The following management's discussion and analysis of financial condition and results of operations should be read in conjunction with our historical consolidated financial statements and their notes included elsewhere in this annual report on Form 10-K. This discussion contains forward-looking statements that reflect our current views with respect to future events and financial performance. Our actual results may differ materially from those anticipated in these forward-looking statements or as a result of certain factors such as those set forth in our Forward-Looking Statements disclaimer on page 1 of this annual report on Form 10-K. 25 -------------------------------------------------------------------------------- This discussion summarizes the significant factors affecting our consolidated operating results, financial condition, liquidity and capital resources during the fiscal years ended September 30, 2013 and 2012. This discussion should be read in conjunction with the Consolidated Financial Statements and notes to the Consolidated Financial Statements included in this annual report on Form 10-K. Except for share and per share amounts, all dollar amounts stated in this Item are presented in thousands unless stated otherwise. 2013 Summary During the 2013 fiscal year, total revenues increased significantly mostly due to increased activity in our onshore geophysical segment - we completed eight successful projects in fiscal 2013 compared to five projects in fiscal 2012. Revenue from our vessel segment remained at nearly the same level as fiscal 2012. While marine base revenue also increased, overall marine base revenue is not significant in comparison to geophysical and vessel revenues. We do not anticipate demand for our services to grow significantly in fiscal 2014 as development of the second phase of the Kashagan oil field development project continues to be delayed. Current projections place commencement of the second phase some time in 2018-2019. We do not anticipate significant growth in demand for our services until the second phase of the Kashagan development project ramps up. Based on current industry expectations for Kashagan development, we remain optimistic about our prospects in the longer-term. Additionally, we continued to work to expand our vessel operations to Turkmenistan and Russian sectors of Caspian Sea , with some success. For the year ended September 30, 2013 we experienced a 34% increase in total revenue as compared to the year ended September 30, 2012 . Vessel revenues increased 3% and marine base service revenue increased 29%, while geophysical service revenues jumped 122%. The higher levels of operating activity caused our operating costs to increase by about 13%, mostly due to increases in cost of geophysical service revenues and general and administrative expenses. As a result of the foregoing, our comprehensive loss attributable to Caspian Services, Inc. decreased from $14,778 , or $0.31 per share, during fiscal 2012 to $12,168 , or $0.23 per share during fiscal 2013. Results of Operations Comparison of the fiscal year ended September 30, 2013 and September 30, 2012 In fiscal 2013 we operated three business segments: Vessel Operations, Geophysical Services and Marine Base Services. 26 -------------------------------------------------------------------------------- For the Years Ended September 30, 2013 2012 % change VESSEL OPERATIONS Operating Revenue $ 20,101 $ 17,688 14% Pretax Operating Income/(Loss) (3,102) (1,077) 188% GEOPHYSICAL SERVICES Operating Revenue $ 13,644 $ 6,164 121% Pretax Operating Income/(Loss) 1,882 (2,342) -180% MARINE BASE SERVICES Operating Revenue $ 9,062 $ 1,173 673% Pretax Operating Loss (5,337) (8,065) -34% CORPORATE ADMINISTRATION Operating Revenue $ - $ - n/a Pretax Operating Loss (3,228) (2,797) 15% This table includes intercompany revenues, which are eliminated on a consolidation level. For details, please, refer to Note 16 to our Financial Statements. Segment Revenues and Operating Expenses Vessel Operations During fiscal 2013 revenue from vessel operations increased 3% to $18,234 . Overall fiscal 2013 and 2012 activities were at the same level, except for a slight increase in daily rates, which resulted in a $546 increase in vessel revenues. We do not expect significant growth in demand for our vessels during fiscal 2014 in the Kazakhstan sector of the Caspian Sea , so we will continue to pursue opportunities in Turkmenistan and Russian sector of Caspian Sea . During fiscal 2013 vessel operating costs of $10,333 were in line with fiscal 2012. During fiscal 2013 we accrued an impairment loss of $1,062 to bring the carrying amounts of two vessels in line with their fair value. This impairment loss caused the loss from vessel operations during fiscal 2013 to increase to $2,022 compared to a loss of $576 during fiscal 2012. Geophysical Services Revenue from geophysical services increased 122% from $6,164 during fiscal 2012 to $13,700 during fiscal 2013. This is a result of completing eight successful projects for fiscal 2013 covering 114,000 physical points in total compared to five projects in fiscal 2012 with 63,000 total physical points. As a result of the increased activity, cost of geophysical service revenues increased by 111% to $7,889 . 27 -------------------------------------------------------------------------------- In August 2013 we determined to discontinue KMG's operations. The corresponding loss from discontinued operations during the fiscal 2013 was $2,571 compared to $2,411 during the fiscal 2012. As a result of increased activity in our onshore seismic business, net income attributable to Caspian Services, Inc. from geophysical operations of $267 was accrued during fiscal 2013 compared to net loss attributable to Caspian Services, Inc. of $4,685 during fiscal 2012. The local market, from which much of our seismic work is generated, remains depressed as a result of the difficult credit market and we continue to struggle to obtain payment from overdue accounts. We take legal action where possible but this is an expensive option in Kazakhstan , as taxes must be paid up front, and it is not always easy to determine whether there are assets which can be seized in a legal action. We anticipate that fiscal 2014 will be flat for seismic work as the credit required by local Kazakh companies to finance these seismic projects remains elusive. Our strategy for the upcoming year is to try contain costs and to continue to target more large international clients. Marine Base Services Our marine base services revenues increased 29% to $1,154 during fiscal 2013. The increased revenue, however, was insufficient to cover our fixed costs, including depreciation. Additionally, interest expense of $5,823 was accrued to reflect our liability under the EBRD loan, the potential accelerated put option and the portion of interest on the loan from Investor, which relates to the marine base. During the fiscal 2013 we realized a marine base services loss of $5,053 compared to a loss of $5,978 during the fiscal 2012. Although we have been able to enter into agreements with some customers to use our base's services we do not expect significant demand for the marine base until Kashagan field development and construction activity increases, which is currently anticipated to start in 2018 or 2019. Until activity in the Caspian Sea region increases, we do not expect the marine base to be able to service its current debt obligations or to operate profitably. Corporate Administration Corporate administration refers to some local administration in Kazakhstan and the administration of our affairs in the United States . During the fiscal year ended September 30, 2013 net loss from corporate administration was $4,736 compared to $2,798 during the fiscal year ended September 30, 2012 . This increase was mostly caused by $1,508 of losses attributable to loans from KMG that were written-off, as KMG operations were discontinued in August 2013 . Additionally, we accrued approximately $230 to reflect default interest on the Consolidated Note. Consolidated Results Impairment Loss During fiscal 2013 we recognized an impairment loss of $1,062 compared to an impairment loss of $1,397 during fiscal 2012. As noted above, the impairment loss accrued during fiscal 2013 represents the loss to bring the carrying amounts of two vessels in line with their fair value. The impairment loss for fiscal 2012 was the result of the impairment of marine base dredging costs. 28 -------------------------------------------------------------------------------- General and Administrative Expenses General and administrative expense for the fiscal year ended September 30, 2013 was $11,078 , which was a 17% increase from the comparable prior period result. This increase is mostly caused by $1,302 of bad debt allowance recognized in the vessel segment during fiscal 2013. Depreciation and Amortization Depreciation and amortization expense decreased by $1,201 or 19% to $5,015 during fiscal 2013 compared to fiscal 2012. This decrease was caused by the sale of one of our vessels and discontinued KMG operations during the fiscal 2013. Interest Expense Interest expense during fiscal 2013 increased to $7,985 or 19% compared to fiscal 2012. This increase was the result of applying default rates to our loans due to EBRD and the Investor during the fiscal 2013. Foreign Currency Transaction Loss During fiscal 2013 we realized an increase in foreign currency transaction loss from $363 during fiscal 2012 to $660 during fiscal 2013. This was caused mainly by significant variations in the value of the US dollar and the Euro during fiscal 2013, while during fiscal 2012 FOREX rates were more stable. It is our policy to try and match foreign currency costs with foreign currency income and we were able to reduce some of the loss as Euro costs for vessel rental were also lower. It is not our business to speculate on currency movements and we have not historically engaged in currency hedging. Other Non-Operating Income (Loss), net During fiscal 2013 we realized other non-operating income, net of $1,950 compared to other non-operating loss, net of $182 during fiscal 2012. This increase is mostly attributable to the net proceeds from the sale of one of our vessel. The vessel sale was a one-time event and we do not expect to realize the significant non-operating income in future. Net Other Expenses Net other expenses decreased 6% to $6,633 during fiscal 2013 as increases in interest expense and foreign currency transaction loss were more than offset by the significant increase other non-operating income, net. 29 -------------------------------------------------------------------------------- Benefit from (provision for) income tax During fiscal 2013 we realized a benefit from income taxes of $528 compared to a benefit of $740 during fiscal 2012. This difference was caused by the fact that more significant taxable losses were recognized during fiscal 2012 than during fiscal 2013. Each entity is taxed separately in Kazakhstan . Net Loss As a result of the aforementioned factors, during fiscal 2013 we realized a net loss during fiscal 2013 of $11,828 compared to a net loss of $15,952 during fiscal 2012. Comprehensive Loss With the closing of KMG, net loss attributable to noncontrolling interests decreased from $1,915 in fiscal 2012 to $284 in fiscal 2013. We also realized a 12% increase in foreign currency translation adjustment during the same period. As a result, comprehensive loss decreased 16% in fiscal 2013 and comprehensive loss attributable to Caspian Services, Inc. decreased 18%. Liquidity and Capital Resources At September 30, 2013 we had cash on hand of $3,973 compared to cash on hand of $4,601 at September 30, 2012 . At September 30, 2013 total current liabilities exceeded total current assets by $66,631 . That was mainly attributable to the EBRD loan and put option and the Investor loans being classified as current liabilities. As discussed in more detail under the heading "Off-Balance Sheet Financing Arrangements" we may also be required to guarantee certain repayment obligations of Balykshi in connection with a loan made to MOBY . In 2007 we entered into a series of debt and equity financing agreements with EBRD to provide funding for our marine base. As of September 30, 2013 the outstanding loan balance and accrued interest of the EBRD loan was $23,387 . The EBRD loan matures in May 2015 . The financing agreements with EBRD contain financial and other covenants, the violation of which could be deemed a default under these agreements. Pursuant to the terms of the financing agreements, following delivery of written notice to us of an event of default and the expiration of any applicable grace period, EBRD may declare all or any portion of its loan, together with all accrued interest, immediately due and payable or payable on demand. The EBRD financing agreements provide that in the event any indebtedness of the Company in excess of $1,000 is declared or otherwise becomes due and payable prior to its specified maturity date, such may be deemed an event of default which would also allow EBRD to declare its loan immediately due and payable or payable on demand. The EBRD loan is collateralized by the property, including the marine base, and bank accounts of Balykshi and CRE. 30 -------------------------------------------------------------------------------- In connection with the EBRD financing, EBRD also made a $10,000 equity investment to purchase a 22% equity interest in Balykshi. To secure that funding we were required to grant EBRD a put option whereby EBRD can require the Company to repurchase the 22% equity interest. The put is exercisable during the period from six to ten years after the signing of the Investment Agreement. The put price is determined based on the fair market value of Balykshi as mutually agreed by the parties, except that in the event of a default, EBRD has the right to accelerate the put option at a fixed rate of return as discussed in more detail below. In the event there is a change in control of the Company, EBRD may, but is not required to exercise its put right to require the Company to repurchase the equity interest at its fair market value. The put option includes an acceleration right in the event: (i) any financial debt of Balykshi in excess of $1,000 is not paid when due, or a default of any nature occurs and such financial debt becomes prematurely due and payable or is placed on demand; (ii) any party to the financing agreements (other than EBRD) fails to meet its obligations under of any of the financing agreements between Balykshi, the Company and EBRD; (iii) any actions are taken or proceeding instituted that would result in the Company's bankruptcy, insolvency, reorganization or similar action, or the Company's consenting to any such action or proceeding; (iv) any representation or warranty made or confirmed by the Company or Balykshi is found to be false or misleading when made or confirmed. If the put option is accelerated, EBRD can require the Company to repurchase the $10,000 equity investment plus a 20% per annum rate of return. In connection with the EBRD financing agreements, the Company is obligated to provide financial assistance to Balykshi to meet its obligations and working capital needs. As noted above, we have agreed with local authorities to complete outstanding dredging work at the marine base within a reasonable period of time. During fiscal 2012 the Company contracted with a contractor to complete the dredging which was initially projected to cost around $3,000 . However, the project was only partially completed at a cost of around $1,500 with further dredging works still required. Currently, Balykshi has insufficient funds to complete the dredging project. As the dredging was not completed in a reasonable period of time, Balykshi could be subject to certain penalties, including the cancelation of permits and termination of operational activities at the marine base until the dredging is completed. The failure by Balykshi or the Company to provide financing for, or to complete, the dredging works could constitute a default under the EBRD financing agreements. In 2008 Balykshi entered into an agreement with the Investment Committee of the Republic of Kazakhstan and agreed to a schedule of work to be performed at the marine base. As of the date of this report, Balykshi has failed to complete approximately $4,000 of the agreed upon scheduled work, which could result in the cancellation of tax preferences granted to Balykshi by the Investment Committee. As discussed above, under the terms of the EBRD Loan Agreement, as amended, the semi-annual repayment installments under the EBRD loan are due each year on November 20 and May 20 . The payments due on November 20, 2011 , May 20, 2012 , November 20, 2012 and May 20, 2013 and November 20, 2013 were not made, which may constitute an event of default under the EBRD Loan Agreement and may constitute a default under the Put Option Agreement. The default interest rate of the EBRD Loan of 9% is applied to the payments due but not paid. 31 -------------------------------------------------------------------------------- Should EBRD accelerate its loan or its put option, we would have insufficient funds to satisfy those obligations individually or collectively. If we are unable to satisfy those obligations, EBRD could seek any legal remedy available to it to obtain repayment, including forcing the Company into bankruptcy, or foreclosing on the loan collateral, which includes the marine base and other assets and bank accounts of Balykshi and CRE. To help meet our additional funding obligations to construct the marine base, in 2008 we entered into two facility agreements pursuant to which we received debt funding of $30,000 . In June and July 2011 , the Investor acquired the two facility agreements. In September 2011 we issued the Investor two secured promissory notes, the Non-Negotiable Note in the principal amount of $10,800 and the Consolidated Note in the principal amount of $24,446 in connection with a proposed restructuring of the facility agreements. Pursuant to the terms of the Non-Negotiable Note, the Investor may, at any time, demand and receive payment of the Non-Negotiable Note by the issuance of our common stock. The price per share for principal and interest is $.12 per share. The Investor has the right, at any time, to demand the issuance of shares in satisfaction of the Non-Negotiable Note. If the issuance of common stock has not been demanded by the Investor or made at our election by the September 30, 2014 maturity date, we must repay the principal and interest in cash. Pursuant to the terms of the Consolidated Note, interest accrues at 12% per annum and shall be paid semi-annually in arrears on each six month anniversary of the Issuance Date ( September 30, 2011 ). The unpaid principal amount of the Consolidated Note, and any accrued but unpaid interest thereon, shall be due and payable on September 30, 2014 . The Consolidated Note provides for a default rate of interest of 13% per annum upon the occurrence and during the continuation of an event of default, as defined in the Consolidated Note, which shall be payable in cash upon demand. With the increase in our authorized common stock in May 2013 , the Investor now has the right at any time following a five-day written notice to convert all or any portion of the principal and any accrued but unpaid interest into shares of our common stock at $.10 per share. As of the date of this report, none of the semi-annual interest payments have been made to the Investor when due. During fiscal 2013 and through the date of this annual report on Form 10-K the Company has paid $1,800 to the Investor to reduce interest due. The failure to pay the interest on the Consolidated Note when due may constitute an event of default under the Consolidated Note. In the event of a default that remains uncured, the Investor may, at any time, demand immediate repayment of the Consolidated Note. As a result, we have included the Consolidated Note and all accrued but unpaid interest as current liabilities at September 30, 2013 and September 30, 2012 . As of the date of this report, to our knowledge, the Investor has not made any demand for immediate repayment of the Consolidated Note. 32 -------------------------------------------------------------------------------- As discussed above in Item 1 Business of this annual report on Form 10-K, during the first quarter of fiscal 2013 we agreed in principle to a non-binding Term Sheet regarding a potential restructuring of our financial obligations to EBRD and the Investor. The Term Sheet does not constitute a legally binding agreement of any of the parties thereto. Subsequent to the end of our 2013 fiscal year, negotiations between the parties stalled and have been discontinued. It appears unlikely that a restructuring of our obligations to EBRD and the Investor will be accomplished on the terms set out in the Term Sheet. We have commenced new discussions with EBRD about a potential restructuring of our obligations to EBRD. There is no guarantee we will be successful in negotiating, obtaining approval of or concluding definitive restructuring agreements with EBRD or the Investor on favorable terms, or at all. While we have made significant efforts to increase our revenues and control our operating expenses, we continue to generate net losses. As noted above, we do not expect revenues from operations to improve significantly until the second phase of the Kashagan development ramps up, which at this time is projected to occur in 2018 or 2019. In order to diversify our operations, during fiscal 2013 we were able to enter the Russian market. Unless we are able to exploit other new markets outside of Kazakhstan for our services, there is no guarantee we will be able to continue to sustain net losses until the second phase of Kashagan development ramps up. Our ability to continue as a going concern is dependent upon, among other things, our ability to (i) successfully restructure our financial obligations to EBRD and the Investor, (ii) increase our revenues and improve our operating results to a level that will allow us to service our financial obligations, and/or (iii) attract other significant sources of funding. Uncertainty as to the outcome of each of these events raises substantial doubt about our ability to continue as a going concern. 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 dictate when oil and gas exploration and development work can be performed. Usually, the work season commences in late March or early April and continues until the Caspian Sea ices over in November. As a result, other than TatArka, which can continue to provide some onshore geophysical services between November and March and the receipt of winter standby rates on vessels, we generate very little revenue from November to March each year. The following table provides an overview of our cash flow during the fiscal years ended September 30, 2013 and 2012: For the fiscal years ended September 30, 2013 2012 Net cash provided by operating activities $ 1,929 $ 1,263 Net cash used in investing activities (503) (1,789) Net cash used in financing activities (1,600) (2,000) Effect of exchange rate changes on cash (454) 991 Net change in cash $ (628) $ (1,535) 33 -------------------------------------------------------------------------------- Net cash flow from operations for fiscal 2013 was positive. This positive cash flow was mostly due to inflow from an increase in our accrued expenses of $5,296 and a decrease in our other receivables of $945 which was partially offset by outflow from increases in our trade accounts receivable of $4,190 . Net cash used in investing activities for the fiscal 2013 mostly represents cash received from the sale of a vessel of $2,878 , which was partially offset by payment for vessel shooter of $900 and the partial advance payment for geophysical equipment of approximately $1,860 . Net cash used in financing activities during the fiscal 2013 represents partial payment of interest due to Investor under the Consolidated Note. Summary of Material Contractual Commitments Payment Period Contractual Commitments Less than After Total 1 Year 1-3 Years 3-5 Years 5 years Loans from an individual $ 40,449 $ 40,449 $ - $ - $ - Loans from EBRD 23,387 23,387 - - - Accelerated put option liability 19,649 19,649 - - - Operating leases - vessels* 1,813 1,532 281 - - Operating leases - other* 864 456 408 - - Purchase commitments* 3,199 3,199 - - - Total $ 89,361 $ 88,672 $ 689 $ - $ - * For additional information regarding our operating leases and purchase commitments please Note 13 - Commitments and Contingencies of our Consolidated Financial Statements. Off-Balance Sheet Financing Arrangements In January 2008 Balykshi, Kyran Holdings Limited and JSC "KazMorTransFlot" formed the MOBY joint venture, to operate a boat repair and drydocking services yard located at our marine base. Balykshi owns a 20% interest in MOBY . In August 2008 MOBY entered into a loan agreement with EBRD. The MOBY loan agreement provided that EBRD would loan MOBY $10,300 (the "MOBY Loan"). In June 2009 in connection with the MOBY loan agreement, EBRD required certain parties, including the Company, as the parent company of Balykshi, to execute a Deed of Guarantee and Indemnity (the "Guarantee"), which guarantees repayment of the MOBY Loan. The MOBY Loan funded and we became liable for the obligations under the Guarantee as of September 2009 . The Guarantee constitutes a direct financial obligation of the Company. 34 -------------------------------------------------------------------------------- Pursuant to and in accordance with the Guarantee, we have agreed to guarantee payment to EBRD, on demand, all monies and liabilities which have been advanced or which shall become due, owing or incurred by MOBY to or in favor of EBRD when such shall become due. Our guarantee obligation is limited, however, to the "Caspian Pro-rata Percentage." The Caspian Pro-rata Percentage is an amount equal to our percentage ownership of Balykshi multiplied by Balykshi's percentage ownership of MOBY , expressed as a percentage. Currently, we own a 78% interest in Balykshi and Balykshi owns a 20% interest in MOBY . Therefore, the Caspian Pro-rata Percentage is currently 15.6%, which, including interest, at September 30, 2013 reflected a total maximum potential obligation of $893 . There is currently no recorded liability for potential losses under this guarantee, nor is there any liability for the Company's obligation to fund such guarantee. We also agreed as a separate and independent obligation and liability to indemnify EBRD on demand against all losses, costs and expenses suffered or incurred by EBRD should any of the financing agreements between EBRD and MOBY be or become unlawful, void, voidable or unenforceable, ineffective or otherwise not recoverable on the basis of the guarantee, provided again our obligation is limited to the Caspian Pro-rata Percentage of such losses, costs and expenses. As a guarantor, we agreed to advance to MOBY at any time on demand of EBRD any additional amount required by MOBY to enable it to comply with its obligations under the financing agreements and to carry out the project. Our obligation in this context is limited to 20% of the total amount. Pursuant to and in accordance with the Guarantee, EBRD is not obliged before taking steps to enforce any of its rights and remedies under the Guarantee to make any demand or seek to enforce any right against MOBY or any other person, to obtain judgment in any court against MOBY or any other person or to file any claim in bankruptcy, liquidation or similar proceedings. The Guarantee provides that each guarantor agrees to pay interest to EBRD on all unpaid sums demanded under the Guarantee at a rate of LIBOR plus 5.6%. The Guarantee also provides that each guarantor shall, on demand and on a full indemnity basis, pay to EBRD, the amount of all costs and expenses, including legal and out-of-pocket expenses and any VAT on such costs and expenses which EBRD incurs in connection with: a) the preparation, negotiation, execution and delivery of the Guarantee; b) any amendment, variation, supplement, waiver or consent under or in connection with the Guarantee; c) any discharge or release of the Guarantee; d) the preservation or exercise of any rights in connection with the Guarantee; and e) any stamping or registration of the Guarantee; provided that our obligation in this context is limited to the Caspian Pro-rata Percentage. As of September 30, 2013 and 2012 MOBY was in violation of certain financial covenants under the MOBY Loan. To our knowledge, as of the date of this report, EBRD has not sought to accelerate repayment of the MOBY Loan. On July 29, 2013 consistent with the terms agreed in the Term Sheet, we entered into an agreement to acquire Kazmortransflot's ("KMTF") 30% interest in MOBY for approximately $4 . Closing of this agreement is subject to various closing conditions including restructuring our obligations with EBRD. 35 -------------------------------------------------------------------------------- New Accounting Standards For details of applicable new accounting standards, please, refer to Note 1 - The Company, Basis of Presentation and Accounting Policies of our Consolidated Financial Statements. Critical Accounting Policies and Estimates The preparation of financial statements in accordance with accounting standards generally accepted in the United States ("US GAAP") 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 our recognition of deferred expenses, bad debts, income taxes, the carrying value of our long-lived assets and our 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 our attention that may vary our 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 our 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. Fair Value of Financial Instruments - The carrying amounts reported in the accompanying consolidated financial statements for other receivables, accounts receivables from related parties, accounts payable to related parties and accrued expenses approximate fair values because of the immediate nature or short-term maturities of these financial instruments. The carrying amount of long-term debts approximates fair value due to the stated interest rates approximating prevailing market rates. See Note 15 to our Consolidated Financial Statements for a discussion of the fair value of the long-term derivative put option liability. Accelerated Put Option Liability - In connection with EBRD's $10,000 equity investment to purchase a 22% equity interest in Balykshi, we entered into a Put Option Agreement granting EBRD the right to require the Company to repurchase the 22% equity interest. The put is exercisable during the period from six to ten years after the signing of the Investment Agreement. The put price is determined based on the fair market value of Balykshi as mutually agreed by the parties. If the put price together with any dividend received by EBRD generates an annual internal rate of return for EBRD in excess of 30% per annum rate (the "put price excess"), the put price shall be reduced by an amount representing half of the put price excess. If the parties are unable to agree upon a fair market valuation, the parties agree to hire a third party expert to determine the put price on the basis of the fair market value 36 -------------------------------------------------------------------------------- of Balykshi, as set forth in the Put Option Agreement. In the event there is a change in control of the Company, EBRD has the right to require the repurchase of the equity interest at its fair market value. The Put Option Agreement also contains an acceleration feature. Should Balykshi: (i) default on $1,000 or more of debt; (ii) fail to meet the obligations of any of the agreements between Balykshi, the Company and EBRD; (iii) be found to have made false representations to EBRD; or (iv) be declared insolvent, EBRD has the right to accelerate the put option. If the put option is accelerated, EBRD can require us to repurchase the $10,000 equity investment plus a 20% per annum rate of return, taking into account any dividend or other distributions received by EBRD, at any time following one of the events mentioned above. Due to the fact that EBRD has verbally notified us that they believe we are in breach of some covenants under the EBRD financing agreements and that such could be deemed to trigger EBRD's acceleration right, we determined to reflect an accelerated put option liability of $19,649 . 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. Geophysical service revenue is recognized when services are rendered, accepted by the customer and collectability 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. Marine base service revenue is recognized when services are rendered, accepted by the customer and collectability is reasonably assured. Receivables - In the normal course of business, we extend credit to our customers on a short-term basis. The principal customers for our vessels 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, typically for our geophysical services, particularly with the current difficulties in equity and credit markets, pose the greatest risks. For new geophysical services customers, we typically require an advance payment and we retain the seismic data generated from these services until payment is made in full. We routinely review our accounts receivable balances and make provisions for doubtful accounts as necessary. Accounts are reviewed on a case by case basis and losses are recognized in the period if we determine it is likely that receivables will not be fully collected. We may also provide a general provision for accounts receivables based on existing economic conditions. 37 -------------------------------------------------------------------------------- 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, 2012 the Company reviewed its long-lived assets and determined the marine base was impaired. At September 30, 2013 the Company also impaired the vessels held for disposal. See Note 15 for details. In August 2013 we decided to discontinue the operations of KMG as it had not generated significant income for the last several fiscal years and, due to a lack of business prospects, we do not expect it will begin generating income in the foreseeable future. The closing of KMG will help us eliminate the losses it has been incurring as a result of KMG's unprofitable operations and allow us to concentrate on more profitable projects. We have agreed to sell the KMG shell company, (after closing down all operations and transferring the assets which may be used in our operations), to a non-related company for approximately $3 . The $1,806 loss on disposal of KMG assets and liabilities and $765 of KMG operational losses are included in the loss from discontinued operations on the consolidated statements of comprehensive income (loss) for fiscal 2013. 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 US GAAP 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, we 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; or (b) Undistributed earnings of a domestic subsidiary or a domestic corporate joint venture that is essentially permanent in duration.
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