**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-K/A-1**

 

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

**                For the fiscal year ended****September 30, 2008**

 

| 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 YesxNo |
|--------|----------|

 

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 YesxNo

 

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.                                                                                                                                 xYes 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, a non-accelerated filer or a smaller reporting company. See the definitions of “*large accelerated filer*,” “*accelerated filer*” and “*smaller reporting            company*” in Rule 12b-2 of the Exchange Act.

 

| Large accelerated filer o | Accelerated filer o |
|---------------------------|---------------------|

| Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting companyx |
|-----------------------------------------------------------------------|----------------------------|

 

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

|                                       o YesxNo |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 31, 2008 was $63,463,043.

 

As of January 5, 2009, the registrant had 51,135,042 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**                                                                                                         |       |
|            |                                                                                                               |       |
|                 | Explanatory Note                                                                                                   | 3          |
|                 |                                                                                                               |       |
|                 |                                                                                                                    |            |
|                 |                                                                                                                    |            |
| Item 1.         | Business                                                                                                           | 4          |
|            |                                                                                                               |       |
| Item 1A.        | Risk Factors                                                                                                       | 20         |
|            |                                                                                                               |       |
| Item 1B.        | Unresolved Staff Comments                                                                                          | 23         |
|            |                                                                                                               |       |
| Item 2.         | Properties                                                                                                         | 23         |
|            |                                                                                                               |       |
| Item 3.         | Legal Proceedings                                                                                                  | 24         |
|            |                                                                                                               |       |
| Item 4.         | Submission of Matters to a Vote of Security Holders                                                                | 24         |
|            |                                                                                                               |       |
|            | **PART II**                                                                                                        |       |
|            |                                                                                                               |       |
| Item 5.         | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | 24

  |
|            |                                                                                                               |       |
| Item 6.         | Selected Financial Data                                                                                            | 27         |
|            |                                                                                                               |       |
| Item 7.         | Management’s Discussion and Analysis of Financial Condition and Results of Operations                        |  

28 |
|            |                                                                                                               |       |
| Item 7A.        | Quantitative and Qualitative Disclosures About Market Risk                                                         | 40         |
|            |                                                                                                               |       |
| Item 8.         | Financial Statements and Supplementary Data                                                                        | 41         |
|            |                                                                                                               |       |
| Item 9.

  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                               |  

41 |
|            |                                                                                                               |       |
| Item 9A(T).     | Controls and Procedures                                                                                            | 41         |
|            |                                                                                                               |       |
| Item 9B.        | Other Information                                                                                                  | 42         |
|            |                                                                                                               |       |
|            | **PART III**                                                                                                       |       |
|            |                                                                                                               |       |
| Item 10.        | Directors, Executive Officers and Corporate Governance                                                             | 42         |
|            |                                                                                                               |       |
| Item 11.        | Executive Compensation                                                                                             | 47         |
|            |                                                                                                               |       |
| 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                                          | 64         |
|            |                                                                                                               |       |
| 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.*

 

**Explanatory Note**

 

We are filing this Amendment No. 1 on Form 10-K/A-1 (the “Amendment”) to correct inadvertent  typographical mistakes in the Annual Report for the period ended September 30, 2008, which was filed with the Securities and Exchange Commission on January 13, 2009 (the “Original Annual Report”).  Specifically, this Amendment is filed to            correct typographical mistakes in the following sections of the Original Annual Report: i)  the Risk Factor “*Possibility of Default on Loan Covenants*” in Item 1A; ii)the “*Summary Of Material Contractual Commitments*” table in Item 7; iii) the table in Item 12 “*Security Ownership of Certain            Beneficial Owners and Management and Related Stock Holder Matters*” to correct a misspelled street name; iv) the “*Option Exercises and Stock Vested Table*” in Item 11 to correct a misspelling and to delete an individual who was inadvertently included in the table who was not, during fiscal 2008, a named executive officer; v) the header to the “*Consolidated            Balance Sheets*”; vi) the header and the “*Supplement disclosure of cash flow information*” in the “*Consolidated Statement of Cash Flows*” and vii) “*Note 10 –Income Taxes*” and “*Note 14 – Segment            Information*”

 

In accordance with Rule 12b-15 under the Securities Exchange Act of 1934, this Amendment also includes currently dated certifications from the Company’s Chief Executive Officer and Chief Financial Officer as required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. The certification exhibits have been revised accordingly.

 

This Amendment speaks only as of the filing date of the Original Annual Report and, except as discussed in this explanatory note, is unchanged from the Original Annual Report. This Amendment does not reflect events that have occurred since the filing of the Original Annual Report or modify or update those disclosures affected by subsequent events.

 

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**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 and 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 Kazakhstan and 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 of 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, you 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.** | **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 restricted common shares of the Company.            Caspian became our wholly owned subsidiary and the Caspian shareholders assumed controlling interest of the Company. The shareholders of both companies approved the Agreement. Since our acquisition of Caspian, we have concentrated our business efforts to provide diversified oilfield services to the oil and gas industry in western Kazakhstan.

 

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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  CJSC (“Kazmorgeophysica”). In September 2005 we increased our ownership interest in Kazmorgeophysica to 51% and in September 2008 to 80%. 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 the Company’s name was changed from EMPS Corporation to Caspian Services, Inc., to better reflect the nature of our business in providing oilfield services in the Caspian Sea region of western Kazakhstan.

 

**Recent Developments**

 

Unless otherwise indicated by the context, all dollar amounts stated in this Annual Report are presented in thousands.

 

In 2008 we purchased and mobilized to the Caspian Sea a dedicated shallow water cable laying barge.  This vessel is being contracted out to Saipem SpA as part of their work commitment on the Kashagan field. 

 

Towards the end of the year, we acquired an important new project with CMOC / Shell for development of the Oman Pearls field. The contract is administered by Caspian and the seismic work has been sub-contracted to Veritas-Caspian, our joint venture with CGG Veritas. This contract is not based on day rates but on the number of kilometers of seismic data acquired. The majority of the            work for this project will occur during our 2009 fiscal year and will utilize six vessels.

 

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We are continuing with development of the marine base in  Bay through our subsidiary Balykshi LLP.  Construction commenced in the first fiscal quarter 2008. We expect the initial phase of the marine base facilities, including dredging, breakwater, wharf front and general site area to be partially functional by April 2009, with final completion of the            base occurring by December 2010.  Anticipated cost to construct the marine base is approximately $71,810.  We plan to achieve this funding through a combination of debt and equity financing. In June 2007 Balykshi entered into a series of agreements with European Bank For Reconstruction and Development (“EBRD”) pursuant to which EBRD agreed to provide $32,000 of debt financing and a $10 million

equity investment in the marine base in exchange for a 22% equity interest in our subsidiary Balykshi LLP. The remaining $29,810 of construction costs is to be contributed by CSI to Balykshi. Funding of the EBRD debt and equity financing is contingent on us contributing our portion of the construction costs. By September 30, 2008, we had contributed $33,121. As of September 30, 2008 no amounts had been            drawn on the EBRD debt or equity financing.In December 2008 pursuant to the Investment Agreement, we received $10,000 from EBRD in exchange for a 22% interest in Balykshi LLP. The $10,000 will be used to fund marine base construction.

 

Currently our common stock is traded on the OTC Bulletin Board in the United States under the symbol CSSV.

 

**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 Services which 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 Services Group 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 rests upon a large hydrocarbon basin. 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.

 

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*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 20 countries in the world with over 180 producing oil fields. Kazakhstan is estimated to contain between 9 and 40 billion barrels of oil and two trillion proven cubic meters of gas in place. In 2007, oil production was            approximately 1.45 million bopd, of which nearly 1.2 million bopd was exported. Production is expected to increase to as much as 3.5 million bopd by 2015.

 

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 2-6 billion barrels of oil and gas condensate reserves and the Kashagan field with 9-13 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.

 

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    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 between geographic 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.

 

**Vessel Fleet**

 

Our vessel fleet has grown to fifteen specialized shallow draft vessels designed for use in the shallow waters of the north Caspian Sea. We operate our fleet through our subsidiary, Caspian Services Group. Of the fifteen vessels in our fleet, we own nine. We operate the other six vessels pursuant to agreement with Actamarine, formerly 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 the customer generally provides for port fees and            consumables such as water, fuel, lubricants and anti-freeze. In return for providing time-chartered services, in most instances we are paid a daily rate of hire. We also provide additional support services for our accommodations vessels.

 

Listed below are the six 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.

 

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***Anchor Handling Multicats and Support Vessel Tugs.***  This is our largest category of vessels, with seven such vessels in our fleet. These vessels are used to tow floating drilling rigs; assist in the docking of tankers; tow barges; assist pipe laying, cable laying and construction barges; 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.

 

***Cable Laying Barges.*** In 2008 we acquired our own six-point anchoring cable laying barge. These vessels are used to lay down communications infrastructure between offshore drilling islands. These vessels typically do not have their own power source as the cable could be damaged by any propulsion mechanism. Therefore, these vessels are normally            assisted by utility vessels, such as anchor handling tugs.

 

***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, laundry and related services.  One of our vessels also has a heli-deck.  Our            accommodations vessels have combined capacity to house up to 123 client personnel and 32 crew members.

 

***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 site earth works.

 

During fiscal 2008, 91% of our vessel revenue came from four clients: Saipem – 41%, Veritas-Caspian – 30%, CMOC – 12% and RXT – 8%.

 

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Five of our vessels spent most of fiscal 2008 on contract to Veritas-Caspian. Veritas-Caspian has the exclusive rights from the Ministry of Energy and Mineral Resources of the Republic of Kazakhstan (“MEMR”) to acquire seismic data over the entire open acreage of the Kazakh sector of the Caspian Sea. During the fourth quarter 2008 we mobilized these five vessels and one            other for the CMOC / Shell contract for the provision of 3D seismic data acquisition and processing services. The contract is administered by Caspian Services, Inc., who provides the vessels, and the seismic work is sub-contracted to Veritas-Caspian.

 

During fiscal 2008, we also had six vessels on charter to Saipem, SpA for the second season of a minimum two season contract. Saipem has exercised their option to extend the contract into a third year.

 

For part of fiscal 2008, we also had three vessels on contract to Reservoir Exploration Technology ASA (“RXT”) for 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 2009 work season.  We anticipate 100% utilization of our fleet for the full 2009 work season.  Our order book for 2009 includes CMOC, Saipem and Veritas-Caspian.

 

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.

 

Our competition varies from small regional companies to large international corporations and competition is intense. Currently, we have only one local Kazakh competitor. We also compete with many larger foreign companies operating in the Kazakh sector of the Caspian Sea. Despite our smaller size relative to some of our competition, we believe we have an advantage because of our            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, we have developed strong relationships with government authorities and other local companies. Based on our local regulatory compliance and business reputation, we believe we have been able to differentiate ourselves from our competitors.

 

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**Geophysical Services**

 

Through our subsidiary Caspian Geophysics we provide onshore, transition zone and marine seismic data acquisition services to independent oil and gas exploration and development companies operating in Kazakhstan and the Caspian Sea and to the national oil company. 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 a continuous volume (100% coverage) of high-quality subsurface data. In a 3D survey, 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 work are structured in one of two            ways. The most widely used are production contracts where the geophysical service provider is paid for the amount of data recorded, usually counted and charged by the number of source points acquired. For any period of time that the service provider is unable to acquire data due to circumstances outside its control, (weather for example), a standby-rate is charged to the client. The other method of contracting is based on time, where the crew can charge the time-rate for any period            that the crew is technically capable and available for work.

 

“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 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.

 

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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: Tat-Arka LLP, a wholly-owned subsidiary; and Kazmorgeophysica, JSC, an 80% owned subsidiary.

 

|   | *Tat-Arka 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 produce acoustic 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.           

 

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

 

|   | *Kazmorgeophysica JSC* |
|--------|------------------------|

 

We own an 80% 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 from customers wishing to utilize our vessels for marine seismic data acquisition.

 

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Historically, 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 well situated local companies and large international exploration companies with advanced technology and sufficient capital have been capable of providing marine seismic services in            Kazakhstan. We believe this trend is changing 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 20% 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, in order to satisfy the local content requirements of Kazakhstan, these international firms are required to tender with a local partner.

 

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”). Veritas-Caspian contracted with the MEMR 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.”

 

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.  During the 2008 work season, work on the State Geophysical Survey continued in the north Caspian. Since 2006, Veritas-Caspian has acquired a total of 3,200 kilometers. This program was temporarily suspended in the fourth            quarter of fiscal 2008 as vessels were redeployed on the CMOC / Shell contract. 

 

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.

 

14

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**Infrastructure Development**

 

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

 

|   | **Bauta JSC** |
|--------|---------------|

 

Through our subsidiary Caspian Real Estate Ltd. we own a 56% interest in Bauta JSC (“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. owned a 50% interest in Pact Caspian Engineering FZC (“Pact Caspian”). Through its wholly-owned subsidiary Pact Engineering KZ LLP (“Pact Engineering”), Pact Caspian marketed and sold in Kazakhstan water and wastewater treatment systems manufactured by Pact Engineering FZC. Pact Caspian was closed in September 2008.

 

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

 

|   | **Balykshi LLP** |
|--------|------------------|

 

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 (“Balykshi”), 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.

 

15

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Construction commenced in the first fiscal quarter 2008. We expect the initial phase of the marine base facilities, including dredging, breakwater, wharf front and general site area to be partially functional by April 2009, with final completion of the base occurring by December 2010.  Anticipated cost to construct the marine base is approximately $71,810.  We plan            to achieve this funding through a combination of debt and equity financing. In June 2007 Balykshi entered into a series of agreements with EBRD pursuant to which EBRD has agreed to provide $32,000 of debt financing. EBRD also agreed to make a $10,000 equity investment in the marine base in exchange for a 22% equity interest in Balykshi. The remaining $29,810 of construction costs is to be contributed by us to Balykshi. Funding of the EBRD debt and equity financing is contingent on            us contributing our portion of the construction costs. As of September 30, 2008, we had contributed $33,121 (more than the full amount required to be contributed) and no amounts had been drawn on the EBRD debt or equity financing. Pursuant to the Investment Agreement, subsequent to the fiscal year end we received a $10,000 equity investment from EBRD in exchange for a 22% equity interest in Balykshi. These funds will be used to finance ongoing marine base construction.

 

Through the marine base we will offer a 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 |
|--------|------------|-----------------|

 

16

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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 |
|--------|------------|-----------------------|

 

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).

 

|   | **Mangistau Oblast Boat Yard, LLP** |
|--------|-------------------------------------|

 

Our subsidiary Balykshi and two unrelated third parties formed Mangistau Oblast Boat Yard LLP (“MOBY’) for the purpose of constructing and operating a boat repair and dry-docking services yard to be located within our marine base. Balykshi holds a 20% equity interest in MOBY.

 

17

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**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.

 

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.

 

18

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Our principal customers are major oil and natural gas exploration, development and production companies or subcontractors of such companies. As noted above, our four largest customers accounted for 91% of our vessel revenues during the fiscal year ended September 30, 2008 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 Shell and their 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**

 

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 850 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 low turnover of our work force. 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.

 

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.

 

19

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**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.

 

*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 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 report. 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.

 

20

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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.

 

*Difficulty in Obtaining Credit.*The current slowdown in world economic growth makes it more difficult to obtain credit and financing. There are two potential risks: firstly, our customers may not be able to obtain the funds to finance or pay for their projects. This increases the chance of doubtful accounts, particularly from our smaller local            customers. We request advance payments when necessary and do not deliver data until invoices have been settled. We are also targeting larger international customers. Secondly, we have to control our own growth and not assume we will find financing as and when necessary. We are therefore taking a prudent view of our cash flows and are giving priority to projects with a high return.

 

*Possibility of Default on Loan Covenants*. During fiscal 2008 we entered into several loan facilities and borrowed an aggregate of $30,000. To date, we have complied with the loan covenants and our projections indicate we will continue to do so. However, if we are unable to continue to satisfy the conditions of one or more of these loan            facilities, this could be deemed an event of default, which could result in the lenders accelerating payment of the loans.  There is no guarantee we would be able to obtain financing to repay the loans in the event the loans are accelerated.

 

*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.

 

*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.

 

21

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**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 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.

 

22

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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.**     **Properties**

                 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 2010.  The monthly rent is $14,609. Themonthly rent for ouroffice in Salt Lake City is$3,854. This lease terminatesinFebruary 2009.            We are currently negotiating the lease of a smaller office in the same building when our lease expires in February 2009. It is anticipated that the term of the new lease will be two years.Monthly rent is expected to be approximately$1,910.Our office lease in Aktau expiredin December 2008 and we have renewed this lease for            2009.  Our current rental rateisabout $27,000 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 eighteen apartmentsisabout $34,000 per month.

**     **

                 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 discussed herein, throughour subsidiary Balykshi, weowna five hectare parcel of real property.Thisproperty forms the basis forourmarine 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 inthe roughly $33,700figureddisclosed as our investment to date in the marine base facility.

                    In connection with the Loan Agreement between Balykshi and EBRD, during the fourth quarter CSI, and our subsidiaries Caspian Real Estate and Balykshi entered            into a Mortgage Agreement, dated August 15, 2008, with EBRD mortgaging this parcel of real property to secure the $32,000 EBRD loan when it funds.

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

 

23

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**Item 3.      Legal Proceedings**             

                  We may, from time to time, be a party to ordinary routine litigation incidental to our business.  We are not currently aware of any pending, or threatened litigation or proceedings            that could have a material adverse effect on our results of operations, cash flows or financial condition.

 

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

     

                  No matters were submitted to a vote of security holders during thequarter endedSeptember 30, 2008.

 

**PART II**

 

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

 

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, 2008 and 2007. The published high and low bid quotations were furnished to us by Pink OTC Markets Inc. These quotations represent prices between dealers and do            not include retail markup, markdown or commissions. They do not represent actual transactions.

 

|                                 |   | High   |   | Low    |
|--------------------------------------|--------|--------|--------|--------|
|                                 |   |   |   |   |
| Fiscal year ended September 30, 2008 |   |   |   |   |
|                                 |   |   |   |   |
| Fourth quarter                       |   | $ 2.20 |   | $ 1.17 |
| Third quarter                        |   | $ 2.50 |   | $ 1.90 |
| Second quarter                       |   | $ 2.75 |   | $ 2.20 |
| First quarter                        |   | $ 3.25 |   | $ 2.30 |
|                                 |   |   |   |   |
| 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 |

 

**Record Holders**

 

As of January 5, 2009 we had approximately 200 shareholders of record holding 51,135,042 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.

 

24

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**Securities for Issuance Under Equity Compensation Plans**

 

As of September 30, 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 securities

to be issued upon

exercise of

outstanding options,

warrants and rights

 

(a) | Weighted-average

exercise price of

outstanding

options, warrants

and rights

 

(b) | Number of securities

remaining available for future issuance under equity compensation plans (excluding securities 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 |  

 

692,333                                                                                      |  

 

$4.00                                                                        |  

 

-0-                                                                                                                                |
|  

Total                                              |  

1,692,333                                                                                            |  

$3.41                                                                                |  

-0-                                                                                                                                        |

 

Our board of directors adopted and our shareholders approved the EMPS Corporation initial 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                         |

 

25

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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 July 2007. 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.

 

In May 2008 our board of directors adopted 2008 Equity Incentive Plan (“Compensation Plan”). The goal of the Compensation Plan is to enhance the interests of the Company and its shareholders. It encourages officers, directors and key employees, upon whose judgment, initiative and effort the Company is largely dependent for the successful conduct of its business, to acquire            and retain a proprietary interest in the Company by ownership of its equity securities.

 

Pursuant to the Compensation Plan, restricted stock grants were made to selected officers in consideration of forfeiture of all stock options granted under employment agreements to which they may have been entitled, whether issued or not, vested or not vested as of March 31, 2008. As a result, 469,772 stock options were forfeited and restricted stock grants totaling 156,591 shares,            were awarded as consideration for the forfeited options. We also awarded the same selected officers and directors additional restricted stock grants totaling 164,167 shares in connection with their employment agreements. We also awarded 356,167 shares of restricted stock grants pursuant to the Compensation Plan to a number of employees. All such restricted stock grants vest, 50% on the grant date, 25% on the first anniversary of the grant date, and 25% on the second anniversary of            the grant date. The stock granted is also subject to a six month holding period during which the shares may not be sold.

 

In September 2008 33,944 shares of non-vested restricted stock grants were forfeited due to the resignation of one of the selected officers.

 

26

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**Recent Sales of Unregistered Securities**

 

Except as disclosed in the Current Report of the Company on Form 8-K filed on September 9, 2008, during the quarter ended September 30, 2008 we sold no securities which were not registered under the Securities Act of 1933.              

 

**Issuer Repurchases**

 

We did not make any repurchases of our equity securities during the year ended September 30, 2008.

 

**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, 2008, 2007 and 2006, the nine months ended September 30, 2005 and the year ended December 31, 2004. 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 year ended**

**December 31,** |        |
|-------------------------------------------------|----------------------------------------------------|--------|--------------------------------------------------|--------|------------------------------------------|--------|
|                                            | **2008**                                           |   | **2007**                                         |   | **2006**                                 |   | **2005** |   | **2004** |  |
| **Consolidated Statements of Operations Data:** |                                               |   |                                             |   |                                     |   |   |   |   |  |
| Vessel revenues                                 | $36,441                                       |   | $23,685                                          |   | $14,444                             |   | $6,026 |   | $7,441  |  |
| Geophysical services revenue                    | 34,739                                        |   | 38,896                                           |   | 27,350                              |   | 11,778 |   | 6,161  |  |
| Product sales                                   | 1,446                                         |   | 1,556                                            |   | 1,249                               |   | 858 |   | 960  |  |
| Total revenues                                  | 72,626                                        |   | 64,137                                           |   | 43,043                              |   | 18,662 |   | 14,562  |  |
| Vessel operating costs                          | 26,409                                        |   | 18,509                                           |   | 13,366                              |   | 4,258 |   | 5,867  |  |
| Geophysical costs of revenues                   | 16,825                                        |   | 17,228                                           |   | 13,982                              |   | 4,182 |   | 2,661  |  |
| Cost of product sold                            | 790                                           |   | 898                                              |   | 647                                 |   | 299 |   | 327  |  |
| Depreciation                                    | 9,443                                         |   | 6,619                                            |   | 3,330                               |   | 1,320 |   | 1,055  |  |
| General and administrative                      | 19,587                                        |   | 11,577                                           |   | 10,162                              |   | 5,520 |   | 3,577  |  |
| Total operating expenses                        | 73,054                                        |   | 54,831                                           |   | 41,487                              |   | 15,579 |   | 13,487  |  |
| Income from operations                          | (428)                                              |   | 9,306                                            |   | 1,556                               |   | 3,083 |   | 1,075  |  |
| Net income (loss)                               | 1,078                                         |   | 9,465                                            |   | (1,700)                                  |   | 1,351 |   | (195) |  |
| Basic income (loss) per common share            | 0.02                                          |   | 0.22                                             |   | (0.04)                                   |   | 0.04 |   | (0.01) |  |
|                                                 |
| Diluted income/(loss) per common share          | 0.02                                          |   | 0.22                                             |   | (0.04)                                   |   | 0.04 |   | 0.00  |  |
|                                                 |

 

27

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|                                 | **As of September 30,** |        |
|--------------------------------------|-------------------------|--------|
|                                 | **2008**                |   | **2007** |   | **2006** |   | **2005** |   | **2004** |  |
| **Balance Sheet Data:**              |                    |   |   |   |   |   |   |   |   |  |
|                                 |                    |   |   |   |   |   |   |   |   |  |
| Total current assets                 | $41,136                 |   | $37,986 |   |  

$23,950 |   | $12,536 |   | $7,297 |  |
| Vessels, equipment and property, net | 82,409                  |   | 49,347 |   | 33,064   |   | 20,711 |   | 12,490 |  |
|                                      |
| Total assets                         | 130,628                 |   | 92,295 |   | 61,650   |   | 38,058 |   | 25,198 |  |
| Total current liabilities            | 22,711                  |   | 11,528 |   | 17,347   |   | 8,146 |   | 14,230 |  |
| Total liabilities                    | 49,768                  |   | 13,371 |   | 18,743   |   | 8,146 |   | 18,648 |  |
| Total shareholders’ equity     | 78,477                  |   | 75,191 |   | 39,616   |   | 27,470 |   | 4,394 |  |

 

**Item 7.     Management’s Discussion and Analysis of Financial Condition and******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, 2008 and 2007. 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 are presented in thousands unless stated otherwise.

 

**2008 Summary**

 

In fiscal 2008 we experienced a 13% increase in total revenue as compared to the year ended September 30, 2007. Growth was slower than in previous years as we expected 2008 to be a year of consolidation. During the year we concentrated our efforts on the development of our marine base which will, in turn, allow us to extend the range of services we can offer. We anticipate the marine            base will, over time, stimulate significant growth. Our loss from operations during fiscal 2008 was $428, compared to income of $9,306 in the previous year. We realized a net income of $1,078 or $0.02 per share compared to a net income of $9,465 or $0.22 per share during 2007. Revenues and results improved in our vessels division but declined in our geophysical division. These trends were expected.

 

The vessels division has improved its performance steadily and was profitable during fiscal 2008. We had additional vessels for a full year and all were under charter. Towards the end of the year, we acquired an important new project with CMOC / Shell for development of the Oman Pearls field. This project will continue into 2009.

 

The geophysical division was unlikely to replicate the outstanding results achieved in 2007. The 2007 results were helped by an unusually strong first quarter, a period when winter weather normally makes it unfeasible to start new projects. During the first quarter 2007, we were able to operate continually. The pattern of fragmented activity returned in the first quarter 2008. There            were also a number of operational and commercial difficulties which occurred in the fourth quarter and caused losses which are discussed in more detail below.

 

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We continue with development of the marine base in Bautino Bay. Construction commenced in the first fiscal quarter 2008. We expect the initial phase of the marine base facilities, including dredging, breakwater, wharf front and general site area to be partially functional by April 2009, with final completion of the base occurring by December 2010. Anticipated cost to            construct the marine base is approximately $71,810. We plan to achieve this funding through a combination of debt and equity financing. In June 2007, our subsidiary Balykshi entered into a series of agreements with EBRD under which EBRD has agreed to provide $32,000 of debt financing and make an equity investment in the marine base in the amount of $10,000 in exchange for a 22% equity interest in Balykshi. The remaining $29,810 of construction costs is to be contributed by the            Company to Balykshi. Funding of the EBRD debt and equity financing is contingent on the Company contributing its portion of the construction costs. By September 30, 2008, the Company had contributed $33,121 (more than the full amount required to be contributed) and no amounts had been drawn on the EBRD debt. In November 2008, EBRD satisfied its full equity investment of $10,000 in exchange for a 22% interest in Balykshi. These funds will be used for ongoing marine base            development.

 

During the years ended September 30, 2008 and 2007, the Company incurred construction costs of $23,619 and $8,011, respectively.

 

|   | *Comparison of the fiscal year ended September 30, 2008 and September 30, 2007* |
|--------|---------------------------------------------------------------------------------|

 

In fiscal 2008, we operated three business segments: Vessel Operations, Geophysical Services and Infrastructure. The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements.

 

|                           | For the YearEnded September 30,                                            |
|--------------------------------|----------------------------------------------------------------------------|
|                           | 2008                                                                       | 2007 | % change |
| VESSEL OPERATIONS              |                                                                       |   |   |
| Operating Revenue              | $  36,988                                                   | $31,881  | 16% |
| Pretax Operating Income/(Loss) | 397                                                                   | (732) | -154% |
|                           |                                                                       |   |   |
| GEOPHYSICAL SERVICES           |                                                                       |   |   |
| Operating Revenue              | $  34,739                                                   | $39,286  | -12% |
| Pretax Operating Income/(Loss) | 2,385                                                                 | 13,878  | -83% |
|                           |                                                                       |   |   |
| INFRASTRUCTURE                 |                                                                       |   |   |
| Operating Revenue/(Loss)       | $    1,512                                        | $  1,588  | -5% |
| Pretax Operating Income/(Loss) | (603)                                                                      | 2,529  | 124% |
|                           |                                                                       |   |   |
| CORPORATE ADMINISTRATION       |                                                                       |   |   |
| Operating Revenue              | $           -  | $         -  | n/a |
| Pretax Operating Income/(Loss) | (855)                                                                      | (778) | -10% |

 

29

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**Revenue**

 

Total revenue for the fiscal year ended September 30, 2008 was $72,626 compared to $64,137 for 2007. This increase was generated by the vessels division, whereas there was a small decline in geophysical revenues.

 

Vessel revenue of $36,441 in fiscal 2008 was 54% higher than in 2007, due to improved utilization of our fleet, more vessels and increased charter rates. Revenue may have been even greater during the year, but we lost one month’s worth of revenue from six vessels as the vessels were not generating revenue while they were being mobilized to fulfill the CMOC/Shell contract. This            lost revenue, however, was partially offset by lump sum payments made upon the signing and start of the contract. The majority of the CMOC/Shell project will take place in 2009, so we anticipate continued good revenues in fiscal 2009.

 

In fiscal 2008 geophysical service revenue was $34,739 or 11% lower than in 2007. We expected activity to be slightly lower as 2007 was an unusually good year which would be difficult to replicate. Unlike vessels, our geophysical services client base is more dependent on local companies. As a result of the credit crunch and economic slowing, many local companies have had difficulty            raising financing to fund exploration. This has depressed their level of activity.

 

Infrastructure revenue in fiscal 2008 of $1,446 decreased 7% compared to 2007. This relates to the sale of desalinized water in the port of Bautino and is a relatively insignificant figure in our results.

 

The corporate administration segment of our business refers to some local administration and the administration of our affairs in the United States. It includes marketing services provided by that segment to the other segments of our operations. Corporate administration generated a pretax operating loss of $855 during the fiscal year ended September 30, 2008 compared to a pretax            operating loss of $778 during 2007.

 

|   | *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 decrease during our first fiscal quarter and are at their 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 2008 fiscal year, as compared to 2007. This increase was largely attributable to improved vessel utilization rates, an increased number of vessels in our fleet and improving day rates. We mobilized one additional vessel to the Caspian Sea during fiscal            2008. During the third quarter 2008 we also acquired a contract to perform work for CMOC/Shell working in the Oman Pearls field. The contract is administered by Caspian Services Group and the seismic work has been sub-contracted to Veritas-Caspian, our joint venture with CGG Veritas. This contract is not based on day rates but on the number of kilometers acquired. The majority of this project will be undertaken in 2009 and will utilize six vessels. Therefore, we             expect the trend of full utilization and increasing revenue to continue in the upcoming year.

 

30

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Vessel operating costs of $26,409 during the fiscal year ended September 30, 2008 were 43% higher than in 2007, although strong revenues make the overall margin higher. The main causes for increased operating expense were:

 

|   | • | Wages – high demand for crews means we have to compete for employees. |
|--------|--------|-----------------------------------------------------------------------------|

|   | • | Fuel – cost per liter increased by over 200% during the 2008 fiscal year. Under our contract with CMOC/Shell we are required to provide fuel, which was purchased in quarter four, when fuel costs were highest. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | • | Insurance – two new vessels accounted for $100 and we took on additional coverage for all vessels. |
|--------|--------|----------------------------------------------------------------------------------------------------------|

|   | • | Vessel rental – weather conditions allowed for a longer work season in fiscal 2008 as compared to fiscal 2007, as a result we rented vessels for a longer period than in fiscal 2007 and also had to pay the winter standby rate. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | • | Repairs – we incurred high costs for the delayed repair of one of our vessels, though these were offset by insurance proceeds, shown in Other Income. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | • | Port fees – we incurred additional cost as we mobilized our vessels for the CMOC/Shell project. |
|--------|--------|-------------------------------------------------------------------------------------------------------|

 

Some of our vessel operating costs are attributable to the vessels we operate under our agreement with Actamarine, formerly, Rederij Waterweg. Pursuant to that agreement we pay a day rate to Actamarine for the vessels they own, that we operate. Currently, six of the vessels in our fleet are owned by Actamarine. While our margins are smaller on the Actamarine vessels, we are willing to            operate these vessels at a reduced profit margin because it allows us to access to additional Actamarine shallow draft vessels when demand requires, which allows us to quickly meet increased demand without having to incur 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.

 

In 2008 we purchased and mobilized to the Caspian Sea a dedicated shallow water cable laying barge. This vessel is being contracted out to Saipem as part of their work commitment on the Kashagan field.

 

We expect that vessel operating costs will continue to increase in fiscal 2009 because of general inflation in Kazakhstan and the fact that we are now paying for fuel on the CMOC/Shell contract. We expect that, with the contracts now in place for fiscal 2009, we will also realize higher revenue compared to fiscal 2008.

 

*Geophysical Services*

 

Geophysical revenues decreased by 11% to $34,739 compared to the 2007 fiscal year. To a great extent this was expected, as we had unusually high utilization rates in 2007. We also found our customer base being constrained by difficulties in obtaining project financing as a result of economic slowdowns and the global

 

31

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credit crisis. We also realized lower income from operations because TatArka had to make an exceptional bad debt write-off of $4,000 for one customer who appears to have ceased operations. We have retained title to the data acquired and it has been valued at cost, so the net effect is that the contract is shown as breakeven and we have written off the profit of $1,700 taken earlier in the year. It is our            intention to either process or market the data ourselves, hopefully recovering the profit.

 

In addition we reviewed our total provision in the light of existing economic conditions. We provided $1,000 of general provision for doubtful accounts. We believe that all debts shown will be paid but, in view of the difficult credit climate which has been affecting our customers, we feel it is prudent to recognize the additional risk attached to these debts.

 

TatArka’s operating costs decreased by approximately 5% but revenue, margins and profits, were also lower.

 

Kazmorgeophysica had a disappointing year with revenues down by 37% to $6,687. This result was partially caused by one contract which had severe operational difficulties. Kazmorgeophysica had chartered a vessel for work in a transition zone on the Caspian Sea, but bad weather made it too difficult to operate in the shallow waters of this zone. Kasmorgeophysica was also using            experimental new equipment which did not perform as expected. As a result, the contract took longer than expected to complete, other work could not be taken on and an expected contract profit became a loss. Despite the operational difficulties, Kazmorgeophysica completed the project, complied with all required standards and its employees acquired valuable experience. Owners of licenses in neighboring areas have expressed an interest in working with Kazmorgeophysica in the            future.

 

Despite operational difficulties and the harsh credit climate, we anticipate exploration activities in the Caspian Sea region to increase in fiscal 2009. Costs of providing geophysical services should increase in line with inflation. 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 2008, revenue from water desalinization decreased 7% compared to fiscal 2007. Lower operating costs and depreciation resulted in smaller loss than last year. This is a small operation and is relatively insignificant to our overall result.

 

*Corporate Administration*

 

During the fiscal year ended September 30, 2008, net loss from corporate administration was $855 compared to $778 during the fiscal year ended September 30, 2007.

 

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**Consolidated Results**

 

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

 

General and administrative expenses increased $8,010, or 69% during fiscal 2008 compared to the fiscal 2007. A contributing factor to this increase was that we awarded more equity incentive grants during fiscal 2008 as we expanded the number of employees to whom grants were awarded. In addition, salary rates were increased in the first quarter 2008. Our infrastructure is now            substantially in place for the expected increase in revenues. Other factors which contributed to the increase in general and administrative expense were the write-off of TatArka’s bad debt and general provision for accounts receivable.

 

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

 

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

 

Interest expense increased to $460 during fiscal 2008 compared to $130 during fiscal 2007. This was primarily due to our entering two convertible loan facilities for an aggregate of $30,000. We expect interest expense will increase in future periods as we continue using funds under the loan facilities.

 

*Other Income*

 

Our seismic companies were able to rent equipment to third parties and this is the major component of other income. In fiscal 2007, the sale of our interest in Bautino Development Company generated $3,000 of other income but this was a one-time event and explains a large part of the drop in profit before tax.

 

**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 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.

 

33

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The following table provides an overview of our cash flow during the fiscal years ended September 30, 2008 and September 30, 2007:

 

|                                      |   | For the fiscal years ended September 30,                         |
|-------------------------------------------|--------|------------------------------------------------------------------|
|                                      |   | 2008                                                             |   | 2007 |
|                                      |   |                                                             |   |   |
| Net cash provided by operating activities |   | $         529  |   | $        6,723  |
| Net cash used in investing activities     |   | (42,969)                                                         |   | (18,169) |
| Net cash provided by financing activities |   | 31,407                                                      |   | 24,734  |
| Effect of exchange rate changes on cash   |   | 24                                                          |   | (676) |
|                                      |   |                                                             |   |   |
| Net change in cash                        |   | $  (11,009)                                            |   | $      12,612  |

 

In fiscal 2008 net cash provided by operating activities was $529, compared to net cash provided by operating activities of $6,723 in fiscal 2007. The lower cash flow from operating activities is the result of decreased net income. There were also increases in receivables linked to revenue growth in 2008.

 

In fiscal 2008 we invested $41,298 in the acquisition of vessels and equipment, land and construction of the marine base, which required additional external financing. These purchases were partially funded by loans from unrelated parties amounting to $31,593.

 

**Summary of Material Contractual Commitments**

 

| (Stated in thousands)                                  |           |         |         |                                                |                                   |
|--------------------------------------------------------|----------------|--------------|--------------|-----------------------------------------------------|----------------------------------------|
|                                                   | Payment Period |
| Contractual Commitments                                |           | Less than    |         |                                                | After                                  |
|                                                   | Total          | 1 Year       | 2-3 Years    | 4-5 Years                                           | 5 Years                                |
| Long-term Debt                                         | $ 3,987   | $ 2,288 | $ 1,699 | $         - | $      - |
| Loans from Petrolinvest                                | 5,000          | 5,000        | -            | -                                                   | -                                      |
| Loans from Altima Central Asia                         | 15,492         | -            | 15,492       | -                                                   | -                                      |
| Loans from Great Circle                                | 7,571          | -            | -            | 7,571                                               | -                                      |
| Loan from related party                                | 600            | 600          | -            | -                                                   | -                                      |
| Operating Leases – Vessels                       | 1,894          | 1,894        | -            | -                                                   | -                                      |
| Operating Leases – Other than  vessels | 3,700          | 3,700        | -            | -                                                   | -                                      |
| Total                                                  | $38,244        | $13,482      | $17,191      | $7,571                                              | $     -       |
|                                                        |                |              |              |                                                     |                                        |  |  |  |

**Financing**

 

During the 2007 fiscal year, Bauta borrowed $26 from a local bank and repaid $11. The notes were collateralized by equipment and inventory, bore interest at 18% and were due by December 2007. During the first quarter of 2008 fiscal year Bauta repaid the remaining $15.

 

34

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In the same period, Kazmorgeophsica borrowed $223 from Caspian Geo-Consulting Services LLP, a company related through common ownership. The notes bore interest at 0% and were fully repaid during 2008. During the fourth quarter of 2008 Kazmorgeophysica borrowed $3,000 from a local bank. The note is collateralized by a corporate guarantee issued by TatArka and seismic equipment. The            note bears interest at 6% per annum plus three-month LIBOR at the date of interest calculation. At September 30, 2008 the annual interest rate was equal to 9.21%. The note is due in July 2010.

 

In the 2006 fiscal year, TatArka borrowed $2,580 from two local banks. The notes were collateralized by equipment and bore interest at 14%. During the 2008 fiscal year TatArka repaid the remaining balance of $442. In 2008, TatArka borrowed an additional $1,000 from a local bank. The note is collateralized by a corporate guarantee issued by Kazmorgeophysica and bears interest at 6% per            annum plus three-month LIBOR at the date of interest calculation. At September 30, 2008 the annual interest rate was equal to 9.21%. The note is due July 2009.

 

During 2008, we borrowed $5,000 from Petrolinvest S.A. The loan had a conversion feature that allowed the Lender to convert the loan amount to common stock of the Company at an issue price of $2.75 per share. Because the conversion price was equal to or greater than the market price of the Company’s common stock on the loan date, no beneficial conversion feature was recorded.            The loan bore interest at the three-month LIBOR rate plus 2% per annum. At September 30, 2008 the annual interest rate was equal to 5.21%. Although the loan matured in July 2008, Petrolinvest agreed to postpone repayment of the loan. The loan was fully repaid in November 2008.

 

In 2008, we also borrowed $15,000 from Altima Central Asia (Master) Fund Ltd. The loan bears interest at 13% and is due in June 2011. The loan has a conversion feature that allows the Lender to convert the loan to common stock of the Company at a price of $2.30 per share. Because the conversion price was equal to or greater than the market price of the Company’s common stock on            the loan date, no beneficial conversion feature was recorded.

 

In 2008, we entered into a loan agreement with Great Circle Energy Services LLC. to borrow $15,000. As of September 30, 2008 $7,500 of the loan had funded. The residual balance of $7,500 funded in October and November 2008. The loan has a conversion feature that allows the Lender to convert it to common stock of the Company at an issue price of $2.30 per share. Because the conversion            price was equal to or greater than the market price of the Company’s common stock on the loan date, no beneficial conversion feature was recorded. The loan bears interest at 13% per annum and is due in December 2011.

 

During the 2008 fiscal year, we borrowed $600 from an individual related to an officer of the Company. The loan bears interest at 13.38% and is due in September 2008. Although the loan matured in September 2008, the lender has indicated that he agrees to postpone the repayment of the loan.

 

35

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**Off-Balance Sheet Financing Arrangements**

 

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

 

**New Accounting Standards**

 

In May 2008, the FASB issued FAS 163, Accounting for Financial Guarantee Insurance Contracts. FAS 163 clarifies how FAS 60, Accounting and Reporting by Insurance Enterprises, applies to financial guarantee insurance contracts issued by insurance enterprises, including the recognition and measurement of premium revenue and claim liabilities. It also requires expanded disclosures about            financial guarantee insurance contracts. FAS 163 is effective on January 1, 2009, except for disclosures about the insurance enterprise’s risk-management activities, which are effective on July 1, 2008. The Company does not expect the adoption of FAS 163 to have a material impact on its consolidated financial statements.

 

In May 2008, the FASB issued Staff Position (FSP) No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement). This Statement is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008, and will require issuers of convertible debt that can be settled            in cash to record the additional expense incurred. Entities will also have to account for liabilities and the equity parts of convertible debt instruments separately. The FSP applies to convertible debt instruments that can be settled in cash, unless the embedded conversion option has to be accounted for separately as a derivative under Statement of Financial Accounting Standards (SFAS) No. 133 ( SFAS No. 133 ), Accounting for Derivative Instruments and Hedging Activities. The            Company is currently evaluating the impact of adopting this standard.

 

In April 2008, FASB issued FASB Staff Position SFAS No. 142-3, Determination of the Useful Life of Intangible Assets (FSP SFAS No. 142-3). FSP SFAS No. 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognizable intangible asset under SFAS No. 142, Goodwill and Other            Intangible Assets (SFAS No. 142). The intent of FSP SFAS No. 142-3 is to improve the consistency between the useful life of a recognizable intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R), Business Combinations and other U.S. generally accepted accounting principles. FSP SFAS No. 142-3 is effective for financial statements issued for fiscal years beginning after            December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The Company does not anticipate that the adoption of FSP SFAS No. 142-3 will have an impact on its financial position or results of operations.

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133, which changes the disclosure requirements for derivative instruments and hedging activities. Enhanced disclosures are required to provide information about (a) how and why an entity uses derivative instruments, (b) how derivative            instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This Statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company does not expect the adoption of SFAS 161 to have a            material impact on its results of operations or financial condition.

 

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In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS 141(R)), which replaces SFAS 141, Business Combinations. SFAS 141(R) retains the underlying concepts of SFAS 141 in that all business combinations are still required to be accounted for at fair value under the acquisition method of accounting, but SFAS 141(R) changed the method of applying            the acquisition method in a number of significant aspects. Acquisition costs will generally be expensed as incurred; noncontrolling interests will be valued at fair value at the acquisition date; in-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date; restructuring costs associated with a business combination will generally be expensed subsequent to the acquisition date; and changes in deferred tax asset            valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense. SFAS 141(R) is effective on a prospective basis for all business combinations for which the acquisition date is on or after the beginning of the first annual period subsequent to December 15, 2008, with the exception of the accounting for valuation allowances on deferred taxes and acquired tax contingencies. SFAS 141(R) amends SFAS 109 such that adjustments            made to valuation allowances on deferred taxes and acquired tax contingencies associated with acquisitions that closed prior to the effective date of SFAS 141(R) would also apply the provisions of SFAS 141(R). Early adoption is not permitted. The Company does not expect that it will have any immediate effect on its financial statements, however, the revised standard will govern the accounting for any future business combinations that the Company may enter into.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (SFAS 160). This statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, with earlier adoption prohibited. This statement requires the recognition of a            noncontrolling interest (minority interest) as equity in the consolidated financial statements and separate from the parent’s equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. It also amends certain of ARB No. 51’s consolidation procedures for consistency with the requirements of SFAS 141(R). This statement also includes expanded disclosure requirements            regarding the interests of the parent and its noncontrolling interest. The Company is currently evaluating this new statement. Based on the current consolidated financial statements, if SFAS 160 were effective, the minority interest in the consolidated balance sheet would be presented as noncontrolling interest in Stockholders’ Equity, the minority interest in loss/(gain) would be included in consolidated net loss in the consolidated statement of operations, and the footnotes            would include expanded disclosure regarding the ownership interests of the Company and of the noncontrolling interests.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company does            not expect the adoption of SFAS No. 159 to have a material impact on its consolidated financial statements.

 

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In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007,            and interim periods within those fiscal years. In February 2008, the FASB issued FASB Staff Position (FSP FIN) No. 157-2 which extended the effective date for certain nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008. The adoption of the portions of SFAS No. 157 that were not postponed by (FSP FIN) No. 157-2 did not have a material impact on its consolidated financial statements. The Company is currently evaluating the effect of            implementation of SFAS 157.

 

**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.

 

***Revenue Recognition***— Vessel revenues are usually 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. In 2008, the Company commenced a major contract with CMOC / Shell where revenue is derived from kilometers of seismic data acquired, rather than from a daily rate. Revenue under this contract is recognized when services are actually performed.

 

Geophysical service revenue is recognized when services are rendered, accepted by the customer and collectibility is reasonably assured. Direct costs are charged to each contract as incurred along with 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.

 

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

 

***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. Credit risks associated with these customers are considered minimal. Dealings with smaller, local companies, particularly            with the current difficulties in equity and credit markets, pose the greatest risks. For new geophysical services customers, the Company typically requires an advance payment and retains the seismic data generated from these services until payment is made in full. The Company routinely reviews its accounts receivable balances and makes provisions for doubtful accounts as necessary. Accounts are reviewed on a case by case basis and losses are recognized in the period if the Company            determines it is likely that receivables will not be fully collected. The Company also may provide a general provision for accounts receivables based on existing economic conditions.

 

***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, 2008, 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 assets and liabilities and their respective tax bases and attributable to operating loss carry forwards. 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 Kazakhstan income tax regulations.

 

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 in question for currency law violations, as well as fines of generally 100% of the unpaid taxes. 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. No interest or penalties have been accrued as a result of any tax positions taken. In the event interest or penalties are assessed, the Company will include these amounts related to unrecognized tax benefits in income tax expense.

 

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A deferred tax liability is not recognized for the following types of temporary differences unless it becomes apparent that those temporary differences will reverse in the foreseeable future:

(a) An excess of the amount for financial reporting over the tax basis of an investment in a foreign subsidiary or a foreign corporate joint venture, that is essentially permanent in duration

(b) Undistributed earnings of a domestic subsidiary or a domestic corporate joint venture that is essentially permanent in duration

(c) “Bad debt reserves” for tax purposes of U.S. savings and loan associations (and other “qualified” thrift lenders)

 

***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 until the next drydocking, generally 24 months. Drydocking            costs are comprised of painting the vessels, hulls and sides, recoating cargo and fuel tanks, and performing other engine and equipment maintenance activities to bring the vessels into compliance with classification standards.

 

|   | ***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. Quantitative and Qualitative 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.

 

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**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.

 

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

 

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

 

**Item 9A(T). Controls and Procedures**

 

*Evaluation of Disclosure Controls and Procedures*

 

We have established disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) to ensure that material information relating to the Company is made known to the officers who certify our financial reports and to other members of senior management and our board of directors. These disclosure            controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and forms. Under the supervision and with the participation of management, including our principal executive officer and principal financial officer, an evaluation of the            effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2008 was completed, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this evaluation, our principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are functioning            effectively.

 

*Management’s Report on Internal Control over Financial Reporting*

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed under the supervision of our principal executive officer and principal financial officer to provide reasonable assurance regarding the reliability of financial reporting and preparation of our financial            statements for external purposes in accordance with generally accepted accounting principles.

 

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Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and, even when determined to be effective, can only provide reasonable, not absolute, assurance with respect to financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to risk that controls may become            inadequate as a result of changes in conditions or deterioration in the degree of compliance.

 

At September 30, 2008, management assessed the effectiveness of our internal control over financial reporting based on the COSO framework. Based on the assessment, our management has concluded that our internal control over financial reporting was effective as of September 30, 2008 and provides reasonable assurance regarding the reliability of financial reporting and the preparation            of financial statements for external reporting purposes in accordance with generally accepted accounting principles.

 

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only management’s report in this annual            report.

 

*Changes in Internal Control over Financial Reporting*

 

There was no change in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is 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             |   | Age    |   | Positions with the Company            |   | Director Since |
|------------------|--------|--------|--------|---------------------------------------|--------|----------------|
|             |   |   |   |                                  |   |           |
| Kerry Doyle      |   | 61     |   | Chief Executive Officer and President |   |           |
| John Baile       |   | 54     |   | Chief Financial Officer               |   |           |
| John Scott       |   | 40     |   | Chief Operating Officer               |   |           |
| Mirgali Kunayev  |   | 51     |   | Chairman of the Board of Directors    |   | July 2002      |
| Paul Rapello     |   | 43     |   | Director                              |   | November 2008  |
| Paul Roberts     |   | 52     |   | Director                              |   | July 2002      |
| Valery Tolkachev |   | 41     |   | Director                              |   | January 2005   |

 

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

 

**Kerry Doyle, Chief Executive Officer and President**. Mr. Doyle has served as the Chief Executive Officer and President of the Company since November 2008. From 2004 to November 2008 Mr. Doyle has served as the President and CEO of Veritas-Caspian, the Company’s joint venture with CGG Veritas (formerly Veritas DGC Ltd.). As the President and            CEO of Veritas-Caspian, Mr. Doyle has been responsible for the day-to-day operations of Veritas-Caspian, particularly the development and growth of its seismic data acquisition activities. From 2003-2004 Mr. Doyle served as the Business Development Manager for Central Asia for Veritas DGC Ltd. While at Veritas DGC Ltd., Mr. Doyle successfully negotiated an exclusive agreement with the Ministry of Energy and Mineral Resources of the Republic of Kazakhstan for the acquisition            of non-exclusive seismic data over the entire open acreage of the Kazakh sector of the Caspian Sea. From 2000-2003 Mr. Doyle was employed with WesternGeco as the Country Manager for Kazakhstan, where he oversaw all of WesternGeco’s geophysical operations and administration within Kazakhstan. Mr. Doyle has over 35 years experience in the geophysical services industry. He holds a 1st Class Certificate of Competency marine engineer (Chief Engineer).            Mr. Doyle is a member of the European Association of Exploration Geophysicists and an Elected Fellow of the Royal Geographical Society. Mr. Doyle is not a nominee or director of any other SEC registrant.

 

**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. Mr. Baile was based in the Philippines where he was responsible for Dogi International factories in the Philippines, China and Thailand. Prior to 2000, Mr. Baile worked            in Portugal, France and Morocco. He has a degree in French andSpanish 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 registrant.

 

**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 a 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 registrant.

 

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**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., during which we 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 registrant.

 

**Paul Rapello, Director.**Mr. Rapello is a partner in Great Circle Capital LLC, an emerging market private equity investment firm specializing in infrastructure, transportation, and related services businesses. Mr. Rapello co-found Great Circle Capital in 2002. Mr. Rapello received a B.A. degree in Economics from Georgetown University in 1987.            He earned an M.B.A. with an emphasis in Finance from Columbia University in 1990. Mr. Rapello is not a nominee or director of any other SEC registrant.  

 

**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            Southeast and Central Asia, China, West and Central Africa, and Australia. He has been involved in the Company since its 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 registrant.

 

**Valery Tolkachev, Director**. Since August, 2008 Mr. Tolkachev has been employed with Russky Slaviansky Bank in Moscow, Russia, where he serves as the Deputy Chairman. From 1991 to 2008, Mr. Tolkachev served in various positions with various employers including UniCreditAton, 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 a director of BMB Munai, Inc., and Bekem Metals, Inc., both SEC registrants.

 

**Family Relationships**

 

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

 

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**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. As 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 services are only            provided by our independent accountants to the extent permitted by law. Pre-approval is required unless a “de minimus” exception is met. To qualify for the “de minimus” exception, the aggregate amount of all such non-audit services provided to the Company must constitute not more than 5% of the total amount of revenues paid by us to our independent auditors during the fiscal year in which the non-audit services are provided; such services were not recognized            by us at the time of the engagement to be non-audit services; and the non-audit services are promptly brought to the attention of the board and approved prior to the completion of the audit by the board or by one or more members of the board to whom authority to grant such approval has been delegated.

 

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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 participate in the            consideration of 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 will 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 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 appointment of 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            Corporate 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. Because of the small size of the Company and the limited need to seek additional directors, there is no assurance that all            shareholder proposed candidates will be fully considered, that all candidates will be considered equally, or that the proponent of any candidate or the proposed candidate will be contacted by the Company or the board, and no undertaking to do so is implied by the willingness to consider candidates proposed by shareholders.

 

*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.

 

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

 

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

 

Our directors and executive officers and persons who are beneficial owners of more than 10% of our common stock are required to file reports of their holdings and transactions in our common stock with the Securities and Exchange Commission and furnish the Company with such reports. Based solely upon the review of these filings, or upon written representations from these persons, we            believe that, during the fiscal year ended September 30, 2008, all our directors, executive officers, and 10% beneficial owners complied with the applicable Section 16(a) filing requirements, except that John Baile, our Chief Financial Officer and Mirgali Kunayev, a director, each filed Form 4s for one transaction, one day late, John Scott, our Chief Operating Officer filed Form 4s for two transactions, each one day late, and Great Circle Energy Services and Altima Central Asia            Master Fund Ltd., each filed one Form 3 late.

 

**Code of Ethics**

 

We have adopted a Code of Ethics (the “Code”) 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.

 

**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, rather our Chief Executive Officer (“CEO”) evaluates officer and employee compensation issues subject to the approval of our board of directors. Our CEO makes recommendations to the board of directors as to employee benefit programs and officer and employee compensation. Historically, our CEO has not made recommendations to            the board of directors regarding his own compensation, although we have no policy prohibiting the CEO from doing so. Our board of directors may seek input from the CEO as to his compensation, but CEO compensation must be approved by a majority of our board of directors.

 

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*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 determine subjectively, on a case-by-case basis, the appropriate level and mix of the various compensation components. Similarly, we do not rely on            benchmarking against our competitors in making compensation related decisions. In the past, however, we have hired executive recruiters as needed to help locate and identify suitable candidates for hire. In this context we typically discuss compensation packages with the recruiter to structure compensation packages we believe will be attractive to prospective executive employees.

 

*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.”

 

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| Name            |   | Corporate Office                                                                                         |
|-----------------|--------|----------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                     |
| Laird Garrard   |   | Former Chief Executive Officer and President, Caspian Services, Inc.(1)                                  |
| John Baile      |   | Chief Financial Officer, Caspian Services, Inc.                                                          |
| John Scott      |   | Chief Operating Officer, Caspian Services, Inc.                                                          |
| Terrance Powell |   | Vice President Investor Relations, 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 |

 

|   | (1) | On November 15, 2008 Mr. Garrard resigned as CEO and President of Caspian Services, Inc. |
|--------|-----|-----------------------------------------------------------------------------------------------|

 

*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. These employment agreements are limited in their 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, and Terrance Powell. 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.

 

During fiscal 2008 the board of directors increased John Scott’s base monthly salary from $15,000 to $20,000. The board of directors did not increase the base salaries of any of the other named executive officers. Instead, as they did in fiscal 2007, the CEO and board of directors elected to rely upon other components of compensation, such as cash bonuses and discretionary            equity awards to motivate and reward executives for significant contributions to the Company. Subsequent to the end of our 2008 fiscal year, our CEO and board of directors reviewed base salaries and decided not to raise the base salaries of any of the named executive officers at the current time. Electing instead to continue its practice of relying upon other components of compensation to motivate and reward its executives. This determination, however, does not preclude the board of            directors from re-evaluating executive salaries and considering salary increases during fiscal 2009.

 

49

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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 2008 our board of directors awarded a cash bonus of $18,034 to Mr. Kunayev. He has been significantly involved in the operations of TatArka and Kazmorgeophysica. None of the other named executive officers were awarded cash bonuses during fiscal 2008. 

 

*Equity incentive awards*

 

Our equity award program is the primary vehicle for offering long-term incentives to our executives. In May 2008 our board of directors adopted the 2008 Equity Incentive Plan (“Compensation Plan”). The Compensation Plan was adopted with the goal of enhancing the interests of the Company and its shareholders. It encourages officers, directors and key employees, upon whose            judgment, initiative and effort the Company is largely dependent for the successful conduct of its business, to acquire and retain a proprietary interest in the Company by ownership of its equity securities. We believe that equity grants provide our executives and key employees with a direct link to our long-term performance, create an ownership culture and align the interests of our executives, key employees and our stockholders.

 

The employment agreements of Mr. Baile, Mr. Scott and Mr. Powell provide that following one year of employment with the Company, each of these individuals is entitled to a mandatory grant of stock options on December 31st each year. At its sole discretion, the Company may award restricted stock grants in lieu of stock options. The number of options to be            granted annually is to be equal to the amount of the named executive officer’s annual base salary divided by the average bid price of our common stock for the five trading days immediately preceding the anniversary date of the named executive’s date of employment with the Company. The exercise price of the options will also be equal to the average bid price of our common stock for the five trading days immediately preceding the grant date. The options will vest over            three years, with vesting beginning one year after the grant date. The options vest as follows: i) 33% on the one year anniversary of the grant date; ii) 34% on the two year anniversary of the grant date; and iii) the final 33% on the three year anniversary of the grant date. The options become exercisable as they vest and are exercisable for a period of five years following vesting of the full grant amount. We believe the vesting feature furthers our objective of executive            retention because this feature provides an incentive to our executives to remain in our employ during the vesting period.

 

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In the future we may also make discretionary equity awards to our executive officers and key employees. In determining the size of equity grants, 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 executive officers and key employees, are 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 the second quarter of fiscal 2008 we issued stock options to purchase shares of our common stock to certain named executive officers pursuant to their employment agreements as follows:

 

| Name            |   | # of Shares underlying Options |   | Exercise Priceper Share |   | Expiration Date  |
|-----------------|--------|--------------------------------|--------|-------------------------|--------|------------------|
|            |   |                           |   |                    |   |             |
| John Scott      |   | 69,231                         |   | $2.60                   |   | March 20, 2016   |
| Terrance Powell |   | 64,749                         |   | $2.78                   |   | January 11, 2016 |
| John Baile      |   | 54,270                         |   | $2.76                   |   | January 18, 2016 |

 

In June 2008, the above named executive officers agreed to cancel the above listed stock options and to forfeit any stock options to which they may have been entitled under their respective employment agreements, whether issued or not, vested or not vested through March 31, 2008 in exchange for restricted stock grants as follows:

 

| Name            |   | Restricted Stock Granted |
|-----------------|--------|--------------------------|
|            |   |                     |
| John Scott      |   | 85,852                   |
| John Baile      |   | 30,938                   |
| Terrance Powell |   | 67,412                   |

 

These restricted stock grants are subject to the following vesting schedule: i) 50% vested on the grant date; ii) 25% will vest upon the first year anniversary of the grant date; and iii) 25% will vest upon the second year anniversary of the grant date.

 

*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.

 

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The employment contracts of Mr. Baile and Mr. 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 Mr. Baile, Mr. Scott and Mr. Powell 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 Mr. Baile, Mr. Scott and Mr. Powell 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 Mr. Baile, Mr. Scott and Mr. Powell 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.

 

|   | 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 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 on the income statement.

 

Pension fund payment

 

In accordance with the legislative requirements of the Republic of Kazakhstan during 2008 we were required to pay approximately $670 per month into a pension fund for Mr. Kunayev, Mr. Garrard and Mr. Roberts, 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, Mr. Roberts or any of the other named officers. We do not currently offer Company sponsored pension benefits to any of our employees, including the named executive officers.

 

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**Summary Compensation Table**

 

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**             |          | **Salary**(1) | **Bonus** | **Stock**

**Awards** | **Option**

**Awards** | **All Other**

**Compensation**(2) | **Total** |
|--------------------------|----------|---------------|-----------|-----------------------|------------------------|------------------------------------|-----------|
| **Principal Position**   | **Year** | **($)**       | **($)**   | **($)**               | **($)**                | **($)**                            | **($)**   |
|                     |     |          |      |                  |                   |                               |      |
| Laird Garrard            | 2008     | 162,000       | -         | -                     | -                      | 49,790                             | 211,790   |
| CEO and President(3)     | 2007     | 162,000       | -         | -                     | -                      | 49,056                             | 211,056   |
|                     |     |          |      |                  |                   |                               |      |
| John Baile               | 2008     | 150,000       | -         | 50,751                |                   | 100,983                            | 301,734   |
| CFO                      | 2007     | 107,258       | -         | -                     | -                      | 37,323                             | 144,581   |
|                     |     |          |      |                  |                   |                               |      |
| John Scott               | 2008     | 210,000       | -         | 89,116                |                   | 114,888                            | 414,004   |
| COO                      | 2007     | 180,000       | 70,000    | -                     | 51,716(4)              | 93,418                             | 395,134   |
|                     |     |          |      |                  |                   |                               |      |
| Terrance Powell          | 2008     | 180,000       | -         | 39,913                | -                      | 93,356                             | 313,269   |
| VP Investor Relations    | 2007     | 180,000       | 30,000    | -                     | 70,669(4)              | 49,048                             | 329,717   |
|                     |     |          |      |                  |                   |                               |      |
| Mirgali Kunayev          | 2008     | 168,000       | 18,034    | -                     | -                      | 64,606                             | 250,640   |
| Chairman of the Board of | 2007     | 168,000       | 19,182    | -                     | -                      | 39,830                             | 227,012   |
| Directors                |     |          |      |                  |                   |                               |      |
|                     |     |          |      |                  |                   |                               |      |
| Paul Roberts             | 2008     | 162,000       | -         | -                     | -                      | 55,814                             | 217,814   |
| Director                 | 2007     | 162,000       | -         | -                     | -                      | 43,081                             | 205,081   |

 

| (1) | Annual salary is net of all taxes and dues required under the 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 2008*” table below. |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (3) | On November 15, 2008 Mr, Garrard resigned as CEO and President of Caspian Services, Inc. |
|-----|------------------------------------------------------------------------------------------|

| (4) | 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. As discussed herein, these options were later canceled in exchange for restricted stock grants. |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

53

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**All Other Compensation                 **

     The table below provides additional information regarding“all other compensation”awarded to the named executive officers during            fiscal 2008 as disclosed in the“All Other Compensation”column of the“*Summary Compensation Table*”above.

 

 
|            |  

**Income Tax** |  

**Social Tax** |  

**Health Insurance** |  

**Pension Fund** |  

**Housing Allowance** |  

**Educational** | **Paid Time                        Off** |
|-----------------|------------------------|------------------------|------------------------------|--------------------------|-------------------------------|-------------------------|------------------------------------------|
| **Name**        | **Assistance**         | **Cash Out**           |
|            |                   |                   |                         |                     |                          |                    |                                     |
| Laird Garrard   | $21,088                | $13,440                | $7,265                       | $7,997                   | -                        | -                  | -                                   |
| John Baile      | $15,847                | $9,365                 | $3,771                       | -                   | $72,000                       | -                  | -                                   |
| John Scott      | $33,196                | $18,560                | $4,731                       |                     | $58,400                       |                    |                                     |
| Terrance Powell | $25,684                | $14,792                | $7,545                       | -                   | -                        | $45,335                 |  -                                  |
| Mirgali Kunayev | $26,510                | $16,053                | -                       | $7,997                   | -                        | -                  | $14,047                                  |
| Paul Roberts    | $25,069                | $16,272                | $6,476                       | $7,997                   | -                        |  -                 | -                                   |

*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      |   | $240,000         |
| Terrance Powell |   | $180,000         |
| Mirgali Kunayev |   | $168,000         |
| Paul Roberts    |   | $162,000         |

(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.

*Termination of Employment Agreements*

The employment agreements ofMr. Garrard,Mr. Kunayev andMr. Roberts may be terminated in accordance with applicable Kazakhstani law. The employment            agreements ofMr. Baile,Mr. Scott andMr. Powell may be terminated: i) involuntarily; ii) for cause; iii) voluntarily; or iv) upon a change in control.

 

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“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 toMr. Baile,Mr. Scott andMr. Powell as            disclosed in“*Potential Payments upon Termination or Change in Control*”below.

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

              Under our employment agreements withMr. Baile andMr. Powell, each would be entitled to severance benefits:             

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

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(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

(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 ofMr. Baile andMr. Powell wouldnot 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.

**             **IfMr. Baile, orMr. Powell becomes eligible for severance benefits, we will pay himthe 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 withMr. 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.

Mr. Scott wouldnot be eligible for the severance benefits if:

(a) his employment is terminated for cause; or

 

56

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

**            **IfMr. Scott becomes eligible for severance benefits, we will pay himthe 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 2008**

     
| **Name**        | **Constructive Grant Date(1)** | **Actual Grant Date** | **Number of shares (#)** | **Base Price of Awards ($/Sh)**(2) | **Grant Date Fair Value of Stock Awards** |
|-----------------|--------------------------------|-----------------------|--------------------------|------------------------------------|-------------------------------------------|
|            |                           |                  |                     |                               |                                      |
| John Scott      | 03/20/2008                     | 07/23/2008            | 67,943                   | 2.50                               | 169,858(1)                                |
| **John Baile**  | 01/18//2008                    | 07/23/2008            | 30,938                   | 2.50                               | 77,345(1)                                 |
| Terrance Powell | 01/11/2008                     | 07/23/2008            | 51,152                   | 2.50                               | 127,880(1)                                |

(1)     During the year we had the obligation to make a mandatory stock option grants to  Mr. Scott,Mr. Baile                andMr. Powell on the anniversary of the date of the employment agreement. Due to delays, the grants                were not actually made until June 23, 2008.

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

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**Outstanding Equity Awards at Fiscal Year-End             **

                As discussed above, pursuant to the Compensation Plan adopted during the fiscal 2008, stock options were awarded to certain of the named executive officers. During 2008, those same named executive officers subsequently agreed to            forfeit all stock options granted under their respective employment agreements to which they may have been entitled, whether issued or not, vested or not vested as of March 31, 2008 in exchange for restricted stock grants. As a result, 435,828 stock options were forfeited and restricted stock grants totaling 122,647 shares were awarded as consideration for the forfeited options. The Company also awarded the named executive officers additional restricted stock grants totaling 130,223            shares in connection with their employment agreements.

                The following table sets forth information regarding the outstanding option awards held by our named executive officers as of September 30, 2008.
| **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                                                                                               | 08/01/2015                                                               |
| Laird Garrard   | 220,000                                                                                                                                                                    | -                                                                                                                                                                                            | -                                                                                                                                                                                                                                                                   | 3.00                                                                                               | 08/01/2015                                                               |
| Paul Roberts    | 110,000                                                                                                                                                                    | -                                                                                                                                                                                            | -                                                                                                                                                                                                                                                                   | 3.00                                                                                               | 08/01/2015                                                               |

                                  The following table sets forth information regarding the outstanding stock awards held by our named executive officers as of September 30, 2008.
| **Name**        | ***Number of***

**shares or units                        of stock that have not vested                        (#)** | **Market value of shares or units or stock that have not vested                        ($)** | **Equity incentive plan awards: Number of unearned shares, unites or other rights that have not vested                        (#)** | **Equity incentive plan awards:                        Market or payout value of unearned shares, units or other rights that have not vested                        ($)** |
|-----------------|----------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |                                                                                                                 |                                                                                         |                                                                                                                                |                                                                                                                                                                      |
| John Scott      | -                                                                                                                    | -                                                                                            | 29,519                                                                                                                              | 73,798(1)                                                                                                                                                                 |
| John Baile      | -                                                                                                                    | -                                                                                            | 10,638                                                                                                                              | 26,595(1)                                                                                                                                                                 |
| Terrance Powell | -                                                                                                                    | -                                                                                            | 23,178                                                                                                                              | 57,945(1)                                                                                                                                                                 |

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

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Option Exercises and Stock Vested             

**     **            During the 2008 fiscal year none of the named executive officers exercised options. The following table sets forth information regarding the restricted shares vested as of September 30,            2008:
| Name            |   | Restricted Stock Vested |
|-----------------|--------|-------------------------|
|            |   |                    |
| John Scott      |   | 42,926                  |
| John Baile      |   | 15,469                  |
| Terrance Powell |   | 33,706                  |

**Nonqualified Deferred Compensation**             

            We offer nodefined 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 andMr. Roberts did not receive any compensation for their service on our board of directors.

*Director 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.

59

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**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 2008 fiscal year.             
|  

 

 

 

**Name** | **Fees Earned or Paid in Cash ($)** |  

 

**Stock                        Awards ($)** |  

 

**Option                        Awards ($)** |  

**Non-Equity Incentive Plan Compensation                        ($)** | ***Nonqualified***

**Deferred                        Compensation                        Earnings                        ($)** |  

 

**All Other**

**Compensation**

**($)** |  

 

 

**Total**

**($)** |
|------------------------------------------|-------------------------------------|-------------------------------------------------------------|--------------------------------------------------------------|-------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------|--------------------------------------------|
|                                     |                                |                                                        |                                                         |                                                                          |                                                                                                                            |                                                     |                                       |
| **Mirgali Kunayev**                      | -                    | -                                                           | -                                                            | -                                                                             | -                                                                                                                               | 250,640(1)                                               | 250,640                                    |
| **Paul Roberts**                         |                                |                                                        |                                                         |                                                                          |                                                                                                                            | 217,814(1)                                               | 217,814                                    |
| **James Passin**                         | -(2)                                | -                                                           | -                                                            | -                                                                             | -                                                                                                                               | -                                    | -                                          |
| **Valery Tolkachev**                     | -(2)                                | -                                                           | -                                                            | -                                                                             | -                                                                                                                               | -                                    | -                                          |

(1)    For details regarding compensation paid toMr. Kunayev andMr. Roberts please            see“*Summary Compensation Table*”and“*All Other            Compensation*”above.

(2)    As non-employee directors,Mr. Passin andMr. Tolkachev were entitled to receive director fees for the 2008 fiscal year.Mr. Passin andMr. Tolkachev, however, elected not to take director fees for the 2008 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.

**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    |
| Paul Rapello       |
| Paul Roberts       |
| Valery Tolkachev   |

 

 

 

 

 

 

 

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

                  The following table sets forth as of January 5, 2009 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 51,135,042 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               | Altima Central Asia Master Fund Ltd.  | 6,972,365(2)                                    | 11.9              |
|                 | Queensgate House                      |                                            |              |
|                 | South Church Street                   |                                            |              |
|                 | Georgetown                            |                                            |              |
|                 | Grand Cayman GT1234                   |                                            |              |
|                 |                                  |                                            |              |
| Common               | John Baile(3)                         | 30,938(4)                                       | *                 |
|                 | Akademik Satpaev Avenue 29/6          |                                            |              |
|                 | Ninth Floor                           |                                            |              |
|                 | Almaty, Kazakhstan 050400             |                                            |              |
|                 |                                  |                                            |              |
| Common               | Kerry Doyle(3)                        | 0                                               | *                 |
|                 | Akademik Satpaev Avenue 29/6          |                                            |              |
|                 | Ninth Floor                           |                                            |              |
|                 | Almaty, Kazakhstan 050400             |                                            |              |
|                 |                                  |                                            |              |
| Common               | Firebird Management LLC(5)            | 8,186,108                                       | 15.6              |
|                 | 152 West 57thStreet, 24thFloor        |                                            |              |
|                 | New York, New York 10019              |                                            |              |
|                 |                                  |                                            |              |
| Common               | Laird Garrard(6)                      | 2,661,624                                       | 5.2               |
|                 | Suite 408                             |                                            |              |
|                 | Old Brompton Road                     |                                            |              |
|                 | South Kensington, London, UK SW7 3DQ  |                                            |              |
|                 |                                  |                                            |              |
| Common               | Great Circle Energy Services LLC      | 6,744,961(7)                                    | 11.7              |
|                 | One Atlantic Street                   |                                            |              |
|                 | Stamford, Connecticut 06901           |                                            |              |
|                 |                                  |                                            |              |
| Common               | Mirgali Kunayev(3) (8)                | 13,497,399                                      | 26.2              |
|                 | Akademik Satpaev Avenue 29/6          |                                            |              |
|                 | Ninth Floor                           |                                            |              |
|                 | Almaty, Kazakhstan 050400             |                                            |              |
|                 |                                  |                                            |              |
| Common               | Mars International Worldwide, Inc.(8) | 2,830,642                                       | 5.5               |
|                 | 135 Gornaya Street                    |                                            |              |
|                 | Almaty, Kazakhstan 050020             |                                            |              |

61

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|  

**Type of Security**     |  

**Name and Address**               | **Amount & Nature of Beneficial Ownership** | **% of Class**(1) |
|----------------------------------|--------------------------------------------|-------------------------------------------------|-------------------|
|                             |                                       |                                            |              |
| Common                           | Petroleum Group Services Limited(5)        | 10,555,757                                      | 20.6              |
|                             | P.O. Box 544                               |                                            |              |
|                             | 14 Britannia Place, Bath Street            |                                            |              |
|                             | St. Helier, Jersey, Channel Islands        |                                            |              |
|                             | JE2 4SU, United Kingdom                    |                                            |              |
|                             |                                       |                                            |              |
| Common                           | Paul Rapello(3)                            | 6,744,961(7)                                    | 11.7              |
|                             | One Atlantic Street                        |                                            |              |
|                             | Stamford, Connecticut 06901                |                                            |              |
|                             |                                       |                                            |              |
| Common                           | Paul Roberts(3) (9)                        | 2,551,624                                       | 4.9               |
|                             | Akademik Satpaev Avenue 29/6               |                                            |              |
|                             | Ninth Floor                                |                                            |              |
|                             | Almaty, Kazakhstan 050400                  |                                            |              |
|                             |                                       |                                            |              |
| Common                           | John Scott(3)(10)                          | 85,852                                          | *                 |
|                             | Akademik Satpaev Avenue 29/6               |                                            |              |
|                             | Ninth Floor                                |                                            |              |
|                             | Almaty, Kazakhstan 050400                  |                                            |              |
|                             |                                       |                                            |              |
| Common                           | Valery Tolkachev(3) (11)                   |      25,000            | *                 |
|                             | 14 Donskaya St., Bldg 2                    |                                            |              |
|                             | Moscow, Russia 117049                      |                                            |              |
|                             |                                       |                                            |              |
| Common                           | UFG Russia Alternative Master Account Ltd. | 3,333,333                                       | 6.5               |
|                             | c/o Covenant House                         |                                            |              |
|                             | 85 Reid Street                             |                                            |              |
|                             | Hamilton, Bermuda                          |                                            |              |
|                             |                                       |                                            |              |
| Officers, Directors and Nominees |                                       |                                            |
| as a Group: (7 persons)          | 22,935,774                                 | 44.5                                            |

* 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 conversion rights, options and/or            warrants.

(2)These shares are not currently issued or outstanding. The shares underlie debt that is convertible to common stock at a fixed price of $2.30 per share.The number of shares            issuable upon conversion will increase over time as interest accruesThe convertible debt is owned directly by Altima Central Asia Master Fund Limited (the“Master Fund”), and may be deemed to be beneficially owned by Altima Central Asia Fund Limited (the“Feeder Fund”), a controlling shareholder of the            Master Fund; Altima Partners LLP (the“Adviser”), the investment adviser to the Master Fund and the Feeder Fund; Mark Donegan, Malcolm Goddard, Edmund Limerick and Alexander Schwarzkopf as partners of the Adviser; and Edmund Limerick and Alexander Schwarzkopf, the portfolio managers for the Master Fund.

(3)Mr. Baile,Mr. Kerry andMr. Scott are executive officers of the Company.Mr. Kunayev,Mr. Rapello,Mr. Roberts andMr. Tolkachev are directors of the Company.

(4)Mr. Baile’s employment agreement provides for annual mandatory and discretionary equity awards. Of the above listed shares, one half vested on June 27, 2008, one quarter will vest on June 27, 2009, and the            final one quarter will vest on June 27, 2010.

62

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(5)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. (“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); (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); (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); and (iv) Firebird Management acts as investment adviser to Firebird Republics Fund, Ltd. (“Republics”), a            private investment fund which owns 1,900,000 shares of common stock (including an aggregate of 125,000 shares issuable upon the exercise of warrants held by such Fund),, and Firebird New Russia Fund, Ltd. (“New Russia”), a private investment fund which owns 72,500 shares of common stock. As investment advisors to the above listed funds (the “Funds”), each of Avrora Advisors, 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.

(6)The shares attributed toMr. 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.

(7)These shares are not currently issued or outstanding. The shares underlie debt that is convertible to common stock at a fixed price of $2.30 per share.The number of shares            issuable upon conversion will increase over time as interest accrues.The convertible debt is held directly by Great Circle Energy Services LLC. (“GCES”).All such shares are beneficially owned by GCES as the lender and may be deemed to be beneficially owned by GCF Holdings LLC (as the sole member of GCES), The Great Circle Fund LP (as the sole member of GCF Holdings LLC), Great            Circle Capital LLC (as the general partner of The Great Circle Fund LP and the manager of GCES), and Paul Rapello and Hew Crooks (in their positions as partners of Great Circle Capital LLC). Each of GCF Holdings LLC, The Great Circle Fund LP, Great Circle Capital LLC, Paul Rapello and Hew Crooks disclaims beneficial ownership.

(8)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 toMr. 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”) 2,608,420 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.

(9)The shares attributed toMr. 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..

(10)Mr. Scott’s employment agreement with the Company provides for annual mandatory and discretionary equity awards. Of the above listed shares, 50% vested on the date of grant, 25% will vest on June 27, 2009 and            the balance will vest on June 27, 2010.

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

 

63

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

     During the years ended September 30, 2008 and 2007 we recognized revenue $2,029 and $2,837, respectively for seismic works we performed for Bolz LLP. Mirgali Kunayev, the chairman of our board of directors, has an indirect interest in Bolz LLP.

     

     During the years ended September 30, 2008 and 2007 we recognized revenue of $0 and $359, respectively for geological services we performed for Erkin Oil.Mr. Kunayev has an indirect interest in Erkin Oil.

     During the years ended September 30, 2008 and 2007 we paid an entity under common management (KazakhstanCaspiShelf) $1,389 and $3,000 for vessel and equipment rental, seismic services and purchase of assets respectively. We also recognized $0 and $107 of vessel revenues, $1,657 and $5,267 of revenue            from performed seismic works, sale of materials and equipment rental during 2008 and 2007 respectively, from the same entity. In September 2008, we purchased additional shares of KMG for $2,900 from KazakhstanCaspiShelf. Mr.Kunayev is a 15% interest holder in KCS.

     In July 2007, TatArka loaned KazakhstanCaspiShelf $661. The loan did not bear interest and was repaid during 2008. During November and December 2007 TatArka loaned $500 to KazakhstanCaspiShelf. As of September 30, 2008 the balance due was $125. The loan bears interest at 0% and was initially due in            December 2007. The loan is currently due on demand.. We are currently negotiating a new maturity date.

     During the years ended September 30, 2008 and 2007 Caspian Geo-Consulting Services, LLP provided marketing services to KMG for $0 and $140, respectively, and performed interpretation of seismic data to KMG and TatArka for $89 and $43, respectively. During the            year ended September 30, 2007 KMG also borrowed $223 from Caspian Geo-Consulting Services. The note bore interest at 0% and was fully repaid during 2008.Mr. Kunayev owns an indirect interest in Caspian Geo-Consulting.

     During the years ended September 30, 2008 and 2007 theaggregatevalue ofMr. Kunayev’s            interest inall of the aforementioned transactionsin each of 2008 and 2007was less than $120.

     In May 2008 the Company borrowed $600 from an individual related to Laird Garrard, our prior Chief Executive Officer and President. The loan bears interest at 13.38% and is due in September 2008. Although the loan matured in September 2008, the lender has indicated that he agrees to postpone the            repayment of the loan.

 

64

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     On November 17, 2008, the board of directors appointed Mr. Paul Rapello to fill a vacancy on the Company’s board of directors.Mr. Rapello was            appointed to the board of directors in satisfaction of an undertaking agreed to by the Company in connection with the Facility agreement, dated September 3, 2008, between the Company and Great Circle Energy Services LLC. (the “Facility Agreement”) to use its best efforts to cause a representative designated by Great Circle Energy Services LLC to be appointed to the board of directors of the            Company. Great Circle Energy Services LLC is beneficially wholly-owned by The Great Circle Fund LP. Great Circle Capital LLC is the general partner of The Great Circle Fund LP and the manager of Great Circle Energy Services LLC.Mr. Rapello is a partner in Great Circle Capital LLC.The value ofMr. Rapello’s interest in this transaction was less than $120.

                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 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 Paul Rapello 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.

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

                Hansen, Barnett & Maxwell, P.C. served as the Company’s independent registered public accounting firm for the fiscal years ended September 30, 2008 and 2007, and is expected to serve in that capacity for the 2009 fiscal year.            Principal accounting fees for professional services rendered for us by Hansen, Barnett & Maxwell for the twelve months ended September 30, 2008 and September 30, 2007, are summarized as follows:
|          |   | Fiscal 2008 |   | Fiscal 2007 |
|---------------|--------|-------------|--------|-------------|
|          |   |        |   |        |
| Audit         |   | $353        |   | $241        |
| Audit related |   | -           |   | -           |
| Tax           |   | 3           |   | 10          |
| All other     |   | -           |   | -           |
| Total         |   | $356        |   | $251        |

65

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*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, 2008 and 2007.

*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.

**Item 15.     Exhibits and 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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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 15, 2009 | /s/ Kerry Doyle                      |
|                   | Kerry Doyle, Chief Executive Officer |
|                   |                                 |
| Date: January 15, 2009 | /s/ John Baile                       |
|                   | John Baile, Chief Financial Officer  |
|                   |                                 |
| Date: January 15, 2009 | /s/ Mirgali Kunayev                  |
|                   | Mirgali Kunayev, Director            |
|                   |                                 |
| Date: January 15, 2009 | /s/ Paul Rapello                     |
|                   | Paul Rapello, Director               |
|                   |                                 |
| Date: January 15, 2009 | /s/ Paul Roberts                     |
|                   | Paul Roberts, Director               |
|                   |                                 |
| Date: January 15, 2009 | /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 as of September 30, 2008 and 2007                                                                | F-3      |
|                                                                                                                         |     |
| Consolidated Statements of Operations for the Years Ended    September 30, 2008 and 2007                 | F-4      |
|                                                                                                                         |     |
| Consolidated Statements of Shareholders’ Equity for the Years Ended    September 30, 2007 and 2008 | F-5      |
|                                                                                                                         |     |
| Consolidated Statements of Cash Flows for the Years Ended  September 30, 2008 and 2007                             | F-6      |
|                                                                                                                         |     |
| Notes to the Consolidated Financial Statements                                                                               | F-7      |

 

 

 

F-1

 

----

 

| **HANSEN,BARNETT& MAXWELL, P.C.** |   |                                   |
|---------------------------------------|--------|----------------------------------------|
| A Professional Corporation            |   | **Registered with the Public Company** |
| CERTIFIED PUBLIC ACCOUNTANTS          |   | **Accounting Oversight Board**         |
| 5 Triad Center, Suite 750             |   |                                   |
| Salt Lake City, UT 84180-1128         |   | **An independent member of**           |
| Phone: (801) 532-2200                 |   | **BAKER TILLY**                        |
| Fax: (801) 532-7944                   |   | **INTERNATIONAL**                      |
| www.hbmcpas.com                       |   | **A Member of the Forum of Firms**     |

 

 

**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, 2008 and 2007, and the related statements of operations, shareholders’ equity, and cash flows for the years then ended. 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial            reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements,            assessing the accounting principles used and significant estimates made by management, 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, 2008 and 2007, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

 

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

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

 

Salt Lake City, Utah

January 12, 2009

 

F-2

 

----

| **CASPIAN SERVICES, INC. AND SUBSIDIARIES**                                  |                                 |   |                           |
|------------------------------------------------------------------------------|--------------------------------------|--------|--------------------------------|
| **CONSOLIDATED BALANCE SHEETS**                                              |                                 |   |                           |
| (Dollars in thousands, except share and per share data)                 |                                 |   |                           |
|                                                                         |                                 |   |                           |
|                                                                         | **As of September 30,**              |
|                                                                         | **2008**                             |   | **2007**                       |
| **ASSETS**                                                                   |                                 |   |                           |
| **Current Assets:**                                                          |                                 |   |                           |
| Cash                                                                         | $   4,461                       |   | $ 15,470                       |
| Trade accounts receivable, net of allowance of $1,000 and $126, respectively | 18,136                               |   | 8,333                          |
| Trade accounts receivable from related parties                               | 5,601                                |   | 8,555                          |
| Other receivables, net of allowance of $17 and $17, respectively             | 1,252                                |   | 1,148                          |
| Notes receivable from related parties, current portion                       | 125                                  |   | 661                            |
| Inventories                                                                  | 4,083                                |   | 872                            |
| Prepaid taxes                                                                | 3,869                                |   | 996                            |
| Advances paid                                                                | 1,068                                |   | 862                            |
| Deferred tax assets                                                          | 1,902                                |   | 38                             |
| Prepaid expenses and other current assets                                    | 639                                  |   | 1,051                          |
| **Total Current Assets**                                                     | **41,136**                           |   | **37,986**                     |
|                                                                         |                                 |   |                           |
| Vessels, equipment and property, net                                         | 82,409                               |   | 49,347                         |
| Drydocking costs, net                                                        | 519                                  |   | 1,233                          |
| Goodwill                                                                     | 5,522                                |   | 3,295                          |
| Intangible assets, net                                                       | 213                                  |   | 259                            |
| Investments                                                                  | 829                                  |   | -                              |
| Long-term other receivables, net of current portion                          | -                                    |   | 175                            |
| **Total Assets**                                                             | **$**  **130,628**         |   | **$**  **92,295**    |
|                                                                         |                                 |   |                           |
| **LIABILITIES AND SHAEHOLDERS’ EQUITY**                                |                                 |   |                           |
|                                                                         |                                 |   |                           |
| **Current Liabilities**                                                      |                                 |   |                           |
| Accounts payable                                                             | $     7,870 |   | $    5,073 |
| Accounts payable to related parties                                          | 1,554                                |   | 1,474                          |
| Accrued expenses                                                             | 2,754                                |   | 1,936                          |
| Accrued taxes                                                                | 899                                  |   | 2,262                          |
| Deferred revenue                                                             | 1,428                                |   | 103                            |
| Obligations under capital lease – current portion                      | 318                                  |   | -                              |
| Notes payable – related parties                                        | 600                                  |   | 223                            |
| Notes payable – current portion                                        | 7,288                                |   | 457                            |
| **Total Current Liabilities**                                                | **22,711**                           |   | **11,528**                     |
| Long-term debt – net current portion                                   | 24,762                               |   | -                              |
| Long-term deferred income tax liability                                      | 2,295                                |   | 1,843                          |
| **Total Liabilities**                                                        | **49,768**                           |   | **13,371**                     |
| **Minority Interests in Consolidated Subsidiaries**                          | **2,383**                            |   | **3,733**                      |
| **Shareholders’ Equity**                                               |                                 |   |                           |
| Common stock, $0.001 par value per share; 150,000,000 shares authorized;     |                                 |   |                           |
| 51,135,042 shares and 50,492,061 shares issued and outstanding               | 51                                   |   | 50                             |
| Additional paid capital                                                      | 63,921                               |   | 63,049                         |
| Retained earnings                                                            | 9,716                                |   | 8,638                          |
| Accumulated other comprehensive income                                       | 4,789                                |   | 3,454                          |
| **Total Shareholders’ Equity**                                         | **78,477**                           |   | **75,191**                     |
| **Total Liabilities and Shareholders’ Equity**                         | **$**  **130,628**         |   | **$**  **92,295**    |

 

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 per share data)                   |                                                                            |   |
|                                                            |                                                                            |   |
|                                                            | **For The Years**

**Ended September 30,**                                      |   |
|                                                            | **2008**                                                                        |   | **2007** |   |
| **Revenues**                                                    |                                                                            |   |   |   |
| Vessel revenues                                                 | $      36,441                                |   | $        23,685  |   |
| Geophysical service revenues                                    | 34,739                                                                     |   | 38,896  |   |
| Product sales                                                   | 1,446                                                                      |   | 1,556  |   |
| **Total Revenues**                                              | **72,626**                                                                 |   | **64,137**  |   |
|                                                            |                                                                            |   |   |   |
| **Operating expenses**                                          |                                                                            |   |   |   |
| Vessel operating costs                                          | 26,409                                                                     |   | 18,509  |   |
| Cost of geophysical service revenues                            | 16,825                                                                     |   | 17,228  |   |
| Cost of product sold                                            | 790                                                                        |   | 898  |   |
| Depreciation and amortization of dry-dock costs                 | 9,443                                                                      |   | 6,619  |   |
| General and administrative expense                              | 19,587                                                                     |   | 11,577  |   |
| **Total Costs and Operating Expenses**                          | **73,054**                                                                 |   | **54,831**  |   |
| **Income (Loss) from Operations**                               | **(428)**                                                                       |   | **9,306**  |   |
|                                                            |                                                                            |   |   |   |
| **Other income (Expense)**                                      |                                                                            |   |   |   |
| Interest expense                                                | (460)                                                                           |   | (130) |   |
| Foreign currency transaction gain (loss)                        | (417)                                                                           |   | 32  |   |
| Interest income                                                 | 99                                                                         |   | 284  |   |
| Loss from equity method investees                               | (58)                                                                            |   | -  |   |
| Net other non-operating income                                  | 2,588                                                                      |   | 5,405  |   |
| **Net Other Income**                                            | **1,752**                                                                  |   | **5,591**  |   |
|                                                            |                                                                            |   |   |   |
| **Income Before Income Tax Minority Interests**                 | **1,324**                                                                  |   | **14,897**  |   |
| Provision for income tax                                        | (951)                                                                           |   | (5,112) |   |
| Minority interest in loss (income) of consolidated subsidiaries | 705                                                                        |   | (320) |   |
| **Net Income**                                                  | **$**        **1,078**             |   | **$**          **9,465**  |   |
| **Basic Income Per Common Share**                               | **$**          **0.02**  |   | **$**           **0.22**   |   |
| **Diluted Income Per Common Share**                             | **$**           **0.02** |   | **$**            **0.22**  |   |
|                                                                 |                                                                                 |        |  |  |  |

 

 

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

 

F-4

 

 

----

 

| **CASPAIN SERVICES, INC. AND SUBSIDIARIES**                                                     |           |   |                                            |   |                                    |   |                                               |   |
|-------------------------------------------------------------------------------------------------|----------------|--------|-------------------------------------------------|--------|-----------------------------------------|--------|----------------------------------------------------|--------|
| **CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY**                                       |           |   |                                            |   |                                    |   |                                               |   |
| For the Years ended September 30, 2007 and 2008                                                 |           |   |                                            |   |                                    |   |                                               |   |
| (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 |   | Equity |
|                                                                                            |           |   |                                            |   |                                    |   |                                               |   |   |   |   |
| **Balance, September 30, 2006**                                                                 | **42,068,735** |   | **$**     **42**            |   | **$**  **38,804**        |   | **$**    **(827)**             |   | **$**    **1,597** |   | **$**  **39,616** |
| Net income for the year ended September 30, 2007                                                | -              |   | -                                               |   | -                                  |   | 9,465                                         |   | - |   |       9,465 |
| Currency translation adjustment                                                                 | -              |   | -                                               |   | -                                  |   | -                                             |   | 1,857 |   | 1,857 |
| **Comprehensive income**                                                                        |           |   |                                            |   |                                    |   |                                               |   |   |   | **$**  **11,322** |
|                                                                                            |           |   |                                            |   |                                    |   |                                               |   |   |   |   |
| Compensation related to issuance of options                              to employees | -              |   | -                                               |   | 212                                |   | -                                             |   | - |   | 212 |
| 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** |
| Net income for the year ended September 30, 2008                                                | -              |   | -                                               |   | -                                  |   | 1,078                                         |   | - |   |     1,078 |
| Currency translation adjustment                                                                 | -              |   | -                                               |   | -                                  |   | -                                             |   | 1,335 |   |     1,335 |
| **Comprehensive income**                                                                        |           |   |                                            |   |                                    |   |                                               |   |   |   | **$**    **2,413** |
|                                                                                            |           |   |                                            |   |                                    |   |                                               |   |   |   |   |
| Issuance of restricted shares                                                                   | 642,981        |   | 1                                               |   | (1)                                     |   | -                                             |   | - |   | - |
| Amortization of unearned compensation                                                           | -              |   | -                                               |   | 873                                |   | -                                             |   | - |   | 873 |
| **Balance, September 30, 2008**                                                                 | **51,135,042** |   | **$**      **51** |   | **$**   **63,921**  |   | **$**     **9,716**  |   | **$**    **4,789** |   | **$ 78,477** |
|                                                                                            |           |   |                                            |   |                                    |   |                                               |   |   |   |   |
|                                                                                            |           |   |                                            |   |                                    |   |                                               |   |   |   |   |

 

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)                                                            |                                                                     |
|                                                                              |                                                                     |
|                                                                              | **For the Years**

**Ended September 30,**                               |
|                                                                              | **2008**                                                                 |   | **2007** |
| **Cash flows from operating activities:**                                         |                                                                     |   |   |
| Net income                                                                        | $     1,078                                |   | $      9,465  |
| Adjustments to reconcile net loss to net cash used in operating activities:       |                                                                     |   |   |
| Loss on sale of property and equipment                                            | 25                                                                  |   | 640  |
| Depreciation and amortization of drydocking costs                                 | 9,443                                                               |   | 6,619  |
| Minority interest in income (loss) of consolidated subsidiaries                   | (705)                                                                    |   | 320  |
| Foreign currency exchange loss                                                    | 588                                                                 |   | (32) |
| Stock based compensation                                                          | 872                                                                 |   | 212  |
| Changes in current assets and liabilities:                                        |                                                                     |   |   |
| Trade accounts receivable                                                         | (9,125)                                                                  |   | 183  |
| Trade accounts receivable from related parties                                    | 2,860                                                               |   | (2,253) |
| Other receivables                                                                 | 452                                                                 |   | (4,182) |
| Inventories                                                                       | (3,186)                                                                  |   | (41) |
| Prepaid expenses and other current assets                                         | (4,215)                                                                  |   | (38) |
| Accounts payable and accrued expenses                                             | 3,680                                                               |   | (382) |
| Accounts payable to related parties                                               | (1,345)                                                                  |   | (493) |
| Accrued taxes                                                                     | (1,210)                                                                  |   | 501 |
| Deferred revenue                                                                  | 1,317                                                               |   | (3,796) |
| **Net cash provided by operating activities**                                     | **$**         **529**  |   | **$**       **6,723**  |
|                                                                              |                                                                     |   |   |
| **Cash flows from investing activities:**                                         |                                                                     |   |   |
| Investment in joint venture                                                       | (2,366)                                                                  |   | -  |
| Purchase of intangible assets                                                     | (2)                                                                      |   | (66) |
| Advances on related party notes receivable                                        | (125)                                                                    |   | (644) |
| Collections on related party notes receivable                                     | 661                                                                 |   | 1,100  |
| Proceeds from sale of property and equipment                                      | 161                                                                 |   | 95  |
| Payments to purchase vessels, equipment and property                              | (41,298)                                                                 |   | (18,654) |
| Net cash used in investing activities                                             | $    (42,969)                                        |   | $    (18,169) |
|                                                                              |                                                                     |   |   |
| **Cash flows from financing activities:**                                         |                                                                     |   |   |
| Proceeds from issuance of common stock                                            | -                                                                   |   | 26,339  |
| Proceeds from issuance of short-term debt to related parties                      | 1,147                                                               |   | -  |
| Proceeds from issuance of notes payable                                           | 31,593                                                              |   | 2,243  |
| Principal payments on notes payable – related parties                       | (771)                                                                    |   | (467) |
| Principal payments on notes payable                                               | (562)                                                                    |   | (3,381) |
| **Net cash provided by financing activities**                                     | **$**     **31,407**                       |   | **$**     **24,734**  |
| **Effect of exchange rate changes on cash**                                       | **24**                                                              |   | **(676)** |
| **Net change in cash**                                                            | **(11,009)**                                                             |   | **12,612**  |
| **Cash at beginning of period**                                                   | **15,470**                                                          |   | **2,858**  |
| **Cash at end of period**                                                         | **$**       **4,461**            |   | **$**     **15,470**  |
|                                                                                   |                                                                          |  |  |
| Supplemental disclosure of cash flow information:                                 |                                                                          |  |  |
|   Cash paid for interest, net of capitalized interest                   | $           328   |  | $           164  |
|   Cash paid for income tax                                              | $        2,544                   |  | $        4,624  |
|   Unpaid portion of the acquisition of the 29% minority interest in KMG | $        1,400                   |  | $                -  |

 

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

 

F-6

 

 

----

****CASPIAN SERVICES, INC. AND SUBSIDIARIES****

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

**NOTE 1 — THE COMPANY, BASIS OF PRESENTATION AND ACCOUNTING POLICIES**

 

***Principles of Consolidation***– The accompanying consolidated financial statements are presented in conformity with accounting principles generally accepted in the United States of America and 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-Caspian”).            Balykshi owns a 20% interest in a joint venture, Mangistau Oblast Boat Yard LLP (“MOBY”). During 2008 CRE owned a 50% interest in Pact Caspian Engineering FZC (“Pact Caspian”). Pact Caspian was closed in September 2008. Both the investments in Veritas-Caspian and Pact Caspian have been reduced to zero due to recurring losses., Ownership of 20% to 50% non-controlling interests are accounted for by the equity method. Intercompany balances and transactions have            been eliminated in consolidation.

 

***Nature of Operations***– The Company’s business consists of three major business segments:

 

*Vessel Operations*– Vessel operations consist of chartering a fleet of shallow draft offshore support vessels to customers performing oil and gas exploration activities in the Kazakhstan Sector of the North Caspian Sea.

 

*Geophysical Services*– Geophysical services consist of providing seismic data acquisition 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 operating a water desalinization and bottling plant and sales of potable water, and the development and planned operation of a ship maintenance facility located at the Port of Bautino.

 

***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 Instruments***– 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 rates approximating prevailing market rates.

 

***Minority Interests in Consolidated Subsidiaries***– Minority interests in consolidated subsidiaries relates to the minority shareholder’s investment in the subsidiaries. In the statements of operations, consolidated net income is adjusted by the minority shareholder’s proportionate share of the income or loss from the consolidated            subsidiaries.

 

F-7

 

----

****CASPIAN SERVICES, INC. AND SUBSIDIARIES****

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

***Cash***– The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.

 

***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. Credit risks associated with these customers are considered minimal. Dealings with smaller, local companies, particularly with            the current difficulties in equity and credit markets, pose the greatest risks. For new geophysical services customers, the Company typically requires an advance payment and retains the seismic data generated from these services until payment is made in full. The Company routinely reviews its accounts receivable balances and makes provisions for doubtful accounts as necessary. Accounts are reviewed on a case by case basis and losses are recognized in the period if the Company            determines it is likely that receivables will not be fully collected. The Company also may provide a general provision for doubtful accounts based onexisting economic conditions.

 

***Inventories***– Inventory consists of bulk and bottled water related to the desalinization plant, fuel, spare parts and supplies related to the geophysical operations. As of September 30, 2008 inventory also consisted of acquired and unsold seismic data of $2,322. 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 method.

 

***Vessels, Equipment and Property***– Vessels, equipment and property are stated at cost less accumulated depreciation. At the time property is disposed of or traded in, 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 marine vessel drydocking expenditures, which are capitalized and amortized.

 

Depreciation of property and equipment is calculated by the straight-line method and resulted in depreciation expense for the years ended September 30, 2008 and 2007 of $8,719 and $6,335, respectively. Depreciation on the marine base will begin once the base is placed in operation which is currently anticipated to be December 2010.

 

***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 until the next drydocking, generally 24 months. Drydocking costs are            comprised of painting the vessels, hulls 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, 2008 and 2007 of $673 and $235, respectively. Accumulated amortization of the drydocking costs was $913 and $235 as of September 30, 2008 and 2007, respectively.

 

F-8

 

----

****CASPIAN SERVICES, INC. AND SUBSIDIARIES****

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

***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, 2008 and 2007, the Company reviewed its long-lived assets and determined no impairments were necessary.

 

***Revenue Recognition***– Vessel revenues are usually 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. In 2008, the Company commenced a major contract with CMOC / Shell where revenue is derived from kilometers of seismic data acquired, rather than from a daily rate. Revenue under this contract is recognized when services are actually performed.

 

Geophysical service revenue is recognized when services are rendered, accepted by the customer and collectibility is reasonably assured. Direct costs are charged to each contract as incurred along with 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, 2008 and 2007 the Company had $1,428 and $103, respectively, 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.

 

***Foreign Currency Transactions***– Caspian Services, Inc., the holding company of the subsidiaries, makes its principal investing and financing transactions in United States Dollars (USD), which is also its functional currency. Transactions and balances denominated in other currencies have been translated into USD 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 (KZT) is the functional currency of the operating subsidiaries. The respective balance sheets have been translated into USD at the exchange rates prevailing at each balance sheet date. The respective statements of operations have been translated into USD using the average exchange rates prevailing during the periods of each statement. The corresponding translation adjustments are part            of accumulated other comprehensive income and are shown as part of shareholders’ equity.

 

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

 

F-9

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

***Income Taxes***–Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences in assets and liabilities and their respective tax bases and attributable to operating loss carry forwards. 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 Kazakhstan income tax regulations.

 

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 in question for currency law violations, as well as fines of generally 100% of the unpaid taxes. 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.No interest or penalties have been accrued as a result of any tax positions taken.  In the event interest or penalties are assessed, the Company will include these amounts related to unrecognized tax benefits in income tax expense.

A deferred tax liability is not recognized for the following types of temporary differences unless it becomes apparent that those temporary differences will reverse in the foreseeable future:
> 
(a) An excess of the amount for financial reporting over the tax basis of an investment in a foreign subsidiary or a foreign corporate joint venture, that is essentially permanent in duration.

(b) Undistributed earnings of a domestic subsidiary or a domestic corporate joint venture that is essentially permanent in duration.

(c) "Bad debt reserves" for tax purposes of U.S. savings and loan associations (and other "qualified" thrift lenders).

***Comprehensive Income***– Total comprehensive income represents the net change in shareholders’ equity during a period from sources other than transactions with shareholders. Accumulated other comprehensive income comprises accumulated foreign currency translation adjustments.

 

***Basic and Diluted Income Per Common Share***– Basic income per common share is calculated by dividing net income by the weighted-average number of common shares outstanding. Diluted income per common share is calculated by dividing net income by the weighted-average number of common shares outstanding giving effect to potentially issuable common shares. The            Company does not include any potentially issuable shares that are anti-dilutive.

 

At September 30, 2008 and 2007, the Company had 5,500,108 and 4,600,113 respectively 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.

 

F-10

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

The following data shows the amounts used in computing basic and diluted weighted-average number of shares outstanding for the years ending September 30, 2008 and 2007:

 

|                                                   | 2008           | 2007           |
|--------------------------------------------------------|----------------|----------------|
| Basic weighted-average common shares outstanding       | 50,759,823     | 43,480,336     |
| Effect of dilutive securities and convertible debt:    |           |           |
| Options                                                | -              | 142,556        |
| Convertible debt                                       | 2,901,619      | -              |
|                                                   |           |           |
| **Diluted weighted-average common shares outstanding** | **53,661,442** | **43,622,892** |

 

***Stock-Based Compensation***– The Company recognizes the cost of employee services received in exchange for an award of equity instruments measured based on the grant date fair value of the award. Stock option compensation expense is recognized over the period during which an employee is required to provide service in exchange for the award (the vesting            period).

 

***Concentrations of Credit Risk***–The Company’s vessel operations are contracted primarily with Agip KCO, Shell and their service providers. Agip KCO operates the fields on behalf of a consortium of international oil companies and subcontracts some of the work. Loss of any of the above customers could have a material negative effect on the Company. Vessel            charter services provided are under contract with varying terms and through various dates in 2009. 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. The geophysical division has a more widespread portfolio of clients and so has a more diversified level of risk.

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of trade and other receivables. The Company manages its exposure to risk through ongoing credit evaluations of its customers; however, the Company generally does not require collateral. In some cases when dealing with new customers the Company requires advance payments. The Company maintains            an allowance for doubtful accounts for potential losses.

 

***Reclassifications***– Certain reclassifications have been made to the 2007 financial statements to conform to the 2008 presentation. The reclassifications had no effect on net income.

***Recent Accounting Pronouncements***– In May 2008, the FASB issued Staff Position (FSP) No. APB 14-1,*Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)*. This Statement is effective for financial statements issued for fiscal years and            interim periods beginning after December 15, 2008, and will require issuers of convertible debt that can be settled in cash to record the additional expense incurred. Entities will also have to account for liabilities and the equity parts of convertible debt instruments separately. The FSP applies to convertible debt instruments that can be settled in cash, unless the embedded conversion option has to be accounted for separately as a derivative under Statement of Financial            Accounting Standards (SFAS) No. 133 ( SFAS No. 133 ),*Accounting for Derivative Instruments and Hedging Activities*. The Company is currently evaluating the impact of adopting this standard.

In April 2008, FASB issued FASB Staff Position SFAS No. 142-3,*Determination of the Useful Life of Intangible Assets*(FSP SFAS No. 142-3). FSP SFAS No. 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognizable intangible asset under

F-11

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

SFAS No. 142, *Goodwill and Other Intangible Assets*(SFAS No. 142). The intent of FSP SFAS No. 142-3 is to improve the consistency between the useful life of a recognizable intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R),*Business Combinations*and other U.S. generally accepted accounting principles. FSP SFAS No. 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The Company does not anticipate that the adoption of FSP SFAS No. 142-3 will have an impact on its financial position or results of operations.

In March 2008, the FASB issued SFAS No. 161,*Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133*, which changes the disclosure requirements for derivative instruments and hedging activities. Enhanced disclosures are required to provide information about (a) how and why an entity uses derivative            instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This Statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company does not expect the            adoption of SFAS 161 to have a material impact on its results of operations or financial condition.

In December 2007, the FASB issued SFAS No. 141 (revised 2007),*Business Combinations*(SFAS 141(R)), which replaces SFAS 141,*Business Combinations*. SFAS 141(R) retains the underlying concepts of SFAS 141 in that all business combinations are still required to be accounted for at fair value under            the acquisition method of accounting, but SFAS 141(R) changed the method of applying the acquisition method in a number of significant aspects. Acquisition costs will generally be expensed as incurred; noncontrolling interests will be valued at fair value at the acquisition date; in-process research and development will be recorded at fair value as an intangible asset at the acquisition date; restructuring costs associated with a business combination will generally be expensed            subsequent to the acquisition date; and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense. SFAS 141(R) is effective on a prospective basis for all business combinations for which the acquisition date is on or after the beginning of the first annual period subsequent to December 15, 2008, with the exception of the accounting for valuation allowances on deferred taxes and acquired            tax contingencies. SFAS 141(R) amends SFAS 109 such that adjustments made to valuation allowances on deferred taxes and acquired tax contingencies associated with acquisitions that closed prior to the effective date of SFAS 141(R) would also apply the provisions of SFAS 141(R). Early adoption is not permitted. The Company does not expect that it will have any immediate effect on its financial statements, however, the revised standard will govern the accounting for any future            business combinations that the Company may enter into.

In December 2007, the FASB issued SFAS No. 160,*Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No.* *51*(SFAS 160). This statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15,            2008, with earlier adoption prohibited. This statement requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financial statements and separate from the parent’s equity. The amount of net income attributable to the

 

F-12

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

noncontrolling interest will be included in consolidated net income on the face of the income statement. It also amends certain of ARB No. 51’s consolidation procedures for consistency with the requirements of SFAS 141(R). This statement also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest. The Company is currently evaluating            this new statement. Based on the current consolidated financial statements, if SFAS 160 were effective, the minority interest in the consolidated balance sheet would be presented as noncontrolling interest in stockholders’ equity, the minority interest in loss/(gain) would be included in consolidated net loss in the consolidated statement of operations, and the notes to the financial statements would include expanded disclosure regarding the ownership interests of the Company            and of the noncontrolling interests.

In February 2007, the FASB issued SFAS No. 159,*The Fair Value Option for Financial Assets and Financial Liabilities*. SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after            November 15, 2007. The Company does not expect the adoptionof SFAS No. 159 to have a material impact on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements*, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and            interim periods within those fiscal years. In February 2008, the FASB issued FASB Staff Position No. 157-2 which extended the effective date for certain nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008. The adoption of the portions of SFAS No. 157 that were not postponed did not have a material impact on its consolidated financial statements. The Company is currently evaluating the effect of implementation of SFAS No. 157.

 

**NOTE 2 – ACQUISITION OF KAZMORGEOPHYSICA**

 

On September 15, 2008, the Company acquired an additional 29% interest in KMG for $2,900. The Company increased its ownership percentage in KMG as it believes the demand of offshore seismic services will increase in the coming years. The Company also sought to gain greater control over the valuable data library and wants to be perceived as a significant provider of all major services in the region. As            a result of this purchase, the Company’s ownership in KMG increased from 51% to 80%. Of the $2,900 purchase price, $699 was recorded as a reduction to minority interests. The balance of $2,201 was allocated to goodwill.

 

F-13

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

Of the $2,900 purchase price $1,400 was unpaid as at September 30, 2008 and this amount is included into related party payables (Note 12). This amount was due to an entity under common management (KazakhstanCaspiShelf) and paid in October 2008.

 

***Pro Forma Information (unaudited):***  Actual results of operations of the portion of KMG acquired are included in the consolidated financial statements from the date of acquisition. The unaudited pro forma condensed consolidated statements of operations of the Company, set forth below, give effect to the purchase of interests in KMG from the Company’s            minority partners using the purchase method as if the acquisitions in 2008 occurred on October 1, 2006. These amounts are not necessarily indicative of the consolidated results of operations for future years or actual results that would have been realized had the acquisition occurred at that date

 

|                                           | Pro Forma                                                                    |
|------------------------------------------------|------------------------------------------------------------------------------|
|                                           | For the Year Ended September 30,                                             |
|                                           | 2008                                                                         |   | 2007 |
| Total revenues                                 | $       72,626                            |   | $      64,137 |
| Net income                                     | $            770 |   | $        9,820 |
|                                                |                                                                              |  |  |
| Net income per common share:                   |                                                                         |   |   |
| Basic                                          | $           0.02      |   | $          0.23 |
| Diluted                                        | $           0.01      |   | $          0.23 |
|                                           |                                                                         |   |   |
| Pro forma weighted average shares outstanding: |                                                                         |   |   |
| Basic                                          | 50,759,823                                                                   |   | 43,480,336 |
| Diluted                                        | 53,661,442                                                                   |   | 43,622,892 |
|                                           |                                                                         |   |   |

 

**NOTE 3 – EQUITY METHOD INVESTMENTS**

 

***Veritas-Caspian***– During 2005, KMG and Veritas DGC, a UK company, formed a joint venture (Veritas-Caspian) 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 $10,839 and $10,700 of vessel revenue during the years ended September 30, 2008 and 2007, 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 DGC and KMG after Veritas-Caspian has recovered its costs.

 

F-14

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

At September 30, 2008 KMG’s investment in Veritas-Caspian was reduced to zero due to Veritas-Caspian’s accumulated losses of $14,579. 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.

 

In June 2008, the Company signed a contract with CMOC / Shell for development of the Oman Pearls field. The contract is administered by CSGL and the seismic work has been sub-contracted to Veritas-Caspian.

 

***Pact Caspian***– Caspian Real Estate, Ltd. (“CRE”) owned a 50% interest in Pact Caspian Engineering FZC (“Pact Caspian”). Through its wholly-owned subsidiary, Pact Engineering KZ LLP (“Pact Engineering”), Pact Caspian marketed and sold in Kazakhstan water and wastewater treatment systems manufactured by Pact Engineering. CRE            accounted for its 50% investment under the equity method of accounting. As mentioned in Note 1, Pact Caspian was closed in September 2008. Net loss from investments recognized in 2008 is $20.

 

***MOBY***– In January 2008, Balykshi and two unrelated companies formed a joint venture, Mangistau Oblast Boat Yard LLP (“MOBY”), to operate a boat repair and drydocking services yard located at the Company’s marine base, which is under construction in Bautino Bay. Balykshi owns a 20% interest in the joint venture, which is accounted for by the            equity method. As of September 30, 2008, the Company had invested $887 fully financing its share in this joint-venture. The investment in the joint venture of $829 as of September 30, 2008 represents the original investment less the Company’s share of the joint venture’s net loss of $58.

 

**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, 2008. Receivables from vessel charter revenues were approximately $12,880 and $6,120 at September 30, 2008 and 2007, respectively.

 

Accounts receivable from geophysical services arise principally from contracts to gather seismic data for further geophysical processing and analysis. The receivables are current and collectable within 45 days from date of invoice. At September 30, 2008 and 2007, receivables related to geophysical services totaled $6,074 and $2,136, respectively. The Company has reviewed the accounts receivable as of            September 30, 2008 on case by case basis. The Company provided a general allowance for doubtful accounts of $1,000 at September 30, 2008 based on existing economic conditions. The Company believes that all receivables will be paid but, in view of the difficult credit climate which has been affecting the Company’s customers, concluded it should recognize the additional risk attached to these debts.

 

At September 30, 2008 and 2007, receivables related to desalinization and bottling operations totaled $182 and $203, respectively. The Company provided no allowances for doubtful accounts for these receivables at September 30, 2008 and 2007.

 

F-15

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

During the year ended September 30, 2008 TatArka had to make an exceptional bad debt write-off of $4,000 for one customer who appears to have closed operations. The Company has retained title to the data acquired and it has been valued as inventory at cost of $2,322.

 

***Other Receivables**–*The Company’s other receivables consisted 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, $0 and $175 is classified as long term at September 30, 2008 and 2007, respectively, (2) refunds of inventory advances,            initial equity investment and land deposits which were subsequently canceled for lack of performance or mutual agreement. These amounts are currently due and expected to be repaid in the near-term.

 

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

 

Vessels, equipment and property consisted of the following:

 

| *As of September 30,*                | **2008**                                                     |   | **2007**                              | **Depreciable****Life in****Years** |
|--------------------------------------|--------------------------------------------------------------|--------|---------------------------------------|-------------------------------------|
| Land                                 | $        7,976  |   | $    7,901        | N/A                                 |
| Buildings and constructions          | 652                                                     |   | 479                              | 10-14                               |
| Marine vessels                       | 26,723                                                  |   | 16,113                           | 10                                  |
| Machinery and equipment              | 27,986                                                  |   | 22,061                           | 2-10                                |
| Field camp                           | 1,269                                                   |   | 2,613                            | 5-13                                |
| Vehicles                             | 2,806                                                   |   | 2,419                            | 4-10                                |
| Office equipment                     | 395                                                     |   | 507                              | 2-10                                |
| Dwelling units                       | 2,192                                                   |   | 289                              | 3-7                                 |
| Other                                | 718                                                     |   | 109                              | 3-7                                 |
| Construction in progress             | 33,739                                                  |   | 10,120                           | N/A                                 |
|                                 | 104,456                                                 |   | 62,611                           |                                |
| Accumulated depreciation             | (22,047)                                                     |   | (13,264)                              |                                |
| Vessels, Equipment and Property, net | $     82,409                   |   | $    49,347  |                                |

 

***Development of Marine Base*****–**The Company continues with development of the marine base in Bautino Bay.  Construction commenced in the first fiscal quarter 2008. The Company expects the initial phase of the marine base facilities, including dredging, breakwater, wharf front and general site area to be            partially completed and functional by April2009, with final completion of the base occurring by December2010. Anticipated cost to construct the marine base is $71,810.  The Company plans to achieve this funding through a combination of debt and equity financing. In June 2007 the Company entered into a series of agreements with European Bank For Reconstruction and Development (“EBRD”) under which EBRD has agreed            to provide $32,000 of debt financing and make an equity investment in the marine base in the amount of $10,000 in exchange for a 22% equity interest in Balykshi LLP. The remaining $29,810 of construction costs is to be contributed by the Company. Funding of the EBRD debt and equity financing is contingent on the Company contributing its portion of the construction costs. By September 30, 2008, the Company had contributed $33,121 (more than the full amount required to be            contributed)and no amounts had been drawn on the EBRD debt or equity financing as of September 30, 2008. Subsequent to the fiscal year end $10,000 were received from the EBRD as a contribution to Balykshi LLP. Balykshi’s and CRE’s property is mortgaged under the EBRD agreement (including bank accounts).

 

F-16

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

During the years ended September 30, 2008 and 2007, the Company incurred construction costs of $23,619 and $8,011, respectively.  The Company capitalized interest costs related to the development of the marine base in the amount of $527 and $137 for the years ended September 30, 2008 and 2007, respectively.

 

**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:

 

|              |         |   | 2008     |   | 2007         |
|-------------------|--------------|--------|----------|--------|--------------|
|              | Estimated    |   | carrying |   | Accumulated  |   | carrying |   | Accumulated |
|              | useful lives |   | amount   |   | amortization |   | amount |   | amortization |
|              |         |   |     |   |         |   |   |   |   |
| Acquired software | 7 years      |   | $ 338    |   | $ 125        |   | $ 333 |   | $   74 |
| Total             |         |   | $ 338    |   | $ 125        |   | $ 333 |   | $   74 |

 

Total amortization expense related to intangible assets was approximately $51 and $49 for the years ended September 30, 2008 and 2007, respectively. The estimated amortization expense for acquired software is as follows for the periods indicated:

 

|                |   | Years Ended September 30, |
|---------------------|--------|---------------------------|
|                |   | 2009                      | 2010 |   | 2011 |   | 2012 |   | thereafter |
|                |   |                      |   |   |   |   |   |   |   |
| Amortizationexpense |   | $ 51                      | $ 51 |   | $ 51 |   | $ 51 |   | $  8 |

 

***Goodwill***– On September 15, 2008, the Company increased its ownership percentage of KMG from 51% to 80% and recorded $2,195 of additional 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 Company evaluated the Goodwill for impairment as of September 30, 2008; no impairment was needed.

 

F-17

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

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

 

|                                              | For The Year EndedSeptember 30, |
|---------------------------------------------------|---------------------------------|
|                                              | 2008                            | 2007 |
| Balance – beginning of period               | $ 3,295                         | $ 3,135 |
| Acuired – KMG                               | 2,195                           | - |
| Effect of foreign currency translation adjustment | 32                              | 160 |
| Balance – end of period                     | $ 5,522                         | $ 3,295 |

 

 

**NOTE 7– LONG-TERM DEBT**

 

During 2007, Bauta borrowed $26 from a local bank and repaid $11. The notes were collateralized by equipment and inventory, bore interest at 18% and were repaid by December 2007.

 

In the same period KMG borrowed $223 from Caspian Geo-Consulting Services LLP, a company related through common ownership. The notes bore interest at 0% and were fully repaid during 2008.

 

During the fourth quarter of 2008 KMG borrowed $3,000 from a local bank. The note is collateralized by a corporate guarantee issued by TatArka and seismic equipment and bears interest at 6% per annum plus the three-month LIBOR rate at the date of interest calculation. As at September 30, 2008 the annual interest rate was equal to 9.21%. The note is due in July 2010.

 

In the 2006 fiscal year, TatArka borrowed $2,580 from two local banks. The notes were collateralized by equipment and bore interest at 14%. During the 2008 fiscal year TatArka repaid the remaining balance of $442. In 2008 TatArka borrowed an additional $1,000 from a local bank. The note is collateralized by a corporate guarantee issued by KMG and bears interest at 6% per annum plus the three-month            LIBOR at the date of interest calculation. At September 30, 2008 the annual interest rate was equal to 9.21%. The note is due July 2009.

 

During 2008 Caspian Services, Inc. borrowed $5,000 from Petrolinvest S.A. The loan had a conversion feature that allowed the Lender to convert the loan amount to common stock of the Company at an issue price of $2.75 per share. Because the conversion price was equal to or greater than the market price of the Company’s common stock on the loan date, no beneficial conversion feature was recorded.            The loan bore interest at the three-month LIBOR rate plus 2% per annum. As at September 30, 2008 the annual interest rate was equal to 5.21%. Although the loan matured in July 2008, Petrolinvest agreed to postpone repayment of the loan. The loan was fully repaid in November 2008.

 

In 2008 Caspian Services, Inc. also borrowed $15,000 from Altima Central Asia (Master) Fund Ltd. The loan bears interest at 13% and is due in June 2011. The loan has a conversion feature that allows the Lender to convert the loan to common stock of the Company at a price of $2.30 per share. Because the conversion price was equal to or greater than the market price of the Company’s common stock            on the loan date, no beneficial conversion feature was recorded.

 

F-18

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

In 2008 Caspian Services, Inc. entered into a loan agreement with Great Circle Energy Services LLC. to borrow $15,000. As of September 30, 2008 $7,500 of the loan had funded. The residual balance of $7,500 funded in October and November 2008. The loan has a conversion feature that allows the Lender to convert it to common stock of the Company at an issue price of $2.30 per share. Because the            conversion price was equal to or greater than the market price of the Company’s common stock on the loan date, no beneficial conversion feature was recorded. The loan bears interest at 13% per annum and is due in December 2011.

 

During the year 2008 Caspian Services Group borrowed $600 from an individual related to an officer of the Company. The loan bears interest at 13.38% and is due in September 2008. Although the loan matured in September 2008, the lender has indicated that he agrees to postpone the repayment of the loan.

 

During the year 2008 Caspian Real Estate and Balykshi borrowed $500 and $41 respectively from an officer of the Company. These loans bear interest at 12% and repaid during the fourth quarter 2008.

 

Long-term debt consists of the following:

 

| *September 30,*                                                                                                                       | 2008                                                                 | 2007                                               |
|---------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------|----------------------------------------------------|
| Bank loan bearing interest at 18% due December 2007;

secured by equipment and inventory                                              | $           - | $      15            |
|                                                                                                                                  |                                                                 |                                               |
| Loan from institutions other than banks at 0% due May 2008                                                                            | -                                                                    | 223                                                |
|                                                                                                                                  |                                                                 |                                               |
| Bank loan bearing interest at 6% p.a. + LIBOR due July 2010;

secured by corporate guarantee issued by TatArka and

seismic equipment | 2,984                                                                | -                                                  |
|                                                                                                                                  |                                                                 |                                               |
| Bank loan bearing interest at 14% due March 2008; secured

by equipment                                                               | -                                                                    | 442                                                |
|                                                                                                                                  |                                                                 |                                               |
| Bank loan bearing interest at 6% p.a. + LIBOR due July 2009;

secured by corporate guarantee issued by KMG                            | 1,002                                                                | -                                                  |
|                                                                                                                                  |                                                                 |                                               |
| Loans from institutions other than banks at 4.81% due July

2008, settled in November 2008                                            | 5,000                                                                | -                                                  |
|                                                                                                                                  |                                                                 |                                               |
| Loan from institutions other than banks at 13% due June 2011                                                                          | 15,492                                                               | -                                                  |
|                                                                                                                                  |                                                                 |                                               |
| Loans from institutions other than banks at 13% due

December 2011                                                                    | 7,572                                                                | -                                                  |
|                                                                                                                                  |                                                                 |                                               |
| Loans from institutions other than banks at 13.38% due

September 2008                                                                | 600                                                                  | -                                                  |
| Total Long-term Debt                                                                                                                  | 32,650                                                               | 680                                                |
| Less: Current Portion                                                                                                                 | 7,888                                                                | 680                                                |
| Long-term Debt – Net of Current Portion                                                                                         | $  24,762                                                  | $        - |

 

 

F-19

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

The annual maturities for the next five years and thereafter:

 

| 2009    | 2010    | 2011     | 2012    | 2013 | thereafter |
|---------|---------|----------|---------|------|------------|
| $ 7,888 | $ 1,699 | $ 15,492 | $ 7,571 | $ -  | $ -        |

 

 

**NOTE 8 – STOCKHOLDERS’ EQUITY**

 

***Common Stock***– In May 2008 the Company issued 642,981 shares at par value of $0.001 as part of a newly adopted Compensation Plan and distributed among the key employees.

 

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 was $9.00 per unit.

 

As a result of this private placement in 2007, the Company issued a total of 8,423,326 shares of common stock and warrants to purchase 3,500,108 shares of common stock at anexercise price of $4.00 per share. 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. 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. The funds raised in the offering were used to fund development of the Company’s marine base            and to acquire vessels and seismic equipment.

 

***Stock-based Compensation Plan -***In May 2008 the Caspian Services, Inc. 2008 Equity Incentive Plan (“Compensation Plan”) was adopted by the Company’s Board of Directors. The Compensation Plan was adopted with the goal of enhancing the interests of the Company and its shareholders. It encourages officers, directors and key employees, upon whose            judgment, initiative and effort the Company is largely dependent for the successful conduct of its business, to acquire and retain a proprietary interest in the Company by ownership of its equity securities.

 

Pursuant to the Compensation Plan, restricted stock grants were made to selected officers in consideration of forfeiture of all stock options granted under employment agreements to which they may have been entitled, whether issued or not, vested or not vested as of March 31, 2008. As a result, 469,772 stock options were forfeited and restricted stock grants totaling 156,591 shares, with an aggregate            value of $391, were awarded as consideration for the forfeited options. The Company also awarded the same selected officers and directors additional restricted stock grants totaling 164,167 shares, valued at $410, in connection with their employment agreements. The Company also awarded 356,167 shares of restricted stock grants pursuant to the Compensation Plan to a number of employees. The restricted stock was valued at $891.

 

In September 2008 33,944 shares of non-vested restricted stock grants valued at $85 were forfeited due to the resignation of one of the selected officers.

 

F-20

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

The above-mentioned restricted stock grants vest as follows: i) 50% on the grant date; ii) 25% on the first anniversary of the grant date, and iii) 25% on the second anniversary of the grant date. The stock granted is also subject to a six month holding period during which the shares may not be sold.

 

The Company recognized as an expense the difference of the fair value of the restricted shares and the expense already taken on the unvested options. Compensation expense charged against income for stock-based awards during the year 2008 was $873, as compared to $212 in 2007, and is included in general and administrative expense in the accompanying financial statements.

 

Based on a market price of $2.50 per share as of May 1, 2008 (the date of grant), the total value of shares issued is as follows:

 

|                             |            | Weighted-Average    |
|----------------------------------|-----------------|---------------------|
|                             | Non-Vested      | Grant Date          |
|                             | Shares          | Fair Value          |
| Non-vested at September 30, 2007 | -               | -    |
| Stock grant                      |  676,925   | $2.50               |
| Stock vested                     |  (321,490) | $2.50               |
| Stock forfeited                  | (33,944)        | $2.50               |
| Non-vested at Sept. 30, 2008     |  321,491   | $2.50               |

 

The value of the non-vested stock under the plan at September 30, 2008 is $450. As of September 30, 2008 unamortized deferred compensation was equal to $524 and will be amortized over the weighted average remaining term of 1.1 years.

 

***Stock Options***– At September 30, 2008, the Company had 1,000,000 options outstanding that were fully vested. These options expire from September 2009 through August 2015.

 

During the year ended September 30, 2008, the Company issued 316,037 options to certain employees in accordance with their respective employment agreements. These options had a weighted average exercise price of $2.2 per share, vested over three years, and expire eight years from the date of issuance. The options had a fair value of $2.08 per share as calculated using the Black-Scholes option-pricing            model with the following weighted average assumptions: dividend yield of 0%, expected volatility of 104.14%, risk free interest rate of 2.23% and expected lives of 8.0 years.

 

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 had a weighted average exercise price of $3.51 per share, vested over three years, and expire eight years from the date of issuance. The options had 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.

 

As noted above, during the year ended September 30, 2008, in accordance with new Compensation Plan, 469,772 unvested stock options were forfeited in exchange for restricted stock grants totaling 156,591 shares.

 

F-21

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

**(Dollars in thousands, except 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, 2008 and 2007 is as follows:

 

|                                                                                                            | 2008                                                                      | 2007                    |
|-----------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------|-------------------------|
|                                                                                                            |                                                                      | Weighted-               |   | Weighted- |
|                                                                                                            |                                                                      | Average                 |   | Average |
|                                                                                                            |                                                                      | Exercise                |   | Exercise |
|                                                                                                            | Warrants                                                                  | Price                   | Warrants | Price |
| Outstanding at beginning of  the year                                                                 | 1,153,735                                                                 | $   3.00 | 1,000,000 | $   3.00 |
| Issued                                                                                                          |   316,037                                                       |   2.20        |   153,735 |  3.51 |
| Forfeited                                                                                                       |   (469,772)                                                     |   2.63        |             - | - |
| Exercised                                                                                                       |             - | -                       |             - | - |
| Outstanding at end of the year                                                                             | 1,000,000                                                                 | $   3.00 | 1,153,735 | $   3.07 |
| Exercisable at end of the year                                                                                  | 1,000,000                                                                 | $   3.00 | 1,000,000 | $   3.00 |
| Weighted average fair value of options                              granted during the year |                                                                      |   2.20        |   |  3.51 |

 

The following table summarizes information related to the Company’s stock options outstanding at September 30, 2008:

 

|     |        | Weighted-Average      |        |
|----------|-------------|-----------------------|-------------|
| Exercise | Number      | Remaining Contractual | Number      |
| Price    | Outstanding | Life (in years)       | Exercisable |
| $ 3.00   | 1,000,000   | 5.8                   | 1,000,000   |

 

At September 30, 2008 there was no intrinsic value for the options outstanding based on the Company’s share price being less than $3 at September 30, 2008.

 

***Warrants***– Warrant activity for the years ended September 30 2008 and 2007 is as follows:

 

|                                      | 2008                                                                             | 2007                    |
|-------------------------------------------|----------------------------------------------------------------------------------|-------------------------|
|                                      |                                                                             | Weighted-               |   | Weighted- |
|                                      |                                                                             | Average                 |   | Average |
|                                      |                                                                             | Exercise                |   | Exercise |
|                                      | Warrants                                                                         | Price                   | Warrants | Price |
| Outstanding at beginning of the year | 4,500,108                                                                        | $   4.22 | 1,000,000 | $   5.00 |
| Issued                                    |              -  | -                       | 3,500,108 | 4.00 |
| Exercised                                 |               - | -                       |              - | - |
| Outstanding at end of the year       | 4,500,108                                                                        |  4.22              | 4,500,108 |  4.22 |
| Exercisable at end of the year            | 4,500,108                                                                        | $   4.22 | 4,500,108 | $   4.22 |

 

F-22

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

The following table summarizes information related to the Company’s warrants outstanding at September 30, 2008:

 

|                    |        | Weighted-Average      |        |
|-------------------------|-------------|-----------------------|-------------|
| Exercise                | Number      | Remaining Contractual | Number      |
| Price                   | Outstanding | Life (in years)       | Exercisable |
| $   4.00 | 3,500,108   | 1.3                   | 3,500,108   |
| $   5.00 | 1,000,000   | 0.5                   | 1,000,000   |

 

 

**NOTE 9— COMPREHENSIVE INCOME**

 

Total comprehensive income for the year ended September 30, 2008 and 2007 was $2,413 and $11,322, respectively. Total comprehensive income consists of net income and changes in accumulated other comprehensive income. Accumulated other comprehensive income is included in stockholder’s equity and consists of foreign currency translation adjustments.

 

**NOTE 10 – 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:

|                                           | Year Ended                                                   |   | Year Ended                                                       |
|------------------------------------------------|--------------------------------------------------------------|--------|------------------------------------------------------------------|
|                                           | September 30,                                                |   | September 30,                                                    |
|                                           | 2008                                                         |   | 2007                                                             |
| United States                                  | $      (132)              |   | $          (6) |
| Kazakhstan and other

international operations | 1,456                                              |   | 14,903                                                      |
|                                           | $       1,324   |   | $   14,897                                   |

 

 

 

F-23

 

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

Income tax expense consists of the following:

 

|               | Year Ended                                                 |   | Year Ended               |
|--------------------|------------------------------------------------------------|--------|--------------------------|
|               | September 30,                                              |   | September 30,            |
|               | 2008                                                       |   | 2007                     |
| Current income tax | $    2,374                   |   | $   4,629 |
| Deferred           | (1,423)                                               |   | 483                      |
|               | $       951   |   | $   5,112 |

 

Deferred tax assets and liabilities are as follows:

 

| *as of September 30,*          | **2008**                             | **2007**                             |
|--------------------------------|--------------------------------------|--------------------------------------|
| Deferred tax assets            |                                 |                                 |
| Tax loss carry forwards        | $   4,010        | $    2,622  |
| Provision for doubtful debts   | 300                             | 38                              |
| Property and equipment         | 421                             | 283                             |
| Valuation allowance            | (2,829)                              | (2,905)                              |
| Total deferred tax assets      | 1,902                           | 38                              |
|                           |                                 |                                 |
| Deferred tax liabilities       |                                 |                                 |
| Property and equipment         | (2,295)                              | (1,843)                              |
| Total deferred tax liabilities | (2,295)                              | (1,843)                              |
| Net deferred income taxes      | $     (393) | $   (1,805)           |

 

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:

 

|                                  | Year Ended                               |   | Year Ended                     |
|---------------------------------------|------------------------------------------|--------|--------------------------------|
|                                  | September 30,                            |   | September 30,                  |
|                                  | 2008                                     |   | 2007                           |
| Tax at federal statutory rate (34%)   | $    613        |   | $   5,065  |
| Utilization of losses                 | (866)                                    |   | -                         |
| Non-deductible expenses               | 537                                 |   | 589                       |
| (Income)/loss not subject to taxation | 359                                 |   | (914)                          |
| Tax effect of loss companies          | 497                                 |   | 575                       |
| Effect of lower foreign tax rates     | (189)                                    |   | (203)                          |
| Income tax provision                  | $     951  |   | $   5,112  |

 

As of September 30, 2008, the Company has loss carry forwards of approximately $1,133 and $8,759 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 2009.

 

 

F-24

 

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

**NOTE 11 – 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 significant 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 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.

 

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 year ended September 30, 2007 the Company entered into four employment agreements, which require the Company to issue options annually on the anniversary of the effective date of the agreement. Each employee received 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. 316,037 and 153,735 options were issued to employees during the year ended September 30, 2008 and 2007, respectively. The options vested over a three year period and had 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.

 

During the year ended September 30, 2008 the Board of Directors adopted a new Compensation Plan. Pursuant to this Plan, restricted stock grants were made to six selected officers in consideration of the forfeiture of all stock options granted under employment agreements to which they may have been entitled, whether issued or not, vested or not vested as of March 31, 2008. As a result, 469,772 stock            options were forfeited and restricted stock grants of 156,591 shares were awarded as consideration for the forfeited options. The Company also awarded the same selected officers and directors additional restricted stock grants totaling 164,167 shares in connection with their employment agreements.

 

***Environmental Uncertainties***— Liabilities are recorded when environmental assessments and/or remedial efforts are probable, and the cost can be reasonably estimated based on ongoing engineering 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 law or government regulations, and the outcome of any potential related litigation. We have no specific concerns about these uncertainties.

 

 

F-25

 

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

***Purchase Commitments***– During fiscal 2008 Balykshi entered into agreements with third parties for construction services and a supply of equipment. As of September 30, 2008 the amount of purchase commitments was equal to $47,000.

 

***Operating Leases –***The Company leases equipment and vehicles. Rent expense for the years ended September 30, 2008 and 2007 was $2,200 and $982, respectively.

 

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, 2008 and 2007 was $1,499 and $1,029, respectively.

 

The future minimum rental payments required under these operating leases for 2009 are $3,700.

 

Some of the vessels in the Company’s fleet are leased from a third party. Rent expense for the years ended September 30, 2008 and 2007 was $8,544 and $6,488, respectively. The future minimum rental payments required under these operating leases are estimated as follows for the periods indicated:

 

|                                        | 2009    | 2010 | 2011 | 2012 | 2013 | thereafter |
|---------------------------------------------|---------|------|------|------|------|------------|
| Estimated vessel  operating lease | $ 1,894 | $ -  | $ -  | $ -  | $ -  | $ -        |

 

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

 

***Capital Leases –***During the year ended September 30, 2008 The Company leased seismic equipment under a capital lease arrangement.

 

The gross amount of assets recorded under the capital lease was $2,245 and accumulated depreciation was $625 as of the year ended September 30, 2008. The amount of depreciation expense of seismic equipment acquired under the capital lease was $625 and included in depreciation expense.

 

As of September 30, 2008 lease obligations for $318 were classified as short term and $0 were classified as long term.

 

F-26

 

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

***Legal Proceedings***— During the first fiscal quarter 2008 we were 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 $600 was decreased to $200. 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. In November 2007 the lower court issued a second decision where it upheld the initial imposition of $100 in            VAT penalties related to the Agip KCO contract. We also appealed this decision and lost. Throughout these matters, Agip KCO has paid our legal expenses. We have incurred no legal or court fees in connection with this matter.

 

In February 2008 we paid the claimed VAT and related penalties, which totaled $300. In accordance with AGIP reimbursement procedures we paid the judgments to the Republic of Kazakhstan before submitting our request for reimbursement to AGIP. We submitted an indemnification request to AGIP and expect to be reimbursed for the full amount paid.

 

**NOTE 12 – RELATED PARTY TRANSACTIONS**

 

During the years ended September 30, 2008 and 2007 the Company recognized revenue from performed seismic works from an entity under common management (Bolz LLP) $2,029 and $2,837, respectively.

 

During the years ended September 30, 2008 and 2007 the Company recognized revenue from vessel rental and cost reimbursement from a company related through common ownership (Veritas-Caspian) $10,839 and $10,700, respectively.

 

During the years ended September 30, 2008 and 2007 the Company recognized revenue from geological services from a company related through common ownership (Erkin Oil) $0 and $359, respectively.

 

During the years ended September 30, 2008 and 2007 the Company paid advances for equipment to a company related through common ownership (Demeu Energy) $595 and $413, respectively.

 

During the years ended September 30, 2008 and 2007 the Company paid an entity under common management (KazakhstanCaspiShelf) $1,389 and $3,000, respectively, for vessel and equipment rental, seismic services and purchase of assets. The Company also recognized from the same entity $0 and $107 of vessel revenues, $1,657 and $5,267 of revenue from performed seismic works, sale of materials and equipment            rental during 2008 and 2007, respectively.From the same entity in September 2008 the Company purchased additional shares of KMG for $2,900. $1,500 was paid during September 2008 and the balance was paid in October 2008.

 

During November – December 2007 TatArka loaned $500 to KazakhstanCaspiShelf. As of September 30, 2008 the balance due was $125. The loan bears interest at 0% and was initially due in December 2007 and is currently due on demand. In July 2007, TatArka entered into an agreement with the same entity and loaned $661. The loan did not bear interest and was repaid during 2008.

 

 

F-27

 

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

During the years ended September 30, 2008 and 2007 the Company paid an entity related through common ownership (Help LLP) $1,640 and $890, respectively, in operating expenses for corporate travel and visa support.

 

During the years ended September 30, 2008 and 2007 a company related through common ownership (Caspian Geo-Consulting Services LLP) provided marketing services to KMG for $0 and $140 and performed interpretation of seismic data to KMG and TatArka for $89 and $43, respectively.

 

The Company recognized $2,806 and $231 of vessel upgrade and repair expenditures during the years ended September 30, 2008 and 2007 respectively from Nico International, a company related through interest in MOBY joint venture.

 

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

 

| **Related party's Name** | **Description**                      | **September 30, 2008**                                   |   | **September 30, 2007**                                         |
|--------------------------|--------------------------------------|----------------------------------------------------------|--------|----------------------------------------------------------------|
|                     |                                 |                                                     |   |                                                           |
| Bolz LLP                 | Seismic services                     | $       4,485         |   | $         2,812   |
| Veritas Caspian          | Vessel rental and cost reimbursement | 459                                                      |   | 2,369                                                          |
| Erkin Oil                | Geological services                  | 292                                                      |   | 359                                                            |
| KazakhstanCaspiShelf     | Vessel rental and seismic work       | -                                                        |   | 2,716                                                          |
| Officers                 | Travel                               | 227                                                      |   | -                                                              |
| Others                   | Services provided                    | 138                                                      |   | 299                                                            |
| **TOTAL**                |                                 | **$**       **5,601** |   | **$**        **8,555** |

 

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

 

| **Related party's Name** | **Description**                   | **September 30, 2008**                                         |   | **September 30, 2007**                                                           |
|--------------------------|-----------------------------------|----------------------------------------------------------------|--------|----------------------------------------------------------------------------------|
|                     |                              |                                                           |   |                                                                             |
| KazakhstanCaspiShelf     | Purchase of shares                | $         1,025   |   | $             - |
| Officers                 | Payroll and travel                | 157                                                            |   | 281                                                                              |
| Help LLP                 | Transportation and legal services | 242                                                            |   | 1,097                                                                            |
| Others                   | Services received                 | 130                                                            |   | 96                                                                               |
| **TOTAL**                |                              | **$**        **1,554** |   | **$**      **1,474**                               |

 

Accounts receivable from related parties and accounts payable to related parties have no stated repayment terms and are dueupon presentation.

 

**NOTE 13 – OTHER INCOME**

 

During the years ended September 30, 2008 and 2007 the Company re-invoiced $940 and $756, respectively, of expenses incurred (mostly QHSE and travel expenses) to Veritas-Caspian and other non-related companies.

 

 

F-28

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

During the year ended September 30, 2008 and 2007 KMG rented some of its idle equipment to a company under common management and recognized $1,557 and $1,649 of other income, respectively.

 

During the year ended September 30, 2008 the Company recognized as net income $91 from the sale of fixed assets and goods to third parties and other income and expenses (net).

 

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.

 

**NOTE 14 – 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.

 

The Company has operations in three segments of its business, namely: Vessel Operations, Geophysical Services and Infrastructure. The vessel operations, geophysical services and infrastructure are located in the Republic of Kazakhstan. Corporate administration is located in the United States of America. Further information regarding the operations and assets of these reportable business segments            follows:

 

 

|                          |   | **For the Years**                                       |
|-------------------------------|--------|---------------------------------------------------------|
|                          |   | **Ended September 30,**                                 |
|                          |   | **2008**                                                | **2007** |
| **Capital Expenditures**      |   |                                                    |   |
| Vessel Operations             |   | $        12,595 | $        6,062 |
| Geophysical Services          |   | 5,185                                                   | 4,955 |
| Infrastructure Development    | 23,516 | 7,630                                                   |
| Total segments                |   | 41,296                                                  | 18,647 |
| Corporate assets              |   | 3                                                       | 7 |
| Less intersegment investments | -      | -                                                       |
| **Total consolidated**        |   | $       41,299       | $      18,654 |
|                          |   |                                                    |   |

 

 

 

F-29

 

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

|                                                       |   | **For the Years**                                                                                                                                  |
|------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                       |   | **Ended September 30,**                                                                                                                            |
|                                                       |   | **2008**                                                                                                                                           |   | **2007** |
| **Revenues**                                               |   |                                                                                                                                               |   |   |
| Vessel Operations                                          |   | $                36,988                                       |   | $                31,881  |
| Geophysical Services                                       |   | 34,739                                                                                                                                        |   | 39,286  |
| Infrastructure Development                                 |   | 1,512                                                                                                                                         |   | 1,588  |
| Total segments                                             |   | 73,239                                                                                                                                        |   | 72,755  |
| Corporate revenue                                          |   | -                                                                                                                                             |   | -  |
| Less intersegment revenues                                 |   | (613)                                                                                                                                              |   | (8,618) |
| **Total consolidated**                                     |   | $                72,626                                       |   | $                64,137  |
|                                                       |   |                                                                                                                                               |   |   |
| **Depreciation and Amortization**                          |   |                                                                                                                                               |   |   |
| Vessel Operations                                          |   | $                (3,878)                                           |   | $                (1,791) |
| Geophysical Services                                       |   | (5,130)                                                                                                                                            |   | (3,998) |
| Infrastructure Development                                 |   | (429)                                                                                                                                              |   | (824) |
| Total segments                                             |   | (9,437)                                                                                                                                            |   | (6,613) |
| Corporate depreciation and amortization                    |   | (6)                                                                                                                                                |   | (6) |
| **Total consolidated**                                     |   | $                (9,443)                                           |   | $                (6,619) |
|                                                       |   |                                                                                                                                               |   |   |
| **Interest expense**                                       |   |                                                                                                                                               |   |   |
| Vessel Operations                                          |   | $                    (56)                      |   | $                      (2) |
| Geophysical Services                                       |   | (213)                                                                                                                                              |   | (125) |
| Infrastructure Development                                 |   | (22)                                                                                                                                               |   | (3) |
| Total segments                                             |   | (291)                                                                                                                                              |   | (130) |
| Corporate interest expense                                 |   | (169)                                                                                                                                              |   | -  |
| **Total consolidated**                                     |   | $                  (460)                                 |   | $                 (130) |
|                                                       |   |                                                                                                                                               |   |   |
| **Loss from Equity Method Investees**                      |   |                                                                                                                                               |   |   |
| Vessel Operations                                          |   | $                       -  |   | $                       -  |
| Geophysical Services                                       |   | -                                                                                                                                             |   | -  |
| Infrastructure Development                                 |   | (58)                                                                                                                                               |   | -  |
| Total segments                                             |   | (58)                                                                                                                                               |   | -  |
| Corporate income (loss)                                    |   | -                                                                                                                                             |   | -  |
| **Total consolidated**                                     |   | $                   (58)                                 |   | $                       -  |
|                                                       |   |                                                                                                                                               |   |   |
| **Income (Loss) Before Income Tax and Minority Interests** |   |                                                                                                                                               |   |   |
| Vessel Operations                                          |   | $                  397                              |   | $                 (732) |
| Geophysical Services                                       |   | 2,385                                                                                                                                         |   | 13,878  |
| Infrastructure Development                                 |   | (603)                                                                                                                                              |   | 2,529  |
| Total segments                                             |   | 2,179                                                                                                                                         |   | 15,675  |
| Corporate loss                                             |   | (855)                                                                                                                                              |   | (778) |
| **Total consolidated**                                     |   | $               1,324                                              |   | $               14,897  |

 

 

 

F-30

 

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

|                               |   | **For the Years**                                                                                                                                                    |
|------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                               |   | **Ended September 30,**                                                                                                                                              |
|                               |   | **2008**                                                                                                                                                             |   | **2007** |
| **Provision for Income Tax**       |   |                                                                                                                                                                 |   |   |
| Vessel Operations                  |   | $                     206                              |   | $                      (523) |
| Geophysical Services               |   | (1,157)                                                                                                                                                              |   | (4,589) |
| Infrastructure Development         |   | -                                                                                                                                                               |   | -  |
| Total segments                     |   | (951)                                                                                                                                                                |   | (5,112) |
| Corporate provision for income tax |   | -                                                                                                                                                               |   | -  |
| **Total consolidated**             |   | $                    (951)                                       |   | $                   (5,112) |
|                               |   |                                                                                                                                                                 |   |   |
| Vessel Operations                  |   | $                          -  |   | $                           -  |
| Geophysical Services               |   | 544                                                                                                                                                             |   | (584) |
| Infrastructure Development         |   | 161                                                                                                                                                             |   | 264   |
| Total segments                     |   | 705                                                                                                                                                             |   | (320) |
| Corporate minority interest        |   | -                                                                                                                                                               |   | -  |
| **Total consolidated**             |   | $                     705                              |   | $                      (320) |
|                               |   |                                                                                                                                                                 |   |   |
| **Segment Net Income (Loss)**      |   |                                                                                                                                                                 |   |   |
| Vessel Operations                  |   | $                     603                              |   | $                   (1,255) |
| Geophysical Services               |   | 1,772                                                                                                                                                           |   | 8,705  |
| Infrastructure Development         |   | (442)                                                                                                                                                                |   | 2,793  |
| Total segments                     |   | 1,933                                                                                                                                                           |   | 10,243  |
| Corporate loss                     |   | (855)                                                                                                                                                                |   | (778) |
| **Total consolidated**             |   | $                  1,078                                              |   | $                    9,465  |
|                               |   |                                                                                                                                                                 |   |   |
|                               |   | September  30,                                                                                                                                                  |
| **Segment Assets**                 |   | **2008**                                                                                                                                                             |   | **2007** |
| Vessel Operations                  |   | $                 40,349                                                   |   | $                  25,414   |
| Geophysical Services               |   | 46,579                                                                                                                                                          |   | 36,275  |
| Infrastructure Development         |   | 44,443                                                                                                                                                          |   | 19,177  |
| Total segments                     |   | 131,371                                                                                                                                                         |   | 80,866  |
| Corporate assets                   |   | 83,593                                                                                                                                                          |   | 57,179  |
| Less intersegment investments      |   | (84,336)                                                                                                                                                             |   | (45,750) |
| **Total consolidated**             |   | $              130,628                                                                    |   | $                   92,295  |
|                               |   |                                                                                                                                                                 |   |   |

 

 

F-31

 

 

----

**CASPIAN SERVICES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2008 AND 2007**

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

 

 

**NOTE 15 – SUBSEQUENT EVENTS**

 

In November 2008 the Company received $10,000 from the EBRD as a contribution to Balykshi LLP.

 

In December 2008 MOBY entered into the Loan agreement with the EBRD in amount $12,000.

 

Kazakhstan Tax Code has been changed effective January 2009, however the Company does not expect a significant increase in tax expense in the next period.

 

 

F-32