master            Fund, Ltd. In 2006, he co-founded FG2 Advisors, LLC, which is an investment advisor to            Firebird Global Master Fund II, Ltd. Mr. Passin is not a director in any other SEC            reporting company.

             

**Paul A. Roberts, Director**. Mr. Roberts            has a technical and managerial background with over 28 years experience in the oil            & gas exploration industry, the last 11 years of which have been focused in            Kazakhstan and the Central Asian region. His career in the industry has taken him to            some of the most challenging regions in the world, including Souteast and Central Asia,            China, West and Central Africa, and Australia. He has been involved in the Company            since inception in 2001. He is also Managing Director of Caspian Real Estate Ltd.            and Director of Balykshi LLP. Mr. Roberts is not a director or nominee in any            other SEC reporting company.

             

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**Valery Tolkachev, Director**. Since 1999,            Mr. Tolkachev has been employed with Aton Investment Company in Moscow, Russia,            where he currently serves as the Managing Director, Capital Markets. From 1991 to 1999,            Mr. Tolkachev served in various positions with various employers including, MDM            Bank, InkomBank, InkomCapital and others. Mr. Tolkachev graduated with Honors from            the High Military School in Kiev, USSR in 1989. In 2005, he completed his studies at            the Academy of National Economy, as a qualified lawyer. Mr. Tolkachev is also a            director of BMB Munai, Inc., and Bekem Metals, Inc., both SEC reporting            companies.

 

**Family Relationships**

             

There are no family relationships among our directors and/or executive            officers.

             

**Involvement in Certain Legal Proceedings**

             

During the past five years none of our executive officers, directors,            promoters or control persons has been involved in any of the following events that            could be material to an evaluation of his ability or integrity, including:

             

(1) Any bankruptcy petition filed by or against any business of which            such person was a general partner or executive officer either at the time of the            bankruptcy or within two years prior to that time.

(2) Any conviction in a criminal proceeding or being subject to a            pending criminal proceeding (excluding traffic violations and other minor            offenses);

(3) Being subject to any order, judgment, or decree, not subsequently            reversed, suspended or vacated, of any court of competent jurisdiction, permanently or            temporarily enjoining, barring, suspending or otherwise limiting his involvement in any            type of business, securities or banking activities; and

(4) Being found by a court of competent jurisdiction (in a civil            action), the Securities and Exchange Commission or the Commodity Futures Trading            Commission to have violated a federal or state securities or commodities law, which            judgment has not subsequently been reversed, suspended, or vacated.

             

**Committees of the Board of Directors**

 

*Audit Committee*

 

We do not currently have a standing audit committee or other committee            performing similar functions, nor have we adopted an audit committee charter. Given the            fact that we do not currently have a board member who we believe would qualify as an            “audit committee financial expert”, coupled with the fact that the OTCBB            does not require us to have an audit committee, the board of directors has determined            that it is in the Company’s best interest to have the full board fulfill the            functions that would be performed by the audit committee, including selection, review            and oversight of the Company’s independent accountants, the approval of all            audit, review and attest services provided by the independent accountants, the            integrity of the Company’s reporting practices and the evaluation of the            Company’s internal controls and accounting procedures. The board is also            responsible for the pre-approval of all non-audit services provided by its independent            auditors. Non-audit

             

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*Nominating Committee*

 

We do not currently have a standing nominating committee or other            committee performing similar functions, nor have we adopted a nominating committee            charter. Given the fact that the OTCBB does not require us to have a nominating            committee, the board of directors has determined that it is in the Company’s best            interest to have the full board of directors to participate in the consideration for            director nominees. In general, when the board determines that expansion of the board or            replacement of a director is necessary or appropriate, the board will review through            candidate interviews with members of management, consult with the candidate’s            associates and through other means determine a candidate’s honesty, integrity,            reputation in and commitment to the community, judgment, personality and thinking            style, residence, willingness to devote the necessary time, potential conflicts of            interest, independence, understanding of financial statements and issues, and the            willingness and ability to engage in meaningful and constructive discussion regarding            Company issues. The board would review any special expertise, for example, that            qualifies a person as an audit committee financial expert, membership or influence in a            particular geographic or business target market, or other relevant business experience.            To date we have not paid any fee to any third party to identify or evaluate, or to            assist it in identifying or evaluating, potential director candidates.

The full board of directors will consider director candidates nominated            by shareholders during such times as the Company is actively considering obtaining new            directors. Candidates recommended by shareholders will be evaluated based on the same            criteria described above. Shareholders desiring to suggest a candidate for            consideration should send a letter to the Company’s Secretary and include: (a) a            statement that the writer is a shareholder (providing evidence if the person’s            shares are held in street name) and is proposing a candidate for consideration; (b) the            name and contact information for the candidate; (c) a statement of the            candidate’s business and educational experience; (d) information regarding the            candidate’s qualifications to be director, including but not limited to an            evaluation of the factors discussed above which the board would consider in evaluating            a candidate; (e) information regarding any relationship or understanding between the            proposing shareholder and the candidate; (f) information regarding potential conflicts            of interest; and (g) a statement that the candidate is willing to be considered and            willing to serve as director if nominated and elected.

             

46

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*Compensation Committee*

 

We do not have a standing compensation committee or a charter; rather            our Chief Executive Officer evaluates officer and employee compensation issues subject            to the approval of our board of directors. Our Chief Executive Officer makes            recommendations to the board of directors as to employee benefit programs and officer            and employee compensation. The compensation of Chief Executive Officer is determined            and approved directly by the board of directors. Neither our Chief Executive Officer            nor our board of directors engaged a compensation consultant during the            year.

 

|   | Our board may establish                            committees from time to time to facilitate our management. |
|--------|---------------------------------------------------------------------------------------------------------------|

 

**Compliance with Section 16(a) of the Exchange Act**

 

Our directors, executive officers and beneficial owners of greater than            10% of our outstanding common stock are required to comply with Section 16(a) of the            Securities Exchange Act of 1934, which requires generally that such persons file            reports regarding ownership of and transactions in securities of the Company on Forms            3, 4, and 5. Form 3 is an initial statement of ownership of securities, Form 4 is to            report changes in beneficial ownership and Form 5 is an annual statement of changes in            beneficial ownership.

 

Based solely on a review of Forms 3, 4 and 5 and amendments thereto            furnished to us during the 2007 fiscal year, it appears that John Baile inadvertently            failed to file a Form 3 at the time he became an executive officer. Mr. Baile did            not acquire or dispose of any of our shares during the fiscal year, and does not own            any of our stock or derivative securities. We anticipate this will be remedied by the            filing of a Form 5 in the near future.

             

**Code of Ethics**

             

We have adopted a Code of Ethics that applies to our principal            executive, financial and accounting officers and persons performing similar duties. The            Code is designed to deter wrong-doing and promote honest and ethical behavior, full,            fair, timely, accurate and understandable disclosure and compliance with applicable            governmental laws, rules and regulations. It is also designed to encourage prompt            internal reporting of violations of the Code to an appropriate person and provides for            accountability for adherence to the Code. A copy of our Code of Ethics has been posted            on our website and may be viewed athttp://www.caspianservicesinc.com. A copy of the Code of Ethics will be provided to any person without            charge upon written request to our Corporate Secretary at our U.S. offices, 257 East            200 South, Suite 340, Salt Lake City, Utah 84111.

             

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**Item 11. Executive Compensation**

 

Unless specifically stated otherwise in this*Item 11*, all compensation amounts stated in            this*Item 11*are as stated, rather            than being stated in thousands.

 

**Compensation Discussion and Analysis**

 

We do not have a standing compensation committee. Our Chief Executive            Officer (“CEO”) makes recommendations to our board of directors as to            employee benefit programs and officer and employee compensation.

             

*Objectives and Philosophy of Our Executive Compensation            Program*

 

The primary objectives of our executive compensation programs are            to:

 

|   | • |   | attract, retain and                            motivate skilled and knowledgeable individuals;                                                                                                                                                                                                                                          |
|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • |   | ensure that executive                            compensation is aligned with our corporate strategies and business                            objectives;                                                                                                                                                                              |
|   | • |   | promote the achievement                            of key strategic and financial performance measures by linking                            short-term and long-term cash and equity incentives to the achievement                            of measurable corporate and individual performance goals;                            and |
|   | • |   | align executives’                            incentives with the creation of stockholder value.                                                                                                                                                                                                                                   |

             

To achieve these objectives, our CEO and board of directors evaluate our            executive compensation program with the objective of setting compensation at levels            they believe will allow us to attract and retain qualified executives. In addition, a            portion of each executive’s overall compensation is tied to key strategic,            financial and operational goals set by our board of directors. We also provide a            portion of our executive compensation in the form of equity awards that vest over time,            which we believe helps us retain our executives and align their interests with those of            our stockholders by allowing the executives to participate in our longer term success            as reflected in asset growth and stock price appreciation.

*Components of our Executive Compensation Program*

 

At this time, the primary elements of our executive compensation program            are:

 

|   | • |   | base salaries;                                              |
|--------|--------|--------|-------------------------------------------------------------|
|   | • |   | cash bonuses;                                               |
|   | • |   | equity incentive awards;                            and     |
|   | • |   | benefits and other                            compensation. |

             

We do not have any formal or informal policy or target for allocating            compensation between short-term and long-term compensation, between cash and non-cash            compensation or among the different forms of non-cash compensation. Instead, we have            determined subjectively on a case-by-case basis the appropriate level and

             

48

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*Named Executive Officers*

 

The following table identifies our principal executive officer, our            principal financial officer and our most highly paid executive and non-executive            officers, who, for purposes of this Compensation Disclosure and Analysis only, are            referred to herein as the “named executive officers.”

 

| Name                                       |   | Corporate                            Office                                                                                                                               |
|--------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                       |   |                                                                                                                                                                      |
| Laird Garrard                              |   | Chief Executive Officer                            and President, Caspian Services, Inc.                                                                                  |
| John Baile                                 |   | Chief Financial Officer,                            Caspian Services, Inc.                                                                                                |
| John Scott                                 |   | Chief Operating Officer,                            Caspian Services, Inc.                                                                                                |
| Mirgali                            Kunayev |   | Chairman of Board of                            Directors, Caspian Services, Inc.                                                                                         |
| Paul Roberts                               |   | Director, Caspian                            Services, Inc., Managing Director, Caspian Real  Estate Ltd. and Director, Balykshi                            LLP |
| Terrance                            Powell |   | Vice President Investor                            Relations, Caspian Services, Inc.                                                                                      |
| Arjan Goris                                |   | Managing Director Caspian                            Services Group Ltd.                                                                                                  |

 

*Employment Agreements*

 

We maintain employment agreements with each of the named executive            officers. The employment agreements we have with Laird Garrard, Mirgali Kunayev and            Paul Roberts is the standard statutorily required employment agreement for all            employees in the Republic of Kazakhstan. This employment agreement is limited in its            terms and primarily provides for base salary, payment of income and social taxes and            pension fund obligations.

We maintain more detailed employment contracts with John Baile, John            Scott, Terrance Powell and Arjan Goris. As discussed in more detail below, in addition            to base salary and payment of income and employment-related taxes, these employment            agreements cover a broad range of other components of the executive’s            compensation package.

             

*Base            salaries*

             

Base salaries are used to recognize the experience, skills, knowledge            and responsibilities required of all our employees, including our named executive            officers. Base salaries for our named executive officers typically have been set in our            offer letter to the individual at the outset of employment. Under the terms of these            employment agreements base salary and other components of compensation, may be            evaluated by our board of directors for adjustment based on an assessment of the            individual’s performance and compensation trends in our industry.

             

Following our 2007 fiscal year end, our CEO and board of directors            evaluated base salaries of our named executive officers. While the Company performed            well during fiscal 2007, the board of directors determined not to raise the base            salaries of any of the named executive officers at the current time. The

             

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*Cash            bonuses*

             

Our board of directors has the discretion to award cash bonuses based on            our financial performance and individual objectives. The corporate financial            performance measures, which have typically been developed by our board of directors,            are given the greatest weight in this bonus analysis. During fiscal 2007 cash bonuses            totaling approximately $120,000 were awarded to three of our named executive officers            in recognition of their contributions to the improvement in Company            performance.

             

Our board of directors granted John Scott, our Chief Operating Officer a            $70,000 cash bonus for fiscal 2007. This bonus was based on the financial and            operational performance of the Company. During fiscal 2007, total revenue increased            51%, gross margin from operations increased from 35% to 44%, net income increased 534%,            as a percentage of total revenue general and administrative expenses decreased from 24%            to 18% and we realized net income per share of $0.22 compared to a net loss per share            of $0.04 during fiscal 2006. While these improvements were the result of the efforts of            all our employees, our CEO and board of directors felt Mr. Scott’s oversight            of operations contributed significantly to the improvements in fiscal 2007 compared to            fiscal 2006.

             

Our board of directors also awarded a cash bonus to Mirgali Kunayev, the            Chairman of our board of directors. Mr. Kunayev has been significantly involved in            the operations of TatArka and Kazmorgeophysica. In recognition of the outstanding            performance of our geophysical services division, which included a 42% increase in            revenue and a 7% improvement in gross margin, the board of directors awarded            Mr. Kunayev a $19,182 cash bonus.

             

For the 2007 fiscal year, our board of directors also awarded a $30,000            cash bonus to our Vice President of Investor Relations, Terrance Powell, in recognition            of the successful investor relations campaign conducted throughout Europe and the            United States during the 2007 fiscal year.

 

*Equity incentive awards*

             

Our equity award program is the primary vehicle for offering long-term            incentives to our executives. Our equity awards to executives have typically been made            in the form of stock options. We believe that equity grants provide our executives with            a direct link to our long-term performance, create an ownership culture and align the            interests of our executives and our stockholders. The employment agreements of John            Baile, John Scott, Terrance Powell and Arjan Goris provide that following one year of            employment with the Company, each

             

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We may also make discretionary equity awards to the named officers. In            determining the size of equity grants to our executives, our board of directors will            consider company-level performance, the applicable individual’s performance, the            amount of equity previously awarded to the individual, the vesting of such awards and            the recommendations of management.

             

Grants of discretionary equity awards, including those to executives,            are all approved by our board of directors and generally are granted based on the fair            market value of our common stock. In the past, vesting of discretionary equity awards            has varied from periods ranging from one to three years.

             

During fiscal 2007 we did not make mandatory or discretionary equity            incentive awards to any of the named executive officers. Under the terms of their            employment agreements, John Scott, Terrance Powell and Arjan Goris, whose employment            agreements became effective in March 2006, January 2006 and March 2006, respectively,            would have been entitled to receive a mandatory stock option grant during our 2007            fiscal year. John Baile, whose employment agreement became effective in January 2007,            was not entitled to a mandatory stock option grant during our 2007 fiscal            year.

             

While Messrs. Scott, Powell and Goris were entitled to mandatory            stock option grants during fiscal 2007, such grants were not made until January 10,            2008. The primary reason for the delay in making the mandatory stock option grants was            an ongoing discussion between management, the board of directors and            Messrs. Scott, Powell and Goris regarding the possibility of revising their            employment agreements to provide for restricted stock grants rather than stock options.            Management and the board of directors believe such a change would provide greater            incentive to the named executive officers and benefits to the Company. Because the            parties were unable to reach agreement on revisions to the employment agreements of            Messrs. Scott, Powell and Goris, on January 10, 2008, with the mutual consent of            all parties, the board of directors awarded the mandatory stock options grants to            Messrs. Scott, Powell and Goris. The parties intend to continue investigating the            possibility of revising the employment contracts to allow for restricted stock grants            in future periods. Following is certain information regarding the stock option            grants.

             

51

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| Name            |   | # of SharesunderlyingOptions |   | Exercise Priceper Share |   | Expiration Date                           |
|-----------------|--------|------------------------------|--------|-------------------------|--------|-------------------------------------------|
|            |   |                         |   |                    |   |                                      |
| John Scott      |   | 53,730                       |   | $3.35                   |   | March 20,                            2015 |
| Terrance Powell |   | 48,780                       |   | $3.69                   |   | January 11, 2015                          |
| Arjan Goris     |   | 51,225                       |   | $3.51                   |   | March 1, 2015                             |

 

The options granted to Mr. Scott will vest: i) one third on March            20, 2008, ii) one third on March 20, 2009, and iii) the final third on March 20, 2010.            The options granted to Mr. Powell vest as follows: i) one third on January 11,            2008, ii) one third on January 11, 2009, and iii) the final third on January 11, 2010.            The options granted to Mr. Goris will vest: i) one third on March 1, 2008, ii) one            third on March 1, 2009, and iii) the final third on March 1, 2010.

             

As the individuals were legally entitled to the mandatory stock option            grant and we were legally obligated to make the mandatory stock option grant pursuant            to the terms of their respective employment agreements, for financial reporting            purposes, we have treated these options as having been constructively granted during            our 2007 fiscal year and we have recognized an appropriate compensation expense for            these option grants during fiscal 2007.

 

*Benefits and other compensation.*

             

Under the terms of their employment contracts, our named executive            officers are permitted to participate in such health care, disability insurance, bonus            and other employee benefits plans as may be in effect with the Company from time to            time to the extent the executive is eligible under the terms of those plans.

The employment contracts of John Baile and John Scott provide for a            housing allowance of up to $5,000 per month, subject to adjustment to reflect inflation            in the local housing market. Under their employment contracts John Baile, John Scott,            Terrance Powell and Arjan Goris are entitled to participate, on the same basis as other            employees of the Company in all general employee benefit plans and programs. Such            benefit plans may include medical, health and dental care, life insurance, disability            protection and retirement plans. Their employment agreements provide that they are            eligible, at the discretion of the board of directors, to receive performance bonuses.            The employment agreements of John Baile, John Scott, Terrance Powell and Arjan Goris            provide for 30 days vacation, including a vacation travel entitlement, in accordance            with the vacation policies of the Company, as well as paid holidays and other paid            leave set forth in the Company’s policies. There is usually no accrual of            vacation days and holidays but exceptions can be made at the Company’s            discretion. Their agreements also provide for a one-time relocation allowance. The            agreements of Messrs. Baile, Scott, Powell and Goris also provide for educational            assistance for dependent children up to age 21.

             

Under all of our employment agreements we agree to pay all income and            social taxes and dues under applicable laws of Kazakhstan for our named executive            officers including income and social taxes and government pension fund payments. This            does not include the officer’s home base income or other taxes in the case of            expatriates.

             

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|   | Income tax |
|--------|------------|

 

As is the custom in Kazakhstan, we pay the income taxes of our            employees, including the named executive officers. The income tax rate for individuals            in Kazakhstan for is currently 10%.

 

|   | Social tax |
|--------|------------|

 

We make payments of mandatory Kazakhstani social taxes, which typically            range between 10% and 13% of an employee’s wages. These costs are recorded in the            period when they are incurred and presented as salary related tax expense in the income            statement.

 

Pension fund payment

             

In accordance with the legislative requirements of the Republic of            Kazakhstan during 2007 we were required to pay approximately $600 per month into a            pension fund for Mirgali Kunayev and Laird Garrard, who are our only named executive            officers holding permanent residence in Kazakhstan. We do not have any other            liabilities related to any supplementary pensions, post retirement health care,            insurance benefits or retirement indemnities for Mr. Kunayev, Mr. Garrard or            any of the other named officers.

             

We do not currently offer a Company sponsored pension benefits to any of            our employees, including the named executive officers.

             

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|   | **Summary Compensation Table for Fiscal Year                            2007** |
|--------|--------------------------------------------------------------------------------|

 

The table below summarizes compensation paid to or earned by our Chief            Executive Officer, our Chief Financial Officer and our other most highly compensated            officers, who we refer to collectively as our “named executive            officers.”

 

| **Name and****Principal Position** | **Year** | **Salary(1)****($)** | **Bonus****($)** | **Option****Awards****($)** | **All Other****Compensation(2)****($)** | **Total****($)** |
|------------------------------------|----------|----------------------|------------------|-----------------------------|-----------------------------------------|------------------|
|                               |     |                 |             |                        |                                    |             |
| Laird Garrard                      | 2007     | 162,000              | -                | -            | 49,056                                  | 211,056          |
| CEO and President                  |     |                 |             |                        |                                    |             |
|                               |     |                 |             |                        |                                    |             |
| John Baile(3)                      | 2007     | 107,258              | -                | -            | 37,323                                  | 144,581          |
| CFO                                |     |                 |             |                        |                                    |             |
|                               |     |                 |             |                        |                                    |             |
| Maksuda Sunnatova(4)               | 2007     | 6,200                | -                | -            | 4,862                                   | 11,062           |
| Former CFO                         |     |                 |             |                        |                                    |             |
|                               |     |                 |             |              |                                    |             |
| John Scott                         | 2007     | 180,000              | 70,000           | 51,716(5)                   | 93,418                                  | 395,134          |
| COO                                |     |                 |             |                        |                                    |             |
|                               |     |                 |             |                        |                                    |             |
| Mirgali Kunayev                    | 2007     | 168,000              | 19,182           | -            | 39,830                                  | 227,012          |
| Chairman of the Board of           |     |                 |             |                        |                                    |             |
| Directors and former CEO           |     |                 |             |                        |                                    |             |
|                               |     |                 |             |              |                                    |             |
| Paul Roberts                       | 2007     | 162,000              | -                | -            | 43,081                                  | 205,081          |
| Director CSI, Managing             |     |                 |             |                        |                                    |             |
| Director Caspian Real              |     |                 |             |                        |                                    |             |
| Estate Ltd. and Director           |     |                 |             |                        |                                    |             |
| Balykshi LLP                       |     |                 |             |                        |                                    |             |
|                               |     |                 |             |                        |                                    |             |
| Terrance Powell                    | 2007     | 180,000              | 30,000           | 70,669(5)                   | 49,048                                  | 329,717          |
| VP Investor Relations              |     |                 |             |                        |                                    |             |
|                               |     |                 |             |                        |                                    |             |
| Arjan Goris                        | 2007     | 180,000              | -                | 57,535(5)                   | 36,894                                  | 274,429          |
| Managing Director CSGL             |     |                 |             |                        |                                    |             |

 

| (1) | Annual salary is net of all taxes and dues required                            under applicable laws of the Republic of Kazakhstan, which is the                            responsibility of the Company. |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (2) | For a breakdown of the compensation components included                            in “All Other Compensation” please see the                            “*All Other Compensation for Fiscal                            2007*” table below. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (3) | Mr. Baile joined the Company as CFO in January                            2007. His employment contract calls for annual base salary of $150,000                            per year. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (4) | Ms. Sunnatova resigned as CFO of the Company in                            January 2007. She has continued her employment with the Company in                            another capacity. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (5) | During the year ended September 30, 2007, the Company                            issued 153,735 options to certain employees in accordance with their                            respective employment agreements. These options have a weighted average                            exercise price of $3.51, vest over a three years, and expire eight                            years from the date of issuance. The options have a fair value of $3.36                            per share as calculated using the Black-Scholes option-pricing model                            with the following weighted average assumptions: dividend yield of 0%,                            expected volatility of 106.0%, risk free interest rate of 4.57% and                            expected lives of 8.0 years. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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**All Other Compensation for Fiscal 2007**

 

The table below provides additional information regarding “all            other compensation” awarded to the named executive officers during fiscal 2007 as            disclosed in the “All Other Compensation” column of the            “*Summary Compensation Table for Fiscal Year            2007*” above.

 

|  

**Name**  | **Income****Tax**                    | **Social****Tax**                    | **Health****Insurance** | **Pension****Fund**                | **Housing****Allowance**            | **Educational****Assistance**      |
|-------------------|--------------------------------------|--------------------------------------|-------------------------|------------------------------------|-------------------------------------|------------------------------------|
|              |                                 |                                 |                    |                               |                                |                               |
| Laird Garrard     | $17,618               | $17,933               | $6,459                  | $                            7,046 | -                                   | -                                  |
| John Baile        | -(1)                                 | -(1)                                 | $1,323                  | -                                  | $ 36,000                            | -                                  |
| Maksuda Sunnatova | $  6,200    | $  3,375    | -                       | $1,487                             | -                                   | -                                  |
| John Scott        | $24,300               | $14,622               | $4,096                  | -                                  | $                            50,400 | -                                  |
| Mirgali Kunayev   | $18,270               | $14,514               | -                       | $                            7,046 | -                                   | -                                  |
| Paul Roberts      | $19,575               | $17,933               | $5,573                  | -                                  | -                                   | -                                  |
| Terrance Powell   | $19,575               | $14,030               | $6,694                  | -                                  | -                                   | $                            8,749 |
| Arjan Goris       | $19,575               | $14,622               | $2,697                  | -                                  | -                                   | -                                  |
| Maksuda Sunnatova | $  6,200    | $  3,375    | -                       | $                            1,487 | -                                   | -                                  |

 

|   | (1)  Mr. Baile did not                            incur any Kazakhstani income or social tax obligations during fiscal                            2007. |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

*Annual Base Salary*

 

The following table discloses the annual salary set forth in the            employment agreement of each of the individual named executive            officers. 

 

| Name                                       |   | Annual Salary(1) |
|--------------------------------------------|--------|------------------|
|                                       |   |             |
| Laird Garrard                              |   | $162,000         |
| John Baile                                 |   | $150,000         |
| John Scott                                 |   | $180,000         |
| Mirgali                            Kunayev |   | $168,000         |
| Paul Roberts                               |   | $162,000         |
| Terrance                            Powell |   | $180,000         |
| Arjan Goris                                |   | $180,000         |

 

| (1) | Annual salary is net of all taxes and dues required                            under applicable laws of the Republic of Kazakhstan, which is the                            responsibility of the Company. |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

As discussed above, our employment agreements provide for an annual            salary. Base salary may be increased from time to time with the approval of the board            of directors. Base salary may not be decreased without the written consent of the named            executive officer. 

 

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*Termination of Employment Agreements*

 

The employment agreements of Laird Garrard, Mirgali Kunayev and Paul            Roberts may be terminated in accordance with applicable Kazakhstani law. The employment            agreements ofJohn Baile, John Scott, Terrance Powell and Arjan            Goris may be terminated: i) involuntarily; ii) for cause; iii) voluntarily; or iv) upon            a change in control.

 

“Involuntary termination”means            termination of employment that is the decision of the Company for reasons other than            cause, disability or death.

 

The agreements provide that the following will constitute            “cause”: i) the named executive officer’s material fraud,            malfeasance, gross negligence, or wilful misconduct with respect to our business            affairs that is directly or materially harmful to our business or reputation or to that            of any of our subsidiaries, or (ii) the named executive officer’s conviction of            or failure to contest prosecution for a felony or a crime involving moral turpitude. A            termination for “cause” shall take effect thirty days after we give written            notice of such termination to the named executive officer, unless he shall, during such            30-day period, remedy the events or circumstances constituting cause to our reasonable            satisfaction.

 

“Voluntary termination means termination of employment that is            voluntary on the part of the named executive officer but is due to:

             

(i) a significant reduction in the named executive officer’s            responsibilities, title or status resulting from a formal change in such title or            status, or from the assignment to him of any duties inconsistent with his title,            duties, or responsibilities;

             

(ii) a reduction in the named executive officer’s compensation,            remuneration or benefits; or

             

(iii) a Company required involuntary relocation of the named executive            officer’s place of residence or a significant increase in his travel            requirements.

             

For purposes of the employment agreements, “change in            control” means: (i) an acquisition by any person or group wherein that person or            group end up beneficially owning 50% or more of our outstanding common stock or 50% or            more of the combined voting power of the Company; or the approval of our shareholders            of a reorganization, merger, consolidation, complete liquidation, or dissolution of the            Company, the sale or disposition of all or substantially all of the assets of the            Company or any similar corporate transaction.

             

Upon termination of employment the Company may be required to make            payments to John Baile, John Scott, Terrance Powell and Arjan Goris as disclosed in            “*Potential Payments upon Termination or Change in            Control*” below.

 

**Potential Payments upon Termination or Change in            Control**

 

Under our employment agreements with John Baile Terrance Powell and            Arjan Goris, each would be entitled to severance benefits:

 

(a) if his employment is voluntarily or involuntarily            terminated;

 

(b) a change in control of the Company occurs with the result that his            employment is voluntarily or involuntarily terminated within six months following the            date of the change in control; or

             

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(c) A change in control occurs with the result that his employment is            voluntarily or involuntarily terminated within six months prior to the date of the            change in control.

 

Each of John Baile Terrance Powell and Arjan Goris would not be eligible            for the severance benefits if:

 

(a) his employment is terminated for cause; or

 

(b) he resigns, except for reasons detailed under voluntary            termination.

 

If John Baile, Terrance Powell or Arjan Goris becomes eligible for            severance benefits, we will pay him the following compensation and benefits:

 

(a)*Salary*. He            will continue to receive his current salary for two months following the date of his            termination.

             

(b)*Stock Option            Grant*. He will continue to participate in stock option            grants for six months following his termination date unless he commences employment            prior to the end of the six month period, in which case, such participation shall end            on the date of his new employment. All options granted during this period will vest            immediately.

             

(c)*Restricted Stock Grants and            Options*. Except for termination due to cause, or            resignation, except for reasons detailed under voluntary termination, all outstanding            restricted stock grants and options under any Company stock plan that he holds on the            date of his termination shall continue to vest in accordance with the vesting schedule            of the applicable plan during the six month period following the date of termination            unless he commences employment prior to the end of the six month period, in which case,            such continued vesting shall end on the date of his new employment.

 

Under our employment agreement with John Scott, he would be entitled to            severance benefits:

 

(a) if his employment is voluntarily or involuntarily            terminated;

 

(b) a change in control of the Company occurs with the result that his            employment is voluntarily or involuntarily terminated within 36 months following the            date of the change in control; or

             

(c) A change in control occurs with the result that his employment is            voluntarily or involuntarily terminated within six months prior to the date of the            change in control.

 

John Scott would not be eligible for the severance benefits            if:

 

(a) his employment is terminated for cause; or

 

(b) he resigns, except for reasons detailed under voluntary            termination.

 

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If John Scott becomes eligible for severance benefits, we will pay him            the following compensation and benefits:

 

(a)*Salary*. He            will continue to receive his current salary for 24 months following the date of his            termination.

             

(b)*Stock Option            Grant*. He will continue to participate in stock option            grants for 24 months following his termination date unless he commences employment            prior to the end of the 24 month period, in which case, such participation shall end on            the date of his new employment. All options granted during this period will vest            immediately.

             

(c)*Restricted Stock Grants and            Options*. Except for termination due to cause, or            resignation, except for reasons detailed under voluntary termination, all outstanding            restricted stock grants and options under any Company stock plan that he holds on the            date of his termination shall continue to vest in accordance with the vesting schedule            of the applicable plan during the 24 month period following the date of termination            unless he commences employment prior to the end of the 24 month period, in which case,            such continued vesting shall end on the date of his new employment.

             

**Grants of Plan-Based Awards Table for Fiscal Year 2007**

 

| **Name**        | **Constructive****Grant Date(1)** | **Actual Grant****Date**(1) | **All Other Option****Awards: Number of****Securities****Underlying Options****(#)** | **Exercise or****Base Price of****Option****Awards****($/Sh)**(2) | **Grant Date Fair****Value of Stock****and Option****Awards** |
|-----------------|-----------------------------------|-----------------------------|--------------------------------------------------------------------------------------|-------------------------------------------------------------------|---------------------------------------------------------------|
|            |                              |                        |                                                                                 |                                                              |                                                          |
| Terrance Powell | 01/11/2007                        | 01/10/2008                  | 48,780                                                                               | 3.69                                                              | 161,188**(3)**                                                |
| Arjan Goris     | 03/01/2007                        | 01/10/2008                  | 51,225                                                                               | 3.51                                                              | 161,659**(3)**                                                |
| John Scott      | 03/20/2007                        | 01/10/2008                  | 53,730                                                                               | 3.35                                                              | 159,544**(3)**                                                |

 

| (1) | As discussed in greater detail in the                            “*Equity Incentive                            Awards*” section of this Item 11, during                            the year we had the obligation to make a mandatory stock option grant                            to Messrs. Scott, Powell and Goris on the anniversary of the date                            of the employment agreement. For reasons discussed above, the options                            were not actually granted until January 10, 2008. As these individuals                            were legally entitled to a mandatory stock option grant and as we were                            legally obligated to make the mandatory stock option grant to them                            during fiscal 2007 on the anniversary date of their employment                            agreement, for financial reporting purposes, we have treated these                            options as having been constructively granted to each individual on the                            anniversary date of the employment agreement of each individual. In the                            case of Mr. Powell, the anniversary date of his employment                            agreement was January 11, 2007. The anniversary date of the employment                            agreement of Mr. Goris was March 1, 2007 and the anniversary date                            of the employment agreement of Mr. Scott was March 20,                            2007. |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (2) | The closing market price of our common stock on the                            actual grant date was $2.80. The employment agreements of each of                            Messrs. Powell, Goris and Scott provide that the exercise price of                            their mandatory stock grant shall be equal to the average bid price of                            the Company’s common stock for the five trading day period                            immediately preceding the anniversary date of the employment agreement                            with the Company. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (3) | See the discussion of assumptions made in valuing these                            awards in note 8 to our consolidated financial statements. |
|-----|-----------------------------------------------------------------------------------------------------------------------------------------------|

 

 

58

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**Outstanding Equity Awards at Fiscal Year End Table for Fiscal Year            End 2007**

 

During fiscal 2007 we made no stock option or stock awards to the named            executive officers. The following table sets forth information regarding the            outstanding stock options held by our named officers as of September 30, 2007. None of            our named executive officers held restricted stock awards as of September 30,            2007.

 

|               | **Option Awards**                                                                         |
|--------------------|-------------------------------------------------------------------------------------------|
| **Name**           | **Number of****Securities****Underlying****Unexercised****Options****(#)****Exercisable** | **Number of****Securities****Underlying****Unexercised****Options****(#)****Unexercisable** | **Equity Incentive****Plan Awards:****Number of****Securities****Underlying****Unexercised****Unearned****Options(#)** | **Option****Exercise****Price****($)** | **Option****Expiration****Date** |
|               |                                                                                      |   |   |   |   |
| Mirgali Kunayev    | 110,000                                                                                   | -    | - | 3.00 | 07/31/2015 |
| Laird Garrard      | 220,000                                                                                   | -    | - | 3.00 | 07/31/2015 |
| Paul Roberts       | 110,000                                                                                   | -    | - | 3.00 | 07/31/2015 |
| Arjan Goris        | 100,000                                                                                   | -    | - | 3.00 | 09/30/2009 |
| Arjan Goris(1)     | -                                                                                         | 51,225(2) | - | 3.51 | 03/01/2015 |
| John Scott(1)      | -                                                                                         | 53,730(3) | - | 3.35 | 03/20/2015 |
| Terrance Powell(1) | 16,290                                                                                    | 32,580(4) | - | 3.69 | 01/11/2015 |

 

(1)As discussed above, under their            employment agreements each of these individuals was entitled to a mandatory stock            option grant during fiscal 2007. For reasons discussed above, the options were not            granted until January 10, 2008. Because these individuals were legally entitled to the            mandatory stock option grant and we were legally obligated to make the mandatory stock            option grants during fiscal 2007, we have treated these options as having been            constructively granted during fiscal 2007.

(2)This option vests over three years. The first third vests            on March 1, 2008, the second third vests on March 1, 2009 and the final third vests on            March 1, 2010.

(3)This option vests over three years. The first third vests            on March 20, 2008, the second third vests on March 20, 2009 and the final third vests            on March 20, 2010.

(4)This option vests over three years. The first third vested            on January 11, 2008, the second third vests on January 11, 2009 and the final third            vests on January 11, 2010.

 

**Option Exercises and Stock Vested for Fiscal Year 2007**

 

During the 2007 fiscal year none of the named executive officers            exercised options nor did any stock vest to any of the named officers.

             

59

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**Nonqualified Deferred Compensation**

 

We offer no defined contribution or other plan that provide for the            deferral of compensation on a basis that is not tax-qualified to any of our employees            including the named executive officers.

**Compensation of Directors**

 

We use a combination of cash and equity-based compensation to attract            and retain candidates to serve on our board of directors. We do not compensate            directors who are also our employees for their service on our board of directors.            Therefore, Mr. Kunayev and Mr. Roberts did not receive any compensation for            their service on our board of directors.

             

*Meeting Fees*

 

Members of the board of directors who are not also employees of the            Company or one of its subsidiaries of the Company are paid a $25,000 stipend per year,            plus travel expenses.

 

*Equity Compensation*

 

We do not currently have a fixed plan for the award of equity            compensation to our non-employee directors.

             

**Director Compensation Table**

 

The following table sets forth a summary of the compensation we paid to            our non-employee directors for services on our board during our 2007 fiscal            year.

 

| **Name**         | **Fees****Earned****or Paid in****Cash****($)** | **Stock****Awards****($)** | **Option****Awards****($)** | **Non-Equity****Incentive Plan****Compensation****($)** | **Change in****Pension Value****and****Nonqualified****Deferred****Compensation****Earnings****($)** | **All Other****Compen-sation****($)** | **Total****($)** |
|------------------|-------------------------------------------------|----------------------------|-----------------------------|---------------------------------------------------------|------------------------------------------------------------------------------------------------------|---------------------------------------|------------------|
|             |                                            |                       |                        |                                                    |                                                                                                 |                                  |             |
| James Passin     | -(1)                                            | -                          | -                           | -                                                       | -                                                                                                    | -                                     | -                |
| Valery Tolkachev | 25,000                           | -                          | -                           | -                                                       | -                                                                                                    | -                                     | 25,000           |

 

(1)As a non-employee director,            Mr. Passin was entitled to receive a $25,000 stipend for the 2007 fiscal year.            Mr. Passin, however, elected not to take this stipend for the 2007 fiscal            year.

 

**Compensation Committee Interlocks and Insider            Participation**

 

We do not currently have a standing Compensation Committee, rather our            entire board of directors participated in deliberations concerning executive officer            compensation. Mirgali Kunayev and Paul Roberts, members of our board of directors, are            currently or have previously been officers of the Company or one or more of its            subsidiaries.

             

60

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**Compensation Committee Report**

             

The board of directors has reviewed and discussed the Compensation            Discussion and Analysis required by Item 402(b) of Regulation S-K with management            and, based on such review and discussions, the board of directors recommended that this            Compensation Discussion and Analysis be included in this Annual Report on Form            10-K.

             

|                                          |
|-----------------------------------------------|
| BOARD OF                            DIRECTORS |
| Mirgali Kunayev                               |
| James Passin                                  |
| Paul Roberts                                  |
| Valery Tolkachev                              |

 

**Item            12.**  **Security Ownership            of Certain Beneficial Owners and Management**

 

The term “beneficial owner” refers to both the power of            investment and the right to buy and sell our shares. It also refers to rights of            ownership or the right to receive distributions from the Company and proceeds from the            sale of Company shares. Since these rights may be held or shared by more than one            person, each person who has a beneficial ownership interest in shares is deemed to be            the beneficial owners of the same shares because there is shared power of investment or            shared rights of ownership.

 

The following table sets forth as of January 9, 2008 the name and the            number of shares of our common stock, par value of $0.001 per share, held of record or            beneficially by each person who held of record, or was known by us to own beneficially,            more than 5% of the 50,492,060 outstanding shares of our common stock, and the name and            shareholdings of each director and of all executive officers and directors as a            group.

 

| **Type of Security** | **Name and Address**                                        | **Amount & Nature of****Beneficial Ownership** | **% of****Class**(1) |
|----------------------|-------------------------------------------------------------|----------------------------------------------------|----------------------|
|                 |                                                        |                                               |                 |
| Common               | John Baile(2)                                               | 0                                                  | *                    |
|                 | Akademik Satpaev Avenue 29/6                                |                                               |                 |
|                 | Ninth Floor                                                 |                                               |                 |
|                 | Almaty, Kazakhstan 050400                                   |                                               |                 |
|                 |                                                        |                                               |                 |
| Common               | Firebird Management LLC(3)                                  | 8,186,108                                          | 15.9                 |
|                 | 152 West 57th Street, 24th                            Floor |                                               |                 |
|                 | New York, New York 10019                                    |                                               |                 |
|                 |                                                        |                                               |                 |
| Common               | Laird Garrard(2) (4)                                        | 2,661,624                                          | 5.3                  |
|                 | Akademik Satpaev Avenue 29/6                                |                                               |                 |
|                 | Ninth Floor                                                 |                                               |                 |
|                 | Almaty, Kazakhstan 050400                                   |                                               |                 |
|                 |                                                        |                                               |                 |
| Common               | Mirgali Kunayev(2) (5)                                      | 13,488,645                                         | 26.5                 |
|                 | Akademik Satpaev Avenue 29/6                                |                                               |                 |
|                 | Ninth Floor                                                 |                                               |                 |
|                 | Almaty, Kazakhstan 050400                                   |                                               |                 |

 

61

 

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|                             |                                                              |       |   |
|----------------------------------|-------------------------------------------------------------------|------------|--------|
| Common                           | Mars International Worldwide, Inc.                            (6) | 2,821,888  | 5.6    |
|                             | 135 Gornaya Street                                                |       |   |
|                             | Almaty, Kazakhstan 050020                                         |       |   |
|                             |                                                              |       |   |
| Common                           | James Passin(2) (7)                                               | 8,211,108  | 15.9   |
|                             | 152 West 57th Street, 14th                            Floor       |       |   |
|                             | New York, New York 10019                                          |       |   |
|                             |                                                              |       |   |
| Common                           | Petroleum Group Services                            Limited(5)    | 10,555,757 | 20.9   |
|                             | P.O. Box 544                                                      |       |   |
|                             | 14 Britannia Place, Bath Street                                   |       |   |
|                             | St. Helier, Jersey, Channel Islands                               |       |   |
|                             | JE2 4SU, United Kingdom                                           |       |   |
|                             |                                                              |       |   |
| Common                           | Paul Roberts(2) (8)                                               | 2,551,624  | 5.0    |
|                             | Akademik Satpaev Avenue 29/6                                      |       |   |
|                             | Ninth Floor                                                       |       |   |
|                             | Almaty, Kazakhstan 050400                                         |       |   |
|                             |                                                              |       |   |
| Common                           | John Scott(2)(9)                                                  | 0          | *      |
|                             | Akademik Satpaev Avenue 29/6                                      |       |   |
|                             | Ninth Floor                                                       |       |   |
|                             | Almaty, Kazakhstan 050400                                         |       |   |
|                             |                                                              |       |   |
| Common                           | Valery Tolkachev(2) (10)                                          | 25,000     | *      |
|                             | Boulevard Ring Office Building                                    |       |   |
|                             | 17 Chistoprundy Blvd., Bldg. 1                                    |       |   |
|                             | Moscow, Russia 101000                                             |       |   |
|                             |                                                              |       |   |
| Common                           | UFG Russia Alternative Master Account Ltd.                        | 3,333,333  | 6.6    |
|                             | c/o Covenant House                                                |       |   |
|                             | 85 Reid Street                                                    |       |   |
|                             | Hamilton, Bermuda                                                 |       |   |
|                             |                                                              |       |   |
| Common                           | Unicredito Italiano S.p.A                                         | 2,529,752  | 5.0    |
|                             | Piazza Cordusio 2                                                 |       |   |
|                             | 20123 Milan, Italy                                                |       |   |
|                             |                                                              |       |   |
| Officers, Directors and Nominees |                                                              |       |
| as a Group: (7 persons)          | 26,938,001                                                        | 51.2       |

 

* Less            than 1%.

(1) This percentage reflects the increase in the number of            shares of common stock that would be issued in connection with the exercise of the            shareholder’s outstanding options and/or warrants.

(2) Mr. Baile, Mr. Garrard and Mr. Scott are            executive officers of the Company. Mr. Kunayev, Mr. Passin, Mr. Roberts            and Mr. Tolkachev are directors of the Company.

(3) Firebird Management, LLC. may be deemed to beneficially            own the shares described above because: (i) Firebird Avrora Advisors, LLC.            (“Avrora Advisors”) acts as investment advisor to Firebird Avrora Fund,            Ltd. (the “Avrora”), a private investment fund which owns 2,119,720 shares            of common ctock (including an aggregate of 305,555 shares of Common Stock issuable upon            the exercise of warrants held by such fund), representing 4.2% of the total issued and            outstanding shares of Common Stock; (ii) FGS Advisers , LLC. (“FGS”) acts            as investment advisor to the Firebird Global Master Fund, Ltd., (“Global”),            which owns 3,649,444 shares of Common Stock (including an aggregate of 736,111 shares            of common stock issuable upon the exercise of warrants held by such fund), representing            7.23% of the total issued and outstanding shares of common stock; (iii) FG2 Advisors,            LLC. (“FG2”) acts as investment advisor to the Firebird Global Master Fund            II, Ltd. (the “Global Fund II”), a private investment fund which owns            444,444 shares of common stock (including an aggregate of 111,111 shares of common            stock issuable upon the exercise of warrants held by such fund), representing 0.88% of            the total issued and outstanding shares of common stock; and (iv) Firebird Management            acts as investment adviser to Firebird RepublicsFund, Ltd.            (“Republics”), a private investment fund which owns 1,900,000 shares of            common

 

62

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stock            (including an aggregate of 125,000 shares issuable upon the exercise of warrants held            by such Fund), representing 3.76% of the total issued and outstanding shares of common            stock, and Firebird New Russia Fund, Ltd. (“New Russia”), a private            investment fund which owns 72,500 shares of common stock, representing 0.14% of the            total issued and outstanding shares of common stock. As investment advisors to the            Funds, each of Avrora Adviors, FGS, FG2 and Management shares voting and investment            control with respect to the shares of Common Stock held by their respective advised            Funds. Harvey Sawikin, as control person of Avrora Advisors and Management, shares has            investment power and voting power with respect to the common stock reported by them.            Mr. Passin and Mr. Sawikin, who serve as the control persons of each of FGS            and FG2, share investment power and voting power with respect to the common stock            reported by each such entity.

(4) The shares attributed to Mr. Garrard include            2,441,624 shares held in his own name and an immediately exercisable option to purchase            up to 220,000 additional shares of common stock.

(5) Mr. Kunayev owns no shares in his own name.            Mr. Kunayev holds an immediately exercisable option to purchase up to 110,000            shares of our common stock. The shares attributed to Mr. Kunayev include 1,000            shares held of record by his spouse, siblings and children, 10,555,757 shares held of            record by Petroleum Group Services Limited, (“PGSL”) 2,599,666 shares held            of record by Mars International Worldwide, Inc. (“Mars”) and an immediately            exercisable warrant to purchase 222,222 shares of our common stock held by Mars.            Mr. Kunayev is managing director of PGSL, and as such he may be deemed to have            voting and investment power over the shares held by PGSL. Mr. Kunayev is the owner            of Mars and may be deemed to own the securities held by Mars.

(6) Mr. Kunayev is the owner of Mars and may be deemed            to own the securities held by Mars. Mars holds 2,599,666 shares in its own name and            holds an immediately exercisable warrant to purchase 222,222 shares of our common            stock.

(7) The shares attributed to Mr. Passin include an            immediately exercisable option to purchase 25,000 shares of our common stock held in            Mr. Passin’s own name. Mr. Passin is a manager and a member of FGS            Advisors, LLC (“FGS”) and FG2 Advisors, LLC (“FG2”), a member            of Firebird Avrora Advisors LLC (“Avrora Advisors”), and may be deemed to            share control of FGS and FG2. FGS, FG2 and Avrora Advisors act as investment advisers            to, respectively, Firebird Global Master Fund, Ltd. (“Global”), Firebird            Global Master Fund II, Ltd. (“Global II”) and Firebird Avrora Fund, Ltd.            (“Avrora”) which, together with affiliates Firebird Republics Fund, Ltd.            and Firebird New Russia Fund, Ltd. (each a “Fund” and collectively, the            “Funds”), own the securities set forth above. FGS is also the General            Partner of Firebird Global Fund, L.P., and FG2 is also the General Partner of Firebird            Global Fund II, L.P., which invest substantially all of their assets in Global and            Global II, respectively. As investment advisers to certain of the Funds, each of FGS,            FG2, Avrora has voting and investment control with respect to the securities held by            the Fund or Funds that it advises. Mr. Passin may be deemed to have an indirect            interest in certain of the securities owned by Global, Global II and Avrora through his            indirect holdings therein. The Reporting Person disclaims beneficial ownership of all            securities except to the extent of any pecuniary interest therein and this filing            should not be deemed an admission of beneficial ownership for Section 16 purposes or            any other purpose.

(9) The shares attributed to Mr. Roberts include            2,441,624 shares held in his own name and an immediately exercisable option to purchase            up to 110,000 additional shares of common stock.

(9) Mr. Scott holds an option to purchase up to 53,730            shares of our common stock. The option vests over three years. The first third of the            options vest and become exercisable on March 20, 2008, the second third vest of the            options vest and become exercisable on March 20, 2009 and the final third vest and            become exercisable on March 20, 2010.

(10) Mr. Tolkachev holds an immediately exercisable            option to purchase up to 25,000 shares of our common stock.

 

**Item            13.**  **Certain            Relationships and Related Transactions and Director Independence**

 

During the years ended September 30, 2007 and 2006, we paid Help LLP            $890 and $440 respectively, for corporate travel and visa support. Yevgeni Kurguzkin, a            director of our wholly-owned subsidiary Caspian Services Group Limited, is the Director            of Help LLP.

 

63

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During the year ended September 30, 2007 and 2006 we paid an entity            under common management, KazakhstanCaspiShelf (“KCS”) $3,000 for vessel            rental and $4,702 for seismic work, respectively. We also recognized $107 and $263 of            vessel revenues, $5,267 and $352 revenue from performed seismic works, sale of            materials and equipment rental during 2007 and 2006 respectively from the same entity.            In July 2007, TatArka entered into an agreement with KCS to provide a loan of $661. The            loan bears no interest and is to be repaid in January 2008. Under the laws of the            Republic of Kazakhstan only licensed lending institutions may collect interest on            loans. Mirgali Kunayev, the chairman of our board of directors, is a 15% interest            holder in KCS.

             

During the year ended September 30, 2007 we paid $380 to Gis-Caspi for            the intermediary services rendered in 2006 including survey scouting technical            feasibility and preparation of tender documentation. Mr. Kunayev is an indirect            owner of Gis-Caspi.

 

During the year ended September 30, 2007 we borrowed $223 from Caspian            Geo-Consulting Services LLP, a company related through common ownership. The notes bear            interest at 0%. $100 was repaid in November and December 2007 and the residual balance            is due by March 31, 2008. During the years ended September 30, 2007 and 2006 the same            company provided marketing services for $140 and performed interpretation of seismic            data for $43, respectively. For the nine months ended September 30, 2005 the company            performed interpretation of seismic data for $100.

 

In February 2006, Laird Garrard, our Chief Executive Officer, loaned the            Company $517 on short-term notes. The notes bore interest at ten percent per annum. In            April 2006 $50 in principal was repaid to Mr. Garrard. In October 2006 we paid            Mr. Garrard $467 in principal and $29 in interest to fully retire the            notes.

 

In accordance with our written policies and procedures our management or            are board of directors are charged with monitoring and reviewing issues involving            potential conflicts of interests and reviewing and approving all related party            transactions. In general, for purposes of our policy, a related party transaction is a            transaction, or a material amendment to any such transaction, involving a related party            and the Company involving $120,000 or more. Our policy requires our management or our            board of directors to review and approve related party transactions. In reviewing and            approving any related party transaction or material amendment to any such transaction,            management or the board of directors must satisfy themselves that they have been fully            informed as to the related party’s relationship to the Company and interest in            the transaction and as to the material facts of the transaction, and must determine            that the related party transaction is fair to the Company.

 

**Director Independence**

 

The board of directors has determined that, Valery Tolkachev and James            Passin are “independent directors” as that term is defined in the listing            standards of the American Stock Exchange. Such independence definition includes a            series of objective tests, including that the director is not an employee of the            company and has not engaged in various types of business dealings with the company. In            addition, as further required by the American Stock Exchange listing standards, the            board of directors has made a subjective determination as to each independent director            that no relationships exist which, in the opinion of the board of directors, would            interfere with the exercise of independent judgment in carrying out the            responsibilities of a director.

             

64

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**Item 14.**  **Principal Accounting Fees and Services**

             

Hansen, Barnett and Maxwell served as the Company’s independent            accountants for the fiscal years ended September 30, 2007 and 2006, and are expected to            serve in that capacity for the 2008 fiscal year. Principal accounting fees for            professional services rendered for us by Hansen, Barnett & Maxwell for the twelve            months ended September 30, 2007 and September 30, 2006, are summarized as            follows:

             

|          |   | Fiscal 2007 |   | Fiscal 2006 |
|---------------|--------|-------------|--------|-------------|
|          |   |        |   |        |
| Audit         |   | $241        |   | $194        |
| Audit related |   | -           |   | -           |
| Tax           |   | 10          |   | 5           |
| All other     |   | -           |   | -           |
| Total         |   | $251        |   | $199        |

             

*Audit Fees*. Audit fees were for            professional services rendered in connection with our annual financial statement audits            and quarterly reviews of financial statements for filing with the Securities and            Exchange Commission.

             

*Tax Fees*. Tax fees related to services for            tax compliance, tax advice and tax planning within the United States for the fiscal            years ended September 30, 2007 and 2006.

 

*Board of Directors Pre-Approval Policies and            Procedures*. At its regularly scheduled and special meetings,            the board of directors, in lieu of an established audit committee, considers and            pre-approves any audit and non-audit services to be performed by our independent            registered public accounting firm. The board of directors has the authority to grant            pre-approvals of non-audit services.

             

The board of directors has not, as of the time of filing this Annual            Report on Form 10-K with the Securities and Exchange Commission, adopted policies and            procedures for pre-approving audit or permissible non-audit services performed by our            independent auditors. Instead, the board of directors as a whole has pre-approved all            such services. In the future, our board of directors may approve the services of our            independent registered public accounting firm pursuant to pre-approval policies and            procedures adopted by the board of directors, provided the policies and procedures are            detailed as to the particular service, the board of directors is informed of each            service, and such policies and procedures do not include delegation of the board of            director’s responsibilities to our management.

             

The board of directors has determined that the provision of services by            Hansen, Barnett & Maxwell described above are compatible with maintaining Hansen,            Barnett & Maxwell’s independence at our independent registered public            accounting firm.

 

65

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**Item 15.**  **Exhibits, Financial Statement Schedules**

 

|   | The following exhibits are included as part of this                            report: |
|--------|----------------------------------------------------------------------------------------|

 

|   | Exhibit 21.1 | Subsidiaries |
|--------|--------------|--------------|

|   | Exhibit 31.1 | Certification of Principal Executive Officer Pursuant to                            Section 302 of the Sarbanes-Oxley Act of 2002 |
|--------|--------------|-----------------------------------------------------------------------------------------------------------------------------------|

|   | Exhibit 31.2 | Certification of Principal Financial Officer                            Pursuant |
|--------|--------------|----------------------------------------------------------------------------------|

|   | to Section 302 of the Sarbanes-Oxley Act of                            2002 |
|--------|-----------------------------------------------------------------------------|

|   | Exhibit 32.1 | Certification of Principal Executive Officer Pursuant to                            Section 906 of the Sarbanes-Oxley Act of 2002. |
|--------|--------------|------------------------------------------------------------------------------------------------------------------------------------|

|   | Exhibit 32.2 | Certification of Principal Financial Officer Pursuant to                            Section 906 of the Sarbanes-Oxley Act of 2002. |
|--------|--------------|------------------------------------------------------------------------------------------------------------------------------------|

             

66

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**SIGNATURES**

 

In accordance with Section 12 of the Securities Exchange Act of 1934,            the registrant caused this report to be signed on its behalf, thereunto duly            authorized.

 

 

|                   | **CASPIAN SERVICES, INC.**             |
|------------------------|----------------------------------------|
|                   |                                   |
|                   |                                   |
| Date: January 14, 2008 | /s/ Laird Garrard                      |
|                   | Laird Garrard, Chief Executive Officer |
|                   |                                   |
|                   |                                   |
| Date: January 14, 2008 | /s/ John Baile                         |
|                   | John Baile, Chief Financial Officer    |
|                   |                                   |
|                   |                                   |
| Date: January 14, 2008 | /s/ Mirgali Kunayev                    |
|                   | Mirgali Kunayev, Director              |
|                   |                                   |
|                   |                                   |
| Date: January 14, 2008 | /s/ James Passin                       |
|                   | James Passin, Director                 |
|                   |                                   |
|                   |                                   |
| Date: January 14, 2008 | /s/ Paul Roberts                       |
|                   | Paul Roberts, Director                 |
|                   |                                   |
|                   |                                   |
| Date: January 14, 2008 | /s/ Valery Tolkachev                   |
|                   | Valery Tolkachev, Director             |

 

 

67

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**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

 

**TABLE OF CONTENTS**

 

 

|   | **Page** |
|--------|----------|

 

| Report of Independent Registered Public Accounting                            Firm | F-2 |
|------------------------------------------------------------------------------------|-----|

 

Consolidated Financial Statements:

 

| Consolidated Balance Sheets – September 30, 2007                            and 2006 | F-3 |
|--------------------------------------------------------------------------------------------|-----|

 

Consolidated Statements of Operations for the Years Ended

September 30, 2007 and 2006 and for the Nine Months

| Ended September 30, 2005 | F-4 |
|--------------------------|-----|

 

Consolidated Statements of Shareholders’ Equity for the Nine            Months

Ended            September 30, 2005 and for the Years Ended

| September 30, 2006 and 2007 | F-5 |
|-----------------------------|-----|

 

Consolidated Statements of Cash Flows for the Years Ended

September 30, 2007 and 2006 and for the Nine Months

| Ended September 30, 2005 | F-6 |
|--------------------------|-----|

 

| Notes to Consolidated Financial Statements | F-8 |
|--------------------------------------------|-----|

 

 

 

F-1

 

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**HANSEN,BARNETT&            MAXWELL, P.C.**

|   | A Professional Corporation |
|--------|----------------------------|

|   | CERTIFIED PUBLIC ACCOUNTANTS |
|--------|------------------------------|

|   | 5 Triad Center, Suite 750 |
|--------|---------------------------|

|   | Salt Lake City, UT 84180-1128 |
|--------|-------------------------------|

|   | Phone: (801) 532-2200 |
|--------|-----------------------|

|   | Fax: (801) 532-7944 |
|--------|---------------------|

|   | www.hbmcpas.com |
|--------|-----------------|

 

                                       

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING            FIRM**

 

 

To the            Board of Directors and the Shareholders

Caspian            Services, Inc.

 

We            have audited the accompanying consolidated balance sheets of Caspian Services, Inc. and            Subsidiaries as of September 30, 2007 and 2006, and the related statements of            operations, shareholders’ equity, and cash flows for the years ended September            30, 2007 and 2006 and for the nine months ended September 30, 2005. These financial            statements are the responsibility of the Company’s management. Our responsibility            is to express an opinion on these financial statements based on our audits.

 

We            conducted our audits in accordance with the standards of the Public Company Accounting            Oversight Board (United States). Those standards require that we plan and perform the            audits 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. An audit also            includes assessing the accounting principles used and significant estimates made by            management, as well as evaluating the overall financial statement presentation. We            believe that our audits provide a reasonable basis for our opinion.

 

In            our opinion, the consolidated financial statements referred to above present fairly, in            all material respects, the financial position of Caspian Services, Inc. and            Subsidiaries as of September 30, 2007 and 2006, and the results of their operations and            their cash flows for the years ended September 30, 2007 and 2006 and for the nine            months ended September 30, 2005 in conformity with U.S. generally accepted accounting            principles.

 

 

|   | **HANSEN, BARNETT & MAXWELL, P.C.** |
|--------|-----------------------------------------|

 

Salt            Lake City, Utah

January 11, 2008

 

 

F-2

 

----

 

| **CASPIAN SERVICES, INC. AND                            SUBSIDIARIES**                                  |
|---------------------------------------------------------------------------------------------------------|
| **CONSOLIDATED BALANCE                            SHEETS**                                              |
| (Dollars in thousands except share                            and per share data)                       |
|                                                                                                    |   |   |   |   |
| *As of September 30,*                                                                                   |   | **2007** |   | **2006** |
| **ASSETS**                                                                                              |   |   |   |   |
| **Current Assets**                                                                                      |   |   |   |   |
| Cash                                                                                                    | $ | 15,470 | $ | 2,858  |
| Trade accounts receivable, net of allowance of $126 and                            $1, respectively     |   | 11,504 |   | 11,125  |
| Trade accounts receivable from related                            parties                               |   | 5,197 |   | 2,873  |
| Other receivables, net of allowance of $17 and $370,                            respectively            |   | 5,569 |   | 1,375  |
| Receivable from shareholders                                                                            |   | - |   | 2,298  |
| Notes receivable from related parties, current                            portion                       |   | 661 |   | -  |
| Inventories                                                                                             |   | 872 |   | 790  |
| Prepaid taxes                                                                                           |   | 996 |   | 890  |
| Advances paid                                                                                           |   | 862 |   | 1,501  |
| Prepaid expenses and other current assets                                                               |   | 1,089 |   | 240  |
| **Total Current Assets**                                                                                |   | 42,220 |   | 23,950  |
| Vessels, equipment and property, net                                                                    |   | 45,481 |   | 33,064  |
| Drydocking costs, net                                                                                   |   | 1,233 |   | 172  |
| Goodwill                                                                                                |   | 3,295 |   | 3,135  |
| Intangible assets, net                                                                                  |   | 259 |   | 229  |
| Long-term receivables, net of current portion                                                           |   | 175 |   | -  |
| Notes receivable from related parties, net of current                            portion                |   | - |   | 1,100  |
| **Total Assets**                                                                                        | $ | 92,663 | $ | 61,650  |
|                                                                                                    |   |   |   |   |
| **LIABILITIES AND SHAREHOLDERS’                            EQUITY**                               |   |   |   |   |
| **Current Liabilities**                                                                                 |   |   |   |   |
| Accounts payable                                                                                        | $ | 5,441 | $ | 7,174  |
| Accounts payable to related parties                                                                     |   | 1,580 |   | 1,989  |
| Accrued expenses                                                                                        |   | 1,830 |   | 1,134  |
| Accrued taxes                                                                                           |   | 2,262 |   | 1,161  |
| Deferred revenue                                                                                        |   | 103 |   | 3,810  |
| Notes payable - related parties                                                                         |   | - |   | 467  |
| Current portion of long-term notes payable                                                              |   | 680 |   | 1,612  |
| **Total Current Liabilities**                                                                           |   | 11,896 |   | 17,347  |
| **Long-Term Liabilities**                                                                               |   |   |   |   |
| Notes payable - net of current portion                                                                  |   | - |   | 148  |
| Deferred income tax liability                                                                           |   | 1,843 |   | 1,248  |
| **Total Long-Term Liabilities**                                                                         |   | 1,843 |   | 1,396  |
| **Total Liabilities**                                                                                   |   | 13,739 |   | 18,743  |
| **Minority Interests in Consolidated                            Subsidiaries**                          |   | 3,733 |   | 3,291  |
| **Shareholders’ Equity**                                                                          |   |   |   |   |
| Common stock, $0.001 par value, 150,000,000 shares                            authorized,               |   |   |   |   |
| 50,492,061 shares and 42,068,735 shares issued and                            outstanding, respectively |   | 50 |   | 42  |
| Additional paid-in capital                                                                              |   | 63,049 |   | 38,804  |
| Retained earnings (accumulated deficit)                                                                 |   | 8,638 |   | (827) |
| Accumulated other comprehensive income                                                                  |   | 3,454 |   | 1,597  |
| **Total Shareholders’ Equity**                                                                    |   | 75,191 |   | 39,616  |
| **Total Liabilities and Shareholders’                            Equity**                         | $ | 92,663 | $ | 61,650  |
|                                                                                                    |   |   |   |   |
|                                                                                                    |   |   |   |   |

             

 

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

 

F-3

 

----

 

| **CASPIAN SERVICES, INC. AND                            SUBSIDIARIES**                      |
|---------------------------------------------------------------------------------------------|
| **CONSOLIDATED STATEMENTS OF                            OPERATIONS**                        |
| (Dollars in thousands, except                            share and per share data)          |
|                                                                                        |   |   |   |   |   |   |   |   |   |
|                                                                                        |   | **For The** |   | **For The** |   | **For The Nine** |
|                                                                                        |   | **Year Ended****September 30,** |   | **Year Ended****September 30,** |   | **Months Ended****September 30,** |
|                                                                                        |   | **2007** |   | **2006** |   | **2005** |
| **Revenues**                                                                                |   |   |   |   |   |   |   |   |   |
| Vessel revenues                                                                             |   | $ | 24,441  |   | $ | 14,444  |   | $ | 6,026  |
| Geophysical service revenues                                                                |   |   | 38,896  |   |   | 27,350  |   |   | 11,778  |
| Product sales                                                                               |   |   | 1,556  |   |   | 1,249  |   |   | 858  |
| **Total Revenues**                                                                          |   |   | **64,893**  |   |   | **43,043**  |   |   | **18,662**  |
|                                                                                        |   |   |   |   |   |   |   |   |   |
| **Costs and Operating Expenses**                                                            |   |   |   |   |   |   |   |   |   |
| Vessel operating costs                                                                      |   |   | 18,509  |   |   | 13,366  |   |   | 4,258  |
| Cost of geophysical service revenues                                                        |   |   | 17,058  |   |   | 13,982  |   |   | 4,182  |
| Cost of product sold                                                                        |   |   | 898  |   |   | 647  |   |   | 299  |
| Depreciation and amortization of drydocking                            costs                |   |   | 6,619  |   |   | 3,330  |   |   | 1,320  |
| General and administrative expense                                                          |   |   | 12,127  |   |   | 10,162  |   |   | 5,520  |
| **Total Costs and Operating Expenses**                                                      |   |   | **55,211**  |   |   | **41,487**  |   |   | **15,579**  |
| **Income from Operations**                                                                  |   |   | **9,682**  |   |   | **1,556**  |   |   | **3,083**  |
|                                                                                        |   |   |   |   |   |   |   |   |   |
| **Other Income (Expense)**                                                                  |   |   |   |   |   |   |   |   |   |
| Interest expense                                                                            |   |   | (130) |   |   | (288) |   |   | (615) |
| Foreign currency exchange gain (loss)                                                       |   |   | 32  |   |   | (111) |   |   | (103) |
| Interest income                                                                             |   |   | 284  |   |   | 14  |   |   | 85  |
| Income from equity method investees                                                         |   |   | -  |   |   | 28  |   |   | 161  |
| Other income (Note 12)                                                                      |   |   | 5,029  |   |   | 446  |   |   | 3  |
| **Net Other Income (Expense)**                                                              |   |   | **5,215**  |   |   | **89**  |   |   | **(469)** |
|                                                                                        |   |   |   |   |   |   |   |   |   |
| **Income Before Income Tax and Minority                            Interests**              |   |   | **14,897**  |   |   | **1,645**  |   |   | **2,614**  |
| Provision for income tax                                                                    |   |   | (5,112) |   |   | (2,533) |   |   | (1,288) |
| Minority interests in (income) loss of consolidated                            subsidiaries |   | (320) |   |   | (812) |   |   | 25  |
| **Net Income (Loss)**                                                                       |   | $ | **9,465**  |   | $ | **(1,700)** |   | $ | **1,351**  |
| **Basic Income (Loss) Per Common Share**                                                    |   | $ | **0.22**  |   | $ | **(0.04)** |   | $ | **0.04**  |
| **Diluted Income (Loss) Per Common Share**                                                  |   | $ | **0.22**  |   | $ | **(0.04)** |   | $ | **0.04**  |
| **Basic Weighted-Average Common Shares                            Outstanding**             |   | **43,480,336**  |   | **40,298,410**  |   | **36,894,742**  |
| **Diluted Weighted-Average Common Shares                            Outstanding**           |   | **43,622,892**  |   | **40,298,410**  |   | **37,164,108**  |
|                                                                                        |   |   |   |   |   |   |   |   |   |
|                                                                                        |   |   |   |   |   |   |   |   |   |

             

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

 

F-4

----

| **CASPIAN SERVICES, INC. AND                            SUBSIDIARIES**               |
|--------------------------------------------------------------------------------------|
| **CONSOLIDATED STATEMENTS OF                            SHAREHOLDERS’ EQUITY** |
| (Dollars in thousands, except                            share and per share data)   |
|                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                 |   |   |   |   |   |   |   |   |   |   |   | Accumulated |   |   |   |
|                                                                                 |   |   |   |   |   | Additional |   | Retained |   | Other |   | Total |
|                                                                                 | Common Stock |   | Paid-in |   | Earnings |   | Comprehensive |   | Shareholders’ |
|                                                                                 | Shares |   | Amount |   | Capital |   | (Deficit) |   | Income (Loss) |   | Equity |
| **Balance, December 31, 2004**                                                       | **31,200,000** |   | **$** | **31** |   | **$** | **4,731** |   | **$** | **(478)** |   | **$** | **110**  |   | **$** | **4,394**  |
| Net income for the nine months ended                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| September 30, 2005                                                                   | - |   |   | - |   |   | - |   |   | 1,351  |   |   | -  |   |   | 1,351  |
| Foreign currency translation adjustment                                              | - |   |   | - |   |   | - |   |   | -  |   |   | (147) |   |   | (147) |
| **Comprehensive income**                                                             | - |   |   | - |   |   | - |   |   | -  |   |   | -  |   |   | **1,204**  |
|                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance of common stock for cash,                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| net of offering costs of $1,135 and                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| warrants with a fair value of $2,679                                                 | 7,658,446 |   |   | 8 |   |   | 21,788 |   |   | -  |   |   | -  |   |   | 21,796  |
| Compensation related to issuance of                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| options to employees                                                                 | - |   |   | - |   |   | 76 |   |   | -  |   |   | -  |   |   | 76  |
| **Balance, September 30, 2005**                                                      | **38,858,446** |   |   | **39** |   |   | **26,595** |   |   | **873**  |   |   | **(37)** |   |   | **27,470**  |
| Net loss for the year ended                                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| September 30, 2006                                                                   | - |   |   | - |   |   | - |   |   | (1,700) |   |   | -  |   |   | (1,700) |
| Foreign currency translation adjustment                                              | - |   |   | - |   |   | - |   |   | -  |   |   | 1,634  |   |   | 1,634  |
| **Comprehensive loss**                                                               | - |   |   | - |   |   | - |   |   | -  |   |   | -  |   |   | **(66)** |
|                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance of common stock for                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| investment in Balykchi                                                               | 444,444 |   |   | - |   |   | 2,000 |   |   | -  |   |   | -  |   |   | 2,000  |
| Compensation related to issuance of                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| options to employees                                                                 | - |   |   | - |   |   | 5 |   |   | -  |   |   | -  |   |   | 5  |
| Issuance of common stock for                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| cash, net of offering costs of $90                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| and warrants with a fair value of $4,730                                             | 2,000,000 |   |   | 2 |   |   | 7,908 |   |   | -  |   |   | -  |   |   | 7,910  |
| Issuance of common stock upon                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| exercise of warrants                                                                 | 765,845 |   |   | 1 |   |   | 2,296 |   |   | -  |   |   | -  |   |   | 2,297  |
| **Balance, September 30, 2006**                                                      | **42,068,735** |   |   | **42** |   |   | **38,804** |   |   | **(827)** |   |   | **1,597**  |   |   | **39,616**  |
| Net income for the year ended                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| September 30, 2007                                                                   | - |   |   | - |   |   | - |   |   | 9,465  |   |   | -  |   |   | 9,465  |
| Foreign currency translation adjustment                                              | - |   |   | - |   |   | - |   |   | -  |   |   | 1,857  |   |   | 1,857  |
| **Comprehensive income**                                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | **11,322**  |
|                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Compensation related to issuance of                                                  | - |   |   | - |   |   | 212 |   |   | -  |   |   | -  |   |   | 212  |
| options to employees                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance of common stock for                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| cash, net of offering costs of $1,139                                                | 8,423,326 |   |   | 8 |   |   | 24,033 |   |   | -  |   |   | -  |   |   | 24,041  |
| **Balance, September 30, 2007**                                                      | **50,492,061** |   | **$** | **50** |   | **$** | **63,049** |   | **$** | **8,638**  |   | **$** | **3,454**  |   | **$** | **75,191**  |
|                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

 

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

 

F-5

 

----

| **CASPIAN SERVICES, INC AND                            SUBSIDIARIES**                  |
|----------------------------------------------------------------------------------------|
| **CONSOLIDATED STATEMENTS OF CASH                            FLOWS**                   |
| (Dollars in thousands, except                            share and per share data)     |
|                                                                                   |   |   |   |   |   |   |   |   |   |
|                                                                                   |   | **For The** |   | **For The** |   | **For The Nine** |
|                                                                                   |   | **Year Ended** |   | **Year Ended** |   | **Months Ended** |
|                                                                                   |   | **September 30,** |   | **September 30,** |   | **September 30,** |
|                                                                                   |   | **2007** |   | **2006** |   | **2005** |
| **Cash flows from operating activities:**                                              |   |   |   |   |   |   |   |   |   |
| Net income (loss)                                                                      |   | $ | **9,465**  |   | $ | **(1,700)** |   | $ | **1,351**  |
| Adjustments to reconcile net income (loss) to net                            cash      |   |   |   |   |   |   |   |
| provided by operating activities:                                                      |   |   |   |   |   |   |   |   |   |
| Loss (gain) on sale of property and equipment                                          |   |   | 640  |   |   | (381) |   |   | 16  |
| Depreciation and amortization of drydocking                            costs           | 6,619  |   |   | 3,330  |   |   | 1,320  |
| Minority interests in income (loss)                                                    |   |   |   |   |   |   |   |   |   |
| of consolidated subsidiaries                                                           |   |   | 320  |   |   | 812  |   |   | (24) |
| Net income in equity method investees                                                  |   |   | -  |   |   | 28  |   |   | (108) |
| Foreign currency exchange (gain) loss                                                  |   |   | (32) |   |   | 111  |   |   | 37  |
| Compensation from issuance of options                                                  |   |   | 212  |   |   | 5  |   |   | 76  |
| Changes in current assets and liabilities, net                            of           |   |   |   |   |   |   |   |   |   |
| acquisition of subsidiaries:                                                           |   |   |   |   |   |   |   |   |   |
| Trade accounts receivable                                                              |   |   | 183  |   |   | (9,008) |   |   | 823  |
| Trade accounts receivable from related                            parties              |   |   | (2,253) |   |   | -  |   |   | -  |
| Other receivables                                                                      |   |   | (4,182) |   |   | (1,169) |   |   | (949) |
| Inventories                                                                            |   |   | (41) |   |   | (251) |   |   | (226) |
| Prepaid expenses and other current assets                                              |   |   | (38) |   |   | 1,715  |   |   | (796) |
| Accounts payable and accrued expenses                                                  |   |   | (382) |   |   | 7,313  |   |   | (2,635) |
| Accounts payable to related parties                                                    |   |   | (493) |   |   | -  |   |   | -  |
| Accrued income taxes                                                                   |   |   | 501  |   |   | (771) |   |   | (45) |
| Deferred revenue                                                                       |   |   | (3,796) |   |   | 556  |   |   | 2,583  |
| **Net cash provided by operating                            activities**               |   |   | **6,723**  |   |   | **590**  |   |   | **1,423**  |
|                                                                                   |   |   |   |   |   |   |   |   |   |
| **Cash flows from investing activities:**                                              |   |   |   |   |   |   |   |   |   |
| Cash acquired in purchase of subsidiaries                                              |   |   | -  |   |   | -  |   |   | 280  |
| Purchase of intangible assets                                                          |   |   | (66) |   |   | -  |   |   | -  |
| Increase in notes receivable from related                            parties           |   |   | (644) |   |   | -  |   |   | (3,251) |
| Payments collected on notes receivable from related                            parties | 1,100  |   |   | -  |   |   | -  |
| Loans made on notes receivable                                                         |   |   | -  |   |   | -  |   |   | 727  |
| Other receivables from related parties                                                 |   |   | -  |   |   | -  |   |   | (654) |
| Payment of drydocking costs                                                            |   |   | (1,428) |   |   | -  |   |   | -  |
| Proceeds from sale of property and equipment                                           |   |   | 95  |   |   | 1,925  |   |   | 205  |
| Proceeds from sale of securities held for                            sale              |   |   | -  |   |   | 319  |   |   | -  |
| Payments to purchase vessels, equipment and                            property        | (17,226) |   |   | (13,580) |   |   | (5,458) |
| **Net cash used in investing activities**                                              |   |   | **(18,169)** |   |   | **(11,336)** |   |   | **(8,151)** |
|                                                                                   |   |   |   |   |   |   |   |   |   |
| **Cash flows from financing activities:**                                              |   |   |   |   |   |   |   |   |   |
| Proceeds from issuance of common stock                                                 |   |   | 26,339  |   |   | 9,921  |   |   | 21,795  |
| Proceeds from issuance of notes payable - related                            parties   | -  |   |   | 5,456  |   |   | 1,206  |
| Proceeds from issuance of notes payable                                                |   |   | 2,243  |   |   | 5,300  |   |   | 1,803  |
| Change in advances to/from related parties                                             |   |   | -  |   |   | 1,494  |   |   | (54) |
| Principal payments on notes payable - related                            parties       |   |   | (467) |   |   | (7,331) |   |   | (6,322) |
| Principal payments on notes payable                                                    |   |   | (3,381) |   |   | (3,604) |   |   | (9,461) |
| **Net cash provided by financing                            activities**               |   |   | **24,734**  |   |   | **11,236**  |   |   | **8,967**  |
| **Effect of exchange rate changes on                            cash**                 |   |   | **(676)** |   |   | **(232)** |   |   | **2**  |
| **Net change in cash**                                                                 |   |   | **12,612**  |   |   | **258**  |   |   | **2,241**  |
| **Cash at beginning of period**                                                        |   |   | **2,858**  |   |   | **2,600**  |   |   | **359** |
| **Cash at end of period**                                                              |   | $ | **15,470**  |   | $ | **2,858**  |   | $ | **2,600** |
|                                                                                   |   |   |   |   |   |   |   |   |   |
|                                                                                        |  |  |  |  |  |  |  |  |  |  |

 

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

 

F-6

 

----

| **CASPIAN SERVICES, INC AND                            SUBSIDIARIES**                                                                             |
|---------------------------------------------------------------------------------------------------------------------------------------------------|
| **CONSOLIDATED STATEMENTS OF CASH                            FLOWS**                                                                              |
| **CONTINUED**                                                                                                                                     |
| (Dollars in thousands, except                            share and per share data)                                                                |
|                                                                                                                                              |   |   |   |   |   |   |   |   |   |
|                                                                                                                                              |   | **For The** |   | **For The** |   | **For The Nine** |
|                                                                                                                                              |   | **Year Ended** |   | **Year Ended** |   | **Months Ended** |
|                                                                                                                                              |   | **September 30,** |   | **September 30,** |   | **September 30,** |
|                                                                                                                                              |   | **2007** |   | **2006** |   | **2005** |
| **Supplemental disclosure of cash flow                            information:**                                                                  |   |   |   |   |   |   |   |   |   |
| Cash paid for interest                                                                                                                            |   | $ | 164  |   | $ | 1,170  |   | $ | 1,037  |
| Cash paid for income tax                                                                                                                          |   |   | 4,624  |   |   | 2,306  |   |   | 1,449  |
| **Supplemental disclosure of non-cash                            investing**  **and financing                            information:** |   |   |   |   |
| Issuance of common stock for investment in                            Balykshi                                                                    |   | $ | -  |   | $ | 2,000  |   | $ | -  |
|                                                                                                                                              |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                   |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

F-7

 

----

 

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

**NOTE            1 — THE COMPANY AND BASIS OF PRESENTATION**

 

***Principles of Consolidation —***The accompanying consolidated financial statements include operations            and balances of Caspian Services, Inc. and its wholly owned subsidiaries: Caspian            Services Group Limited (“CSGL”), Caspian Services Group LLP (“Caspian            LLP”), TatArka LLP (“TatArka”), Caspian Real Estate, Ltd            (“CRE”), Caspian Geophysics, Ltd (“CGEO”), Balykshi LLP            (“Balykshi”); and include majority owned subsidiaries: CJSC Bauta,            (“Bauta”) and Kazmorgeophysica CJSC (“KMG”), collectively            “Caspian” or the “Company”. KMG owns a 50% non-controlling            interest in Veritas Caspian LLP (“Veritas”) for which the investment is            accounted by the equity method. CRE currently owns a 50% interest in Pact Caspian            Engineering FZC (“Pact Caspian”) for which the investment is also accounted            by the equity method. Caspian had a non-controlling 50% interest in Bautino Development            Company, LLC (“Bautino”) which was sold in March 2007 and was accounted for            by the equity method. Intercompany balances and transactions have been eliminated in            consolidation.

 

***Nature of Operations***— The            Company’s business consists of thee major business segments:

             

*Vessel Operations*–Vessel Operations            consist of a fleet of shallow draft vessels which are chartered to companies performing            oil and gas exploration activities in the Kazakh Sector of the North Caspian Sea. Our            vessels are referred broadly to as offshore support vessels.

             

Vessel revenues are derived from a daily charter rate, mobilization and            demobilization fees and a daily meal and accommodation rate. The Company earns this            revenue by providing the crew to maintain and upkeep the vessels, to provide            accommodations, meals, laundry and other services to the charter company's personnel on            the vessels.

             

*Geophysical Services*–Geophysical            Services consist of providing seismic data acquisition and interpretation services to            oil and gas companies operating both onshore in Kazakhstan and offshore in the            Kazakhstan sector of the North Caspian Sea and the adjacent Transition Zone.

             

*Infrastructure Development –*Infrastructure Development consists of a water desalinization and            bottling plant and the development of a marine base located at the Port of            Bautino.

 

In            July 2005, the Company’s stockholders approved a change in the fiscal year of the            Company from December 31 to September 30. The change in year end was accomplished            during the nine months ended September 30, 2005.

 

***Use of            Estimates*****—**The            preparation of financial statements in conformity with accounting principles generally            accepted in the United States of America requires management to make estimates and            assumptions that affect the reported amounts of assets and liabilities at the date of            the financial statements and the reported amounts of revenues and expenses during the            reporting period. Actual results could differ from those estimates.

 

***Fair Value of Financial            Statements*****—**The            carrying amounts reported in the accompanying consolidated financial statements for            other receivables, accounts and notes receivables from related parties, accounts            payable to related parties and accrued expenses approximate fair values because of the            immediate nature of short-term maturities of these financial instruments. The carrying            amount of long-term debt approximates fair value due to the stated interest rate(s)            approximating prevailing market rates.

 

 

F-8

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

 

***Minority Interests in Consolidated Subsidiaries***— Minority interests in consolidated subsidiaries presented on the            balance sheet refers to the minority shareholder’s investment in the voting stock            of Bauta and KMG. In the statement of operations, consolidated net income is adjusted            by the minority shareholder’s proportionate share of the income or loss from the            consolidated subsidiaries.

 

***Trade Accounts Receivables***—            In the normal course of business, the Company extends credit to its customers on a            short-term basis. The principal customers are major oil and natural gas exploration,            development and production companies. Although credit risks associated with these            customers are considered minimal, the Company routinely reviews its accounts receivable            balances and makes provisions for doubtful accounts as necessary.

 

***Inventories***— Inventory            consists of bulk and bottled water related to the desalinization plant, and fuel, spare            parts and supplies related to the geophysical operations. Inventories are stated at the            lower of cost or market, cost being determined by an average cost method, which            approximates the first-in, first-out (FIFO) method.

 

***Vessels, Equipment and Property***— Vessels, property and equipment are stated at cost less            accumulated depreciation. At the time property is disposed of, the assets and related            accumulated depreciation are removed from the accounts, and any resulting gain or loss            is charged to other income. Major renewals and betterments that extend the life of the            property and equipment are capitalized. Maintenance and repairs are expensed as            incurred except for dry-docking expenditures, which are capitalized and            amortized.

 

Depreciation of property and equipment is calculated by using the            straight-line method and resulted in depreciation expense for the years ended September            30, 2007 and 2006 of $6,384 and $3,103, respectively, and $1,224 for the nine months            ended September 30, 2005.

 

***Drydocking Costs***—            Caspian’s vessels must be periodically drydocked and pass certain inspections to            maintain their operating classification, as mandated by certain maritime regulations.            Costs incurred to drydock the vessels for certification are deferred and amortized over            the period to the next drydocking, generally 24 months. Drydocking costs comprise            painting the vessel hull and sides, recoating cargo and fuel tanks, and performing            other engine and equipment maintenance activities to bring the vessels into compliance            with classification standards.

 

Amortization of drydocking costs is calculated by using the            straight-line method and resulted in amortization expense for the years ended September            30, 2007 and 2006 of $235 and $227, respectively and $96 for the nine months ended            September 30, 2005. Accumulated amortization of the drydocking costs was $235 and $172            as of September 30, 2007 and 2006, respectively and $153 as of September 30,            2005.

 

***Impairment of Long-Lived Assets and Long-Lived Assets to be            Disposed Of***— Long-lived assets are reviewed for            impairment whenever events or changes in circumstances indicate that the carrying            amount of an asset may not be recoverable. Recoverability of assets to be held and used            is measured by comparison of the carrying amount of an asset to future net cash flows            expected to be generated by the asset. If such assets are considered to be impaired,            the impairment to be recognized is measured by the amount that the carrying amount of            the assets exceeds the fair

 

 

F-9

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

value of the assets. Assets to be disposed of are reported at the lower            of the carrying amount or fair value less costs to sell. At September 30, 2007, 2006            and 2005, the Company reviewed its long-lived assets as disclosed above and determined            no impairment was necessary.

 

***Revenue Recognition***— Vessel            revenues are derived from time charter contracts on a rate-per-day of service basis;            therefore, vessel revenues are recognized on a daily basis throughout the contract            period. These time charter contracts are generally on a term basis, ranging from three            months to three years. The base rate of hire for a contract is generally a fixed rate;            however, these contracts often include clauses to recover specific additional costs and            mobilization and demobilization costs which are billed on a monthly basis.

 

Geophysical service revenue is recognized when services are rendered and            collectibility is reasonably assured. Direct costs are charged to each contract as            incurred along with an allocated indirect costs for the specific period of service.            Losses on contracts are recognized during the period in which the loss first becomes            probable and reasonably estimated. Due to the nature of some of the geophysical            services provided, certain customers have prepaid their contract services. These            prepayments have been deferred and are recognized as revenue as the services are            provided. At September 30, 2007 and 2006 the Company had $103 and $3,810 of deferred            revenue related to these prepaid services.

 

Product sales revenue is recorded upon delivery or shipment of bulk or            bottled water to the customer.

 

***Vessel Operating Costs***—            Vessel operating costs are incurred on a daily basis and consist primarily of costs            such as crew wages, repair and maintenance, insurance, fuel, lube oil and supplies, and            other vessel expenses such as crew personnel training costs. Vessel operating costs are            recognized as incurred on a daily basis.

 

***Foreign Currency Transactions***— Caspian Services, Inc., the holding company of the subsidiaries,            makes its principal investing and financing transactions in United States dollars and            the United States dollar is its functional currency. Transactions and balances            denominated in other currencies have been translated into United States dollars using            historical exchange rates. Exchange gains and losses from holding foreign currencies            and having liabilities payable in foreign currencies are included in the results of            operations.

 

The            Kazakh Tenge is the functional currency of the operating subsidiaries. The respective            balance sheets have been translated into United States dollars at the exchange rates            prevailing at each balance sheet date. The respective statements of operations have            been translated into United States dollars using the average exchange rates prevailing            during the periods of each statement. The corresponding translation adjustments are            part of accumulated other comprehensive income and shown as part of shareholders’            equity.

 

The            translation of Kazakh Tenge denominated assets and liabilities into United States            Dollars for the purpose of these consolidated financial statements does not necessarily            mean that the Company could realize or settle, in United States Dollars, the reported            values of these assets and liabilities. Likewise it does not mean that the Company            could return or distribute the reported United States Dollar value of its Kazakh            subsidiaries’ capital to its shareholders.

 

 

F-10

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

***Income Taxes —***Deferred tax            assets and liabilities are recognized for the future tax consequences attributable to            differences in the balances of existing assets and liabilities on the Company’s            financial statements and their respective tax bases and attributable to operating loss            carry forwards. Deferred taxes are computed at the enacted tax rates for the periods            when such amounts are expected to be realized or settled. Differences generally result            from the calculation of income under accounting principles generally accepted in the            United States of America and the calculation of taxable income calculated under Kazakh            income tax regulations.

 

***Comprehensive Income (Loss)***—Total comprehensive income (loss) represents the net change in            shareholders’ equity during a period from sources other than transactions with            shareholders. For the Company, accumulated other comprehensive income (loss) is            comprised of accumulated foreign currency translation adjustments.

 

***Basic and Diluted Income (Loss) Per Common Share***– Basic income (loss) per common share is calculated by dividing            net income (loss) by the weighted-average number of common shares outstanding. Diluted            income per common share is calculated by dividing net income (loss) by the            weighted-average number of common shares outstanding giving effect to potentially            issuable common shares.

 

The            following data shows the amounts used in computing basic and diluted weighted-average            number of shares outstanding for the years ending September 30, 2007 and 2006 and for            the nine months ended September 30, 2005:

 

|                                                                          |   | 2007       |   | 2006       |   | 2005       |
|-------------------------------------------------------------------------------|--------|------------|--------|------------|--------|------------|
| Basic weighted-average common shares                            outstanding   |   | 43,480,336 |   | 40,298,410 |   | 36,894,742 |
| Effect of dilutive securities:                                                |   |       |   |       |   |       |
| Options                                                                       |   | 142,556    |   | -          |   | 94,278     |
| Warrants                                                                      |   | -          |   | -          |   | 175,088    |
| Diluted weighted-average common shares                            outstanding |   | 43,622,892 |   | 40,298,410 |   | 37,164,108 |

 

At            September 30, 2007, the Company had 4,600,113 options and warrants outstanding that            were not included in the computation of diluted net income per common share as their            effects would be anti-dilutive. At September 30, 2006, the Company had 2,000,000            options and warrants outstanding that were not included in the computation of diluted            net loss per common share as their effects would be anti-dilutive. At September 30,            2005, the Company had 1,000,000 warrants outstanding that were not included in the            computation of diluted net loss per common share as their effects would be            anti-dilutive.

 

***Stock-Based Compensation Plans***– Effective October 1, 2006, the Company adopted SFAS 123R, using            the modified prospective method. SFAS 123R requires the recognition of the cost of            employee services received in exchange for an award of equity instruments in the            financial statements and is measured based on the grant date fair value of the award.            SFAS 123R also requires the stock option compensation expense to be recognized over the            period during which an employee is required to provide service in exchange for the            award (the vesting period). Prior to the adoption of SFAS 123R, the Company accounted            for stock-based compensation plans under Accounting Principles Board Opinion            (“APB”) No. 25, “Accounting for Stock Issued to Employees”            (“APB 25”) and related interpretations. The Company adopted the            disclosure-only provision of SFAS No. 123, “Accounting for Stock-Based            Compensation” (“SFAS 123”).

 

 

F-11

 

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**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

Prior to October 1, 2006, the Company determined the value of            stock-based compensation arrangements under the provisions of APB 25 and made pro forma            disclosures required under SFAS 123. Had compensation expense for stock option grants            been determined based on the fair value at the grant dates consistent with the method            prescribed in FASB 123R, the Company’s net income (loss) and net income (loss)            per share would have been adjusted to the pro forma amounts below for the year ended            September 30, 2006 and for the nine months ended September 30, 2005:

 

|                                                                               |   |   | 2006    |    | 2005   |
|------------------------------------------------------------------------------------|--------|--------|---------|---------|--------|
| Net income (loss) as reported                                                      |   |   | $       | (1,700) |   | $ | 1,351 |
| Add: Total stock-based employee compensation                            expense    |   |   |    |    |   |   |
| recorded                                                                           |   |   |    | 5       |   |   | 76 |
| Deduct: Total stock-based employee compensation                            expense |   |   |    |    |   |   |
| determined under fair value based method for all                            awards |   |   | (2,008) |    |   | (851) |
| **Pro Forma Net Income (Loss)**                                                    |   |   | $       | (3,703) |   | $ | 576 |
|                                                                               |   |   |    |    |   |   |   |
| Income (loss) per share:                                                           |   |   |    |    |   |   |   |
| As reported:                                                                       |   |   |    |    |   |   |   |
| Basic                                                                              |   |   | $       | (0.04)  |   | $ | 0.04 |
| Diluted                                                                            |   |   | $       | (0.04)  |   | $ | 0.04 |
| Pro forma:                                                                         |   |   |    |    |   |   |   |
| Basic                                                                              |   |   | $       | (0.09)  |   | $ | 0.04 |
| Diluted                                                                            |   |   | $       | (0.09)  |   | $ | 0.04 |

 

***Concentrations of Credit Risk —***Vessel operations are contracted primarily with subcontractors of Agip            KCO. Agip KCO is the operator of the Kashagan and Kalamkas fields that lie in the            northeastern sector of the Caspian Sea. Agip KCO operates the fields on behalf of a            consortium of international oil companies and subcontracts some of the work to other            contractors. Also, approximately 39 percent of the revenue from geophysical services            seismic operations was from one customer. Loss of these customers could have a material            negative effect on the Company. Vessel charter services provided to these customers            were under contract with varying terms and dates during 2007. However, it is possible            that a loss of business could occur in the short or long term. While Management expects            to renew the contracts periodically, there is no assurance that these customers will            renew, or will renew on terms favorable to the Company.

 

Financial instruments that potentially subject the Company to            concentrations of credit risk consist principally of trade accounts, notes and other            receivables. The Company manages its exposure to risk through ongoing credit            evaluations of its customers and generally does not require collateral. The Company            maintains an allowance for doubtful accounts for potential losses.

 

***New Accounting Standards***–            During June 2006, the FASB issued FASB Interpretation            No. 48,*“Accounting for Uncertainty in Income            Taxes* *— an            interpretation of FASB Statement No.* *109”*(“FIN 48”),            which clarifies the accounting for uncertainty in income taxes. FIN 48 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. FIN 48 also provides guidance on derecognition, classification, interest            and penalties, accounting in interim periods, disclosure and transition. FIN 48 is            effective for fiscal years beginning after December 15, 2006. The Company is            required to adopt the provisions of FIN 48 in the fiscal year beginning            October 1, 2007. The Company is currently evaluating the effects, if any, that            this pronouncement may have on the Company’s financial statements.

 

 

F-12

 

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**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

During September 2006, the FASB issued            SFAS 157,*“Fair Value Measurements”*(“SFAS 157”), which provides enhanced guidance for            using fair value to measure assets and liabilities. The standard applies whenever other            standards require (or permit) assets or liabilities to be measured at fair value. The            standard does not expand the use of fair value in any new circumstances. SFAS 157            is effective for financial statements issued for fiscal years beginning after            November 15, 2007, and interim periods within those fiscal years. This standard is            effective in the Company’s financial statements beginning October 1, 2008. The            Company is currently evaluating the effects, if any, that this pronouncement may have            on the Company’s financial statements.

 

In            February 2007, the FASB issued            SFAS No. 159,*“The Fair Value Option for            Financial Assets and Financial Liabilities* *— Including an amendment of FASB Statement            No.* *115”*(“SFAS 159”). SFAS 159 permits entities to choose            to measure many financial instruments and certain other items at fair value. The            objective is to improve financial reporting by allowing entities to mitigate volatility            in reported earnings caused by measuring related assets and liabilities differently            without having to apply complex hedge accounting provisions. SFAS 159 is effective            as of the beginning of an entity’s first fiscal year that begins after            November 15, 2007. If the Company elects to adopt the provisions of SFAS 159,            it would be effective in the fiscal year beginning October 1, 2008. The Company is            currently evaluating the impact, if any, that SFAS 159 may have on the            Company’s financial statements. 

 

In            December 2007, the FASB issued            SFAS No. 141(R)*“Business            Combinations”*(“SFAS 141(R)”) and            SFAS No. 160,*“Non-controlling Interests in            Consolidated Financial Statement”*(“SFAS 160”). SFAS 141(R) requires the acquiring            entity in a business combination to record all assets acquired and liabilities assumed            at their respective acquisition-date fair values and changes other practices under            FAS 141, some of which could have a material impact on how the Company accounts            for business combinations. SFAS 141(R) also requires additional disclosure of            information surrounding a business combination, such that users of the entity’s            financial statements can fully understand the nature and financial impact of the            business combination. SFAS 160 requires entities to report non-controlling            (minority) interests in subsidiaries as equity in the consolidated financial            statements. The Company is required to adopt SFAS 141(R) and SFAS 160            simultaneously in the fiscal year beginning October 1, 2009. The provisions of            SFAS 141(R) will only impact the Company if the Company is party to a business            combination after the pronouncement has been adopted. The Company is currently            evaluating the effects that SFAS 160 will have on the Company’s financial            statements.

 

***Corrected prior year financial statements***–During the course of preparing the financial statements for the            three months ended December 31, 2006, the Company identified certain prior period            misstatements whose impact was not material, either individually or in the aggregate,            to the Company’s financial statements for the year ended September 30, 2006.            However, these misstatements were considered material to the Company’s financial            statements for the three months ended December 31, 2006. As a result, the Company            corrected the financial statements for the year ended September 30, 2006. The corrected            consolidated balance sheet and consolidated statement of operations as of and for the            year ended September 30, 2006 is included in these financial statements.

 

 

F-13

 

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**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

These misstatements related to capitalizing certain costs associated            with the acquisition of a new vessel, accrual of certain geophysical costs and            allocation of minority interests. The effect of correcting these misstatements resulted            in an increase in total assets of $612, total liabilities of $341, a decrease in            minority interest of $208 and an increase in total equity of $479, which included a            decrease in net lost of $219 and a decrease in loss per share of $0.01. These problems            were caused mainly by communication difficulties with a subsidiary in its first year of            consolidation.

 

**NOTE 2 – ACQUISITION OF KAZMORGEOPHYSICA**

 

On            May 26, 2004, the Company finalized its acquisition of 50% of the outstanding common            stock of Kazmorgeophysica CJSC (“KMG”) The purchase price of $2,730 for 50%            of the KMG common stock was accounted for in accordance with APB 18,*The Equity Method of Accounting for Investments in Common            Stock.*On September 21, 2005, the Company increased its            ownership percentage of KMG from 50% to 51% for $56. The Company allocated the $3,131            carrying value of the investment in KMG to the assets acquired and liabilities assumed            on September 21, 2005, based on their estimated fair values. The additional 1%            acquisition changed the accounting for this investment from the equity method to being            consolidated. Beginning September 22, 2005, KMG’s operations have been included            in the consolidated operations of the Company.

 

The            following unaudited pro forma information is presented to reflect the operations of the            Company for the nine months ended September 30, 2005 as if the acquisition of KMG had            been completed on January 1, 2005:

 

| Revenues                        |   | $      | 20,631 |
|---------------------------------|--------|--------|--------|
| Net Income                      |   | $      | 1,353  |
|                            |   |   |   |
| Basic Income Per Common Share   |   | $      | 0.04   |
| Diluted Income Per Common Share |   | $      | 0.04   |

 

 

**NOTE 3 – EQUITY METHOD INVESTMENTS**

 

***Veritas Caspian***– During 2005,            KMG and Veritas DGC (“Veritas”), a UK company, formed a joint venture            (Veritas Caspian LLP) to gather and market seismic data from unlicensed blocks of the            Kazakhstan sector of the Caspian Sea. The Kazakhstan Government owns the data gathered;            however, Veritas Caspian has the exclusive right to market and sell the data to            prospective bidders on tendered Kazakhstan oil blocks. To accomplish the gathering of            the seismic data, Veritas Caspian charters vessels from the Company. The Company            recognized $10,700 and $5,638 of vessel revenue during the years ended September 30,            2007 and 2006 respectively from the charter of vessels to Veritas Caspian.

 

KMG            obtained its 50% non-controlling interest in Veritas Caspian for a capital contribution            of $0.4 and accounts for the investment under the equity method of accounting. The            joint venture agreement states that Veritas DGC will provide all funding for the            operations of Veritas Caspian and KMG will provide the local ownership requirements.            KMG has no responsibility to provide further funding and has no obligation to assume            any losses of the joint venture. Revenues from the sale of the data will be split            between the Kazakhstan government and Veritas Caspian at various percentages after            Veritas Caspian has recovered its costs. In turn, revenue will be split between Veritas            and KMG after Veritas has recovered its costs.

 

 

F-14

 

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**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

At            September 30, 2007 KMG’s investment in Veritas Caspian LLP was reduced to zero            due to Veritas Caspian’s accumulated losses of $6,445. If Veritas Caspian has            income in the future, the Company will resume applying the equity method after its            share of that income equals the share of net losses not recognized during the period            the equity method was suspended.

 

***Pact Caspian***– Caspian Real            Estate, Ltd. (CRE) owns a 50% interest in Pact Caspian Engineering FZC (“Pact            Caspian”). Through its wholly-owned subsidiary, Pact Engineering KZ LLP            (“Pact Engineering”), Pact Caspian markets and sells in Kazakhstan water            and wastewater treatment systems manufactured by Pact Engineering. CRE accounts for its            50% investment under the equity method of accounting. At September 30, 2007,            CRE’s investment in Pact Caspian was reduced to zero due to Pact Caspian’s            accumulated losses of $181. If Pact Caspian has income in the future, the Company will            resume applying the equity method after its share of that income equals the share of            net losses not recognized during the period the equity method was suspended.

 

**NOTE 4 – TRADE AND OTHER ACCOUNTS RECEIVABLE**

 

***Trade Accounts Receivable***–            The Company believes accounts receivable for vessel charters are fully collectable            within one year, and no allowance for doubtful accounts was deemed necessary at            September 30, 2007 or 2006. Receivables from vessel charter revenues were approximately            $6,120 and $3,705 at September 30, 2007 and 2006, respectively.

 

Accounts receivable from geophysical services arise principally from            contracts to gather seismic data for future geophysical processing and analysis. The            receivables are current and collectable within 45 days from date of invoice. At            September 30, 2007 and 2006, receivables related to geophysical services totaled $5,307            and $7,324, respectively. The Company provided an allowance for doubtful accounts for            these receivables of $126 and $0 at September 30, 2007 and 2006,            respectively.

 

At            September 30, 2007 and 2006, receivables related to desalinization and bottling            operations totaled $203 and $97, respectively. The Company provided an allowance for            doubtful accounts for these receivables of $0 and $1 at September 30, 2007 and 2006,            respectively.

 

***Other Receivables**–*The Company’s other receivables consists primarily of the            following: (1) loans and advances to employees which bear no interest and have terms            ranging from less than one year to five years, $175 is classified as long term at            September 30, 2007, (2) refunds of inventory advances, initial equity investment and            land deposits which were either subsequently cancelled for either lack of performance            or mutual agreement. These amounts are currently due and expected to be repaid in the            near-term.

 

 

F-15

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

**NOTE 5 –VESSELS, EQUIPMENT AND PROPERTY**

 

Vessels, equipment and property consisted of the following:

 

| *As of September 30,*                    |   |   | **2007**         |   |   | **2006**         | **Depreciable****Life in Years** |
|------------------------------------------|--------|--------|------------------|--------|--------|------------------|----------------------------------|
| Land                                     |   | $      | 5,068       |   | $      | 4,615       | N/A                              |
| Buildings and leasehold improvements     |   |   | 479         |   |   | 450         | 14                               |
| Marine vessels                           |   |   | 16,075      |   |   | 12,279      | 10-12                            |
| Machinery and equipment                  |   |   | 17,443      |   |   | 16,198      | 2-20                             |
| Field camp                               |   |   | 1,580       |   |   | 1,602       | 10-14                            |
| Vehicles                                 |   |   | 7,075       |   |   | 1,760       | 4-10                             |
| Office equipment                         |   |   | 507         |   |   | 381         | 4-10                             |
| Other                                    |   |   | 398         |   |   | 280         | 2-3                              |
| Construction in progress                 |   |   | 10,120      |   |   | 2,109       | N/A                              |
|                                     |   |   | 58,745      |   |   | 39,674      |                             |
| Accumulated depreciation                 |   |   | (13,264)         |   |   | (6,610)          |                             |
| **Vessels, Equipment and Property, net** |   | $      | **45,481**  |   | **$**  | **33,064**  |                             |

 

***Development of Marine            Base*****–**The Company            continues with development plans for the marine base in Bautino Bay. Construction is            expected to commence in the first fiscal quarter 2008. The Company also expects the            initial phase of the marine base facilities, including dredging, breakwater, wharf            front and general site area to be completed and functional by November 2008, with            final completion of the base occurring by November 2009. Anticipated cost to            construct the marine base is approximately $71,810. The Company plans to achieve this            funding through a combination of debt financing in the amount of $32,000 and cash            equity financing in the amount of $39,810 of which $10,120has already been            expended by the Company for the initial feasibility studies, preliminary            construction costs and materials. The Company also obtained the land for the project            through its acquisition of Balykshi LLP.

 

In            February 2007, Balykshi entered into a short-term loan agreement with Halyk Bank for            $2,000. The loan was fully repaid in August 2007. The purpose of the loan was to pay            for marine base construction costs.

 

During the years ended September 30, 2007 and 2006, the Company incurred            construction costs of $8,011 and $1,115, respectively. The Company capitalized interest            costs related to the development of the marine base in the amount of $137 and $0 for            the years ended September 30, 2007 and 2006, respectively.

 

 

F-16

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

**NOTE            6 – INTANGIBLE ASSETS AND GOODWILL**

 

***Intangible Assets***–The following table summarizes the gross carrying amounts and the            related accumulated amortization of intangible assets except goodwill as of September            30:

 

|              |                  |   | **2007**                                             |                                                      | **2006** |
|-------------------|-----------------------|--------|------------------------------------------------------|-----------------------------------------------------------|----------|
|              | Estimateduseful lives |   | Grosscarryingamount                                  | Accumulatedamortization                                   |     | Grosscarryingamount | Accumulatedamortization |
|              |                  |   |                                                 |                                                      |     |   |   |
| Acquired software | 7 years               |   | $        333 | $         74 |     | $        254 | $          25 |
| Total             |                  |   | $        333 | $         74 |     | $        254 | $          25 |

 

 

Total amortization expense related to intangible assets was            approximately $49, and $21 for the years ended September 30, 2007 and 2006,            respectively, and $4 for the nine months ended as of September 30, 2005. The            estimated amortization expense for acquired software is as follows for the periods            indicated:

 

|                 | For the Year Ending September 30:                   |
|----------------------|-----------------------------------------------------|
|                 | **2008**                                            | **2009** | **2010** | **2011** | **2012** | **thereafter** |
| Amortization expense | $        49 | $        49 | $        49 | $        49 | $        49 | $        14 |

 

***Goodwill***– During May 2004,            the Company recorded $257 of goodwill in conjunction with the purchase of TatArka.            And on September 21, 2005, the Company increased its ownership percentage of KMG from            50% to 51% and recorded $2,654 of goodwill. In accordance with the requirements of SFAS            No. 142, the Company does not amortize goodwill. SFAS No. 142 requires the Company to            periodically perform tests for goodwill impairment, at least annually, or sooner if            evidence of possible impairment arises.

 

The            changes in the carrying amount of goodwill, which all relates to the Geophysical            Services segment, were as follows:

 

|                                                                         | **For The**       |   | **For The**       |   | **For The Nine**  |
|------------------------------------------------------------------------------|-------------------|--------|-------------------|--------|-------------------|
|                                                                         | **Year Ended**    |   | **Year Ended**    |   | **Months Ended**  |
|                                                                         | **September 30,** |   | **September 30,** |   | **September 30,** |
|                                                                         | **2007**          |   | **2006**          |   | **2005**          |
| Balance - beginning of period                                                | $                 | 3,135  |              | $      | 2,911             |   | $ | 250 |
| Acquired - KMG                                                               |              | -      |              |   | -                 |   |   | 2,654 |
| Effect of foreign currency translation                            adjustment |              | 160    |              |   | 224               |   |   | 7 |
| Balance - end of period                                                      | $                 | 3,295  |              | $      | 3,135             |   | $ | 2,911 |

 

 

 

 

F-17

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

**NOTE 7 – LONG-TERM DEBT**

 

During the 2007 fiscal year, Bauta borrowed $26 from a local bank and            repaid $11. The notes are collateralized by equipment and inventory, bear interest at            18% and are due by December 2008.

 

During the year ended September 30, 2007, KMG borrowed $223            from a company related through common ownership. The notes bear interest at 0%. $100            was repaid in November and December 2007 and the residual balance is due by March 31,            2008.

 

During the 2006 fiscal year, TatArka borrowed $2,580 from two local            banks. The notes are collateralized by equipment and bear interest at 14%.

 

| Long-term debt consists of the following: |
|-------------------------------------------|

 

| *September 30,*                                                                          |   | **2007** |   | **2006** |
|------------------------------------------------------------------------------------------|--------|----------|--------|----------|
| Bank loan bearing interest at 18% due                                                    |   |     |   |     |   |   |
| December 2008; secured by equipment and                            inventory             |   | $        | 15     |     | $ | 26 |
|                                                                                     |   |     |   |     |   |   |
| Loans from institutions other than banks at                            0%                |   |     |   |     |   |   |
| due March 2008                                                                           |   |     | 223    |     |   | - |
|                                                                                     |   |     |   |     |   |   |
| Bank loan bearing interest at 14% repaid                                                 |   |     |   |     |   |   |
| in October 2006; secured by geophysical                            equipment             |   |     | -      |     |   | 700 |
|                                                                                     |   |     |   |     |   |   |
| Bank loan bearing interest at 14%. Payments are due                            quarterly |   |     |   |     |   |   |
| through March 2008; secured by geophysical                            equipment          |   |     | 442    |     |   | 1,034 |
| Total Long-term Debt                                                                     |   |     | 680    |     |   | 1,760 |
| Less: Current Portion                                                                    |   |     | 680    |     |   | 1,612 |
| Long-term Debt - Net of Current Portion                                                  |   | $        | -      |     | $ | 148 |
|                                                                                     |   |     |   |     |   |   |

 

**NOTE 8 – STOCKHOLDERS’ EQUITY**

 

***Common Stock***– In July 2007,            the Company completed a private placement of 2,807,775 Units raising net proceeds of            $24,041 after offering costs of $1,228. Each Unit offered in the private placement            consisted of three shares of common stock and a redeemable warrant to purchase an            additional share of common stock at an exercise price of $4.00 per share. The warrant            contained in each Unit is immediately exercisable and has a three-year term. The price            per Unit was $9.00 per Unit.

 

As a            result of this private placement, the Company issued a total of 8,423,326 shares of            common stock and warrants to purchase 3,500,108 shares of common stock. The proceeds            were allocated to the common stock and warrants based on their relative fair value and            resulted in $4,970 being allocated to the warrants. The warrants had a fair value of            $5,981 which was determined by the Black-Scholes option pricing model using the            following assumptions: volatility of 134.3%, risk-free interest rate of 4.9%, dividend            yield of 0% and life of 3.0 years.

 

 

F-18

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

As            part of the private placement, the placement agent was issued 692,333 warrants that            were immediately exercisable, expire in two years and have an exercise price of $4.00            per share. The funds raised in the offering were used to fund development of the            Company’s marine base and to acquire vessels and seismic equipment.

 

In            March 2006, the Company completed a private placement of 1,000,000 Units raising            $8,000. Each Unit offered in the private placement consisted of two shares of            restricted common stock and a warrant to purchase an additional share of common stock            at an exercise price of $5.00 per share. The warrant contained in each Unit is            immediately exercisable and has a three-year term. The price per Unit was $8.00 per            unit.

 

As a            result of this private placement, the Company issued a total of 2,000,000 shares of            common stock and warrants to purchase 1,000,000 shares of common stock. The proceeds            were allocated to the common stock and warrants based on their relative fair value and            resulted in $2,586 being allocated to the warrants. The warrants had a fair value of            $4,730 which was determined by the Black-Scholes option pricing model using the            following assumptions: volatility of 228.8%, risk-free interest rate of 4.8%, dividend            yield of 0% and life of 3.0 years.

 

In            November 2005, the Company issued 444,444 shares of common stock valued at $2,000 or            $4.50 per share as partial compensation for the land acquisition of Balykshi            LLP.

 

During March 2005, the Company completed a private placement of            7,658,446 shares of common stock for $3.00 per share. The Company received $21,796            after offering costs of $1,135. In connection with the offering, the Company issued a            warrant to the placement agent to purchase 765,845 shares of common stock. The warrant            was exercisable at $3.00 per share, was exercisable immediately and expired in            September 2006. In September 2006, certain warrant holders exercised their right to            purchase 765,845 shares of the Company’s restricted common stock for $2,298. The            Company received the cash proceeds from the exercise of these warrants in October            2006.

 

***Stock Options***– During the            year ended September 30, 2007, the Company issued 153,735 options to certain employees            in accordance with their respective employment agreements. These options have a            weighted average exercise price of $3.51 per share, vest over a three years, and expire            eight years from the date of issuance. The options have a fair value of $3.36 per share            as calculated using the Black-Scholes option-pricing model with the following weighted            average assumptions: dividend yield of 0%, expected volatility of 106.0%, risk free            interest rate of 4.57% and expected lives of 8.0 years.

 

On            August 1, 2005, the Company granted 800,000 options to key employees to purchase shares            of common stock with an exercise price of $3.00 per share. These options vested through            September 30, 2006 and expire 10 years from the date of issuance. The options have a            fair value of $2.80 per share as calculated using the Black-Scholes option-pricing            model with the following weighted average assumptions: dividend yield of 0%, expected            volatility of 255.6%, risk free interest rate of 4.32% and expected lives of 10.0            years.

 

F-19

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

 

The            expected life of stock options represents the period of time that the stock options            granted are expected to be outstanding based on historical exercise trends. The            expected volatility is based on the historical price volatility of our common stock.            The risk-free interest rate represents the U.S. Treasury bill rate for the expected            life of the related stock options. The dividend yield represents our anticipated cash            dividend over the expected life of the stock options.

 

Stock option activity for the years ended September 30, 2007 and 2006            and for the nine months ended September 30, 2005 is as follows:

 

|                                                                          |   | 2007      |                                      | 2006   |      | 2005             |
|-------------------------------------------------------------------------------|--------|-----------|-------------------------------------------|--------|-----------|------------------|
|                                                                          |   |      | Weighted-Average                          |   |      | Weighted-Average |   |   | Weighted-Average |
|                                                                          |   | Options   | Exercise                            Price |   | Options   | Exercise Price   |   | Options | Exercise                            Price |
| Outstanding at beginning                              of the period |   | 1,000,000 | $ 3.00                                    |   | 1,000,000 | $ 3.00           |   | 200,000 | $ 3.00 |
| Issued                                                                        |   | 153,735   | 3.51                                      |   | -         | -                |   | 800,000 | 3.00 |
| Exercised                                                                     |   | -         | -                                         |   | -         | -                |   | - | - |
| Outstanding at end of the period                                              |   | 1,153,735 | $ 3.07                                    |   | 1,000,000 | $ 3.00           |   | 1,000,000 | $ 3.00 |
| Exercisable at end of the period                                              |   | 1,000,000 | $ 3.00                                    |   | 925,000   | $ 3.00           |   | 75,000 | $ 3.00 |
| Weighted average fair value of                                                |   |      |                                      |   |      |             |   |   |   |
| options granted during the period                                             |   |      | $ 3.51                                    |   |      | -                |   |   | $ 2.80 |

 

During the years ended September 30, 2007 and 2006 and for the nine            months ended September 30, 2005, the Company recognized $212, $5 and $76 of            compensation expense related to options issued to employees, respectively. As of            September 30, 2007, there was approximately $302 of unrecognized compensation cost            related to stock options that will be recognized over a weighted-average period of 1.61            years. The aggregate intrinsic value of options expected to vest and that were            exercisable at September 28, 2007 was zero. The year-end intrinsic value is based on a            September 30, 2007 closing price of $2.89.

 

The            following table summarizes information related to the Company’s stock options            outstanding at September 30, 2007:

 

| Exercise       | Number      |   | Weighted-Average Remaining  |   | Number      |
|----------------|-------------|--------|-----------------------------|--------|-------------|
| Price          | Outstanding |   | Contractual Life (in years) |   | Exercisable |
| $ 3.00         | 1,000,000   |   | 6.8                         |   |        | 1,000,000 |
| $ 2.85 - $3.69 | 153,735     |   | 6.9                         |   |        | - |

 

***Warrants***– Warrant activity            for the years ended September 30, 2007 and 2006 and for the nine months ended September            30, 2005 is as follows:

|                                   |   | 2007      |                                                                    | 2006   |      | 2005                                                                          |
|----------------------------------------|--------|-----------|-------------------------------------------------------------------------|--------|-----------|-------------------------------------------------------------------------------|
|                                   |   |      | Weighted-                            Average                            |   |      | Weighted-                            Average                                  |   |   | Weighted-                            Average |
|                                   |   | Warrants  | Exercise                            Price                               |   | Warrants  | Exercise                            Price                                     |   | Warrants | Exercise                            Price |
| Outstanding at beginning of the period |   | 1,000,000 | $           5.00 |   | 765,845   | $            3.00 |   | - | $                                            - |
| Issued                                 |   | 3,500,108 | 4.00                                                                    |   | 1,000,000 | 5.00                                                                          |   | 765,845 | 3.00 |
| Exercised                              |   | -         | -                                                                       |   | (765,845) | 3.00                                                                          |   | - | - |
| Outstanding at end of the period       |   | 4,500,108 | 4.22                                                                    |   | 1,000,000 | 5.00                                                                          |   | 765,845 | 3.00 |
| Exercisable at end of the period       |   | 4,500,108 | $           4.22 |   | 1,000,000 | $            5.00 |   | 765,845 | $                                       3.00 |

 

 

 

 

F-20

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

The            following table summarizes information related to the Company’s warrants            outstanding at September 30, 2007:

 

| Exercise | Number      |   | Weighted-Average Remaining  |   | Number      |
|----------|-------------|--------|-----------------------------|--------|-------------|
| Price    | Outstanding |   | Contractual Life (in years) |   | Exercisable |
| $ 4.00   | 3,500,108   |   | 2.6                         |   |        | 3,500,108 |
| $ 5.00   | 1,000,000   |   | 1.5                         |   |        | 1,000,000 |

 

 

**NOTE 9 – INCOME TAXES**

 

Kazakh tax legislation and practice is in a state of continuous            development and therefore is subject to varying interpretations and frequent changes,            which may be retroactive. Further, the interpretation of tax legislation by tax            authorities as applied to the transactions and activities of the Company may not            coincide with that of management. As a result, tax authorities may challenge            transactions and the Company may be assessed additional taxes, penalties and interest.            Tax periods remain open to review by the tax authorities for five years.

 

The            principle of group consolidation for tax purposes does not exist in Kazakhstan. This            means that the Company pays tax on all profits realized by its subsidiaries, but cannot            offset the losses of other subsidiaries. These losses can only be carried forward in            the same company.

 

Management believes it has paid or accrued for all taxes that are            applicable. Where practice concerning the provision of taxes is unclear, management has            accrued tax liabilities based on its best estimate.

 

Earnings and (losses) before income taxes and minority interests derived            from United States and international operations are as follows:

 

|                                         |   | **For The**                                                                              |   | **For The**                                                              |   | **For The Nine**                                                               |
|----------------------------------------------|--------|------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------|
|                                         |   | **Year Ended**                                                                           |   | **Year Ended**                                                           |   | **Months Ended**                                                               |
|                                         |   | **September 30,**                                                                        |   | **September 30,**                                                        |   | **September 30,**                                                              |
|                                         |   | **2007**                                                                                 |   | **2006**                                                                 |   | **2005**                                                                       |
| United States                                |   | $              (6) |   | $           (382) |   | $          (261)             |
| Kazakhstan and otherinternational operations |   | 14,903                                                                              |   | 2,027                                                               |   | 2,875                                                                     |
|                                         |   | $       14,897                                   |   | $         1,645        |   | $           2,614  |

 

Income tax expense consists of the following:

 

|                |   | **For The**                                                  |   | **For The**                                                        |   | **For The Nine**                                                   |
|---------------------|--------|--------------------------------------------------------------|--------|--------------------------------------------------------------------|--------|--------------------------------------------------------------------|
|                |   | **Year Ended**                                               |   | **Year Ended**                                                     |   | **Months Ended**                                                   |
|                |   | **September 30,**                                            |   | **September 30,**                                                  |   | **September 30,**                                                  |
|                |   | **2007**                                                     |   | **2006**                                                           |   | **2005**                                                           |
| Current income tax  |   | $        4,629  |   | $         1,289  |   | $         1,018  |
| Deferred income tax |   | 483                                                     |   | 1,244                                                         |   | 270                                                           |
|                |   | $        5,112  |   | $         2,533  |   | $       1,288              |

 

 

 

F-21

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

Deferred tax assets and liabilities are as follows:

 

| *as of September 30,*          |   | **2007** |        | **2006** |
|--------------------------------|--------|----------|-------------|----------|
| Deferred tax assets            |   |     |        |     |   |   |
| Tax loss carry forwards        |   | $        | 2,441  |     | $ | 1,602  |
| Property and equipment         |   |     | 283    |     |   | 198  |
| Total deferred tax assets      |   |     | 2,724  |     |   | 1,800  |
|                           |   |     |        |     |   |   |
| Deferred tax liabilities       |   |     |        |     |   |   |
| Property and equipment         |   |     | (1,843)     |     |   | (1,248) |
| Total deferred tax liabilities |   |     | (1,843)     |     |   | (1,248) |
|                           |   |     |        |     |   |   |
| Valuation allowance            |   |     | (2,724)     |     |   | (1,800) |
| Net deferred income taxes      |   | $        | (1,843)     |     | $  | (1,248) |

 

The            following is a reconciliation of the amount of tax that would result from applying the            federal rate to pretax income with the provision for income taxes:

 

|                                  | **For The**       |        | **For The**       |    | **For The Nine**  |
|---------------------------------------|-------------------|-------------|-------------------|---------|-------------------|
|                                  | **Year Ended**    |        | **Year Ended**    |    | **Months Ended**  |
|                                  | **September 30,** |        | **September 30,** |    | **September 30,** |
|                                  | **2007**          |        | **2006**          |    | **2005**          |
| Tax at federal statutory rate (34%)   | $                 | 5,065  |              | $       | 559          |   | $ | 889  |
| Non-deductible expenses               |              | 589    |              |    | 828          |   |   | 504  |
| (Income)/loss not subject to taxation |              | (914)       |              |    | 398          |   |   | -  |
| Tax effect of loss companies          |              | 575    |              |    | 854          |   |   | -  |
| Effect of lower foreign tax rates     |              | (203)       |              |    | (106)             |   |   | (105) |
| Income tax provision                  | $                 | 5,112  |              | $  | 2,533        |   | $  | 1,288  |

 

As            of September 30, 2007, the Company has loss carry forwards of approximately $1,500 and            $6,200 in the United States and Kazakhstan, respectively. Tax loss carry forwards            available in the United States begin to expire in 2022, and tax loss carry forwards            available in Kazakhstan begin to expire in 2008.

 

**NOTE 10 – COMMITMENTS AND CONTINGENCIES**

 

***Economic Environment***— In            recent years, Kazakhstan has undergone substantial political and economic change. As an            emerging market, Kazakhstan does not possess a well-developed business infrastructure,            which generally exists in a more mature free market economy. As a result, operations            carried out in Kazakhstan can involve risks which are not typically associated with            those in developed markets. Instability in the market reform process could subject the            Company to unpredictable changes in the basic business infrastructure in which it            currently operates. Uncertainties regarding the political, legal, tax or regulatory            environment, including the potential for adverse changes in any of these factors could            significantly affect the Company’s ability to operate commercially. Management is            unable to estimate what changes may occur or the resulting effect of such changes on            the Company’s financial condition or future results of operations.

 

 

F-22

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

 

Legislation and regulations regarding taxation, foreign currency            translation, and licensing of foreign currency loans in the Republic of Kazakhstan            continue to evolve as the central Government manages the transformation from a command            to a market-oriented economy. The various legislation and regulations are not always            clearly written and their interpretation is subject to the opinions of the local tax            inspectors. Instances of inconsistent opinions between local, regional and national tax            authorities are not unusual.

 

***Employment Agreements***— During            the years ended September 30, 2007 and 2006, the Company entered into four and three            employment agreements respectively, which require the Company to issue options annually            on the anniversary of the effective date of the agreement. Each employee shall receive            options equal to their annual salary divided by the average bid price of the            Company’s common stock for the five days immediately preceding the            employee’s anniversary date. 153,735 options were issued to employees during the            year ended September 30, 2007. The options shall vest over a three year period and            shall have an exercise price equal to the average bid price of the Company’s            common stock for the five days immediately preceding the employee’s anniversary            date. The employees are also eligible to receive discretionary options.

 

***Environmental Uncertainties***—            Current local laws do not impose any particular requirements on the Company with regard            to its fleet operation beyond the standard maritime regulations followed by the            Company. Liabilities are recorded when environmental assessments and/or remedial            efforts are probable, and the cost can be reasonably estimated based on studies,            discussions with the environmental authorities and assumptions as to the areas that may            have to be remediated along with the nature and extent of the remediation that may be            required. Ultimate cost to the Company is primarily dependent upon factors beyond its            control such as the scope and methodology of the remedial action requirements to be            established by environmental and public health authorities, new laws or government            regulations, and the outcome of any potential related litigation.

 

The            Company’s management believes that the Company acts in compliance with existing            governmental regulations that have been enacted or adopted regulating the discharge of            materials into the environment, or otherwise relating to the protection of the            environment, has not had, nor is expected to have, a material effect on the            Company.

 

***Purchase Commitments***– In            August 2007 TatArka entered into a purchase agreement with a third party to acquire            drilling equipment for approximately $860. As of September 30, 2007 total advances paid            on that agreement were $355.

 

During 2007 Caspian entered into agreements to purchase a barge and its            upgrade for approximately $4,600. As of September 30, 2007 total advances paid on these            agreements were $180. In connection with the purchase, the Company is required to            provide a performance bond in the amount of approximately $1,100 for the period of 6            months. In November 2007, the Company started negotiations to get a short-term credit            line in order to obtain the performance bond with a local bank and expects the Bond to            be issued in January 2008.

 

In            2007 Caspian signed the memorandum of understanding with two companies to form a joint            venture to set up a boat repair and dry-docking services yard in Bautino with an            interest share of 20%. One of these companies has not yet completed its formation. In            connection with this, the Company is required to partially finance the acquisition of            the marine travel lift with a total

 

 

F-23

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

purchase cost of $3,300. Caspian has to finance that purchase for $1,155            and 35% of all future expenses until the formation of the third participant is            complete. Such costs will be counted against equity capital. The formation agreement            has not been finalized as of September 30, 2007. The Company’s expected liability            to finance the joint venture’s equity capital with interest of 20% is $1,200            which is expected to be paid prior to completion of the marine base occurring by            November 2009.

 

***Operating Leases –***The Company            leases equipment and vehicles. Rent expense for the years ended September 30, 2007 and            2006 was $982 and $146 respectively and $406 for the nine months ended September 30,            2005.

 

The            Company maintains its corporate office in Salt Lake City, Utah, and administrative            offices in Almaty and Aktau, Kazakhstan. The Company also leases apartments in Almaty            and Aktau for use by employees. Rent expense for the years ended September 30, 2007 and            2006 was $1,029 and $260, respectively and $140 for the nine months ended as of            September 30, 2005.

 

The            future minimum rental payments required under these operating leases for 2008 are            $2,847.

 

The            Company leases vessels. Rent expenses for the years ended September 30, 2007 and 2006            was $6,488 and $5,601 respectively and $723 for the nine months ended September 30,            2005. The future minimum rental payments required under these operating leases are as            follows for the periods indicated:

 

|                    | For the Year Ending September 30: |
|-------------------------|-----------------------------------|
|                    | **2008**                          | **2009** | **2010** | **2011** | **2012** | **thereafter** |
| Vessel operating leases | $ 6,424                           | $ 2,060 | $                                     - | $                                     - | $                                     - | $                                             - |

 

The            current vessel lease agreements expire in January – March 2009. The Company            intends to renew these agreements.

 

**NOTE            11 – RELATED PARTY TRANSACTIONS**

 

During the years ended September 30, 2007 and 2006 and the nine months            ended September 30, 2005, the Company paid an entity related through common ownership            (Help LLP) $890, $440 and $250, respectively, in operating expenses for corporate            travel and visa support.

 

During the years ended September 30, 2007 and 2006 and the nine months            ended September 30, 2005, the Company paid an entity under common management            (KazakhstanCaspiShelf) $3,000 for vessel rental, and $4,702 and $0 for seismic work,            respectively. The Company also recognized $107, $263 and $0 of vessel revenues, $5,267,            $352 and $0 of revenue from performed seismic works, sale of materials and equipment            rental during 2007, 2006 and the nine months ended September 30, 2005, respectively,            from the same entity.

 

During the year ended September 30, 2007 the Company paid $380 to            Gis-Caspi, an entity under common management for the intermediary services rendered in            2006 including survey scouting technical feasibility and preparation of tender            documentation.

 

As mentioned in Note 7 during the year ended September 30, 2007, KMG borrowed $223 from a company related throughcommon ownership (Caspian Geo-Consulting Services LLP). The notes bear interest at 0%. $100 was repaid byDecember 2007 and the residual balance is due by March 31, 2008. During the years ended September 30, 2007 and2006 the same company provided marketing services to KMG for $140 and performed seismic data interpretationservices for $43, respectively. For the nine months ended September 30, 2005 the company performed seismic datainterpretation services for $100.

 

F-24

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

 

Accounts receivable from related parties as of September 30 consist of            the following:

 

| Related Party’s Name | Description                 |   | 2007  |   |   | 2006  |
|----------------------------|-----------------------------|--------|-------|--------|--------|-------|
| KazakhstanCaspiShelf       | vessel rental, seismic work | $      | 2,716 |   | $      | -     |
| Veritas Caspian            | vessel rental               |   | 2,369 |   |   | 2,834 |
| Others                     | services provided           |   | 112   |   |   | 39    |
| TOTAL                      |                        | $      | 5,197 |   | $      | 2,873 |

 

In            July 2007, TatArka entered into an agreement with and loaned $661 to a related party            under common management (KazakhstanCaspiShelf). The loan does not bear interest and is            to be repaid in January 2008.

 

In            December 2003, the Company entered into an agreement with Bautino and loaned            $1,100 to build, furnish and equip the phase two addition to the hotel. Interest            began accruing on January 1, 2005 at the rate of 6%. As discussed in Note 1 and 12, the            Company sold its interest in Bautino. The notes receivable including interest was fully            repaid during 2007.

 

Accounts payable due to related parties as of September 30 consist of            the following:

 

| Related Party’s Name | Description                                                                                                                         |   | 2007  |   |   | 2006  |
|----------------------------|-------------------------------------------------------------------------------------------------------------------------------------|--------|-------|--------|--------|-------|
| Help LLP                   | freight and legal services                                                                                                          | $      | 1,097 |   | $      | 12    |
| Officers                   | business trip expenses, payroll                                                                                                     |   | 387   |   |   | 61    |
| KazakhstanCaspiShelf       | vessel rental, seismic work                                                                                                         |   | -     |   |   | 1,470 |
| Gis-Caspi                  | intermediary services includingsurvey scouting technical feasibility and preparation of                            tender documents |   | -     |   |   | 352   |
| Others                     | services received                                                                                                                   |   | 96    |   |   | 94    |
| TOTAL                      |                                                                                                                                | $      | 1,580 |   | $      | 1,989 |

 

In            February 2006, Laird Garrard, the Company’s President, loaned Caspian $517 on            short-term notes. The notes bear interest at ten percent per annum. In April 2006, $50            in principal was repaid to Mr. Garrard. In October 2006, the Company paid            Mr. Garrard $467 in principal and $29 in interest to fully retire the            notes.

 

**NOTE 12 – OTHER INCOME**

 

In            January 2007, the Company entered into an agreement with the Chagala Group Limited, the            Company’s joint venture partner in Bautino Development Company            (“Bautino”) to sell its 50% interest in Bautino for $3,000. The sale of the            hotel closed in March 2007. The total gain from the sale was $3,000 as the initial            investment of $96 was reduced to zero in previous years due to losses incurred by            Bautino. The $3,000 gain is included in other income.

 

 

F-25

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

During the year ended September 30, 2007, KMG rented some of its idle            equipment to a company under common management and recognized $1,649 of other            income.

 

Residual balance of $380 is TatArka’s doubtful accounts repaid            during the year ended September 30, 2007.

 

**NOTE            13 – SEGMENT INFORMATION**

 

Accounting principles generally accepted in the United States of America            establish disclosures related to components of a company for which separate financial            information is available and evaluated regularly by a company’s chief operating            decision makers in deciding how to allocate resources and in assessing performance.            They also require segment disclosures about products and services as well as geographic            area.

 

During the nine months ended September 30, 2005, the Company            re-organized their segments into the following: Vessel Operations – daily            operations of the fleet of vessels; Geophysical Services – providing onshore and            offshore geophysical data extraction and interpretation; Infrastructure Development            – Operation of a hotel, water desalinization plant and the development of a            marine base; and Corporate Administration. The vessel operations, infrastructure and            geophysical services are located in the Republic of Kazakhstan. The administration            operations are located in the United States of America. Information regarding the            operations and assets of these reportable business segments follows:

|                       |   | **For The**       |         | **For The**       |   | **For The Nine**  |
|----------------------------|--------|-------------------|--------------|-------------------|--------|-------------------|
|                       |   | **Year Ended**    |         | **Year Ended**    |   | **Months Ended**  |
|                       |   | **September 30,** |         | **September 30,** |   | **September 30,** |
|                       |   | **2007**          |         | **2006**          |   |              | **2005** |
| **Revenues**               |   |              |         |              |   |              |   |   |   |
| Vessel Operations          |   | $                 | 32,637  |              | $      | 14,444       |   | $ | 6,026  |
| Geophysical Services       |   |              | 39,286  |              |   | 27,406       |   |   | 11,778  |
| Infrastructure Development |   |              | 1,588   |              |   | 1,280        |   |   | 858  |
| Corporate Administration   |   |              | -       |              |   | -            |   |   | -  |
| Less Intersegment Revenues |   |              | (8,618)      |              |   | (87)              |   |   | -  |
| Total Revenues             |   | $                 | 64,893  |              | $      | 43,043       |   | $ | 18,662  |
|                       |   |              |         |              |   |              |   |   |   |
| **Depreciation**           |   |              |         |              |   |              |   |   |   |
| Vessel Operations          |   | $                 | (1,791)      |              | $      | (1,428)           |   | $ | (662) |
| Geophysical Services       |   |              | (3,998)      |              |   | (1,702)           |   |   | (553) |
| Infrastructure Development |   |              | (824)        |              |   | (196)             |   |   | (102) |
| Corporate Administration   |   |              | (6)          |              |   | (4)               |   |   | (3) |
| Total Depreciation         |   | $                 | (6,619)      |              | $      | (3,330)           |   | $ | (1,320) |
|                       |   |              |         |              |   |              |   |   |   |

 

 

 

F-26

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

|                                       |   | **For The**       |         | **For The**       |   | **For The Nine**  |     |
|--------------------------------------------|--------|-------------------|--------------|-------------------|--------|-------------------|----------|
|                                       |   | **Year Ended**    |         | **Year Ended**    |   | **Months Ended**  |     |
|                                       |   | **September 30,** |         | **September 30,** |   | **September 30,** |     |
|                                       |   | **2007**          |         | **2006**          |   |              | **2005** |   |
| **Interest Expense**                       |   |              |         |              |   |              |     |   |   |   |
| Vessel Operations                          |   | $                 | (2)          |              | $      | (43)              |     | $ | (199) |   |
| Geophysical Services                       |   |              | (125)        |              |   | (234)             |     |   | (410) |   |
| Infrastructure Development                 |   |              | (3)          |              |   | (11)              |     |   | (6) |   |
| Corporate Administration                   |   |              | -       |              |   | -            |     |   | -  |   |
| Interest Expense                           |   | $                 | (130)        |              | $      | (288)             |     | $ | (615) |   |
|                                       |   |              |         |              |   |              |     |   |   |   |
| **Income (Loss) from Equity**              |   |              |         |              |   |              |     |   |   |   |
| **Method Investees**                       |   |              |         |              |   |              |     |   |   |   |
| Vessel Operations                          |   | $                 | -       |              | $      | -            |     | $ | -  |   |
| Geophysical Services                       |   |              | -       |              |   | 28           |     |   | -  |   |
| Infrastructure Development                 |   |              | -       |              |   | -            |     |   | -  |   |
| Corporate Administration                   |   |              | -       |              |   | -            |     |   | 161  |   |
| Income (Loss) from Equity Method Investees |   | $                 | -       |              | $      | 28           |     | $ | 161  |   |
|                                       |   |              |         |              |   |              |     |   |   |   |
| **Income (Loss) Before Income**            |   |              |         |              |   |              |     |   |   |   |
| **Tax and Minority Interest**              |   |              |         |              |   |              |     |   |   |   |
| Vessel Operations                          |   | $                 | (732)        |              | $      | (3,178)           |     | $ | (1,969) |   |
| Geophysical Services                       |   |              | 13,878  |              |   | 5,640        |     |   | 5,022 |   |
| Infrastructure Development                 |   |              | 2,529   |              |   | (282)             |     |   | (214) |   |
| Corporate Administration                   |   |              | (778)        |              |   | (535)             |     |   | (225) |   |
| Income (Loss) before Income                |   |              |         |              |   |              |     |   |   |   |
| Tax and Minority Interest                  |   | $                 | 14,897  |              | $      | 1,645        |     | $ | 2,614  |   |
|                                       |   |              |         |              |   |              |     |   |   |   |
| **Provision for Income Tax**               |   |              |         |              |   |              |     |   |   |   |
| Vessel Operations                          |   | $                 | (523)        |              | $      | -            |     | $ | -  |   |
| Geophysical Services                       |   |              | (4,589)      |              |   | (2,533)           |     |   | (1,288) |   |
| Infrastructure Development                 |   |              | -       |              |   | -            |     |   | -  |   |
| Corporate Administration                   |   |              | -       |              |   | -            |     |   | -  |   |
| Provision for Income Tax                   |   | $                 | (5,112)      |              | $      | (2,533)           |     | $ | (1,288) |   |
|                                       |   |              |         |              |   |              |     |   |   |   |
| **Minority Interest**                      |   |              |         |              |   |              |     |   |   |   |
| Vessel Operations                          |   | $                 | -       |              | $      | -            |     | $ | -  |   |
| Geophysical Services                       |   |              | (584)        |              |   | (818)             |     |   | -  |   |
| Infrastructure Development                 |   |              | 264     |              |   | 6            |     |   | 25  |   |
| Corporate Administration                   |   |              | -       |              |   | -            |     |   | -  |   |
| Minority Interest                          |   | $                 | (320)        |              | $      | (812)             |     | $ | 25  |   |
|                                       |   |              |         |              |   |              |     |   |   |   |
| **Segment Income (Loss)**                  |   |              |         |              |   |              |     |   |   |   |
| Vessel Operations                          |   | $                 | (1,255)      |              | $      | (3,178)           |     | $ | (1,969) |   |
| Geophysical Services                       |   |              | 8,705   |              |   | 2,289        |     |   | 3,734  |   |
| Infrastructure Development                 |   |              | 2,793   |              |   | (276)             |     |   | (189) |   |
| Corporate Administration                   |   |              | (778)        |              |   | (535)             |     |   | (225) |   |
| Net Income                                 |   | $                 | 9,465   |              | $      | (1,700)           |     | $ | 1,351  |   |
|                                       |   |              |         |              |   |              |     |   |   |   |

 

 

 

F-27

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2007, 2006 AND 2005**

**(Dollars in thousands, except share and per share            data)**

 

|                                         |   | **September 30,** |         | **September 30,** |   | **September 30,** |
|----------------------------------------------|--------|-------------------|--------------|-------------------|--------|-------------------|
|                                         |   | **2007**          |         | **2006**          |   | **2005**          |
| **Segment Assets**                           |   |              |         |              |   |              |   |   |   |
| Vessel Operations                            |   | $                 | 25,414  |              | $      | 20,200       |   | $ | 14,613  |
| Geophysical Services                         |   |              | 36,643  |              |   | 30,190       |   |   | 15,797  |
| Infrastructure Development                   |   |              | 19,177  |              |   | 8,990        |   |   | 5,562  |
| Corporate Administration                     |   |              | 57,179  |              |   | 33,415       |   |   | 21,316  |
| Less intersegment investments                |   |              | (45,750)     |              |   | (31,146)          |   |   | (19,230) |
| Total Assets                                 |   | $                 | 92,663  |              | $      | 61,650       |   | $ | 38,058  |
|                                         |   |              |         |              |   |              |   |   |   |
| **Investments in Equity Method Investees**   |   |              |         |              |   |              |   |   |   |
| Vessel Operations                            |   | $                 | -       |              | $      | -            |   | $ | -  |
| Geophysical Services                         |   |              | -       |              |   | -            |   |   | 303  |
| Infrastructure Development                   |   |              | -       |              |   | -            |   |   | -  |
| Corporate Administration                     |   |              | -       |              |   | -            |   |   | -  |
| Total Investments in Equity Method Investees |   | $                 | -       |              | $      | -            |   | $ | 303  |

 

 

**NOTE            14 – SUBSEQUENT EVENTS**

 

As            discussed in Note 10, in connection with the vessel purchase in November 2007, the            Company started negotiations with a local bank to get a performance bond required by            the supplier of the vessel. As a result, the Company was required to open a short-term            credit line for approximately $1,100 in the same bank. The agreement has yet to be            finalized as of December 2007.

 

**NOTE 15 – QUARTERLY FINANCIAL DATA (unaudited)**

 

 

|                          | **Three Months Ended** |
|-------------------------------|------------------------|
|                          | **December 31,**       |   | **March 31,** |   | **June 30,** |   | **September 30,** |
|                          | **2006**               |   | **2007** |   | **2007** |   | **2007** |
| Revenues                      | $                      | 19,066 |   | $ | 5,847  |   | $ | 15,108  |   | $ | 24,872 |
| Income (loss) from operations | 3,621                  |   |   | (3,460) |   |   | 1,409  |   |   | 8,112 |
| Net income                    |                   | 1,806 |   |   | 23  |   |   | 520  |   |   | 7,116 |
| Basic net income per share    | $                      | 0.04 |   | $ | -  |   | $ | 0.01  |   | $ | 0.15 |
| Diluted net income per share  | $                      | 0.04 |   | $ | -  |   | $ | 0.01  |   | $ | 0.15 |
|                          |                   |   |   |   |   |   |   |   |   |   |   |
|                          | **Three Months Ended** |
|                          | **December 31,**       |   | **March 31,** |   | **June 30,** |   | **September 30,** |
|                          | **2005**               |   | **2006** |   | **2006** |   | **2006** |
| Revenues                      | $                      | 11,814 |   | $ | 5,499  |   | $ | 10,234  |   | $ | 15,496 |
| Income (loss) from operations | 2,533                  |   |   | (1,198) |   |   | (820) |   |   | 1,041 |
| Net income (loss)             |                   | 2,062 |   |   | (3,592) |   |   | (1,593) |   |   | 1,423 |
| Basic net income per share    | $                      | 0.05 |   | $ | (0.09) |   | $ | (0.04) |   | $ | 0.03 |
| Diluted net income per share  | $                      | 0.05 |   | $ | -  |   | $ | (0.04) |   | $ | 0.03 |
|                          |                   |   |   |   |   |   |   |   |   |   |   |

|                          |   |   |   | **Three Months Ended** |
|-------------------------------|--------|--------|--------|------------------------|
|                          |   |   |   | **March 31,**          |   | **June 30,** |   | **September 30,** |
|                          |   |   |   | **2005**               |   | **2005** |   | **2005** |
| Revenues                      |   |   |   | $                      | 688  |   | $ | 7,674  |   | $ | 10,300 |
| Income (loss) from operations |   |   |   | (2,630)                |   |   | 2,067  |   |   | 3,646 |
| Net income (loss)             |   |   |   |                   | (3,042) |   |   | 1,839  |   |   | 2,554 |
| Basic net income per share    |   |   |   | $                      | (0.09) |   | $ | 0.05  |   | $ | 0.07 |
| Diluted net income per share  |   |   |   | $                      | -  |   | $ | 0.05  |   | $ | - |
|                          |   |   |   |                   |   |   |   |   |   |   |   |

 

 

 

 

F-28