General Development of Business

GeoResources, Inc. is a natural resources company engaged in three principal business segments:  a) oil and gas exploration, development and production; b) oil and gas drilling; and c) mining of leonardite (oxidized lignite coal) and manufacturing of leonardite based products, which are sold primarily as oil and gas drilling mud additives.  We were incorporated under Colorado law in 1958 and were originally engaged in uranium mining.  We built our first leonardite processing plant in 1964 in Williston, North Dakota, and began participating in oil and gas exploration and production in 1969.  In 1982, we completed construction of a larger leonardite processing plant in Williston, which was in operation until it sustained damage from a fire on May 17, 2005.  The facility was insured to replacement cost value, and we have notified the insurance company that we plan to restore the facility for operations.  No one was injured in the fire.  See Item 2 and Note N to the Consolidated Financial Statements.  We purchased our oil and gas drilling rig in 2001 and formed a subsidiary for drilling operations in 2002.  Financial information about our three operating segments is presented in Note B to the Financial Statements in Item 7 of this report.

Information contained in this Form 10-KSB contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which can be identified by the use of words such as “may,” “will,” “expect,” “anticipate,” “estimate” or “continue,” or variations of these words or comparable terminology.  In addition, all statements other than statements of historical facts that address activities, events or developments that we expect, believe or anticipate will or may occur in the future, and other such matters, are forward-looking statements.

Our future results may vary materially from those anticipated by management and may be affected by various trends and factors, which are beyond our control.  Please review some of the more significant risks we face under the heading “Risk Factors” presented at the end of this item.

Oil and Gas Exploration, Development and Production

Our oil and gas exploration and production efforts are concentrated on oil properties in the North Dakota and Montana portions of the Williston Basin.  We typically generate prospects for our own exploitation, but when we believe a prospect may have substantial risk or cost, we may attempt to raise all or a portion of the funds necessary for exploration or development through farmouts, joint ventures, or other similar types of cost-sharing arrangements.  The amount of interest retained by us in a cost-sharing arrangement varies widely and depends upon many factors, including the exploratory costs and the risks involved.

In addition to originating our own prospects, we occasionally participate in exploratory and development prospects originated by other individuals and companies.  We also evaluate interests in various proved properties to acquire for further operation and/or development.

As of December 31, 2005, we had developed oil and gas leases covering approximately 16,019 net acres in Montana and North Dakota, and during 2005 sold an average 331 net equivalent barrels of oil and gas per day from 138 gross (113 net) productive wells located primarily in North Dakota.

We sell our crude oil and natural gas to purchasers with facilities located near our wells.  

Oil and Gas Drilling

Our subsidiary, Western Star Drilling Company (“WSDC”), owns and operates a drilling rig, which is capable of drilling to 8,000 feet.  The rig consists of engines, drawworks, a mast, pumps, blowout preventers, a drillstring, and related equipment.  From time to time, the rig will be used to drill our prospects; however, WSDC will also contract with other entities to drill their wells.  We believe that the ownership of WSDC facilitates the development of our leasehold acreage while providing an additional revenue stream through contract drilling.  

WSDC provides the rig, equipment and personnel on a contract basis.  The drilling contracts are obtained through competitive bidding or as a result of negotiations with customers.  To date, all of the drilling contracts have been performed on a “daywork” basis, under which a fixed rate is charged per day, with the price determined by the location, depth, and complexity of the well to be drilled, operating conditions and the competitive forces of the market.  In most instances, contracts provide for additional payments for mobilization and demobilization of the rig.

Mining and Manufacturing of Leonardite Products

We operate a leonardite mine and processing plant in Williston, North Dakota.  Leonardite is mined from leased reserves and is sold as a raw material or is processed to make a basic or blended specialty product.  Our manufacturing facility sustained damage from a fire on May 17, 2005, and the majority of the damage was to the electrical systems that control the operation of the plant to process and bag the basic and blended leonardite specialty products.  We have notified our insurance company that we plan to restore our plant, but the timing for that restoration is not known at this time due to possible processing changes we are investigating.  See Item 2 and Note N to the Consolidated Financial Statements.  

Historically, our leonardite products were sold primarily to drilling mud companies located in coastal areas of the Gulf of Mexico.  Leonardite products act as a dispersant or thinner and provide filtration control when used as an additive in drilling muds.  Leonardite is also sold by us for use in metal working foundries and in agricultural applications.  Demand for our plant’s output is governed mainly by the level of oil and gas drilling activities, particularly in the gulf coast area, both onshore and offshore.  Drilling activity has increased during the past year.  We have no significant leonardite supply contracts with individual customers.  

Status of Products, Services or Industry Segments in Development

We own all the stock of Western Star Drilling Company (“WSDC”), a North Dakota corporation formed to provide contract oil and gas well drilling services.  WSDC’s drilling equipment can be expanded to allow a greater realm of project and drilling technology capabilities.  We may devote resources to this segment if warranted by economic conditions in the drilling industry.

We also own land under seven patented mining claims in Arizona, as well as a minor amount of geothermal and other mineral rights in Oregon.  We do not expect to devote any substantial resources to hard mineral or geothermal exploration or development in 2006; however, under a lease agreement, the Arizona property is being mined for commercial rock production.  (See Item 2.)

Sources and Availability of Raw Materials and Leases

Maintaining sufficient leasehold mineral interests for oil and gas exploration and development is a primary continuing need in the oil and gas business.  We believe that our current undeveloped acreage is sufficient to meet our presently foreseeable oil and gas leasehold needs.  Maintaining sufficient leasehold mineral interests for leonardite mining is also a continuing need for our mining and manufacturing of leonardite products.  We believe the leonardite held under our current leases is sufficient to maintain our historical output for many years.  In December 2005, we received final approval for a new mining permit to develop 160 acres of the Logical Mining Unit (LMU) created in 1994.  This permit involves regulations by both the North Dakota Public Service Commission and the United States Department of the Interior, Bureau of Land Management (BLM).  (See Item 2.)

Major Customers

In 2005, we sold our crude oil to 15 purchasers.  Plains Marketing Canada, L.P. and Flint Hills Resources were the major purchasers, accounting for approximately 47% and 37%, respectively, of our oil and gas revenue in 2005 or approximately 35% and 27%, respectively, of our total operating revenue.  We believe there are other crude oil purchasers to whom we would be able to sell our oil, if any of our current purchasers discontinued purchasing from us.

In 2005, we sold leonardite products to 36 customers.  The largest customer in 2005 for leonardite products made purchases totaling 15% of our mining and manufacturing revenue or approximately 2% of our total operating revenue.

In 2005, WSDC had seven customers.  The largest customer accounted for approximately 35% of our drilling revenue or approximately 6% of our total operating revenue.

Backlog Orders, Research and Development

We do not have any material long-term or short-term contracts to supply leonardite products.  When we are in production, all orders are reasonably expected to be filled within three weeks of receipt.  From time to time, we enter into short-term contracts to deliver any quantities of oil or gas; however, no significant backlog exists.  Our oil and gas division order contracts and any off-lease-marketing arrangements are typical of those in the industry with 30 to 90 day cancellation notice provisions.  They generally do not require long-term delivery of fixed quantities of oil or gas.  We have not spent any material time or funds on research and development and do not expect to do so in the foreseeable future.

Competition

Oil and Gas  In addition to being highly speculative, the oil and gas business is intensely competitive among the many independent operators and major oil companies in the industry.  Many competitors possess financial resources and technical facilities greater than those available to us; and they may, therefore, be able to pay more for desirable properties or find more potentially productive prospects.  However, we believe we have the ability to obtain leasehold interests, which will be sufficient to meet our oil and gas needs in the foreseeable future.

Leonardite Products  Uses and specifications of leonardite-based drilling mud additives are subject to change if better products are found.  Our leonardite products compete with leonardite and non-leonardite products used as additives in numerous types of drilling mud.  In addition, leonardite deposits are available in other areas within the United States, and competitors may be able to enter the leonardite business with relative ease.  At the present time, similar products are marketed by other companies who mine, process and market leonardite products.  Competition lies primarily in delivery time, transportation costs, quality of the product, performance of the product when used in drilling mud and access to high-quality leonardite deposits.  In addition, higher fuel prices can significantly affect our leonardite operations, because our processing which requires heat is located in a colder climate.  The market for drilling mud additives and the demand for our leonardite products remain strong.  However, we have been absent from the market since May 17, 2005, when a fire caused extensive damage to our processing facility.  In the future, we may face difficulty in reestablishing meaningful leonardite sales, as all of our leonardite customers have used alternative suppliers or products since May 2005.

Contract Drilling  The contract drilling business is highly competitive.  Contract drilling competition involves price, rig availability and capability, rig condition, reputation, customer relations and other factors.  However, we believe there is a current shortage of drilling rigs available in shallow drilling areas of the Williston Basin.  

Contract drilling and oil and natural gas activities are subject to a number of risks and hazards.  These could cause serious injury or death to persons, suspension of drilling operations, serious damage to equipment or property of others, and damage to producing formations in surrounding areas.  Our operations could also cause environmental damage, particularly through oil spills, gas leaks, discharges of toxic gases or extensive uncontrolled fires.  In addition, we could become subject to liability for reservoir damages.  The occurrence of a significant event, including pollution or environmental damage, could materially affect our operating results and financial condition.  We believe we are adequately insured or indemnified against normal and foreseeable risks in our drilling operations in accordance with industry standards.  However, such insurance or indemnification may not be adequate to protect us against liability from all consequences of well disasters, extensive fire damage or damage to the environment.  Likewise, we cannot assure that we will be able to maintain adequate insurance in the future at reasonable rates or that any particular types of coverage will be available.

Environmental Regulations

All of our operations are generally subject to numerous stringent federal, state and local environmental regulations under various acts including the Comprehensive Environmental Response, Compensation and Liability Act; the Federal Water Pollution Control Act; and the Resources Conservation and Recovery Act.  

For example, our oil and gas business segment is affected by diverse environmental regulations including those regarding the disposal of produced oilfield brines, other oil-related wastes, and wastes not directly related to oil and gas production.  Additional regulations exist regarding the containment and handling of crude oil as well as preventing the release of oil into the environment and a number of others.  It is not possible to estimate future environmental compliance costs due in part to the uncertainty of continually changing environmental initiatives.  While future environmental costs can be expected to be significant to the entire oil and gas industry, we do not believe that our costs would be any more of a relative financial burden than those of our peers and environmental compliance costs will be recovered in the marketplace.  During 2005, 2004 and 2003, environmental compliance costs identified to an actual account were $6,774, $21,471 and $6,795, respectively.  However, that is materially less than the real costs, because compliance costs are complex and difficult to differentiate in a system of invoicing.  

Our leonardite mining and processing segment is also subject to an abundant number of federal, state and local environmental regulations, particularly those concerned with air contaminant emission levels of our processing plant and mine permit and reclamation regulations pertaining to surface mining at our leonardite mine.  We believe that maintenance of acceptable air contaminant emission levels at our processing plant could become more costly in the future if plant production increases substantially above levels experienced over the past several years.  Management believes significantly higher plant utilization would increase emission levels and could make it necessary to replace or upgrade air quality control equipment.  Environmental compliance costs that might be required to upgrade air quality control equipment cannot be reasonably estimated, because future regulatory requirements are unknown.

Foreign Operations and Export Sales

We have no production facilities or operations in foreign countries but have exported leonardite products to foreign countries including Mexico, Italy and Spain.  Some of our leonardite products are also sold to distributors in the United States who in turn export these products.

Employees

At March 16, 2006, we had 13 full-time employees.  Our employees are not represented by any unions or other collective bargaining agreements, and we believe our employee relationships are excellent.

Risk Factors

Our operations are subject to a variety of risks, including the following:

We must successfully acquire or develop additional reserves of oil and gas.

Our future production of oil and gas is highly dependent upon our level of success in acquiring or finding additional reserves. The rate of production from our oil and gas properties generally decreases as reserves are depleted, as has occurred over the past few years.  We compete with a number of exploration and production companies that possess greater financial resources than are available to us.  We may not be able to economically compete for oil and gas properties due to a lack of capital and inability to obtain adequate financing, which may be required to fund prospect generation, drilling operations and property acquisitions. To the extent financing is obtained, it may not be on terms beneficial to our stockholders.

A substantial or extended decline in oil and natural gas prices may adversely affect our business, financial condition or results of operations and our ability to meet our capital expenditure obligations and financial commitments.

The price we receive for our oil and natural gas production is the primary factor in determining our revenue, profitability, access to capital and future rate of growth.  Oil and natural gas are commodities, and therefore, their prices are subject to wide fluctuations in response to relatively minor changes in supply and demand.  Historically, the markets for oil and natural gas have been volatile.  These markets will likely continue to be volatile in the future.  The prices we receive for our production, and the levels of our production, depend on numerous factors beyond our control.  These factors include, but are not limited to, the following:

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changes in global supply and demand for oil and natural gas;

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the actions of the Organization of Petroleum Exporting Countries, or OPEC;

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the price and quantity of imports of foreign oil and natural gas;

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political conditions, including embargoes, in or affecting other oil-producing activity;

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the level of global oil and natural gas exploration and production activity;

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the level of global oil and natural gas inventories and pipeline access to markets;

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weather conditions;

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technological advances affecting energy consumption; and

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the price and availability of alternative fuels.

Lower oil and natural gas prices may not only decrease our revenues on a per unit basis, but also may reduce the amount of oil and natural gas that we can produce economically.  Lower prices will also negatively impact the value of our proved reserves.  A substantial or extended decline in oil or natural gas prices may materially and adversely affect our future business, financial condition, results of operations, liquidity or ability to finance planned capital expenditures.  Approximately 42% of our 2005 oil and gas production came from two fields.  Any substantial decline in production from any one field would result in lower revenue to us.

We face significant competition.

We operate in a highly competitive environment. We compete with major integrated and independent oil and gas companies for the acquisition of desirable oil and gas properties and leases, for the equipment and labor required to develop and operate such properties, and in the marketing of oil and gas to end-users. Many of our competitors have financial and other resources, which are substantially greater than ours. In addition, many of our larger competitors may be better able to respond to factors that affect the demand for oil and natural gas production, such as changes in worldwide oil and natural gas prices and levels of production, the cost and availability of alternative fuels and the application of government regulations.  We also compete in attracting and retaining technical personnel, including geologists, geophysicists and other specialists.

We also face the same competitive matters discussed above with respect to our leonardite operations.

Our reported reserves of oil and gas represent estimates, which may vary materially over time due to many factors.

Generally. Our estimated reserves may be subject to downward revision based upon future production, results of future development, prevailing oil and gas prices, operating and development costs and other factors. There are numerous uncertainties and uncontrollable factors inherent in:

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estimating quantities of oil and gas reserves;

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projecting future rates of production; and

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timing of development expenditures.

In addition, the estimates of future net cash flows from our proved reserves and the present value of such reserves are based upon various assumptions about future production levels, prices and costs that may prove to be incorrect over time. Any significant variance from the assumptions could result in material differences in the actual quantity of our reserves and amount of estimated future net cash flows from our estimated oil and gas reserves.

Proved Reserves; Ceiling Test . A deterioration of oil or gas prices could result in our recording a non-cash charge to earnings at the end of a quarter or year. Our proved reserve estimates are based upon an independent analysis of our oil and gas properties and are subject to rules set by the SEC. We periodically review the carrying value of our oil and gas properties under the full cost accounting rules of the SEC. Under these rules, capitalized costs of oil and gas properties may not exceed the present value of estimated future net cash flows from proved reserves, discounted at 10%, plus the lower of cost or fair market value of unproved properties as adjusted for related tax effects. At the end of each quarter, the test is applied using unescalated prices in effect at the applicable time and may result in a write-down if the “ceiling” is exceeded, even if prices decline for only a short period of time.  We have made write downs of the carrying value of our oil and gas properties on our financial statements in the past due to low prices, and may do so in the future.

Any hedging activities we engage in may prevent us from realizing the benefits in oil or gas price increases.

To the extent that we engage in hedging activities, we may be prevented from realizing the benefits of price increases above the levels of the hedges during certain time periods. From time to time, we have engaged in hedging activities with respect to some of our projected oil and gas production through financial arrangements designed to protect against price declines, such as swaps, collars and futures agreements. We currently are not a party to any hedging contracts but may engage in hedging in the future.

Drilling for and producing oil and natural gas are high-risk activities with many uncertainties that could adversely affect our business, financial condition or results of operations.

Our future success will depend on the success of our exploitation, exploration, development and production activities.  Our oil and natural gas exploration and production activities are subject to numerous risks beyond our control, including the risk that drilling will not result in commercially viable oil or natural gas production.  Our decisions to purchase, explore, develop or otherwise exploit prospects or properties will depend in part on the evaluation of data obtained through geophysical and geological analyses, production data and engineering studies, the results of which are often inconclusive or subject to varying interpretations.  Our cost of drilling, completing and operating wells is often uncertain before drilling commences.  Overruns in budgeted expenditures are common risks that can make a particular project uneconomical.  Further, many factors may curtail, delay or cancel drilling, including:

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delays imposed by or resulting from compliance with regulatory requirements;

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pressure or irregularities in geological formations;

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shortages of or delays in obtaining equipment and qualified personnel;

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equipment failures or accidents;

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adverse weather conditions;

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reductions in oil and natural gas prices;

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title problems; and

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limitations in the market for oil and natural gas.

We may incur substantial losses and be subject to substantial liability claims as a result of our oil and natural gas operations.

We are not insured against all risks.  Losses and liabilities arising from uninsured and underinsured events could materially and adversely affect our business, financial condition and results of operations.  Our oil and natural gas exploration and production activities are subject to all of the operating risks associated with drilling for and producing oil and natural gas, including the possibility of:

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environmental hazards, such as uncontrollable flows of oil, natural gas, brine, well fluids, toxic and other pollution into the environment, including groundwater and shoreline contamination;

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abnormally pressured formations;

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mechanical difficulties, such as stuck oil field drilling and service tools and casing collapse;

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fires and explosions;

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personal injuries and death; and

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natural disasters.

Any of these risks could adversely affect our ability to conduct operations or result in substantial losses to our company.  We may elect not to obtain insurance, if we believe that the cost of available insurance is excessive relative to the risks presented.  In addition, pollution and environmental risks generally are not fully insurable.  If a significant accident or other event occurs and is not fully covered by insurance, then it could adversely affect us.

We face extensive government regulation, which can negatively impact the success of our operations and financial success.

The oil and gas and mining industries are extensively regulated by federal, state and local authorities.  Legislation and regulations affecting the industry are under constant review for amendment or expansion, raising the possibility of changes that may affect, among other things, the pricing or marketing of our oil, gas and leonardite production. Substantial penalties may be assessed for noncompliance with various applicable statutes and regulations, and the overall regulatory burden to us increases our cost of doing business and, in turn, decreases our profitability. State

and local authorities regulate various aspects of oil and gas drilling and production activities, including the drilling of wells (through permit and bonding requirements), the spacing of wells, the unitization or pooling of oil and gas properties, environmental matters, safety standards, the sharing of markets, production limitations, plugging and abandonment, and restoration.

We are dependent upon the services of our Chief Executive Officer.

We are highly dependent on the services of our Chief Executive Officer, Jeffrey P. Vickers.  We do not have an employment agreement with Mr. Vickers, nor do we carry any key man life insurance on Mr. Vickers. The loss of his services would likely negatively impact our operations.