**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      DC 20549**




**FORM
      10-KSB**




**(Mark
      One)**




R
            **ANNUAL
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**




**for
      the fiscal year ended December 31, 2006**




**or**




£
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**




**For
      the transition period from** **** **to** ****





**Commission
      File** **No.:
      33-94884**












(Name
      of
      small business issuer in its charter)




**Delaware**
            
            **22-2925432**(State
                or other jurisdiction of incorporation or organization)
            
            (I.R.S.
                Employer Identification No.)


**Highway
      34 & Ridgewood Road**


**Wall
        Township, New Jersey 07719**
 (Address
        of principal executive offices)




Issuer’s
      telephone number, including area code: **(732)**  **449-7717**




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




Securities
      registered pursuant to Section 12(g) of the Exchange Act: **Common
      Stock, $.0001 par value**







Check
      whether the issuer (1) has filed all reports required to be filed by
      Section 13 or 15(d) of the Exchange Act during the preceding 12 months
      (or for such shorter period that the issuer was required to file such reports),
      and (2) has been subject to such filing requirements for the past
      90 days.    Yes R No £




Check
      if
      there is no disclosure of delinquent filers in response to Item 405 of
      Regulation S-B contained in this Form 10-KSB, and no disclosure will be
      contained, to the best of the issuer’s knowledge, in definitive proxy or
      information statements incorporated by reference in Part III of this Form 10-KSB
      or any amendment to this Form 10-KSB. R




Check
      whether the issuer is a shell company (as defined in Rule 12b-2 of the
      Exchange Act). Yes £ No R




State
      issuer’s revenues for its most recent fiscal year: $565,000




Number
      of shares
      of
      the issuer's Common Stock outstanding at April
      12,
      2007 : 268,894,278




State
      the
      aggregate market value of the voting and non-voting common equity held by
      non-affiliates: $19,763,655




Transitional
      Small Business Issuer Disclosure Format (check one): Yes £  No R









**COATES
      INTERNATIONAL, LTD.**





**CONTENTS**


**PART
                    I**
                
                
                **Page**Item
                    1.
                Description
                    of Business
                
                2Item
                    1A.
                Risk
                    Factors
                
                7Item
                    2.
                Description
                    of Property
                
                10Item
                    3.
                Legal
                    Proceedings
                
                10Item
                    4.
                Submission
                    of Matters to a Vote of Security Holders
                
                11**PART
                    II**Item
                    5.
                Market
                    for Registrant's Common Equity and Related Shareholder
                    Matters
                
                12Item
                    6.
                Management's
                    Discussion and Analysis and Plan of Operation
                
                14Item
                    7.
                Financial
                    Statements
                
                17Item
                    8.
                Changes
                    in and Disagreements with Accountants on Accounting and Financial
                    Disclosure
                
                17Item
                    8A.
                Controls
                    and Procedures
                
                17Item
                    8B.
                Other
                    Information
                
                18**PART
                    III**Item
                    9.
                Directors,
                    Executive Officers, Promoters and Control Persons; Compliance
                    with
                    Sections 16 (a) of the Exchange Act
                
                19Item
                    10.
                Executive
                    Compensation
                
                22Item
                    11.
                Security
                    Ownership of Certain Beneficial Owners and Management and Related
                    Stockholder Matters
                
                26Item
                    12.
                Certain
                    Relationships and Related Transactions
                
                28Item
                    13.
                Exhibits
                
                29Item
                    14.
                Principal
                    Accountant Fees and Services
                
                31Signatures
                
                32Financial
                    Statements
                
                F-1
                    to F-23


-1-




**PART
      I**





**Item
      1. Description of Business**





**General**





Coates
      International, Ltd. ("we" or the "Company") has been developing over a period
      of
      more than 15 years a patented spherical rotary valve system which is adaptable
      for use in piston-driven internal combustion engines of many types.





The
      Coates spherical rotary valve system (“CSRV System”) is designed to replace the
      intake and exhaust conventional “poppet valves” currently used in almost all
      piston-driven stationary, automotive, motorcycle and marine engines. Unlike
      conventional valves which protrude into the engine cylinder, the CSRV System
      utilizes spherical valves that rotate in a cavity formed between a two-piece
      cylinder head. The CSRV System utilizes
      approximately 1/10 th of the
      moving parts of conventional poppet valve assemblies .
      As a
      result of these design improvements, management believes that the engines
      incorporating the CSRV System (“Coates Engines”) will last significantly longer
      and will require less lubrication over the life of the engine, as compared
      to
      conventional engines. In addition, CSRV’s can be designed with larger openings
      into the engine cylinder than conventional valves so that more fuel and air
      can
      be inducted into and expelled from the cylinder in a shorter period of time.
      Larger valve openings permit higher revolutions-per-minute (RPMs) and permit
      higher compression ratios with lower combustion chamber temperatures, allowing
      the Coates Engine to produce more power than equivalent conventional engines.
      The higher the RPM range, the greater the volumetric efficiency and thermal
      efficiency that can be achieved.





We
      hold
      an exclusive license to this technology from our founder, George J. Coates,
      and
      his son, Gregory Coates (the “Coates License Agreement”), in the Territory
      defined to include North America, Central America and South America (the
“Americas”).




Since
      our
      inception, the bulk of our development costs and related operational costs
      have
      been funded primarily through cash generated from the sale of stock, through
      capital contributions, loans made by George Coates, through a sale-and-leaseback
      transaction related to our principal facility, and from the sale of prototype
      models and licensing fees. The Company has only received a minimal amount of
      revenues, a number of years ago, from a small number of sales of engines, which
      incorporated the CSRV technology. The Company has never been profitable and
      has
      incurred substantial losses from operations of approximately $1,302,000 and
      $895,000 for the years ended
      December 31, 2006 and 2005, respectively, resulting in an accumulated deficit
      at
      December 31, 2006, of approximately $20,184,000. The Company expects that losses
      from operations will continue until the Coates Engine is successfully introduced
      into the marketplace, or the Company receives substantial licensing revenues.
      These losses from operations were substantially related to research and
      development of our intellectual property, patent filing and maintenance costs
      and general and administrative expenses incurred in connection with operating
      the Company.





Coates
      International, Ltd. is a Delaware corporation organized in October 1991 as
      successor-in-interest to a Delaware corporation of the same name incorporated
      in
      August 1988.  Our operations are located in Wall Township, New Jersey
      (outside of New York City). We maintain a website at the following address: www.coatesengine.com. Through
      a
      link on our website to the SEC website, www.sec.gov ,
      we
      provide free access to our annual reports on Form 10-KSB, quarterly reports
      on Form 10-QSB, current reports
      on Form 8-K and amendments to those reports filed or furnished pursuant to
      Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as
      reasonably practicable after electronic filing with the SEC. We intend to make
      the charters of our Board committees, and our Code of Business Conduct and
      Ethics for our directors, officers and employees, available on our website,
      and
      we will post on our website any waivers of, or amendments to, such code of
      ethics. Our website and the information contained therein or linked thereto
      are
      not incorporated by reference into this report.




-2-




**Background**





The
      internal combustion engine has been in use for approximately 100 years and
      is
      the most widely used engine in the
      world. Industry sources indicate that there are more than 120 million new
      internal combustion engines built in the world every year and that 40 million
      engines are rebuilt annually. In the late 1960's and 1970's, most internal
      combustion vehicle engines in the United States were running at a compression
      ratio of 12 to 1 which resulted in an engine efficiency of approximately 35
      percent. The rest of the engine's power is lost in friction, pumping and heat
      loss. When it was found that lead additives in fuel had an adverse effect on
      the
      environment, unleaded gasoline was Federally mandated. Unleaded gasoline is
      not
      as desirable as a fuel as leaded gasoline from a density and efficiency
      standpoint, and the early use of unleaded gasoline created a number of design
      problems, principally related to overheating of the engine combustion chamber,
      pre-ignition and resultant damage. That problem was largely solved by lowering
      engine compression ratios, but at a cost of reduced efficiency from
      approximately 35% to approximately 22%. This loss of efficiency reduces gas
      mileage and engine performance. Efficiency can be increased by increasing
“volumetric efficiency” at maximum RPMs, but conventional valves tend to “float”
or bounce at higher RPMs and are consequently unable to deliver adequate air
      and
      fuel to the cylinder. In an attempt to solve this problem, engine manufacturers
      increased the number of valves per cylinder, but this approach created other
      problems that cause unburned fuel to escape through the exhaust valves leading
      to a loss of power, lower gas mileage and increased pollutants .
      In
      addition, variable valve timing partially solved some of these additional
      problems, but that solution involves additional moving parts that eventually
      degrade and wear out. Also, variable valve timing on quick deceleration can
      cause piston and valve contact with resultant serious damage. Furthermore,
      conventional valves with solid “valve lifters” as opposed to hydraulic valve
      lifters must have clearances readjusted periodically. In sum, conventional
      “poppet” valves have been the most troublesome part of the internal combustion
      engine. The basic inefficiencies of the conventional poppet valve design result
      in engine inefficiency and decreases in engine life.





Conventional
      valves also have significant environmental deficiencies. Conventional exhaust
      valves are lubricated with engine oil which burns in combustion and is expelled
      directly into the atmosphere. Intake valves are also lubricated with engine
      oil,
      which is washed off and forced into the combustion chamber with the air and
      fuel
      mixture. This slows down the combustion process and produces further emissions
      and eventually clogs the catalytic converter.





Management
      believes that the patented Coates rotary valve system solves or significantly
      mitigates these problems. Coates rotary valves are vented and charged on the
      opposite side of each valve sphere and rotate away from the combustion chamber
      reducing engine combustion chamber heat and allowing higher compression ratios
      that make the engine significantly more efficient and powerful.





We
      are
      now engaged in adapting our technology to manufacturing
      industrial engines to power electric generators ,
      and
      intend to begin to market engines utilizing our proprietary
      designs.





**Markets**





The
      design of the Coates Spherical Rotary Valve System (the “CSRV System”) gives
      the
      Company the flexibility to retrofit it to existing internal combustion engines
      of all sizes and in a wide variety of markets. In addition, the CSRV System
      can
      run on alternative fuels. Accordingly, the Company can sell the CSRV System
      in
      all markets in which internal combustion engines are sold, including, but not
      limited to the following: engines for electric generators for various
      applications, ranging from home use to the largest industrial complexes to
      augmented “grid” installations; engines to power motorcycles, automobiles, light
      trucks, heavy trucks and machinery; marine engines; military equipment; light
      aircraft and helicopters; and lawn mowers, snow mobiles and jet ski’s, etc.




According
      to the latest information published by the US Census Bureau in 2002, the annual
      internal combustion engine market in the U.S. was in excess of $96 billion.




-3-




**Strategy**





The
      long-term objective of the Company is to become the leader in the Americas
      in
      the design and manufacture of internal combustion engines for a wide variety
      of
      uses. The primary market the Company initially is focused on is the industrial
      generators market. The Company adapted the CSRV System to manufacture its 14.0
      liter inline, 6-cylinder, 855 cubic inch engine/generator fueled by natural
      gas
      which is undergoing engineering design refinements and testing. The Company
      has
      been informed by Compliance and Research Services, Inc. of Plainfield New
      Jersey, a federal Environmental Protection Agency-recognized, independent
      testing facility, that our product as described above complies with the
      governmental standards as set forth in Title 40 of the Code of Federal
      Regulations Part 1048, that regulates environmental standards for natural gas
      powered industrial engines. In parallel to penetrating the commercial/industrial
      generators market, the Company intends to adapt the CSRV System to be used
      in
      the other markets in which internal combustion engines are used, such as motor
      vehicles, motorcycles, trucks, ships, trains, military equipment, light
      aircraft, helicopters and others.




**Operational
      Plan**





Currently,
      the prototypes of the CSRV System-based generator engine are undergoing
      performance and other tests. Initially, the Company intends to sell the
      engine/generators to a party that has expressed indications of interest to
      purchase Coates Engines upon the successful completion of the above tests.
      If
      these indications of interest become firm orders, the fulfillment of these
      orders may occur over a three to five year period. The Company intends to take
      advantage of the fact that essentially all the components of the CSRV generator
      engine may be readily sourced and acquired from subcontractors, and accordingly,
      intends to manufacture the generator engine in the two following
      ways:




·
            Assembly
                - to develop assembly lines within the Company’s premises. The Company has
                been evaluating various opportunities to expand or acquire additional
                manufacturing capacity. When the demand for our products justifies
                it, the
                Company will take the required steps in order to increase its work
                force.
                We may hire a significant number of new employees within the next
                12 to 24
                months after production commences.




·
            Licensing
                the technology to Original Equipment Manufacturers (“OEM”) - to take
                advantage of third party manufacturers’ production ability by signing OEM
                agreements.




**Material
      Agreements**




*License
      Agreement - George J. Coates and Gregory Coates*




On
      October 23, 2006, the Company signed a license agreement with George J. Coates
      and Gregory Coates (the “New Coates License Agreement”), that replaces license
      agreements signed on December 22, 1997 and November 10, 2005. On April 6, 2007,
      the New Coates License Agreement was amended and restated (the “Amended Coates
      License Agreement”). The Amended Coates License Agreement became effective upon
      execution. Under the Amended Coates License Agreement, George J. Coates and
      Gregory Coates granted to the Company: an exclusive, perpetual, royalty-free,
      fully paid-up license to the intellectual property that specifically relates
      to
      an internal combustion engine that incorporates the CSRV System technology
      (the
“CSRV Engine”) and that is currently owned or controlled by them (the “CSRV
      Intellectual Property”), plus any CSRV Intellectual Property that is developed
      by them during their employment with the Company. The employment agreements
      with
      George J. Coates and Gregory Coates contain two-year non-compete provisions
      relating to the CSRV Intellectual Property in the event either of them is
      terminated for cause, as defined, or if either of them terminates their
      employment without good reason, as defined.




-4-




Under
      the
      Amended Coates License Agreement, George J. Coates and Gregory Coates agreed
      that they will not grant any licenses to any other party with respect to the
      CSRV Intellectual Property.




*License
      Agreement - Coates Trust*




We
      did
      not satisfy the working capital funding requirements of our license agreement
      with the Coates Trust, dated October 23, 2006, covering the licensing of
      intellectual property rights for the territory outside of the Western
      Hemisphere. On April 6, 2006, this agreement was formally
      terminated.




*License
      Agreement - Well to Wire Energy, Inc.*





On
      September 29, 1999, we signed a license agreement with Well to Wire Energy,
      Inc.
      ("WWE"), an oil and gas company in Canada. The agreement exclusively licenses
      within Canada the use of the Coates technology for V-8 engines to be fueled
      by
      natural gas to generate electrical power. The agreement provided for a license
      fee of $5,000,000, of which a deposit payment in the amount of $300,000 was
      made
      in 1999. A separate research and development agreement with WWE provides for
      development and delivery of certain prototype engines. The research and
      development agreement was not reduced to the form of a signed written agreement.
      The Company received non-refundable payments totaling $1,200,000 under the
      research and development agreement which has previously been recognized as
      revenue.





On
      July
      7, 2006, the Company and WWE signed a confirmation letter agreement with WWE
      that provides as follows:





·
            The
                Company expects to ship to WWE the third power unit of the Company’s
                generator for up to 300 kilowatts, depending on the fuel used (the
                855
                cubic inch, 6 cylinder industrial electric power generator, incorporating
                the CSRV Engine, the “Generator”). Upon receipt of the Generator, and
                pending test results meeting WWE’s expectations, the balance of $3,800,000
                on account of the research and development agreement mentioned above
                will
                become due and payable to the Company by WWE. In addition, 180 days
                later,
                the remaining balance of $4,700,000 from the September 29, 1999 agreement
                will become due and payable by WWE in 16 equal quarterly
                installments.




·
            WWE
                will have the exclusive right to use, lease, and sell the Generators
                that
                are based on the CSRV System technology within
                Canada.




·
            WWE
                will have a specified right of first refusal to market the Generators
                worldwide.




·
            Upon
                commencement of the production and distribution of Generators, the
                minimum
                annual number of Generators to be purchased by WWE in order to maintain
                exclusivity is 120. Until otherwise agreed between the parties, the
                price
                per Generator shall be $150,000.In
                the event WWE fails to purchase the minimum 120 Coates generator
                engines
                during any year, WWE will automatically lose its exclusivity. In
                such a
                case, WWE would retain non-exclusive rights to continue to use the
                Coates
                generator engine in the territory of
                Canada.




·
            WWE
                shall not be required to pay any royalties to us as part of the agreements
                between the parties.




·
            All
                licensed rights under the Coates License Agreement related to the
                CSRV
                System technology will remain with the
                Company.




*License
      Agreement with Coates Motorcycle Company, Ltd.*




-5-




On
      April
      30, 2003, the Company amended its license agreement with Coates Motorcycle
      (the
“Amended Motorcycle License Agreement”). Prior thereto, Gregory Coates, son of
      George J. Coates and an officer of the Company, owned 100% of Coates Motorcycle.
      Pursuant to a prior license agreement, the Company granted certain exclusive
      licenses in exchange for approximately 51% of the common shares of Coates
      Motorcycle. In addition, the Company had an anti-dilution right. The Amended
      Motorcycle License Agreement expanded the license rights granted and removed
      the
      anti-dilution provision in exchange for 1,000,000 common shares of Coates
      Motorcycle. As a result of these transactions, the Company owned 3,558,000
      shares of Coates Motorcycle, representing a 30% ownership interest. The Company
      is under no obligation to provide any funding or support to Coates Motorcycle
      under any circumstances. Under the Amended Motorcycle License Agreement, the
      Company granted an exclusive sublicense for North America, South America and
      Central America and their territories (collectively, the "Western Hemisphere")
      to make, use and sell motorcycles utilizing the CSRV Technology.




*License
        Agreement with Coates Motorcycle Company, Ltd.*
 
 On
        April
        30, 2003, the Company amended its license agreement with Coates Motorcycle
        (the
“Amended Motorcycle License Agreement”). Prior thereto, Gregory Coates, son of
        George J. Coates and an officer of the Company, owned 100% of Coates Motorcycle.
        Pursuant to a prior license agreement, the Company granted certain exclusive
        licenses in exchange for approximately 51% of the common shares of Coates
        Motorcycle. In addition, the Company had an anti-dilution right. The Amended
        Motorcycle License Agreement expanded the license rights granted and removed
        the
        anti-dilution provision in exchange for 1,000,000 common shares of Coates
        Motorcycle. As a result of these transactions, the Company owned 3,558,000
        shares of Coates Motorcycle, representing a 30% ownership interest. The Company
        is under no obligation to provide any funding or support to Coates Motorcycle
        under any circumstances. Under the Amended Motorcycle License Agreement,
        the
        Company granted an exclusive sublicense for North America, South America
        and
        Central America and their territories (collectively, the "Western Hemisphere")
        to make, use and sell motorcycles utilizing the CSRV
        Technology.





**Competition**





Management
      believes that the Coates generator engine prototypes which are based on the
      CSRV
      System will provide substantially enhanced efficiencies in power generation
      and
      longevity. We believe that the Coates generator engine will outperform all
      other
      comparable natural gas-fueled electric generator engines currently utilized
      in
      the energy conversion market.





Notwithstanding
      our perceived competitive advantages, the power generation market is a highly
      competitive industry currently occupied by extremely large companies such as
      Caterpillar, Inc., which owns MAK, Perkins and FG Wilson, Detroit Diesel
      Corporation, AB Volvo, Cummins and Marathon, among others. All of these
      companies have far greater financial and other resources than us and already
      occupy segments of the power generation market. In order to successfully
      penetrate this industry, the Coates generator engine will have to produce the
      performance and durability results anticipated by management and sell at a
      price
      or prices that will enable it to effectively compete and gain entrance into
      this
      market.





**Parts
      and Supplies**





To
      date,
      management has utilized the services of various vendors and manufacturers
      available throughout the United States to provide all of the parts necessary
      to
      assemble the Coates generator engine. We expect to continue to purchase all
      of
      our raw materials and parts, manufactured to our specifications, from a wide
      assortment of suppliers. We intend to commence the assembly of the Coates
      generator engines at our New Jersey facility and to acquire additional
      facilities if and when needed.





**Patents
      and Licenses**





The
      Amended Coates License Agreement grants us an exclusive, perpetual,
      royalty-free, fully paid-up license to use, in North, Central and South America
      all intellectual property rights that are currently owned or controlled by
      the
      licensors that directly relate to an internal combustion engine that includes
      the CSRV Engine. The license also covers any new or improved technology and
      related intellectual property rights that are directly related to the CSRV
      Engine that are developed by the licensors during their employment with us.




Included
      in the licensed intellectual property rights are 17 patents registered in the
      United States; certain patents registered in Canada, Mexico and in countries
      in
      Central and South America relating to the CSRV System; and one U.S. patent
      application filed by Mr. George Coates. For a description to our sublicense
      agreement with Coates Motorcycle Company, see Item 12, “Certain Relationships
      and Related Transactions”.




We
      rely
      upon patents, trade secrets, know-how and continuing technological innovation
      to
      develop and maintain our competitive position. We cannot assure you that we
      can
      limit unauthorized or wrongful disclosures of trade secrets or otherwise
      confidential information. In addition, to the extent we rely on trade secrets
      and know-how to maintain our competitive technological position, we cannot
      assure you that others may not independently develop the same, similar or
      superior techniques.




-6-




**Environmental
      Regulatory Compliance**





All
      of
      our new engines, including the Coates generator engine, will be subject to
      extensive environmental laws, rules and regulations that impose standards for
      emissions and noise. Initially, compliance with the emissions standards
      promulgated by the U.S. Environmental Protection Agency ("EPA"), as well as
      those imposed by the State of New Jersey and other jurisdictions where we expect
      our engines will be used, will have to be achieved in order to successfully
      market the Coates generator engine. Our natural gas powered engine/generators
      comply with governmental standards as set forth in 40CFR (Code of Federal
      Regulations) 1048, that regulates environmental standards for natural
      gas-powered industrial engines. The Company's ability to comply with applicable
      and future emissions standards is necessary for us to enter the power generation
      and other markets. Failure to comply with these standards could result in
      material adverse effect on our business and financial condition.





**Employees**





At
      December 31, 2006, we had 8 employees, including George J. Coates and his son
      Gregory Coates, who perform management, assembly and research and development
      functions. Bernadette Coates, the spouse of George J. Coates, is employed as
      administrative manager for the Company. We subcontract for certain labor
      services, parts and materials from Coates Precision Engineering, Inc., a
      corporation owned by George J. Coates, to which, during the years ended December
      31, 2006 and 2005, the Company paid $42,400 and $84,058,
      respectively.





**Item
      1A. Risk Factors**





The
      following risk factors should be considered carefully in addition to the other
      information contained in this report. This report contains forward-looking
      statements. Forward-looking statements relate to future events or our future
      financial performance. We generally identify forward-looking statements by
      terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,”
“could,” “intends,” “target,” “projects,” “contemplates,” “believes,”
“estimates,” “predicts,” “potential” or “continue” or the negative of these
      terms or other similar words. These statements are only predictions. The outcome
      of the events described in these forward-looking statements is subject to known
      and unknown risks, uncertainties and other factors that may cause our customers’
or our industry’s actual results, levels of activity, performance or
      achievements expressed or implied by these forward-looking statements, to
      differ. “Risk Factors,” “Management’s Discussion and Analysis of Financial
      Condition and Results of Operations” and “Business,” as well as other sections
      in this report, discuss some of the factors that could contribute to these
      differences.





The
      forward-looking statements made in this report relate only to events as of
      the
      date on which the statements are made. We undertake no obligation to update
      any
      forward-looking statement to reflect events or circumstances after the date
      on
      which the statement is made or to reflect the occurrence of unanticipated
      events.





This
      report also contains market data related to our business and industry. These
      market data include projections that are based on a number of assumptions.
      If
      these assumptions turn out to be incorrect, actual results may differ from
      the
      projections based on these assumptions. As a result, our markets may not grow
      at
      the rates projected by these data, or at all. The failure of these markets
      to
      grow at these projected rates may have a material adverse effect on our
      business, results of operations, financial condition and the market price of
      our
      Common Stock.




**We
      have only received a minimal amount of revenues, a number of years ago, from
      a
      small number of sales of engines, which incorporated the CSRV technology and
      we
      have never been profitable.**




-7-




None
      of
      the cash needed to finance our business has come from sales of engines in recent
      years. We have never been profitable, and we expect to continue to incur losses.
      We may not be profitable or cash flow positive in 2007, unless we receive
      payments we may be entitled to from Well to Wire Energy Inc., as described
      under
“Material Agreements” above. In addition, we may not be profitable or cash flow
      positive for several additional years after 2007.





**The
      Coates Engine may not have the performance characteristics and longevity that
      we
      expect.**




The
      Coates Engine has been tested in a “real world” environment to a very limited
      degree. Commercial use of our industrial engines may not have the performance
      characteristics that we expect. Similarly, until the Coates Engine has been
      in
      use for a substantial period of time, there is no certain
      way to ascertain its expected longevity. Superior performance and longevity
      are
      essential elements of our ability to penetrate the power generation and other
      markets. Our failure to do so would have a material adverse effect on our
      business and we may be forced to close our operations.





**We
      are substantially dependent on our founder, George J. Coates.**




We
      are
      substantially dependent on our founder, George J. Coates, and to a lesser extent
      his son, Gregory Coates. We expect that our future
      market capitalization will be highly dependent on the productivity of George
      Coates. If the employment of George Coates by the Company were to cease for
      any
      reason before we have hired additional senior management and engineering
      personnel, our business would be materially adversely affected and we may have
      to discontinue operations. We do not maintain key person insurance on either
      George J. Coates or Gregory Coates. Our success will also depend on our ability
      to attract and retain a staff of qualified managerial and engineering personnel.
      Qualified individuals are in high demand and are often subject to competing
      offers. We cannot be certain that we will be able to attract and retain the
      qualified personnel we need for our business. If we are unable to hire
      additional personnel as needed, it would have a material adverse effect on
      us.





**Our
      industry is subject to intense competition, and our competitors are
      well-entrenched and are among the world’s largest companies.**




The
      power
      generation market is a highly competitive industry currently occupied by
      extremely large companies. All of these companies have far greater financial
      and
      other resources than us and already occupy segments of the power generation
      market. In order to successfully penetrate this industry, the Coates Engine
      will
      have to produce the performance and durability results anticipated by management
      and sell at a price or prices that will enable it to effectively compete and
      gain entrance into this market.




**We
      have no marketing and sales experience.**




The
      Company has no marketing and sales experience. The sales process is expected
      to
      be lengthy, in part because of skepticism about the performance of the Coates
      Engine. We are evaluating alternative marketing and sales channels,
      distributors, sublicensees and marketing partners. The Company may never
      successfully market and sell the Coates Engine.





**We
      have only a token number of employees, and in order to grow our business we
      will
      need to hire significant additional personnel.**




The
      Company needs to hire, train and retain additional employees for all aspects
      of
      its business if it is to achieve its sales goals. In particular, the Company
      needs trained engineers and sales personnel to educate potential customers
      and
      provide post-installation customer support. The Company is likely to experience
      difficulty in recruiting and retaining qualified people because the pool of
      experienced candidates is small and the competition to hire them is intense.





**We
      have significant immediate capital needs, and our ability to raise funds is
      highly uncertain.**




The
      Company will need additional financing in the near future for a number of uses,
      including:





·
            developing
                the Company’s engineering, administrative and marketing and sales
                organizations;


·
            expanding
                manufacturing capacity;


·
            conducting
                testing of the Coates Engine and obtaining requisite governmental
                approvals;


·
            expanding
                our research and development programs with respect to the basic CSRV
                technology and applying the CSRV technology to engines for different
                applications; and


·
            implementation
                of new systems, processes and procedures to support
                growth.




-8-




Additional
      financing may not be available on terms acceptable to the Company or not
      available at all.





**There
      is a limited public market for our outstanding Common Stock, and there are
      restrictions on transferability.**




There
      is
      presently a limited public market for our outstanding Common Stock. Our
      Common Stock is quoted on the OTC Bulletin Board. Trading in stock quoted on
      the
      OTC Bulletin Board is often thin and characterized by wide fluctuations in
      trading prices, due to many factors that may have little to do with our
      operations or business prospects. Moreover, the OTC Bulletin Board is not a
      stock exchange, and trading of securities on the OTC Bulletin Board is more
      sporadic than the trading of securities listed on a quotation system or a stock
      exchange. Shares of our Common Stock have not been registered and cannot be
      disposed of unless the requirements of Rule 144 under the Securities Act can
      be
      satisfied.





**Trading
      of our Common Stock is restricted by the SEC’S “penny stock” regulations which
      may limit a stockholder’s ability to buy and sell our
      stock.**




The
      Securities and Exchange Commission has adopted regulations which generally
      define a “penny stock” to be any equity security that has a market price less
      than $5.00 per share or an exercise price of less than $5.00 per share, subject
      to certain exceptions. Our securities will likely be covered by the penny stock
      rules, which impose additional sales practice requirements on broker-dealers
      who
      sell to persons other than established customers and accredited investors.
      The
      penny stock rules require a broker-dealer, prior to a transaction in a penny
      stock not otherwise exempt from the rules, to deliver a standardized risk
      disclosure document in a form prepared by the Securities and Exchange Commission
      that provides information about penny stocks and the nature and level of risks
      in the penny stock market. The broker-dealer also must provide the customer
      with
      current bid and other quotations for the penny stock, the compensation of the
      broker-dealer and its salesperson in the transaction and monthly account
      statement showing the market value of each penny stock held in the customer’s
      account. The bid and offer quotations, and the broker-dealer and salesperson
      compensation information, must be given to the customer orally or in writing
      prior to effecting the transaction and must be given to the customer in writing
      before or with the customer’s confirmation. In addition, the penny stock rules
      require that prior to a transaction in a penny stock not otherwise exempt from
      these rules, the broker-dealer must make a special written determination that
      the penny stock is a suitable investment for the purchaser and receive the
      purchaser’s written agreement to the transaction. These disclosure and
      suitability requirements may have the effect of reducing the level of trading
      activity in the secondary market for a stock that is subject to these penny
      stock rules. Consequently, these penny stock rules may affect the ability of
      broker-dealers to trade our securities. We believe that the penny stock rules
      discourage investor interest in and limit the marketability of our capital
      stock. Trading of our capital stock may be restricted by the SEC’S “penny stock”
regulations which may limit a stockholder’s ability to buy and sell our
      stock.





**George
      J. Coates and his family own a majority of our Common Stock allowing him to
      unilaterally determine the outcome of all matters submitted to our stockholders
      for approval, which influence may or may not conflict with our interests and
      the
      interests of our other stockholders.**




George
      J.
      Coates, together with members of his family and related trusts, beneficially
      own
      more than 80% of the outstanding shares of Common Stock at March 31, 2007,
      and
      will therefore be able to unilaterally determine the outcome of all matters
      submitted to our stockholders for approval, including the election of our
      directors and other corporate actions.




-9-




**Because
      we do not intend to pay dividends for the foreseeable future, stockholders
      will
      benefit from an investment in our Common Stock only if it appreciates in
      value.**




We
      have
      never declared or paid any cash dividends on our Common Stock. We currently
      intend to retain our future earnings, if any, to finance further research and
      development, commence production of the Coates Engine and general and
      administrative expenses and do not expect to pay any cash dividends in the
      foreseeable future. As a result, the success of an investment in our Common
      Stock will depend upon any future appreciation in its value. There is no
      guarantee that our Common Stock will appreciate in value or even maintain the
      price at which stockholders have purchased their shares.




**Trading
      in our Common Stock may be volatile, which may result in substantial declines
      in
      its market price.**




Our
      Common Stock is likely to experience significant volatility in response to
      periodic variations in:





·
            results
                of testing of the Coates Engine;


·
            performance
                of the Coates Engine in the field;


·
            improvements
                in competitive engines; and


·
            changes
                in general conditions in the economy or the financial
                markets.




The
      market has also experienced significant volatility which has affected the market
      prices of securities issued by many companies; often for reasons unrelated
      to
      their operating performance, and may adversely affect the price of our Common
      Stock.




The
      market for our Common Stock is limited. We cannot assure that an active trading
      market can be maintained. In such case, our stockholders may find it difficult
      to dispose of shares of our Common Stock and, as a result, may suffer a loss
      of
      all or a substantial portion of their investment.




**Item
      2. Description of Property.**





Our
      executive offices and testing facility are located in an approximately 25,000
      square foot building in Wall Township, New Jersey, outside of New York City.
      At
      the end of November 2005, the Company entered into a sale/leaseback arrangement
      for this property. The Company has an option to repurchase the property at
      any
      time during the first three years of the agreement for $5,200,000. The new
      lease
      agreement with the purchaser provides for monthly payments of $32,500 over
      a six
      year period. Under the lease agreement, the Company is responsible for all
      real
      estate taxes and operating expenses of the property, including insurance. We
      will only be able to finance the repurchase of the leased premises if we are
      successful in obtaining outside financing on terms and conditions satisfactory
      to us.





In
      our
      research and development operations, we own and utilize milling machines,
      lathes, grinders, hydraulic lifts and presses, tooling, dynamometers and
      emission testing machines and computerized drafting and printing equipment.
      All
      of such equipment is in good condition.





**Item
      3. Legal Proceedings.**





The
      Company, its officers and directors and other related and unrelated parties
      have
      been named as defendants in a lawsuit brought in the Superior Court of New
      Jersey that is captioned H. Alton Neff v. George Coates, Coates International,
      Ltd. et al (the “Neff Complaint”). Plaintiff contends that he is the assignee of
      1107 North West Central Avenue Inc. ("1107"). Preliminary agreements and an
      amendment thereto relating to purchase of a certain license by 1107 from the
      Company provided, inter alia, that the $500,000 deposit made by 1107 to the
      Company would convert to the stock of the Company if certain conditions were
      not
      met by 1107. The Company maintains that 1107 did not fulfill such conditions,
      and failed to make a certain payment, and therefore, the deposit converted
      into
      shares of the Company's restricted Common Stock. Management believes that this
      lawsuit is without merit and intends to vigorously defend this action. On February
      13, 2007 ,
      the
      Superior Court of New Jersey, dismissed the complaint “with prejudice.” The
      plaintiff and a third party defendant have since filed motions for
      reconsideration which were denied on March 30, 2007. It is anticipated that
      the
      plaintiffs and the third party defendant will appeal. The Company has proposed
      to dismiss, without prejudice, its counterclaim and third party complaint in
      order to avoid the costs associated with a proof hearing.




-10-


The
      Company is not a party to any other litigation that is material to the Company's
      business.




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




No
      matters were submitted to a stockholder vote in 2006.




-11-


**PART
      II**





**Item
      5. Market for Registrant’s Common Equity and Related Stockholder
      Matters.**





**Market**




There
      was
      no established public trading market for our Common Stock during the years
      ending December 31, 2006 and 2005. Our Common Stock began trading on the Over
      the Counter Bulletin Board (“OTC Bulletin Board”), ticker symbol COTE, on
      February 26, 2007. The closing price of the common stock on March 27, 2007
      was
      $0.275 per share.





**Holders**




At
      December 31, 2006, the number of holders of record of the Common Stock was
      1,169.





**Recent
      Sales of Unregistered Securities**




In
      March
      and April 2007, we sold 2,000,000 shares of our common stock in a private sale
      to the son of a director of the Company, an accredited investor, and received
      aggregate gross proceeds of $500,000 therefrom.





In
      March
      2007, we issued $120,000 principal amount of 10% Convertible Subordinated Notes,
      due March 2010 (the “Convertible Notes”) to two of our outside directors and
      received proceeds of $120,000. The Convertible Notes are convertible into shares
      of our common stock at an initial conversion rate which shall be equal to the
      weighted average of the closing prices of our common stock on the Over the
      Counter Bulletin Board on the first ten trading days beginning on the fifth
      trading day after the Company files this annual report on Form 10-KSB with
      the
      Securities and Exchange Commission. However, such conversion rate shall not
      be
      greater than $0.45 per share nor less than $0.25 per share. Interest shall
      accrue at the rate of 10% per annum and shall be payable in cash only at
      maturity.





In
      March
      2007, we completed the sale of an aggregate of 42,000 shares of 6% Series A
      Convertible Preferred Stock (“Preferred Stock”) and 42 Warrants to purchase an
      aggregate of 210,000 shares of our Common Stock at $1.10 per share and received
      total gross proceeds of $420,000. Each
      share of Preferred Stock is convertible into ten shares of our common stock
      at
      any time.The Company is currently seeking approval from the investors to
      directly issue the underlying 420,000 shares of common stock in lieu of issuing
      the Preferred Stock. This will not affect the Company’s obligation with respect
      to the Warrants, which are being issued to these subscribers.




There
        were no sales of our Common Stock in 2006. In 2005, the Company issued 29,000
        shares and 6,000 shares of its Common Stock in private transactions at a
        price
        of $5.00 per share, in consideration for cash proceeds of $145,000 which
        has
        been used for working capital purposes and the satisfaction of a $30,000
        account
        payable, respectively.


We
      did
      not employ an underwriter in connection with the issuance of the securities
      described above. We believe that the issuance of the foregoing securities was
      exempt from registration under the Securities Act of 1933, as amended (the
      “Securities Act”). Each of the purchasers was an accredited investor, and
      acquired the securities for investment purposes only and not with a view to
      distribution.




**Rule
      144**




In
      general, under Rule 144 under the Securities Act, a person who has beneficially
      owned shares of our Common Stock for at least one year would be entitled to
      sell
      within any three-month period a number of shares that does not exceed the
      greater of:





·
            1%
                of the number of shares of our Common Stock then outstanding, which
                will
                equal approximately2,668,942shares of our Common Stock; or


·
            the
                average weekly trading volume of our Common Stock on the OTC Bulletin
                Board during the four calendar weeks preceding the filing of a notice
                on
                Form 144 with respect to the sale.




-12-




Sales
      under Rule 144 are also subject to manner of sale provisions and notice
      requirements and to the availability of current public information about us
      for
      at least 90 days. As of December 31, 2006, a total of 266,890,278 shares of
      our
      Common Stock are eligible for resale under Rule 144.





Under
      Rule 144(k) under the Securities Act, a person who is not deemed to have been
      one of our affiliates at any time during the 90 days preceding a sale, and
      who
      has beneficially owned the shares proposed to be sold for at least two years,
      is
      entitled to sell the shares without complying with the manner of sale, public
      information, volume limitation or notice provisions of Rule 144. As of December
      31, 2006, 42,792,798 shares of our Common Stock qualified for resale under
      Rule
      144(k).




**Dividends**




We
      have
      never declared or paid any cash dividends on shares of our capital stock. We
      currently intend to retain earnings, if any, to fund the development and growth
      of our business and do not anticipate paying cash dividends in the foreseeable
      future. Our payment of any future dividends will be at the discretion of our
      board of directors after taking into account various factors, including our
      financial condition, operating results, cash needs and growth
      plans.





**Stock
      Options**




The
      following table sets forth information with respect to our securities authorized
      for issuance as of March 28, 2007, under our 2006 Stock Option and Incentive
      Plan:





Plan
                Category
            
            Number
                of securities to be issued upon exercise of outstanding options,
                rights
                and warrants
            
            Weighted
                average exercise price of outstanding options, rights and
                warrants
            
            Number
                of securities remaining available for future issuance under equity
                compensation plans excluding securities reflected in column
                (a)(a)
            
            (b)
            
            (c)Equity
                Compensation plans approved by security holders
            
            
            None
            
            
            None
            
            
            NoneEquity
                Compensation plans without approval by security holders
            
            
            1,800,000
            
            
            *
            
            
            10,700,000Total
            
            
            1,800,000
            
            
            *
            
            
            10,700,000





*
      Represents stock option grants to employees and outside directors on March
      28,
      2007. The weighted average exercise price of the stock options issued in column
      (a) cannot be determined at this time because the exercise price has been
      established to equal the closing trading price of our Common Stock on the Over
      the Counter Bulletin Board on the first trading day after the filing of this
      annual report on Form 10-KSB.





The
      Company’s 2006 Stock Option and Incentive Plan (the “Stock Plan”) was adopted by
      the Company’s Board of Directors in October 2006. We may, at our option,
      undertake to have the Stock Plan adopted by our shareholders. The Stock Plan
      provides for the grant of stock-based awards to employees, officers and
      directors of, and consultants or advisors to, the Company and its subsidiaries.
      A total of 12,500,000 shares of Common Stock may be issued upon the exercise
      of
      options or other awards granted under the Stock Plan.





Upon
      the
      consummation of an acquisition of the business of the Company, by merger or
      otherwise, the Board shall, as to outstanding awards (on the same basis or
      on
      different bases as the Board shall specify), make appropriate provision for
      the continuation of such awards by the Company or the assumption of such awards
      by the surviving or acquiring entity and by substituting on an equitable basis
      for the shares then subject to such awards either (a) the consideration
      payable with respect to the outstanding shares of Common Stock in connection
      with the acquisition, (b) shares of stock of the surviving or acquiring
      corporation or (c) such other securities or other consideration as the
      Board deems appropriate, the fair market value of which (as determined by the
      Board in its sole discretion) shall not materially differ from the fair market
      value of the shares of Common Stock subject to such awards immediately preceding
      the acquisition.




-13-




The
      Board
      may at any time provide that any stock options shall become immediately
      exercisable in full or in part, that any restricted stock awards shall be free
      of some or all restrictions, or that any other stock-based awards may become
      exercisable in full or in part or free of some or all restrictions or
      conditions, or otherwise realizable in full or in part, as the case may
      be.





**Item
      6. Management’s Discussion and Analysis and Plan of
      Operation.**





**Background**




We
      have
      substantially completed the development of the Coates spherical rotary valve
      engine .
      We are
      now engaged in adapting our technology to manufacturing industrial engines
      to
      power electric generators with output of up to 300kw, depending on the primary
      fuel. Thereafter, we intend to manufacture engines for multiple other
      applications and uses.




**Significant
        Estimates**
 
 The
        Company utilizes significant estimates in the preparation of its financial
        statements. These significant estimates include assigning useful lives to
        our
        property, plant and equipment, assigning an average life to our deferred
        licensing costs and determining an appropriate amount to reserve for obsolete
        and slow moving inventory.




**Results
      of Operations for the Years Ended December 31, 2006 and December 31,
      2005**




The
      Company earned revenues of $565,000 in 2006 in connection with the termination
      of a license agreement with one of its sublicensees and did not earn any
      revenues during 2005. The Company's principal business activities and efforts
      during 2006 and 2005 were devoted to (i) the continuation of the research,
      development, construction and testing of the prototype Coates Engines for WWE,
      (ii) undertaking an effort to raise additional working capital through the
      private placement of securities, and (iii) securing additional working capital
      in 2005 from the sale and leaseback financing of its principal offices,
      warehouse and manufacturing facility.





Total
      operating expenses for the years ended December 31, 2006 and 2005 were
      approximately $1,867,000 and $895,000, respectively, representing an increase
      of
      approximately 108.6%, which was primarily attributable to the Company's
      resumption of its efforts towards continuing research and development relating
      to its prototype CSRV engine generator and increased legal fees primarily
      related to its efforts to sell securities. A shortage of available working
      capital during most of 2005 prevented the Company from undertaking extensive
      testing for the functionality, design and components of the prototype engines
      and the Company focused on reducing general and administrative expenses.
      Approximately $429,000 and $380,000 for the years ended December 31, 2006 and
      2005, respectively, represented labor charges. Research and development expenses
      increased to approximately $437,000 in 2006 from approximately $18,000 in 2005
      primarily as a result of the resumption of our efforts towards research and
      development relating to our prototype CSRV engine generator, a provision for
      slow moving inventory amounting to approximately $145,000 and a charge to write
      down inventories to net realizable value amounting to approximately $118,000.
      General and administrative expenses increased to approximately $1,373,000 in
      2006 from approximately $820,000 in 2005. This approximately $553,000, or 67.4%
      increase primarily resulted from an increase of approximately $377,000 in legal
      fees, approximately $98,000 of offering costs charged to expense as a result
      of
      delays in our effort to sell securities through a private placement offering
      and
      approximately $41,000 of accrued compensation for a former executive
      officer.





The
      loss
      from operations of approximately $1,302,000 in 2006 increased approximately
      $407,000 from approximately $895,000 in 2005. This was the result of the
      increase in operating expenses in 2006 described above, partially offset by
      the
      research and development revenues from a terminated sublicense agreement in
      2006. During 2005, the Company's activities were adversely affected by
      inadequate working capital.





Other
      expense, net decreased to a net expense in 2006 of approximately $360,000 from
      approximately $365,000 in 2005. This resulted from (i) discontinuance of the
      recording of our equity in the losses of Coates Motorcycle Company, Ltd. (“CMC”)
      which amounted to approximately $260,000 in 2005, because our investment in
      and
      securities of CMC owned were written down to $-0- in 2005, (ii) an increase
      of
      approximately $237,000 in interest expense to approximately $390,000 in 2006,
      from $153,000 in 2005, resulting from the higher finance obligation related
      to
      the sale/leaseback of our principal offices, manufacturing and warehouse
      facility outstanding for all of 2006 and outstanding for a little more than
      one
      month in 2005, (iii) a gain on sale of investment in related party only in
      2005,
      of $47,000; and (iv) a partial offset from interest income of approximately
      $30,000 earned on invested working capital.




-14-




In
      2006,
      the change in deferred taxes was fully offset by a valuation allowance,
      resulting in a $-0- net income tax provision for 2006. In 2005, net income
      tax
      expense was $11,117 comprised of $127,156 of state income taxes relating to
      the
      taxability of the sale/leaseback transaction for state tax purposes, partially
      offset by the aggregate proceeds amounting to $116,039 from the sale of our
      unused State Net Operating Loss Carryover and Research and Development Tax
      Credits to corporate taxpayers in New Jersey.


The
      net
      result for the year 2006 was a loss of approximately $1,321,000 or $0.00 per
      share, as compared to a net loss of approximately $1,272,000 or $0.00 per share
      for 2005.





**Liquidity
      and Capital Resources**




We
      have
      incurred recurring losses from operations, and as of December 31, 2006, had
      a
      working capital deficiency of $519,000 and a Stockholders’ Deficiency of
      approximately $2,981,000. These factors raise substantial doubt about our
      ability to continue as a going concern. We have instituted a cost reduction
      program intended to cut variable costs to only those expenses that are necessary
      to perform activities related to making engineering refinements to the Coates
      Engine, raising additional working capital and general administrative costs
      in
      support of such activities. In March and April 2007, we raised $1,140,000 of
      new
      working capital as discussed below. We continue to actively seek out new sources
      of working capital, however, there can be no assurance that we be successful
      in
      these efforts.





We
      are
      currently refining the production prototype Coates generator engines and testing
      them. Subject to meeting WWE’s expectations with respect to the prototype Coates
      generator engine, we expect to receive the balance of $3,800,000 from WWE under
      our research and development agreement with them. Under our agreement with
      WWE,
      an additional balance due to us of $4,700,000 is payable in equal quarterly
      payments over a four year period, commencing 180 days following delivery to
      WWE
      of the third prototype engine, and subject to meeting WWE expectations as
      mentioned above. We expect that the prototype Coates generator engine will
      meet
      WWE’s expectations. There can be no assurance, however, that these agreements,
      as well as those presently in negotiations with prospective licensees, will
      be
      consummated in accordance with these expectations or that payments will be
      received as called for in the agreements.





During
      fiscal 2006, the Company expended significant working capital for our
      activities relating to the research, development, construction and testing
      of
      the production prototype Coates generator engines for WWE and costs incurred
      in
      connection with our effort to raise additional working capital through the
      private placement of our securities. At the end of 2006, we had negative working
      capital of approximately ($275,000) compared with positive working capital
      of
      approximately $1,722,000 at the end of 2005. In 2007, the Company closed on
      a
      series of financing and equity transactions that generated aggregate cash
      proceeds of $1,140,000 which are being used for working capital purposes. A
      summary of these transactions is as follows:





·
            In
                March and April 2007, we sold 2,000,000 shares of our common stock
                in a
                private sale to the son of a director of the Company, an accredited
                investor, and received aggregate gross proceeds of $500,000
                therefrom.





·
            In
                April 2007, the Company issued a $192,337 principal amount Promissory
                Note
                due April 4, 2008 to the Coates Trust in consideration for cash proceeds
                of $100,000 and conversion of a non-interest bearing demand loan
                due to
                the Coates Trust in the amount of $92,337. George J. Coates, Bernadette
                Coates and Gregory Coates are beneficiaries of this
                Trust.




-15-




·
            In
                March 2007, the Company issued $120,000 principal amount of 10%
                Convertible Subordinated Notes, due March 2010 (the “Convertible Notes”)
                to two of its outside directors and received proceeds of $120,000.
                The
                Convertible Notes are convertible into shares of the Company’s common
                stock at an initial conversion rate which shall be equal to the weighted
                average of the closing prices of the Company’s common stock on the Over
                the Counter Bulletin Board on the first ten trading days beginning
                on the
                fifth trading day after the Company files this annual report on Form
                10-KSB with the Securities and Exchange Commission. However, such
                conversion rate shall not be greater than $0.45 per share nor less
                than
                $0.25 per share. Interest shall accrue at the rate of 10% per annum
                and
                shall be payable in cash only at
                maturity.





·
            The
                Company commenced a private placement offering in December 2006 (the
                “Offering”) of “Units” consisting of (i) one share of the Company’s Series
                A Convertible Preferred Stock (the “Preferred Stock”) and (ii) a Warrant
                to purchase five thousand shares of the Company’s Common Stock at an
                initial exercise price of $1.10 per share (the “Warrants”), and terminated
                the Offering in March 2007. Aggregate proceeds from this Offering,
                which
                amounted to $420,000 is being used for working capital purposes.
                In
                consideration of the commencement of trading of the Company’s common
                stock, the Company is currently in the process of obtaining approval
                from
                the investors in the Offering to directly issue shares of its common
                stock
                in lieu of the Preferred Stock. Upon obtaining such approval, the
                Company
                will issue in the aggregate 420,000 shares of its common stock and
                42
                Warrants for
                the 42 Units sold.




The
      Company will continue its efforts to identify sources of additional funding
      for
      its working capital in 2007 in order to further support its operations. Such
      sources of working capital and new funding being pursued by the Company include
      (i) proceeds from WWE as provided for in the research and development agreement
      with WWE and our agreement with WWE upon delivery of the production prototype
      Coates generator engine, (ii) initial down payments on provisional orders from
      WWE upon conversion to firm orders, (iii) direct investment and/or finance
      facilities from institutional investors, (iv) new equity investment and/or
      up
      front licensing fees from prospective new sublicensees; and, (v) cash down
      payments from potential new customers. There can be no assurance that the
      Company will be successful in securing any of these sources of additional
      funding. In this event, we may be required to substantially or completely
      curtail our operations, which could have a material adverse affect on our
      operations and financial condition.





Current
      liabilities are primarily composed of approximately $782,000 of legal fees
      due
      to a law firm for its representation of us in litigation over the past several
      years, legal fees of approximately $93,000 due to a law firm for representation
      of us for various securities related matters, approximately $41,000 of accrued
      compensation due to a director and former executive officer, approximately
      $60,000 due to our former independent auditors for audit and tax services and
      a
      stockholder loan from the Coates Trust for approximately $92,000. Payments
      for
      interest, real estate taxes and insurance under our sale/leaseback agreement
      amount to approximately $465,000 per year. We have employment agreements in
      place in place that provide for minimum annual salary payments to three of
      our
      executives aggregating $263,000. This amount would increase to approximately
      $675,000 upon the Company achieving an adequate level of working capital as
      defined in the employment agreements.





In
      February 2007, the Company entered into a settlement agreement with Rosenberg,
      Rich Baker Berman & Company (“RRBB”) which provided for a mutual release of
      any claims by the parties and that the balance of fees due RRBB would be
      converted to an approximately $50,000 principal amount, promissory note, payment
      of which became accelerated and is now due. RRBB served as the Company’s
      Independent Registered Public Accounting Firm for the year ended December 31,
      2005 and performed reviews of our quarterly reports on Form 10-QSB through
      the
      third quarter of 2006.





**Contractual
      Obligations and Commitments**





The
      following table summarizes our contractual obligations and commitments at
      December 31, 2006:





Amount
                Due WithinContractual
                  Obligations
            
            Total
            
            2007
            
            2008
            
            2009
            
            2010
            
            2011Sale/Leaseback
                Arrangement
            
            $
            1,917,500
            
            $
            390,000
            
            $
            390,000
            
            $
            390,000
            
            $
            390,000
            
            $
            357,500Employment
                Agreements(1)
            
            
            1,266,000
            
            
            263,000
            
            
            263,000
            
            
            263,000
            
            
            263,000
            
            
            214,000Total
            
            $
            3,183,500
            
            $
            653,000
            
            $
            653,000
            
            $
            653,000
            
            $
            653,000
            
            $
            571,500





(1)
            Our
                obligation under employment agreements would increase to $675,000
                per year
                through October 17, 2009 and to $550,000 per year from October 18,
                2009
                through October 23, 2011, upon the Company achieving an adequate
                level of
                working capital, as defined.




-16-


**Plan
      of Operation**





Currently,
      the prototypes of the CSRV System-based generator engine are undergoing
      performance and other tests. Initially, the Company intends to sell the
      engine/generators to a party that has expressed indications of interest to
      purchase Coates Engines upon the successful completion of the above tests.
      If
      these indications of interest become firm orders, the fulfillment of these
      orders may occur over a three to five year period. The Company intends to take
      advantage of the fact that essentially all the components of the CSRV generator
      engine may be readily sourced and acquired from subcontractors, and accordingly,
      intends to manufacture the generator engine in the two following
      ways:




·
            Assembly
                - to develop assembly lines within the Company’s premises. The Company has
                been evaluating various opportunities to expand or acquire additional
                manufacturing capacity. When the demand for our products justifies
                it, the
                Company will take the required steps in order to increase its work
                force.
                We may hire a significant number of new employees within the next
                12 to 24
                months after production commences.




·
            Licensing
                the technology to Original Equipment Manufacturers (“OEM”) - to take
                advantage of third party manufacturers’ production ability by signing OEM
                agreements.




**Item
      7. Financial Statements.**




Reference
      is made to the Index to Financial Statements on page F-1.




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




None.





**Item
      8A. Controls and Procedures.**




**Evaluation
      of disclosure controls and procedures:**




Based
      on
      their evaluation as of a date within 90 days of the filing date of this report,
      George J. Coates, our principal executive officer and Barry C. Kaye, our
      principal financial officer, have concluded that our disclosure controls and
      procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities
      Exchange Act of 1934, as amended (the "Exchange Act") are sufficiently effective
      to ensure that the information required to be disclosed by the Company in the
      reports that we file under the Exchange Act is gathered, analyzed and disclosed
      with adequate timeliness, accuracy and completeness.




**Changes
      in internal controls:**




There
      have been no significant changes in our internal controls or in other factors
      that could significantly affect these controls subsequent to the date of the
      evaluation referred to above, nor were there any significant deficiencies or
      material weaknesses in the Company's internal controls. Accordingly, no
      corrective actions were required or undertaken.




-17-




**Limitations
      on the effectiveness of controls:**




A
      control
      system, no matter how well conceived and operated, can provide only reasonable,
      not absolute, assurance that the objectives of the control system are met.
      Because of inherent limitations in all control systems, no evaluation of
      controls can provide absolute assurance that all control issues, if any, within
      a company have been detected.





**Item
      8B. Other Information.**




The
      Company has entered into the following material agreements, which are described
      in Item 10: Executive Compensation, under the caption “Employment contracts and
      termination of employment and change-in-control arrangements”:





·
            Amended
                and Restated Employment Agreement between the Company and George
                J. Coates
                dated April 6, 2007.




·
            Amended
                and Restated Employment Agreement between the Company and Gregory
                Coates
                dated April 6, 2007.




·
            Amended
                and Restated Employment Agreement between the Company and Barry C.
                Kaye
                dated April 6, 2007.




The
      Company has entered into the following material agreements, which are described
      in Item 1: Description of Business, under caption “Patents and
      Licenses”:




·
            Amended
                and Restated License Agreement between the Company and George J.
                Coates
                and Gregory Coates dated April 6,
                2007.




**Election
      of Director and Principal Officer and Departure of Principal
      Officer**





On
      March
      28, 2007, the Board of Directors of the Company appointed George J. Coates,
      founder and majority stockholder of the Company to the position of Chairman
      of
      the Board. George J. Coates replaces his son Gregory Coates as Chairman, who
      will continue to serve as a Director and President, Technology Division. George
      J. Coates has also been appointed Chief Executive Officer and President,
      replacing Mark Goldsmith. In March 2007, the Board of Directors approved the
      conditional appointment of Mr. Goldsmith to the position of Chief Operating
      Officer, subject to the prior execution of an employment agreement. To date,
      the Company
      and Mr. Goldsmith have not agreed on the terms and conditions for an employment
      agreement. Currently, the Company continues to consider a possible future role
      for Mr. Goldsmith. On April 13, 2007, Mr. Goldsmith resigned his position as
      a
      member of the Board of Directors.




-18-





**PART
      III**





**Item
      9. Directors, Executive Officers, Promoters and Control Persons; Compliance
      with
      Section 16(a) of the Exchange Act.**





The
      following table lists the current members of our board of directors and our
      executive officers as of April 13, 2007. The address for our directors is c/o
      Coates International, Ltd., Highway 34 & Ridgewood Road, Wall Township, New
      Jersey 07719. There are no family relationships among members of our board
      or
      our executive officers, with the exception of Gregory Coates, who is the son
      of
      George J. Coates.





**Name**
            
            **Age**
            
            **Position**George
                J. Coates
            
            67
            
            Director,
                Chairman of the Board, Chief Executive Officer and
                PresidentGregory
                Coates
            
            36
            
            Director
                and President, Technology DivisionBarry
                C. Kaye
            
            53
            
            Director,
                Treasurer and Chief Financial OfficerRichard
                W. Evans
            
            75
            
            Director
                and SecretaryDr.
                Frank Adipietro
            
            49
            
            Director
                *, **Glenn
                Crocker
            
            58
            
            Director
                *, **, ***Dr.
                Michael J. Suchar
            
            51
            
            Director
                *, **Richard
                Whitworth
            
            58
            
            Director
                *, **, ***





*
            Serves
                as an independent director.




**
            Serves
                as a member of our compensation
                committee




***
            Serves
                as a member of our audit committee





George
      J. Coates is our
      founder and served since our organization and until October 23, 2006 as a
      director of our Company, Chairman of the Board of Directors, President, Chief
      Executive Officer, Treasurer and Chief Financial Officer. Since October 23,
      2006, he was employed by us in a non-executive position, and was considered
      by
      us as to be a significant employee. Effective March 28, 2007, Mr. Coates assumed
      the position as Chairman of our Board. He replaced his son Gregory Coates who
      will continue to serve as a Director and President, Technology Division. Mr.
      Coates was appointed Chief Executive Officer and President, replacing Mark
      Goldsmith.





George
      J.
      Coates served two apprenticeships in Europe while attending the College of
      Technology in London, and as an associate member of the S.A.E. He received
      The
      City and Guilds of London for electrical and mechanical engineering. He is
      a
      former management director of SCR motor engineers of Europe and holds the
      certificates of Ministry of Transport in the United Kingdom. He worked as an
      engineer for Rolls Royce and Mercedes Benz, and holds approximately 300 patents
      worldwide. He invented coolant disc brakes, invented a hydraulic suspension,
      invented and patented the Coates rotary valve system and invented and patented
      a
      turbine engine. George Coates is 67 years old.





Gregory
      Coates became a
      director of the Company on October 24, 2006, and has served as the Chairman
      of
      our Board of Directors until March 28, 2007. On October 23, 2006, he became
      our
      President - Technology Division. For more than fifteen years, Gregory Coates
      has
      worked with us as a design engineer, working in
      the
      research and development, designing and building of the CSRV System and adapting
      this system to various existing applications. He created certain of our licensed
      inventions, and patented certain of them. Gregory Coates is an Associate Member
      of the Society of Automotive Engineers, Inc., and a Member of the American
      Society of Mechanical Engineers. He
      graduated from the College of Technology of Ireland.




-19-




Barry
      C. Kaye became a
      director of the Company on October 24, 2006 and has been serving as our
      Treasurer and Chief Financial Officer since October 18, 2006. Mr. Kaye is a
      Certified Public Accountant in both New York and New Jersey. From 2006 to 2007,
      Mr. Kaye has been the Vice President, Finance and Operations for Corporate
      Subscription Management Services LLC, a company that provide comprehensive
      knowledge resources management services to large companies and organizations.
      Since 1999, he has been an Executive Business Consultant with BCK Business
      Consulting which provides various business consulting services to the business
      community. From 2004 to 2005, Mr. Kaye served as Corporate Controller of
      Development Corporation for Israel, a registered broker-dealer that distributes
      bonds of the government of Israel. He was the Vice President, Finance &
Operations for Alliance Corner Distributors, Inc., a company engaged in sales
      and distribution of video games and other forms of digital entertainment media
      from 2003 to 2004. From 1987 to 1999, he served as Group Vice President, Finance
      at Sharp Electronics Corporation, a $3.5 billion company engaged in sales and
      distribution of consumer electronics, office equipment products and
      microelectronic components, where he was responsible for all finance and
      operations. From 1976 to 1987, Mr. Kaye was a Senior Audit Manager for Arthur
      Andersen & Co. He is a member of the American Institute of Certified Public
      Accountants as well as a member of the New York and New Jersey State Societies
      of Certified Public Accountants. Mr. Kaye received his Bachelor of Science
      in
      Accounting degree, graduating with Cum Laude distinction from Brooklyn College
      of the City University of New York.





Richard
      W. Evans became a
      director of the Company in May 1996. Dr. Evans holds an ED.D degree from Rutgers
      University, was a Supervisor of the Highland Park School in Highland Park,
      New
      Jersey, a post held for more than the preceding five years until his retirement
      in June 1996.





Michael
      J. Suchar became a
      director of the Company in May 1996. Dr. Suchar, who holds a Doctor of Dental
      Surgery degree from Temple University Dental School, has been a practicing
      pediatric dentistry for more than twenty years. Mr. Suchar also has a patented
      invention in the field of aviation security.





Frank
      J. Adipietro became a
      director of the Company on October 24, 2006. Dr. Adipietro earned an M.D. degree
      from Downstate Medical School, Brooklyn, New York. He has also earned an
      undergraduate degree from New York University, graduating with Phi Beta Kappa
      and Magna Cum Laude distinction. He has been practicing in the area of
      anesthesia and interventional pain management for more than twenty years. He
      has
      been Vice President of the Medical Staff at Eastern Long Island Hospital in
      Greenpoint, New York since 2001 and serves on numerous hospital committees.
      He
      was affiliated with Lenox Hill Hospital, New York, NY for more than ten years
      in
      the field of anesthesiology.





Glenn
      Crocker became a
      director of the Company on October 24, 2006. Mr. Crocker, who holds an MBA
      degree in Engineering Design, has been working for most of the past thirty
      five
      years as a designer and design engineer with various vehicle manufacturers
      including Ford Motor Company, British Leyland, Mercedes Benz, Volvo Cars, Saturn
      GM, and BMW, among others.





Richard
      Whitworth became a
      director of the Company on October 24, 2006. Mr. Whitworth earned a Bachelor
      of
      Science degree from the University of Florida and has completed extensive
      post-graduate coursework and seminars in Law, Public Administration, Health
      Policy, Finance, Criminal Justice, Social Work and Education. He has been
      serving as the president of the Whitworth Group Inc. for the past 20 years.
      The
      Whitworth Group specializes in governmental and public relations, organizational
      development and financial services. Prior to that, he was the Director for
      the
      DWI Program Office for the Florida Supreme Court from 1979 to 1987. From 1976
      to
      1978 he was the Director of Prevention for the Florida Association Drug Abuse
      Treatment and Education Centers, Inc. From 1974 to 1976 he served as Specialist,
      Health and Mental Health, Aging Program Office for the Department of Health
      and
      Rehabilitation Services. Prior to that, he was the Director of Prevention for
      the Drug Abuse Program under the direction of the Department of Health and
      Rehabilitation Services.




-20-




**Board
      Committees**





Our
      board
      of directors established an audit committee and a compensation committee in
      October 2006. All of the members of each of these standing committees are
      independent as defined under NASDAQ rules and, in the case of the audit
      committee, the independence requirements contemplated by Rule 10A-3 under
      the Securities Exchange Act.





*Audit
      Committee*





The
      audit
      committee’s responsibilities will include:  appointing, approving the
      compensation of, and assessing the independence of our independent
      auditor;  overseeing the work of our independent auditor, including
      through the receipt and consideration of reports from the independent
      auditor;  reviewing and discussing with management and our independent
      auditor our annual and quarterly financial statements and related
      disclosures;  monitoring our internal control over financial
      reporting, disclosure controls and procedures, and code of business conduct
      and
      ethics;  discussing our risk management policies; establishing
      policies regarding hiring employees from our independent auditor and procedures
      for the receipt and retention of accounting related complaints and concerns;
      meeting independently with our independent auditor and management; and
      preparing the audit committee report required by SEC rules to be included in
      our
      proxy statements.





All
      audit
      services and all non-audit services, except de minimis non-audit services,
      must
      be approved in advance by the audit committee.





Our
      Board
      of Directors has determined that it does not have a member of its audit
      committee that qualifies as an "audit committee financial expert" as defined
      in
      Item 401(e) of Regulation S-B, and is "independent" as the term is used in
      Item
      7(d)(3)(iv) of Schedule 14A under the Securities Exchange Act of 1934, as
      amended.





*Compensation
      Committee*





The
      compensation committee’s responsibilities will include:





·
            annually
                reviewing and approving corporate goals and objectives relevant to
                compensation of our chief executive officer;




·
            determining
                the compensation of our chief executive officer;




·
            reviewing
                and approving, or making recommendations to our board of directors
                with
                respect to, the compensation of our other executive
                officers;




·
            overseeing
                an evaluation of our senior executives;




·
            overseeing
                and administering our cash and equity incentive
                plans; and




·
            reviewing
                and making recommendations to our board with respect to director
                compensation.





**Corporate
      Governance**





We
      believe that good corporate governance is important to ensure that, as a public
      company, we will manage for the long-term benefit of our stockholders. In that
      regard, we have established and adopted charters for the audit committee and
      compensation committee, as well as a code of business conduct and ethics
      applicable to all of our directors, officers and employees.





**Compensation
      Committee Interlocks and Insider Participation**





George
      J. Coates, Gregory Coates and Barry C. Kaye are executive officers and members
      of our board of directors. None of our executive officers serves as a member
      of
      our compensation committee, audit committee or other committee serving an
      equivalent function. None of the current members of the compensation committee
      of our board has ever been one of our employees.




-21-




**Liability
      Limitations and Indemnification**





The
      following description is intended as a summary only and is qualified in its
      entirety by reference to our amended and restated charter and amended and
      restated by-laws filed as exhibits to this report and to Delaware law. We refer
      in this section to our amended and restated charter as our charter, and we
      refer
      to our amended and restated by-laws as our by-laws.





Our
      charter and by-laws limit the liability of directors to the maximum extent
      permitted by Delaware law. Delaware law provides that directors of a corporation
      will not be personally liable for monetary damages for breach of their fiduciary
      duties as directors, except liability for:




·
            any
                breach of their duty of loyalty to the corporation or its stockholders;




·
            acts
                or omissions that are not in good faith or that involve intentional
                misconduct or a knowing violation of
                law;




·
            unlawful
                payments of dividends or unlawful stock repurchases or
                redemptions; or




·
            any
                transaction from which the director derived an improper personal
                benefit.





The
      limitations do not apply to liabilities arising under the federal securities
      laws and do not affect the availability of equitable remedies, including
      injunctive relief or rescission.





Our
      charter and by-laws provide that we will indemnify our directors and officers,
      and may indemnify other employees and agents, to the maximum extent permitted
      by
      law. We believe that indemnification under our by-laws covers at least
      negligence and gross negligence on the part of indemnified parties. Our by-laws
      also permit us to secure insurance on behalf of any officer, director, employee
      or agent for any liability arising out of actions taken in his or her capacity
      as an officer, director, employee or agent, regardless of whether the by-laws
      would permit indemnification.





Insofar
      as indemnification for liabilities arising under the Securities Act may be
      permitted to our directors, officers and controlling persons under our charter
      or by-laws or the indemnification agreements we have entered into with our
      directors and officers, we have been advised that in the opinion of the SEC
      this
      indemnification is against public policy as expressed in the Securities Act
      and
      is, therefore, unenforceable.





**Compliance
      with Section 16(a) of the Securities Exchange Act of 1934**





The
      Company knows of no person, who, at any time during the fiscal year ended
      December 31, 2006 to the date hereof, was a director, officer, beneficial owner
      of more than ten percent of any class of equity securities of the Company (a
      "Reporting Person"), that failed to file on a timely basis any reports required
      to be furnished pursuant to Section 16(a). Based upon a review of Forms 3,
      4 and
      5 furnished to the Company under Rule 16(a)-3(d), the Company knows of no
      Reporting Person that failed to file the required reports within the required
      time limits.





**Item
      10. Executive Compensation.**





The
      following table sets forth the compensation of specified executive officers
      for
      fiscal 2006 and 2005:





**Summary
      Compensation Table**





**Option**
            
            **All
                Other****Name
                and Principal Position**
            
            **Year**
            
            **Salary**
            
            **Awards**
            
            **Compensation**George
                J. Coates (1)
              *Chief
                Executive Officer and President*
            
            
            2006
            
            $
            183,549
            (1)
            $
            0
            (1)
            
            (5),
            (7)2005
            
            $
            183,549
            
            $
            0
            
            
            (5),
            (7)Mark
                D. Goldsmith (2)
              *Former
                Chief Executive Officer and President*
            
            
            2006
            
            $
            41,096
            (2)
            $
            02005
            
            $
            0
            
            $
            0Barry
                C. Kaye (3)
              *Chief
                Financial Officer and Treasurer*
            
            
            2006
            
            $
            0
            
            $
            0
            (1)
            $
            15,500
            (6)2005
            
            $
            0
            
            $
            0
            
            $
            3,000
            (6)Gregory
                Coates (4)
              *President,
                Technology Division*
            
            
            2006
            
            $
            82,971
            (4)
            $
            0
            (1)
            
            
            (7)2005
            
            $
            82,971
            
            $
            0




-22-




(1) The
        Company executed an amended and restated employment agreement with George
        J.
        Coates (the “GJC Agreement”) that replaces an employment agreement signed in
        2006. The term of the GJC Agreement, which became effective as of October
        23,
        2006, is for five years. The GJC Agreement provides for annual salary of
        $183,549, an annual performance bonus determined by unanimous vote of the
        independent members of the Board of Directors, plus vacation, sick leave
        and
        participation in health, dental and life insurance and any other established
        benefit plans. The GJC Agreement further provides that upon the Company
        achieving a sufficient level of working capital, the amount of annual salary
        shall be increased to $300,000, an automobile will be provided to Mr. Coates
        and
        he will be entitled to a severance payment equal to three years’ annual
        compensation, should he terminate his employment with Good Reason, as defined,
        or upon his death. He will also work with the Company in securing key-man
        life
        insurance. In accordance with the GJC Agreement, the Company committed to
        grant
        Mr. Coates 1,000,000 stock options at an exercise price that will equal the
        closing price of the Company’s shares of commons stock on the Over the Counter
        Bulletin Board on the first trading day after the filing of this annual report
        on Form 10-KSB (the “To Be Determined Exercise Price”). These stock options are
        being granted with a service inception date equal to the effective date of
        the
        GJC Agreement. As the exercise price of these options is currently not known,
        it
        is not possible to estimate the fair market value of these stock options
        when
        issued. The Company could not record stock option compensation expense for
        the
        related 2006 service period. Upon the stock price becoming known, the
        corresponding expense will be recorded.





(2) In
        late
        March 2007, Mark D. Goldsmith stepped down from his positions as Chief Executive
        Officer and President, and in April 2007, Mr. Goldsmith resigned his position
        as
        a member of the Board of Directors. In March 2007, the Board of Directors
        approved the conditional appointment of Mr. Goldsmith to the position of
        Chief
        Operating Officer, subject to the prior execution of an employment agreement.
        To
        date, the Company and Mr. Goldsmith have not agreed on the terms and conditions
        for an employment agreement.





Any
      such
      employment agreement would be conditioned upon the adequacy of the Company’s
      working capital and upon execution of a mutual release of any claims under
      a
      prior employment agreement between the Company and Mr. Goldsmith executed in
      October 2006. However, there can be no assurance that the parties will reach
      an
      agreement on the terms and conditions or that any such conditions will be
      satisfied. The
      amount of compensation that could be due Mr. Goldsmith for his employment in
      2006 pursuant to the employment agreement, amounted to $41,096. This amount
      has
      been recorded as an expense in the Company’s financial statements in 2006. Mr.
      Goldsmith may attempt to assert claims under this employment agreement. The
      Company does not intend to make any payments to Mr. Goldsmith in connection
      with
      this employment agreement.





(3)  The
      Company executed an amended and restated employment agreement with Mr. Kaye
      (the
“Kaye Agreement”) that replaces an employment agreement signed in 2006. The term
      of the Kaye Agreement, which became effective as of October 18, 2006, is for
      three years. The Kaye Agreement initially provides for minimum wages and
      benefits. The Kaye Agreement further provides that upon the Company achieving
      a
      sufficient level of working capital, the amount of annual salary shall be
      increased to $125,000, he will become eligible for an annual performance bonus
      and he will be entitled to a severance payment equal to one year’s annual
      compensation, should he be terminated by the Company without Cause, as defined,
      or if he should terminate his employment with Good Reason, as defined. In
      accordance with the Agreement, the Company committed to grant Mr. Kaye 125,000
      stock options at an exercise price that will equal the To Be Determined Exercise
      Price. These stock options are being granted with a service inception date
      equal
      to the effective date of the Kaye Agreement. As the exercise price of these
      options is currently not known, it is not possible to estimate the fair market
      value of these stock options when issued. The Company could not record stock
      option compensation expense for the related 2006 service period. Upon the stock
      price becoming known, the corresponding expense will be recorded




-23-




(4)  The
      Company executed an amended and restated employment agreement with Gregory
      Coates (the “GC Agreement”) that replaces an employment agreement signed in
      2006. The term of the GC Agreement, which became effective as of October 23,
      2006, is for five years. The GC Agreement provides for annual salary of $79,898,
      plus vacation, sick leave and participation in health, dental and life insurance
      and any other established benefit plans. The GC Agreement further provides
      that
      upon the Company achieving a sufficient level of working capital, the amount
      of
      annual salary shall be increased to $250,000, he will become eligible for an
      annual performance bonus, an automobile will be provided to Gregory Coates
      and
      he will be entitled to a severance payment equal to two years’ annual
      compensation, should he terminate his employment with Good Reason, as defined.
      He will also be provided with a $2 million life insurance policy and will work
      with the Company in securing key-man life insurance. In accordance with the
      GC
      Agreement, the Company committed to grant Mr. Coates 500,000 stock options
      at an
      exercise price that will equal the To Be Determined Exercise Price. These stock
      options are being granted with a service inception date equal to the effective
      date of the GC Agreement. As the exercise price of these options is currently
      not known, it is not possible to estimate the fair market value of these stock
      options when issued. The Company could not record stock option compensation
      expense for the related 2006 service period. Upon the stock price becoming
      known, the corresponding expense will be recorded





(5)  The
      Company issued Mr. Coates 1,000,000 shares of its common stock as consideration
      for a license agreement.





(6)  This
      amount represents payments to Mr. Kaye for consulting services provided to
      the
      Company during 2006 and 2005, respectively.





(7)  George
      J.
      Coates and Gregory Coates were provided with health care, dental care and life
      insurance benefits amounting to approximately $9,800 and $9,100, respectively,
      in 2006 and amounting to approximately $8,700 and $9,600, respectively in
      2005.





**Outstanding
      Equity Awards at Fiscal Year End**





In
      connection with the employment agreements entered into with George J. Coates,
      Gregory Coates and Barry C. Kaye, the Company became obligated to grant stock
      options to these employees. In 2007, the Company committed to grant the stock
      options enumerated in the table below at an exercise price that will equal
      To Be
      Determined Exercise Price.





Name
            
            Number
                of Securities Underlying Unexercised Options that are
                Exercisable
            
            Number
                of Securities Underlying Unexercised Options that are
                Unexercisable
            
            Equity
                Incentive Plan Awards: Number of Securities Underlying Unexercised
                Unearned Options
            
            Option
                Exercise Price
            
            Option
                Expiration DateGeorge
                J. Coates
            
            
            0
            
            
            0
            
            
            1,000,000(1
            )
            
            (3
            )
            
            10/23/2021Gregory
                Coates
            
            
            0
            
            
            0
            
            
            500,000(1
            )
            
            (3
            )
            
            10/23/2021Barry
                C. Kaye
            
            
            0
            
            
            0
            
            
            125,000(2
            )
            
            (3
            )
            
            10/17/2021





(1)
            One-third
                of these stock options shall vest on April 30, 2007 and the balance
                in two
                equal installments on October 23, 2008 and 2009.





(2)
            The
                options granted to Mr. Kaye will vest as follows: 25,000 stock options
                on
                April 30, 2007 and the balance in three equal installments on October
                18,
                2007, 2008 and 2009. The options will immediately fully vest in the
                event
                the employee terminates his employment for a good reason, or if we
                terminate such an employee without cause.





(3)
            Theexercise price will equal the To Be Determined Exercise Price. These
                stock
                options were granted with a service inception date equal to the employment
                agreement date.




-24-




Vesting
      of the stock options is subject to acceleration under certain circumstances
      in
      the event of an acquisition of the Company.





**Director
      Compensation**





Prior
          to
          March 28, 2007, the directors did not receive any compensation for serving
          on
          the Company’s Board of Directors, the audit or compensation committees. A
          compensation program was adopted by the Board of Directors on March 28,
          2007
          which provides for compensation to our directors in the amount of $1,000
          per
          day, plus reasonable travel expenses. This compensation plan further provides
          for the granting of stock options to our non-employee directors from time
          to
          time under our equity incentive plan to purchase our common stock at an
          exercise
          price equal to the closing prices of our stock on the Over the Counter
          Bulletin
          Board on the day prior to the date of grant. In March 2007, our five
          non-employee directors were each granted 25,000 stock options to purchase
          shares
          of our common stock at an exercise price that will equal the To Be Determined
          Date. On-fifth of these stock options will vest on the first five anniversary
          dates of the grant.





**Employment
      contracts and termination of employment and change-in-control
      arrangements**





In
      October 2006, we signed employment contracts with George J. Coates, Gregory
      Coates and Barry C. Kaye, who are serving as employees of the Company. These
      employment agreements were amended and restated on April 6, 2007. On October
      18,
      2006, we entered into an employment agreement with Mark D. Goldsmith covering
      the terms and conditions of his employment as Chief Executive Officer and
      President. On March 28, 2007, Mr. Goldsmith stepped down from these
      positions.





A
      summary
      of the compensation terms under the employment agreements appears in the table
      below.





Name
                & position
            
            Annual
                compensation
            
            Number
                of stock options4
            
            Life
                insurance
            
            Severance
                payment5
            
            Term
                of the AgreementGeorge
                Coates, President and Chief Executive Officer
            
            $
            183,549
            1
            
            1,000,000
            
            $
            2,000,000
            
            
            Three
                years salary6
            
            
            Five
                yearsGregory
                Coates, President Technology Division
            
            $
            79,898
            1
            
            500,000
            
            $
            2,000,000
            
            
            Two
                years salary6
            
            
            Five
                yearsMark
                D, Goldsmith, former Chief Executive Officer and President2
            
            $
            200,000
            2
            
            0
            2
            
            None
            
            
            None
            
            
            Three
                YearsBarry
                C. Kaye, Treasurer and Chief Financial Officer
            
            $
            0
            3
            
            125,000
            
            
            None
            
            
            One
                year salary3
            
            
            Three
                years





1
            The
                annual salary for George J. Coates and Gregory Coates shall be increased
                to $300,000 and $250,000, respectively, at such time that the Board
                of
                Directors determines that the Company has Sufficient Capital, as
                defined.





2
            In
                late March 2007, Mark D. Goldsmith stepped down from his positions
                as
                Chief Executive Officer and President, and in April 2007, Mr. Goldsmith
                resigned his position as a member of the Board of Directors. In March
                2007, the Board of Directors approved the conditional appointment
                of Mr.
                Goldsmith to the position of Chief Operating Officer, subject to
                the prior
                execution of an employment agreement. To date, the Company and Mr.
                Goldsmith have not agreed on the terms and conditions for an employment
                agreement.




-25-




Any
      such
      employment agreement would be conditioned upon the adequacy of the Company’s
      working capital and upon execution of a mutual release of any claims under
      a
      prior employment agreement between the Company and Mr. Goldsmith executed in
      October 2006. However, there can be no assurance that the parties will reach
      an
      agreement on the terms and conditions or that any such conditions will be
      satisfied. The amount of compensation that could be due Mr. Goldsmith for his
      employment in 2006 pursuant to the employment agreement, amounted to $41,096.
      This amount has been recorded as an expense in the Company’s financial
      statements in 2006. Mr. Goldsmith may attempt to assert claims under this
      employment agreement. The Company does not intend to make any payments to Mr.
      Goldsmith in connection with this employment agreement.





3
            Mr.
                Kaye’s compensation, severance and benefits shall not commence until the
                Board of Directors determines that the Company has Sufficient Capital,
                as
                defined. At that time, Mr. Kaye’s salary shall be $125,000 per annum.
                Until Mr. Kaye’s salary commences he is being paid for his services by the
                Company as a consultant on a per diem basis. In 2006, Mr. Kaye received
                $15,500 in consulting fees from the
                Company.





4
            These
                Options, which were granted on March 28, 2007, expire in October
                2021. The
                options will be granted with the following vesting schedule:





·
            The
                options granted to George J. Coates and Gregory Coates vest on each
                of
                April 30, 2007 and the balance in two equal installments on October
                23,
                2008 and 2009.





·
            The
                options granted to Mr. Kaye will vest as follows: 25,000 stock options
                on
                April 30, 2007 and the balance in three equal installments on October
                18,
                2007, 2008 and 2009. The options will immediately fully vest in the
                event
                the employee terminates his employment for a good reason, or if we
                terminate his employment without cause.





5
            The
                entitlement for the severance payment is subject to the employee
                terminating his employment for a good reason.





6
            The
                severance payment shall become effective in the event such termination
                for
                a good reason occurs after the Board of Directors determines that
                the
                Company has Sufficient Capital, as defined.





Under
      the
      applicable employment agreements, these employees are eligible for an annual
      performance bonus only after the Board of Directors determines that the Company
      has Sufficient Capital, as defined.





Under
      their employment agreements, George and Gregory Coates undertook to vote all
      their shares in the Company to elect to our Board of Directors at least two
      ‘independent directors’ as defined by the rules of the SEC and NASDAQ. In
      addition, our rights in intellectual property developed by George and Gregory
      Coates will be as set forth in a certain amended and restated license agreement
      dated April 6, 2007 and described in Item 1, under caption ‘Patents and
      Licenses’. Under their employment agreements we are not entitled to terminate
      either George or Gregory Coates employment unless they are terminated for cause.





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





The
      following table sets forth information with respect to the beneficial ownership
      of our Common Stock as of March 27, 2007 for:




·
            each
                of our executive officers and directors;




·
            all
                of our executive officers and directors as a group; and




·
            any
                other beneficial owner of more than 5% of our outstanding Common
                Stock.




-26-




Beneficial
      ownership is determined in accordance with the rules of the SEC. These rules
      generally attribute beneficial ownership of securities to persons who possess
      sole or shared voting power or investment power with respect to those securities
      and include ordinary shares issuable upon the exercise of stock options that
      are
      immediately exercisable or exercisable within 60 days. Except as otherwise
      indicated, all persons listed below have sole voting and investment power with
      respect to the shares beneficially owned by them, subject to applicable
      community property laws. The information is not necessarily indicative of
      beneficial ownership for any other purpose.





Percentage
      ownership calculations are based on 266,894,278 shares outstanding as of March
      27,
      2007. Addresses
      of named beneficial owners are care of Coates International, Ltd., Highway
      34 & Ridgewood Road, Wall Township, New Jersey 07719.




**Beneficial
                    Ownership****Outstanding
                      Shares**
                    **Beneficially**
                
                **Right
                    to Acquire Within 60 DaysAfter December 31,**
                
                **Shares
                    Beneficially Owned****Name
                    and Address of Beneficial Owner**
                
                **Owned**
                
                **2006**
                
                **Number**
                
                **Percentage**George
                    J Coates
                
                
                208,272,760
                1
                
                0
                
                
                208,272,760
                1
                
                78.03
                %Gregory
                    Coates
                
                
                14,032,520
                
                
                0
                
                
                14,032,520
                
                
                5.26
                %Frank
                    Adipietro
                
                
                810,500
                
                
                0
                
                
                810,500
                
                
                0.3
                %Richard
                    Evans
                
                
                660,000
                
                
                0
                
                
                660,000
                
                
                0.25
                %Michael
                    J. Suchar
                
                
                241,600
                2
                
                0
                
                
                241,600
                2
                
                0.09
                %All
                    executive officers and directors as a group (5 persons)
                
                
                224,017,380
                
                
                0
                
                
                224,017,380
                
                
                83.93
                %




(1)
            Includes
                1,956,960 shares owned by Mr. Coates' spouse, beneficial ownership
                of
                which is disclaimed by George J.
                Coates.





(2)
            Includes
                20,000 shares owned by Dr. Suchar's spouse, beneficial ownership
                of which
                is disclaimed by Michael J. Suchar.





**2006
      Stock Option and Incentive Plan**





The
      Company’s 2006 Stock Option and Incentive Plan (the “Stock Plan”) was adopted by
      the Company’s Board of Directors in October 2006, subject to stockholder
      approval. The Stock Plan provides for the grant of stock-based awards to
      employees, officers and directors of, and consultants or advisors to, the
      Company and its subsidiaries. Under the Stock Plan, the Company may grant
      options that are intended to qualify as incentive stock options (“incentive
      stock options”) within the meaning of Section 422 of the Internal Revenue
      Code of 1986, as amended (the “Code”), options not intended to qualify as
      incentive stock options (“non-statutory options”), restricted stock and other
      stock-based awards. Incentive stock options may be granted only to employees
      of
      the Company. A total of 12,500,000 shares of Common Stock may be issued upon
      the
      exercise of options or other awards granted under the Stock Plan. The maximum
      number of shares with respect to which awards may be granted to any employee
      under the Stock Plan shall not exceed 25% of that number.




-27-




The
      Stock
      Plan is administered by the Board of Directors and the Compensation Committee.
      Subject to the provisions of the Stock Plan, the Board of Directors and the
      Compensation Committee each has the authority to select the persons to whom
      awards are granted and determine the terms of each award, including the number
      of shares of Common Stock subject to the award. Payment of the exercise price
      of
      an award may be made in cash, in a “cashless exercise” through a broker, or if
      the applicable stock option agreement permits, shares of Common Stock or by
      any
      other method approved by the Board or Compensation Committee. Unless otherwise
      permitted by the Company, awards are not assignable or transferable except
      by
      will or the laws of descent and distribution.





Upon
      the
      consummation of an acquisition of the business of the Company, by merger or
      otherwise, the Board shall, as to outstanding awards (on the same basis or
      on
      different bases as the Board shall specify), make appropriate provision for
      the continuation of such awards by the Company or the assumption of such awards
      by the surviving or acquiring entity and by substituting on an equitable basis
      for the shares then subject to such awards either (a) the consideration
      payable with respect to the outstanding shares of Common Stock in connection
      with the acquisition, (b) shares of stock of the surviving or acquiring
      corporation or (c) such other securities or other consideration as the
      Board deems appropriate, the fair market value of which (as determined by the
      Board in its sole discretion) shall not materially differ from the fair market
      value of the shares of Common Stock subject to such awards immediately preceding
      the acquisition. In addition to or in lieu of the foregoing, with respect to
      outstanding stock options, the Board may, on the same basis or on different
      bases as the Board shall specify, upon written notice to the affected optionees,
      provide that one or more options then outstanding must be exercised, in whole
      or
      in part, within a specified number of days of the date of such notice, at the
      end of which period such options shall terminate, or provide that one or more
      options then outstanding, in whole or in part, shall be terminated in exchange
      for a cash payment equal to the excess of the fair market value (as determined
      by the Board in its sole discretion) for the shares subject to such Options
      over
      the exercise price thereof. Unless otherwise determined by the Board (on the
      same basis or on different bases as the Board shall specify), any
      repurchase rights or other rights of the Company that relate to a stock option
      or other award shall continue to apply to consideration, including cash, that
      has been substituted, assumed or amended for a stock option or other award
      pursuant to these provisions. The Company may hold in escrow all or any portion
      of any such consideration in order to effectuate any continuing
      restrictions.





The
      Board
      may at any time provide that any stock options shall become immediately
      exercisable in full or in part, that any restricted stock awards shall be free
      of some or all restrictions, or that any other stock-based awards may become
      exercisable in full or in part or free of some or all restrictions or
      conditions, or otherwise realizable in full or in part, as the case may
      be.





The
      Board
      of Directors or Compensation Committee may, in its sole discretion, amend,
      modify or terminate any award granted or made under the Stock Plan, so long
      as
      such amendment, modification or termination would not materially and adversely
      affect the participant.





**Item
      12. Certain Relationships and Related Transactions.**





The
      Company subcontracts its project expense from Coates Precision Engineering,
      of
      which George J. Coates is the sole shareholder. During the years ended December
      31, 2006 and 2005, the Company paid $42,400 and $84,058, respectively, for
      these
      services.





On
      April
      30, 2003, the Company entered into a sublicense agreement with Coates Motorcycle
      Company, Ltd ("Coates Motorcycle"). Prior to the agreement, Gregory Coates,
      son
      of George J. Coates, owned 100% of Coates Motorcycle. Pursuant to the agreement,
      the Company granted an exclusive license to utilize the CSRV System for the
      manufacturing use or sale of motorcycles and gasoline powered internal
      combustion engines used in motorcycles in North America, Central America and
      South America. In addition, the Company granted the non-exclusive license to
      use
      the CSRV Seals in the manufacture of the CSRV Systems for incorporation into
      motorcycle engines in North America, Central America and South America. In
      consideration, we received approximately 51% of the common shares of Coates
      Motorcycle. In addition, the Company had an anti-dilution right. On March 5,
      2004, the Company amended its license agreement with Coates Motorcycle to expand
      the license rights granted and to remove the anti-dilution provision in exchange
      for 1,000,000 common shares of Coates Motorcycle. As a result of the
      transactions, the Company owned 3,558,000 shares of Coates Motorcycle,
      representing a 30% ownership interest. During 2005, the Company sold 9,400
      shares of Coates Motorcycle for $5.00 per share and realized a gain of $47,000
      on the sale.




-28-


During
      the years ended December 31, 2006 and 2005, Mark Goldsmith, former Chief
      Executive Officer and President also served as the Chief Executive Officer,
      President and Interim Chief Financial Officer of Coates Motorcycle pursuant
      to
      an employment agreement. Mr. Goldsmith received salary payments of $185,000,
      a
      portion of which represented deferred salary from the prior year, and $81,500
      from Coates Motorcycle in 2006 and 2005, respectively and was provided with
      a
      leased automobile.





During
      the year ended December 31, 2005, the Company received $76,911 from Coates
      Motorcycle as partial reimbursement for various overhead expenses, incurred
      on
      its behalf.





The
      Coates Trust has made loans to the Company at various times to provide working
      capital. George J. Coates, Bernadette Coates, wife of George J. Coates and
      Gregory Coates are beneficiaries of the Coates Trust. The net outstanding
      balance was $92,337 at December 31, 2006. These borrowings are in the form
      of a
      demand loan which carry no interest and are repaid from time to time depending
      upon cash availability. It is the intention of the Coates Trust to assist the
      Company with its working capital requirements as needed in the future, even
      though it is not legally obligated to do so. In April 2007, this demand loan
      was
      converted to a 6% promissory note due April 4, 2008.




Bernadette
      Coates, George’s wife has made loans to the Company at various times to provide
      working capital. The amount due to Mrs. Coates was repaid in 2006.




The
      Company paid compensation and benefits to George J. Coates, Gregory Coates
      and
      Bernadette Coates for management of the office amounting to approximately
      $184,000, $83,000 and $41,000, respectively, in 2006 and amounting to $184,000
      $83,000 and $41,000, respectively in 2005. In 2006, the Company paid Gregory
      Coates $25,000 towards a newly created technology in connection with a
      computerized, sequential injection system.




Barry
      C.
      Kaye, Treasurer and Chief Financial Officer was paid consulting fees of $15,500
      and $3,000 in 2006 and 2005, respectively.





**Item
      13. Exhibits.**




**Exhibit
                No.**
            
            **Description**3.1
                =
            -
            Restated
                Certificate of Incorporation3.1(i)
                +
            -
            Certificate
                of Amendment to Certificate of Incorporation filed with the Secretary
                of
                State of Delaware on May 22, 20003.1(ii)
                +
            -
            Certificate
                of Amendment to Certificate of Incorporation filed with the Secretary
                of
                State of Delaware on August 31, 20013.2
                =
            -
            Bylaws10.6
                +
            -
            License
                Agreement, dated September 29, 1999, with Well to Wire Energy,
                Inc.10.7
                +
            -
            Amendment
                No. 1 to License Agreement with Well to Wire Energy Inc. dated April
                6,
                200010.8
                +
            -
            Amendment
                No. 2 to License Agreement with Well to Wire Energy Inc. dated July
                21,
                2000




-29-




10.11
                #
            -
            Sublicense
                Agreement, dated April 30, 2003, the Company and Coates Motorcycle
                Company, Ltd.10.12
                &
            
            Amendment
                No. 1 to Sublicense Agreement, dated March 5, 2004, between the Company
                and Coates Motorcycle Company, Ltd.10.13
                ^
            -
            Confirmation
                Letter between the Company and Well to Wire Energy Inc. dated July
                7,
                200610.14
                ~
            -
            2006
                Employee Stock Option and Incentive Plan adopted on October 25,
                200610.15
                ~
            -
            License
                Agreement between the Company and Coates Trust dated October 23,
                200610.16
                *
            -
            Amended
                and Restated Employment Agreement between the Company and George
                J. Coates
                dated April 6, 200710.17
                *
            -
            Amended
                and Restated Employment Agreement between the Company and Gregory
                Coates
                dated April 6, 200710.18
                *
            -
            Amended
                and Restated Employment Agreement between the Company and Barry C.
                Kaye
                dated April 6, 200710.19
                *
            -
            Amended
                and Restated License Agreement between the Company and George J.
                Coates
                and Gregory Coates dated April 6, 200710.20
                *
            -
            Termination
                of License Agreement between the Company and Coates Trust dated April
                6,
                200731.1*
            -
            Certification
                of George J. Coates pursuant to Rule 13a-14(a) of the Securities
                Exchange
                Act of 1934.31.2*
            -
            Certification
                of Barry C. Kaye pursuant to Rule 13a-14(a) under the Securities
                Exchange
                Act of 1934.32*
            -
            Certification
                pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
                906 of
              the Sarbanes-Oxley Act of 2002.









*
            File
                herewith.




=
            incorporated
                by reference from the Company's Registration Statement filed on Form
                S-1
                with the Securities and Exchange Commission on November 1, 1995,
                File No.
                33-94884.




+
            Incorporated
                by reference from the Company's Registration Statement and amendments
                thereto filed on Form 10-SB with the Securities and Exchange Commission,
                File No. 000-33155.




#
            Incorporated
                by reference from the Company's Form 10-QSB for the quarter ended
                June 30,
                2003.




&
            Incorporated
                by reference from the Company’s Form 10-KSB for the fiscal year ended
                December 31, 2004.




^
            Incorporated
                by reference from the Company's Form 10-QSB for the quarter ended
                June 30,
                2006.




~
            Incorporated
                by reference from the Company’s Form 10-KSB/A for the fiscal year ended
                December 31, 2005.










No
      reports on Form 8-K were filed during the last quarter of the fiscal year ended
      December 31, 2006.




-30-





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





Audit
      Fees:




On
      February 29, 2007, we engaged Weiser LLP (“Weiser”), Certified Public
      Accountants as our new Independent Registered Public Accounting Firm and
      dismissed Rosenberg Rich Baker Berman & Company ("Rosenberg"). Weiser did
      not perform nor bill the Company for any audit services during the last two
      fiscal years.





Rosenberg
      billed us in the aggregate amount of $44,625 and $42,445 for professional
      services rendered for their audit of our annual financial statements and their
      reviews of the financial statements included in our Forms 10-KSB and 10-QSB
      for
      the years ended December 31, 2005 and December 31, 2004,
      respectively.





Audit-related
      Fees:




Weiser
      did not perform nor bill the Company for any audit-related services during
      the
      last two fiscal years.





Rosenberg
      did not bill us for, nor perform professional services rendered for assurance
      and related services that were reasonably related to the performance of audit
      or
      review of the Company's financial statements for the fiscal years ended December
      31, 2006 and December 31, 2005.





Tax
      Fees:




Weiser
      did not perform nor bill the Company for any tax related services during the
      last two fiscal years.





Rosenberg
      billed us in the aggregate amount of $3,294 and $2,194 for professional services
      rendered for tax related services for the fiscal years ended December 31, 2005
      and December 31, 2004, respectively.





All
      Other
      Fees:




Weiser
      did not perform nor bill the Company for any other services during the last
      two
      fiscal years.




No
      fees
      were billed by Rosenberg for services rendered to the Company during the last
      two fiscal years, other than as audit and tax fees.




-31-





**SIGNATURES**





In
      accordance with Section 13 or 15(d) of the Exchange Act, the issuer has caused
      this report to be signed on its behalf by the undersigned, thereunto duly
      authorized, on April 13, 2007.




COATES
              INTERNATIONAL, LTD.By:
            /s/ George
              J. CoatesGeorge
              J. Coates, Chairman




In
      accordance with the Exchange Act, this report has been signed below by the
      following persons on behalf of the issuer and in the capacities and on the
      dates
      indicated.





Signature
            
            Title
            
            Date/s/
                George J. Coates
              George
                J. Coates
            
            Director,
                Chairman, Chief Executive Officer and President (principal executive
                officer)
            
            April
                13, 2007/s/
                Gregory Coates
              Gregory
                Coates
            
            Director,
                President-Technology Division
            
            April
                13, 2007/s/
                Barry C. Kaye
              
              Barry
                C. Kaye
            
            Director,
                Treasurer, Chief Financial Officer (principal financial and accounting
                officer)
            
            April
                13,
                2007/s/
                Richard W. Evans
              
              Richard
                W. Evans
            
            Director
                and Secretary
            
            April
                13,
                2007/s/
                Michael J. Suchar
              
              Michael
                J. Suchar
            
            Director
            
            April
                13,
                2007/s/
                Frank Adipietro
              
              Frank
                Adipietro
            
            Director
            
            April
                13,
                2007/s/
                Glenn Crocker
              
              Glenn
                Crocker
            
            Director
            
            April
                13,
                2007/s/
                Richard Whitworth
              
              Richard
                Whitworth
            
            Director
            
            April
                13,
                2007




-32-


**Coates
      International, Ltd.**





**Index
      to the Financial Statements**





**December
      31, 2006**




PageReport
                of Weiser LLP, Independent Registered Public Accounting
                Firm
            
            F-2Report
                of Rosenberg Rich Berman Baker & Company, Independent Registered
                Public Accounting Firm
            
            F-3Financial
                StatementsBalance
                Sheet
            
            F-4Statements
                of Operations
            
            F-5Statements
                of Stockholders' Deficiency
            
            F-6Statements
                of Cash Flows
            
            F-7Notes
                to the Financial Statements
            
            F-8
                to 23




F-1




REPORT
      OF
      INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To
      the
      Board of Directors and


Stockholders
      of Coates International Ltd.




We
      have
      audited the accompanying balance sheet of Coates International Ltd. as of
      December 31, 2006, and the related statements of operations, stockholders’
deficiency, and cash flows for the year 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
      audit.




We
      conducted our audit 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. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audit provides a
      reasonable basis for our opinion.




In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the financial position of Coates International Ltd. as of
      December 31, 2006 and the results of its operations and its cash flows for
      the
      year then ended, in conformity with U.S. generally accepted accounting
      principles.




The
      accompanying financial statements have been prepared assuming that the Company
      will continue as a going concern. As discussed in Note 1 to the financial
      statements, the Company has had recurring losses from operations, has a working
      capital deficit and a stockholders’ deficiency. These factors raise substantial
      doubt about the Company’s ability to continue as a going concern. Management’s
      plans in regard to these matters are also discussed Note 1. The financial
      statements do not include any adjustments that might result from the outcome
      of
      this uncertainty.




/s/
      Weiser LLP




New
      York,
      NY


April
      12,
      2007





F-2




Report
        of
        Independent Registered Public Accounting Firm
 
 To
        the
        Board of Directors and Shareholders
 Coates
        International, Ltd.
 
 We
        have
        audited the accompanying statements of operations, cash flows and stockholders'
        deficiency of Coates International, Ltd. for the year ended December 31,
        2005.
        These financial statements are the responsibility of the Company's management.
        Our responsibility is to express an opinion on these financial statements
        based
        on our audit.
 
 We
        conducted our audit 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. An audit includes examining,
        on a
        test basis, evidence supporting the amounts and disclosures in the financial
        statements. An audit also includes assessing the accounting principles used
        and
        significant estimates made by management, as well as evaluating the overall
        financial statement presentation. We believe that our audit provides a
        reasonable basis for our opinion.
 
 In
        our
        opinion, the financial statements referred to above present fairly, in all
        material respects, the results of operations and cash flows of Coates
        International, Ltd., for the year ended December 31, 2005 in conformity with
        accounting principles generally accepted in the United States of America.
 
 /s/
        Rosenberg Rich Berman Baker & Company
 
 Bridgewater,
        New Jersey
 February
        28, 2006




F-3




**Coates
      International, Ltd.**


**Balance
      Sheet**





AssetsDecember
                31, 2006Current
                AssetsCash
            
            $
            254,242Inventory,
                net of reserve for obsolescence of $144,889
            
            
            350,957Prepaid
                and other assets
            
            
            500Total

                Current Assets
            
            
            605,699Investment
                in related party
            
            
            -Deferred
                offering costs
            
            
            15,180Property, 
                plant and equipment, net of accumulated depreciation of $761,909
            
            
            1,495,946Deferred
                licensing costs, net of accumulated amortization of $4,568
            
            
            81,095Security
                deposits
            
            
            197,500Total
                Assets
            
            $
            2,395,420Liabilities
                and Stockholders’ DeficiencyCurrent
                LiabilitiesAccounts
                payable and accrued liabilities
            
            $
            1,032,189Demand
                loan due to related party
            
            
            92,337Total
                Current Liabilities
            
            
            1,124,526License
                deposits
            
            
            375,000Finance
                obligation
            
            
            3,876,607Total
                Liabilities
            
            
            5,376,133Commitments
                and Contingencies
            
            
            -Stockholders'
                DeficiencyPreferred
                stock, Series A, $0.001 par value 14,000,000 shares authorized, no
                shares
                issued or outstanding
            
            
            -Common
                stock, $0.0001 par value, 1,000,000,000 shares authorized,266,894,278
                shares issued and outstanding
            
            
            26,689Additional
                paid-in capital
            
            
            17,176,155Accumulated
                deficit
            
            
            (20,183,557
            )Total
                Stockholders' Deficiency
            
            
            (2,980,713
            )Total
                Liabilities and Stockholders' Deficiency
            
            $
            2,395,420




The
      accompanying notes are an integral part of this
      balance sheet.


F-4


**Coates
      International, Ltd.**


**Statements
      of Operations**




For
                the Years Ended
              December
                31,2006
            
            2005Research
                and development revenue
            
            $
            565,000
            
            $
            -Operating
                Expenses:Research
                and development costs
            
            
            437,307
            
            
            18,290General
                and administrative expenses
            
            
            1,373,049
            
            
            819,915Depreciation
                and amortization
            
            
            57,084
            
            
            56,758Total
                Operating Expenses
            
            
            1,867,440
            
            
            894,963Loss
                From Operations
            
            
            (1,302,440
            )
            
            (894,963
            )Other
                Income (Expense):Interest
                income
            
            
            30,127
            
            
            -Interest
                expense
            
            
            (390,386
            )
            
            (152,609
            )Equity
                loss in related party investment
            
            
            -
            
            
            (260,344
            )Gain
                on sale of investment in related party
            
            
            -
            
            
            47,000Other
                Expense, net
            
            
            (360,259
            )
            
            (365,953
            )Loss
                Before Income Taxes
            
            
            (1,662,699
            )
            
            (1,260,916
            )Provision
                for income taxes
            
            
            -
            
            
            (11,117
            )Net
                Loss
            
            $
            (1,662,699
            )
            $
            (1,272,033
            )Basic
                and Diluted Net Loss Per Share
            
            $
            (0.01
            )
            $
            (0.00
            )Basic
                and Diluted Weighted Average Number of Shares
            
            
            266,894,278
            
            
            265,996,673




The
        accompanying notes are an integral part of these financial
        statements.
  F-5
  **Coates
      International, Ltd.**


**Statements
      of Stockholders' Deficiency**


**For
      the Years Ended December 31, 2006 and 2005**




Common
                  Stock
                $0.0001
                  par value per share
              
              Additional
                Paid
                  in
                Capital
              
              Accumulated
                Deficit
              
              Shareholders'
                DeficiencyShares
              
              AmountBalance,
                  January 1, 2005
              
              
              265,859,278
              
              $
              26,586
              
              $
              17,001,258
              
              $
              (17,248,825
              )
              $
              (220,981
              )Issuance
                  of common stock for license agreement
              
              
              1,000,000
              
              
              100
              
              
              (100
              )
              
              -
              
              
              -Issuance
                  of common stock for cash
              
              
              29,000
              
              
              2
              
              
              144,998
              
              
              -
              
              
              145,000Issuance
                  of common stock in settlement of accounts payable and accrued
                  interest
              
              
              6,000
              
              
              1
              
              
              29,999
              
              
              -
              
              
              30,000Net
                  loss for the year
              
              
              -
              
              
              -
              
              
              -
              
              
              (1,272,033
              )
              
              (1,272,033
              )Balance,
                  December 31, 2005
              
              
              266,894,278
              
              
              26,689
              
              
              17,176,155
              
              
              (18,520,858
              )
              
              (1,318,014
              )Net
                  loss for the year
              
              
              -
              
              
              -
              
              
              -
              
              
              (1,662,699
              )
              
              (1,662,699
              )Balance,
                  December 31, 2006
              
              
              266,894,278
              
              $
              26,689
              
              $
              17,176,155
              
              $
              (20,183,557
              )
              $
              (2,980,713
              )




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




F-6




**Coates
      International, Ltd.**


**Statements
      of Cash Flows**





For
                the Years Ended
              December
                31,2006
            
            2005Cash
                Flows From Operating Activities:Net
                Loss
            
            $
            (1,662,699
            )
            $
            (1,272,033
            )Adjustments
                  to Reconcile Net Loss to Net Cash Used in Operating Activities
                  -Depreciation
                and amortization
            
            
            57,084
            
            
            56,758Provision
                for slow moving inventory and inventory write down
            
            
            262,897
            
            
            -Gain
                on sale of investment in related party
            
            
            -
            
            
            (47,000
            )Equity
                losses from investment in related party
            
            
            -
            
            
            260,344Changes
                in Operating Assets and Liabilities -Inventory
            
            
            (204,554
            )
            
            (86,100
            )Prepaid
                expenses
            
            
            191,144
            
            
            (191,644
            )License
                deposits
            
            
            (565,000
            )Accounts
                payable and accrued liabilities
            
            
            542,163
            
            
            479Accrued
                interest
            
            
            -
            
            
            (12,076
            )Income
                taxes payable
            
            
            (127,156
            )
            
            127,156Net
                Cash Used in Operating Activities
            
            
            (1,506,121
            )
            
            (1,164,116
            )Cash
                Flows From Investing Activities:Acquisition
                of property, plant and equipment
            
            
            (47,070
            )
            
            (3,047
            )Costs
                for patents
            
            
            (30,205
            )
            
            (55,458
            )Proceeds
                from sale of investment - related party
            
            
            -
            
            
            47,000Security
                deposit on leased property
            
            
            -
            
            
            (195,000
            )Net
                Cash Used in Investing Activities
            
            
            (77,275
            )
            
            (206,505
            )Cash
                Flows From Financing Activities:Deferred
                offering costs paid
            
            
            (45,185
            )
            
            (22,500
            )Repayment
                of loan from related party
            
            
            (45,300
            )
            
            (212,800
            )Cash
                received from finance obligation
            
            
            -
            
            
            3,876,607Proceeds
                from related party loan
            
            
            -
            
            
            200,437Proceeds
                from issuance of stock
            
            
            -
            
            
            145,000Repayment
                of mortgage
            
            
            -
            
            
            (868,182
            )Net
                Cash Provided by ( Used in) Financing Activities
            
            
            (90,485
            )
            
            3,118,562Net
                Increase (Decrease) in Cash
            
            
            (1,673,881
            )
            
            1,747,941Cash
                - Beginning of Period
            
            
            1,928,123
            
            
            180,182Cash
                - End of Period
            
            $
            254,242
            
            $
            1,928,123Schedule
                of Supplemental Cash Flow Data:Cash
                paid for:Income
                Taxes
            
            $
            141,309
            
            $
            -Interest
            
            $
            227,886
            
            $
            327,185




The
        accompanying notes are an integral part of these financial
        statements.
  F-7


**Coates
      International, Ltd.**


**Notes
      to Financial Statements**





**1.
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**





Nature
      of
      Organization and Basis of Presentation





Coates
      International, Ltd. is a Delaware corporation organized in October 1991 as
      successor-in-interest to a Delaware corporation of the same name incorporated
      in
      August 1988.  Our operations are located in Wall Township, New
      Jersey.





Coates
      International, Ltd. (the "Company") has acquired the exclusive licensing rights
      for the Coates spherical rotary valve system (“CSRV System”) technology in North
      America, Central America and South America (the “CSRV License”). The CSRV System
      technology has been developed over a period of more than 15 years by the
      Company’s founder George J. Coates and his son Gregory Coates. The CSRV System
      is adaptable for use in piston-driven internal combustion engines of many types
      and has been patented in the United States and numerous countries throughout
      the
      world.




The
        CSRV
        System is designed to replace the intake and exhaust conventional “poppet
        valves” currently used in almost all piston-driven, automotive, motorcycle and
        marine engines. Unlike conventional valves which protrude into the engine
        cylinder, the CSRV System utilizes spherical valves that rotate in a cavity
        formed between a two-piece cylinder head. The CSRV System utilizes
        significantly fewer moving parts of conventional poppet valve
        assemblies .
        As a
        result of these design improvements, management believes that the engines
        incorporating the CSRV System (“Coates Engines”) will last significantly longer
        and will require less lubrication over the life of the engine, as compared
        to
        conventional engines. In addition, CSRV’s can be designed with larger openings
        into the engine cylinder than conventional valves so that more fuel and air
        can
        be inducted into and expelled from the cylinder in a shorter period of time.
        Larger valve openings permit higher revolutions-per-minute (RPMs) and permit
        higher compression ratios with lower combustion chamber temperatures, allowing
        the Coates Engine to produce more power than equivalent conventional engines.
        The higher the RPM range, the greater the volumetric efficiency and thermal
        efficiency that can be achieved.




Since
        the
        Company’s inception, the Company has been responsible for the development costs
        of this technology in order to optimize the value of the licensing rights
        and
        has incurred related operational costs, the bulk of which have been funded
        primarily through cash generated from the sale of stock, through capital
        contributions, loans made by George Coates, through a sale-and-leaseback
        transaction related to the Company’s principal facility, and from prototype
        models and licensing fees. The Company has never received any revenues from
        the
        sale of engines, has never been profitable and has incurred substantial losses
        from operations .
        The
        Company expects that losses from operations will continue until the Coates
        Engine is successfully introduced into the marketplace, or the Company receives
        substantial licensing revenues. These losses from operations were substantially
        related to research and development of the Company’s intellectual property
        rights, patent filing and maintenance costs and general and administrative
        expenses.





As
      shown
      in the accompanying financial statements, the Company has incurred recurring
      losses from operations, and as of December 31, 2006, had a working capital
      deficiency of $519,000 and a Stockholders’ Deficiency of approximately
      $2,981,000. These factors raise substantial doubt about the Company’s ability to
      continue as a going concern. Management has instituted a cost reduction program
      intended to cut variable costs to only those expenses that are necessary to
      complete its activities related to making engineering refinements to the Coates
      Engine, identifying additional sources of working capital and general
      administrative costs in support of such activity. The Company has also been
      actively undertaking efforts to identify new sources of working capital. In
      March and April 2007, the Company raised $1,140,000 of new working capital
      as
      discussed in Note 19. The Company continues to actively seek out new sources
      of
      working capital, however, there can be no assurance that it will be successful
      in these efforts. The accompanying financial statements do not include any
      adjustments that might be necessary if the Company is unable to continue as
      a
      going concern.




F-8




Revenue
      Recognition





The
      Company has not generated revenue from the sales of engines. Licensing deposits,
      which are non-refundable, received from the granting of sub-licenses, are
      recognized as earned, generally commencing upon the completion of certain tests
      and acceptance by the licensee. At that time, license revenue will be recognized
      ratably over the period of time that the sub-license has been granted (i.e.
      upon
      expiration of the Company's patent protection period which expires at the
      earliest in 2007), using the straight-line method. Upon termination of a
      sub-license agreement, non-refundable license deposits, less any costs related
      to the termination of the sub-license agreement are recognized as revenue.
      Revenue from research and development activities is recognized when earned
      provided that financial risk has been transferred from the Company to its
      customer.





Research
      and Development





Research
      and development costs are expensed when incurred.





Advertising
      Costs





Advertising
      costs, which are included in general and administrative expenses, are expensed
      when incurred. Advertising expense amounted to $6,643 and $20,757 for the years
      ended December 31, 2006 and 2005, respectively.





Share-Based
      Compensation





C ompensation
      expense relating to share-based payments is recognized as an expense using
      the
      fair-value measurement method. Under the fair value method, the estimated fair
      value of awards to employees is charged to income on a straight-line basis
      over
      the requisite service period, which is the earlier of the employee’s retirement
      eligibility date or the vesting period of the award. No stock options had been
      granted to any employees for the years ended December 31, 2006 and
      2005.





Inventory





Inventory
      consists of raw materials and work-in-process, including overhead and is stated
      at the lower of cost or market determined by the first-in, first-out method.
      Inventory items designated as obsolete or slow moving are reduced to net
      realizable value. Market value is determined using current replacement
      cost.





Property,
      Plant and Equipment





Property,
      plant and equipment are stated at cost. Depreciation is computed using the
      straight line method over the estimated useful life of the assets: 40 years
      for
      building and building improvements, 3 to 7 years for machinery and equipment
      and
      5 to 10 years for furniture and fixtures. Repairs and maintenance expenditures,
      which do not extend the useful lives of the related assets, are expensed as
      incurred.





In
      the
      event that facts and circumstances indicate that long-lived assets may be
      impaired, an evaluation of recoverability is performed. Should such evaluation
      indicate that there has been an impairment of one or more long-lived assets,
      the
      cost basis of such assets would be adjusted accordingly at that
      time.




F-9




Deferred
      Licensing Costs





Under
      the
      CSRV Licensing Agreement for the CSRV technology, the Company is responsible
      for
      all costs in connection with applying for, obtaining and maintenance of patents
      to protect the CSRV System intellectual technology. In 2005, the Company changed
      it accounting policy for costs incurred in connection with registering new
      patent protection of patent technology it licenses from George J. Coates,
      controlling stockholder, Chairman, Chief Executive Officer and President and
      from Gregory Coates. Prior to 2005, such costs were charged to expense in the
      year incurred. Effective with the year ended December 31, 2005, patent fees
      including legal costs for registration and legal fees, if any, from the costs
      incurred in successful defense to the extent of an evident increase in the
      value
      of the patents and models and drawings required for registration are stated
      at
      cost, less accumulated amortization. Amortization is calculated on a
      straight-line basis over the lesser of the life of the license or the life
      of
      the asset, estimated by management to average 20 years. Such amount is reflected
      in the accompanying balance sheet as Deferred Licensing Costs.





Income
      Taxes


Income
        taxes are accounted for under the asset and liability method. Deferred tax
        assets and liabilities are recognized for the future tax consequences
        attributable to differences between the financial statement carrying amounts
        of
        existing assets and liabilities and their respective tax bases, and operating
        loss and tax credit carryforwards. Deferred tax assets and liabilities are
        measured using enacted tax rates expected to apply to taxable income in the
        years in which those temporary differences are expected to be recovered or
        settled. The effect on deferred tax assets and liabilities of a change in
        tax
        rates is recognized in income in the period that includes the enactment
        date.
 
 The
        Company records a valuation allowance against any portion of the deferred
        income
        tax asset when it believes, based on the weight of available evidence, it
        is
        more likely than not that some portion of the deferred tax asset will not
        be
        realized. No tax benefit has been recorded related to the Company’s equity in
        undistributed earnings of Coates Motorcycle Company, Ltd., as described in
        Note
        17. The income tax benefit from sales of unutilized state tax net operating
        losses to third parties is recognized in the period of sale.




Loss
      per
      Share





In
      accordance with the provisions of Financial Accounting Standards Board No.
      128,
      "Earnings Per Share," Loss per share is determined by dividing the net loss
      by
      the weighted average number of common shares outstanding during the
      period.





Use
      of
      Estimates





The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America (“generally accepted
      accounting principles”) requires management to make estimates and assumptions
      that affect the reported amounts of assets and liabilities and disclosure of
      contingent 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.





Reclassifications





Certain
      reclassifications of prior year amounts were made to conform to the 2006
      presentation. This had no effect on the reported net loss.




F-10




**2.
      SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION**





Cash
      and
      cash equivalents for purposes of the statements of cash flows is comprised
      of
      cash and short-term, highly liquid investments with a maturity of three months
      or less from their inception date.





During
      2005, the Company issued 1,000,000 shares of its common stock to acquire a
      patent license from a related party.





In
      2005,
      the Company issued a total of 35,000 shares of its Common Stock to two
      accredited investors at a price of $5.00 per share and realized proceeds of
      $145,000 in cash which has been used for working capital purposes and settlement
      of its payables in the amount of $30,000.





**3.
      CONCENTRATIONS OF CREDIT AND BUSINESS RISK**





The
      Company maintains cash balances in several financial institutions. Accounts
      at
      each institution are insured by the Federal Deposit Insurance Corporation up
      to
      $100,000, of which the Company's accounts may, at times, exceed the federally
      insured limits.





Development
      of the CSRV
      System technology was invented by George J. Coates, the Company’s founder, Chairman,
      Chief Executive Officer, President and controlling stockholder in the late
      1970's and development efforts have been conducted continuously since such
      time.
      From July 1982 through May 1993, seven U. S. patents as well as a number of
      foreign patents were issued with respect to the CSRV
      System .
      Since
      the inception of the Company in 1988, all aspects of the business have been
      completely dependent upon the activities of George J. Coates. The loss of George
      J. Coates’ availability or service due to death, incapacity or otherwise would
      have a material adverse effect on the Company's business and operations. The
      Company does not presently have any key-man life insurance in force for Mr.
      Coates.





Upon
      delivery and acceptance of the third production prototype engine and
      commencement of production, the Company will become highly dependent on Well
      to
      Wire Energy, Inc. for cash flows, revenues and profits.





**4.
      FAIR VALUE OF FINANCIAL INSTRUMENTS**





Cash,
      Other Assets, Accounts Payable and Accrued Liabilities and Other
      Liabilities





The
      carrying amount of these items approximates their fair value because of the
      short maturity of these instruments.





Limitations





Fair
      value estimates are made at a specific point in time, based on relevant market
      information and information about the financial instrument. These estimates
      are
      subjective in nature and involve uncertainties and matters of significant
      judgment and therefore cannot be determined with precision. Changes in
      assumptions could significantly affect the estimates.





**5.
      COMMITMENTS**




In
        December 2006, the Company received subscriptions aggregating $210,000 in
        connection with its private placement offering (the “Offering”) of units of its
        capital stock. Each unit consisted of one share of its 6% Series A Convertible
        Preferred Stock (the “Preferred Stock”) and one warrant to purchase 5,000 shares
        of its Common Stock at a $1.10 per share (the “Warrants”). Each share of
        Preferred Stock is convertible into ten shares of common stock. The cash
        proceeds therefrom were held in escrow pending the Company’s acceptance of the
        subscriptions and closing of the securities purchase transactions. In March
        2007, these transactions closed and the aggregate gross proceeds became
        available to the Company to supplement its working capital. The Company is
        currently seeking approval from investors in the Offering to directly issue
        the
        underlying shares of common stock in lieu of issuing the Preferred Stock.
        This
        will not affect the company’s obligation with respect to the Warrants, which are
        being issued to these subscribers.




F-11




**6.
      INVENTORY**





Inventory
      at December 31, 2006 consists of the following:





Raw
                Materials
            
            $
            255,846Work
                in Process
            
            
            240,000Reserve
                for slow moving inventory
            
            
            (144,889
            )Total
            
            $
            350,957





**7.
      AGREEMENT WITH WELL TO WIRE ENERGY, INC. AND LICENSE
      DEPOSITS**





On
      September 29, 1999, the Company signed a license agreement with Well to Wire
      Energy, Inc. ("WWE"), an oil and gas company in Canada. The agreement
      exclusively licenses within Canada the use of the Coates technology for V-8
      engines to be fueled by natural gas to generate electrical power. The agreement
      provided for a license fee of $5,000,000, of which a deposit payment in the
      amount of $300,000. A separate research and development agreement with WWE
      provides for development and delivery of certain prototype engines. The research
      and development agreement was not reduced to the form of a signed written
      agreement.





On
      July
      7, 2006, the Company signed a confirmation letter with WWE that provides as
      follows:





·
            The
                Company expects to ship to WWE in the near term the third power unit
                of
                the Company’s generator for up to 300 kilowatts, depending on the fuel
                used (the 855 cubic inch, 6 cylinder industrial electric power generator,
                incorporating the CSRV Engine, the “Generator”). Upon receipt of the
                Generator, and pending test results meeting WWE’s expectations, the
                balance of $3,800,000 on account of the research and development
                agreement
                mentioned above will become due and payable to the Company by WWE.
                In
                addition, 180 days later, the remaining balance of $4,700,000 from
                the
                September 29, 1999 agreement will become due and payable by WWE in
                16
                equal quarterly installments.




·
            WWE
                will have the exclusive right to use, lease, and sell the generators
                that
                are based on the CSRV System technology within
                Canada.




·
            WWE
                will have a specified right of first refusal to market the Generators
                worldwide.




·
            Upon
                commencement of the production and distribution of Generators, the
                minimum
                annual number of Generators to be purchased by WWE in order to maintain
                exclusivity is 120. Until otherwise agreed between the parties, the
                price
                per Generator shall be $150,000.In
                the event WWE fails to purchase the minimum 120 Coates generator
                engines
                during any year, WWE will automatically lose its exclusivity. In
                such a
                case, WWE would retain non-exclusive rights to continue to use the
                Coates
                generator engine.




·
            WWE
                shall not be required to pay any royalties as part of the agreements
                between the parties.




·
            All
                rights related to patent and other intellectual property related
                to the
                engine will remain with the
                Company.




License
      deposits, which are non-refundable, primarily relate to the $300,000 license
      deposit described above from WWE.





During
      2006, the Company and a sublicensee agreed to terminate their sublicensee
      agreement. The non-refundable license deposit of $565,000 related to research
      and development of a truck engine incorporating the CSRV system technology
      under
      this sublicense agreement has been recognized as research and development
      revenue in 2006.




F-12




**8.
      PROPERTY, PLANT AND EQUIPMENT**





Property,
      plant and equipment at cost, less accumulated depreciation, consists of the
      following at December 31:




2006Land
            
            $
            920,550Building
            
            
            579,450Building
                improvements
            
            
            219,371Machinery
                and equipment
            
            
            499,189Furniture
                and fixtures
            
            
            39,2952,257,855Less:
                Accumulated depreciation
            
            
            (761,909
            )Total
            
            $
            1,495,946





Depreciation
      expense amounted to $53,618 and $55,656 for the years ended December 31, 2006
      and 2005, respectively.





**9.
      SECURITY DEPOSITS**





Security
      deposits primarily consist of a deposit on the Company’s principal offices,
      warehouse and manufacturing facility pursuant to the sale/leaseback agreement
      described in Note 10.





**10.
      SALE/LEASEBACK OF LAND AND BUILDING**





In
      2005,
      the Company entered into a sale/leaseback arrangement of the property which
      houses its principal offices, warehouse and manufacturing facilities. Pursuant
      to generally accepted accounting principles this transaction is being accounted
      for under the finance method because the Company has a continuing interest
      in
      the property represented by an option to repurchase the property at any time
      during the first three years of the agreement for $5,200,000. The Company
      realized net proceeds from this transaction of $3,876,607, which was partially
      used to repay the $868,182 remaining balance of a mortgage loan bearing interest
      at a 13.99% annual rate and the balance of the proceeds was utilized for working
      capital purposes. The monthly rental payments provided for by the lease
      agreement are being accounted for as interest expense, which amounted to
      $390,000 and $35,750 in the accompanying statement of operations for the years
      ended December 31, 2006 and 2005, respectively.




Had
      this
      transaction qualified for sale reporting, the Company would have realized a
      net
      gain of $2,411,579. This gain will be recognized upon expiration or exercise
      of
      the option to repurchase. The new lease agreement with the purchaser, which
      is
      being accounted for on the finance method, provides for monthly payments of
      $32,500 over a six year period expiring November 2011. Under the finance method,
      these payments are to be accounted for as interest expense at the implicit
      annual interest rate of 10.06%. In addition, the property continues to be
      carried at cost and depreciated. Under the lease agreement, the Company is
      responsible for all real estate taxes and operating expenses of the property,
      including insurance. Minimum payments under the lease agreement, which are
      being
      charged to interest expense, are as follows:




Year
                Ending December 31,
            
            Amount2007
            
            $
            390,0002008
            
            
            390,0002009
            
            
            390,0002010
            
            
            390,0002011
            
            
            357,500Total
            
            $
            1,917,500




F-13




**11.
      LICENSING AGREEMENTS AND DEFERRED LICENSING COSTS**





On
      October 23, 2006, the Company signed a license agreement with George J. Coates
      and Gregory Coates (the “New Coates License Agreement”), that replaces license
      agreements signed on December 22, 1997 and November 10, 2005. On April 6, 2007,
      the New Coates License Agreement was amended and restated (the “Amended Coates
      License Agreement”). The Amended Coates License Agreement became effective upon
      execution. Under the Amended Coates License Agreement, George J. Coates and
      Gregory Coates granted to the Company: an exclusive, perpetual, royalty-free,
      fully paid-up license to the intellectual property that specifically relates
      to
      an internal combustion engine that incorporates the CSRV System technology
      (the
“CSRV Engine”) and that is currently owned or controlled by them (the “CSRV
      Intellectual Property”), plus any CSRV Intellectual Property that is developed
      by them during their employment with the Company. The employment agreements
      with
      George J. Coates and Gregory Coates contain two-year non-compete provisions
      relating to the CSRV Intellectual Property in the event either of them is
      terminated for cause, as defined, or if either of them terminates their
      employment without good reason, as defined.




Under
      the
      Amended Coates License Agreement, George J. Coates and Gregory Coates agreed
      that they will not grant any licenses to any other party with respect to the
      CSRV Intellectual Property.




At
      December 31, 2006, deferred licensing costs comprised of expenditures for patent
      costs incurred pursuant to the CSRV licensing agreement, net of accumulated
      amortization amounted to $81,095.





**12.
      ACCOUNTS PAYABLE AND ACCRUED LIABILITIES**





Accounts
      payable and accrued expenses at December 31 are comprised of the
      following:





2006Legal
                and professional fees
            
            $
            967,917Accrued
                compensation
            
            
            41,096Other
            
            
            23,176Total
            
            $
            1,032,189





**13.
      CAPITAL STOCK**





Common
      Stock





There
      were no issuances of our common stock in 2006. In 2005, the Company issued
      1,000,000 shares of its common stock to George J. Coates in exchange for a
      new
      technology license agreement granting the Company the non-exclusive rights
      to
      make, use, sell and have made in all of the countries and their territories
      and
      possessions, comprising North America, Central America and South America, three
      licensed products patented by George J. Coates. These products consist of a
      self-adjusting bearing assembly, an improved valve seal (pressure regulated)
      and
      a cooling system for the rotary valve engine. This license agreement was
      superseded and replaced by the Amended Coates License Agreement described in
      Note 11. Also, in 2005, the Company issued a total of 35,000 shares of its
      common stock to two accredited investors at a price of $5.00 per share.





Series
      A
      Convertible Preferred Stock





The
      Company is authorized to issue up to 14,000,000 shares of Series A Convertible
      Preferred Stock, $0.001 par value per share (the “Preferred Stock”). Dividends
      on the Preferred Stock may be declared from time to time by the Board of
      Directors. Holders of shares of Preferred Stock may convert their shares at
      any
      time into ten shares of the Company’s common stock, and upon such conversion
      will forfeit any unpaid dividends. The Preferred Shares are entitled to a
      preference over holders of the Company’s common stock equal to the par value of
      the shares of Preferred Stock held, plus any unpaid dividends declared. As
      of
      December 31, 2006, no shares of Preferred Stock had been issued.




F-14




**14.
      EMPLOYMENT AGREEMENTS**





George
      J.
      Coates





The
      Company executed an amended and restated employment agreement with George J.
      Coates (the “GJC Agreement”) that replaces an employment agreement signed in
      2006. The term of the GJC Agreement, which became effective as of October 23,
      2006, is for five years. The GJC Agreement provides for annual salary of
      $183,549, an annual performance bonus determined by unanimous vote of the
      independent member of the Board of Directors, plus vacation, sick leave and
      participation in health, dental and life insurance and any other established
      benefit plans. The GJC Agreement further provides that upon the Company
      achieving a sufficient level of working capital, the amount of annual salary
      shall be increased to $300,000, an automobile will be provided to Mr. Coates
      and
      he will be entitled to a severance payment equal to three years’ annual
      compensation, should he terminate his employment with Good Reason, as defined,
      or upon his death. He will also work with the Company in securing key-man life
      insurance. In accordance with the GJC Agreement, the Company committed to grant
      Mr. Coates 1,000,000 stock options at an exercise price that will equal the
      closing price of the Company’s shares of common stock on the Over the Counter
      Bulletin Board on the first trading day after the filing of this annual report
      on Form 10-KSB (the “To Be Determined Exercise Price”). These stock options are
      being granted with a service inception date equal to the effective date of
      the
      GJC Agreement. As it was not practicable to estimate the fair market value
      of
      these stock options at December 31, 2006, it was not possible to provide for
      stock option compensation expense for the related 2006 service period. Upon
      the
      stock option compensation cost becoming determinable, the corresponding expense
      will be recorded.





Barry
      C.
      Kaye





The
      Company executed an amended and restated employment agreement with Mr. Kaye
      (the
“Kaye Agreement”) that replaces an employment agreement signed in 2006. The term
      of the Kaye Agreement, which became effective as of October 18, 2006, is for
      three years. The Kaye Agreement initially provides for minimum wages and
      benefits. The Kaye Agreement further provides that upon the Company achieving
      a
      sufficient level of working capital, the amount of annual salary shall be
      increased to $125,000, he will become eligible for an annual performance bonus
      and he will be entitled to a severance payment equal to one year’s annual
      compensation, should he be terminated by the Company without Cause, as defined,
      or if he should terminate his employment with Good Reason, as defined. In
      accordance with the Kaye Agreement, the Company committed to grant Mr. Kaye
      125,000 stock options at an exercise price that will equal the To Be Determined
      Exercise Price. These stock options are being granted with a service inception
      date equal to the effective date of the Kaye Agreement. As it was not
      practicable to estimate the fair market value of these stock options at December
      31, 2006, it was not possible to provide for stock option compensation expense
      for the related 2006 service period. Upon the stock option compensation cost
      becoming determinable, the corresponding expense will be recorded.





Gregory
      Coates





The
      Company executed an amended and restated employment agreement with Gregory
      Coates (the “GC Agreement”) that replaces an employment agreement signed in
      2006. The term of the GC Agreement, which became effective as of October 23,
      2006, is for five years. The GC Agreement provides for annual salary of $79,898,
      plus vacation, sick leave and participation in health, dental and life insurance
      and any other established benefit plans. The GC Agreement further provides
      that
      upon the Company achieving a sufficient level of working capital, the amount
      of
      annual salary shall be increased to $250,000, he will become eligible for an
      annual performance bonus, an automobile will be provided to Gregory Coates
      and
      he will be entitled to a severance payment equal to two years’ annual
      compensation, should he terminate his employment with Good Reason, as defined.
      He will also be provided with a $2 million life insurance policy and will work
      with the Company in securing key-man life insurance. In accordance with the
      GC
      Agreement, the Company committed to grant Gregory Coates 500,000 stock options
      at an exercise price that will equal the To Be Determined Exercise Price. These
      stock options are being granted with a service inception date equal to the
      effective date of the GC Agreement. As it was not practicable to estimate the
      fair market value of these stock options at December 31, 2006, it was not
      possible to provide for stock option compensation expense for the related 2006
      service period. Upon the stock option compensation cost becoming determinable,
      the corresponding expense will be recorded.




F-15




Mark
      D.
      Goldsmith





In
      late
      March 2007, Mark D. Goldsmith stepped down from his positions as Chief Executive
      Officer and President, and in April 2007, Mr. Goldsmith resigned his position
      as
      a member of the Board of Directors. In March 2007, the Board of Directors
      approved the conditional appointment of Mr. Goldsmith to the position of Chief
      Operating Officer, subject to the prior execution of an employment agreement.
      To
      date, the Company and Mr. Goldsmith have not agreed on the terms and conditions
      for an employment agreement.





Any
      such
      employment agreement would be conditioned upon the adequacy of the Company’s
      working capital and upon execution of a mutual release of any claims under
      a
      prior employment agreement between the Company and Mr. Goldsmith executed in
      October 2006. However, there can be no assurance that the parties will reach
      an
      agreement on the terms and conditions or that any such conditions will be
      satisfied. The amount of compensation that could be due Mr. Goldsmith for his
      employment in 2006 pursuant to the employment agreement, amounted to
      approximately $41,000. This amount has been expensed in 2006 and is included
      in
      Accounts Payable and Accrued Expenses in the accompanying balance sheet. Mr.
      Goldsmith may attempt to assert claims under this employment agreement. The
      Company does not intend to make any payments to Mr. Goldsmith in connection
      with
      this employment agreement.





Aggregate
      minimum payments under the employment agreements for George J. Coates, Gregory
      Coates and Barry C. Kaye, are approximately as follows:




Year
                Ending December 31,
            
            Amount(1)2007
            
            $
            263,0002008
            
            
            263,0002009
            
            
            263,0002010
            
            
            263,0002011
            
            
            214,000Total
            
            $
            1,266,000





(1)
            There
                  is no salary provided for in Mr. Kaye’ employment agreement. The minimum
                  payments under these employment agreements, including Mr. Kaye’s would
                  increase to $675,000 per year through October 17, 2009 and to $550,000
                  per
                  year from October 18, 2009 through October 23, 2011, upon the Company
                  achieving an adequate level of working capital, as defined in the
                  employment agreements.





**15.
      STOCK OPTIONS**





The
      Company’s 2006 Stock Option and Incentive Plan (the “Stock Plan”) was adopted by
      the Company’s Board of Directors in October 2006, subject to stockholder
      approval. The Stock Plan provides for the grant of stock-based awards to
      employees, officers and directors of, and consultants or advisors to, the
      Company and its subsidiaries, if any. Under the Stock Plan, the Company may
      grant options that are intended to qualify as incentive stock options
      (“incentive stock options”) within the meaning of Section 422 of the
      Internal Revenue Code of 1986, as amended (the “Code”), options not intended to
      qualify as incentive stock options (“non-statutory options”), restricted stock
      and other stock-based awards. Incentive stock options may be granted only to
      employees of the Company. A total of 12,500,000 shares of Common Stock may
      be
      issued upon the exercise of options or other awards granted under the Stock
      Plan. The maximum number of shares with respect to which awards may be granted
      to any employee under the Stock Plan shall not exceed 25% of the 12,500,000
      shares of common stock covered by the Stock Plan.




F-16




The
      Stock
      Plan is administered by the Board of Directors and the Compensation Committee.
      Subject to the provisions of the Stock Plan, the Board of Directors and the
      Compensation Committee each has the authority to select the persons to whom
      awards are granted and determine the terms of each award, including the number
      of shares of Common Stock subject to the award. Payment of the exercise price
      of
      an award may be made in cash, in a “cashless exercise” through a broker, or if
      the applicable stock option agreement permits, shares of Common Stock or by
      any
      other method approved by the Board or Compensation Committee. Unless otherwise
      permitted by the Company, awards are not assignable or transferable except
      by
      will or the laws of descent and distribution.





Upon
      the
      consummation of an acquisition of the business of the Company, by merger or
      otherwise, the Board shall, as to outstanding awards (on the same basis or
      on
      different bases as the Board shall specify), make appropriate provision for
      the continuation of such awards by the Company or the assumption of such awards
      by the surviving or acquiring entity and by substituting on an equitable basis
      for the shares then subject to such awards either (a) the consideration
      payable with respect to the outstanding shares of Common Stock in connection
      with the acquisition, (b) shares of stock of the surviving or acquiring
      corporation or (c) such other securities or other consideration as the
      Board deems appropriate, the fair market value of which (as determined by the
      Board in its sole discretion) shall not materially differ from the fair market
      value of the shares of Common Stock subject to such awards immediately preceding
      the acquisition. In addition to or in lieu of the foregoing, with respect to
      outstanding stock options, the Board may, on the same basis or on different
      bases as the Board shall specify, upon written notice to the affected optionees,
      provide that one or more options then outstanding must be exercised, in whole
      or
      in part, within a specified number of days of the date of such notice, at the
      end of which period such options shall terminate, or provide that one or more
      options then outstanding, in whole or in part, shall be terminated in exchange
      for a cash payment equal to the excess of the fair market value (as determined
      by the Board in its sole discretion) for the shares subject to such Options
      over
      the exercise price thereof. Unless otherwise determined by the Board (on the
      same basis or on different bases as the Board shall specify), any
      repurchase rights or other rights of the Company that relate to a stock option
      or other award shall continue to apply to consideration, including cash, that
      has been substituted, assumed or amended for a stock option or other award
      pursuant to these provisions. The Company may hold in escrow all or any portion
      of any such consideration in order to effectuate any continuing
      restrictions.





The
      Board
      may at any time provide that any stock options shall become immediately
      exercisable in full or in part, that any restricted stock awards shall be free
      of some or all restrictions, or that any other stock-based awards may become
      exercisable in full or in part or free of some or all restrictions or
      conditions, or otherwise realizable in full or in part, as the case may
      be.





The
      Board
      of Directors or Compensation Committee may, in its sole discretion, amend,
      modify or terminate any award granted or made under the Stock Plan, so long
      as
      such amendment, modification or termination would not materially and adversely
      affect the participant.




F-17




In
      connection with the employment agreements entered into with George J. Coates,
      Gregory Coates and Barry C. Kaye, the Company became obligated to grant
      non-qualified stock options to these employees. On March 28, 2007, the Company
      committed to grant such non-qualified stock options these employees at the
      To Be
      Determined Exercise Price. As the exercise price of these options is not known,
      the Company could not determine the fair market value of these stock options
      at
      December 31, 2006. Accordingly, no compensation expense was recorded in 2006;
      however, the obligation for such granted stock options does represent a
      contingent liability. At the same time, the Company also committed to grant
      25,000 stock options to each of its outside directors exercisable at the To
      Be
      Determined Price. On April 4, 2007, the Company committed to grant 25,000 stock
      options to its corporation general counsel and 25,000 stock options to an
      employee. No other stock options have been granted by the Company. The following
      table sets forth information with respect to such stock options
      granted:





Name
            
            Title
            
            Number
                of Shares of Common Stock Underlying Non-vested
                Options
            
            Option
              Expiration
                DateGeorge
                J. Coates
            
            Chairman,
              Chief Executive Officer and President
            
            
            1,000,000(1
            )
            10/23/2021Gregory
                Coates
            
            Director
              and President, Technology Division
            
            
            500,000(1
            )
            10/23/2021Barry
                C. Kaye
            
            Director,
              Treasurer and Chief Financial Officer
            
            
            125,000(2
            )
            10/18/2021All
                other employees
            
            
            
            
            25,000(4
            )
            4/4/2022Dr.
                Frank J. Adipietro
            
            Non-employee
              Director
            
            
            25,000(3
            )
            3/28/2022Glenn
                Crocker
            
            Non-employee
              Director
            
            
            25,000(3
            )
            3/28/2022Richard
                W. Evans
            
            Non-employee
              Director
            
            
            25,000(3
            )
            3/28/2022Dr.
                Michael J. Suchar
            
            Non-employee
              Director
            
            
            25,000(3
            )
            3/28/2022Richard
                Whitworth
            
            Non-employee
              Director
            
            
            25,000(3
            )
            3/28/2022William
                Wolf. Esq.
            
            Outside
              General Counsel
            
            
            25,000(4
            )
            4/4/2022




(1)
            One-third
                of these stock options shall vest on April 30, 2007 and the balance
                in two
                equal installments on October 23, 2008 and
                2009.




(2)
            The
                options granted to Mr. Kaye shall vest as follows: 25,000 stock options
                on
                April 30, 2007 and the balance in three equal installments on October
                18,
                2007, 2008 and 2009.




(3)
            One-fifth
                of these stock options shall vest on each of March 28, 2008, 2009,
                2010,
                2011 and 2012.




(4)
            One-fifth
                of these stock options shall vest on each of April 4, 2008, 2009,
                2010,
                2011 and 2012.




Vesting
      of all stock options is subject to acceleration under certain circumstances
      in
      the event of an acquisition of the Company.





**16.
      INCOME TAXES**




The
      current income tax provision is comprised of the following:


2006
            
            2005Federal
            
            $
            -
            
            $
            -State,
                net of benefit from sale of tax net operating loss
            
            $
            -
            
            $
            11,117





In
      1998,
      the State of New Jersey enacted legislation allowing emerging technology and/or
      biotechnology companies to sell their unused New Jersey Net Operating Loss
      (“NOL”) Carryover Research and Development Tax Credits (“R&D Credits”) to
      corporate taxpayers in New Jersey. During 2005, the Company entered into an
      agreement under which it retained a third party broker to identify a buyer
      for
      its New Jersey State income tax net operating loss carryforward from the 2004
      tax year. As a result, the Company realized a current tax benefit of $116,039
      for the year ended December 31, 2005.




F-18




Total
      deferred tax asset and valuation allowance are approximately as follows at
      December 31:





2006Current
                deferred tax asset - inventory reserve
            
            $
            83,000Non-current
                Deferred Tax Assets:Net
                operating loss carryforwards
            
            
            5,457,000Gain
                on sale of property
            
            
            1,071,000Total
                long term deferred tax assets
            
            
            6,579,000Total
                deferred tax assets
            
            
            6,611,000Less:
                valuation allowance
            
            
            (6,611,000
            )Net
                deferred tax assets
            
            $
            -





The
      differences between income tax benefit (provision) in the financial statements
      and the tax benefit (provision) computed at the U.S. Federal statutory rate
      of
      34% at December 31, are as follows:





2006
            
            2005Federal
                Tax benefit at the statutory rate
            
            
            34.0
            %
            
            34.0
            %State
                income taxes, net of federal benefit
            
            
            -
            
            
            (6.7
            )Inventory
                reserves
            
            
            (5.0
            )Depreciation
                deduction for financial reporting purposes
            
            
            (0.4
            )Sale
                of prior year state net operating loss carryforward, net of federal
                tax
            
            
            -
            
            
            6.1Gain
                on sale of property deferred for financial reporting
                purposes
            
            
            -
            
            
            (65.0
            )Equity
                in loss of unconsolidated subsidiary not deductible
            
            
            -
            
            
            (7.0
            )Utilization
                of Federal net operating loss carryforward
            
            
            -
            
            
            37.7Valuation
                Allowance
            
            
            (28.6
            )
            
            -Effective
                Tax Rate
            
            
            0.0
            %
            
            0.9
            %





At
      December 31, 2006, the Company had available approximately $16,199,000 of net
      operating loss carryforwards which may be used to reduce future federal taxable
      income, which expire between December 31, 2008 and 2024. There are no available
      net operating loss carryforwards available for state income tax purposes. For
      the year ended December 31, 2006, the valuation allowance increased by
      approximately $314,000.





**17.
      RELATED PARTY TRANSACTIONS**





The
      Company subcontracts its project expense from Coates Precision Engineering,
      of
      which George J. Coates is the sole shareholder. During the years ended December
      31, 2006 and 2005, the Company paid $42,400 and $84,058, respectively, for
      these
      services.




On
        April
        30, 2003, the Company amended its license agreement with Coates Motorcycle
        (the
“Amended Motorcycle License Agreement”). Prior thereto, Gregory Coates, son of
        George J. Coates and an officer of the Company, owned 100% of Coates Motorcycle.
        Pursuant to a prior license agreement, the Company granted certain exclusive
        licenses in exchange for approximately 51% of the common shares of Coates
        Motorcycle. In addition, the Company had an anti-dilution right. The Amended
        Motorcycle License Agreement expanded the license rights granted and removed
        the
        anti-dilution provision in exchange for 1,000,000 common shares of Coates
        Motorcycle. As a result of these transactions, the Company owned 3,558,000
        shares of Coates Motorcycle, representing a 30% ownership interest. The Company
        is under no obligation to provide any funding or support to Coates Motorcycle
        under any circumstances. Under the Amended Motorcycle License Agreement,
        the
        Company granted an exclusive sublicense for North America, South America
        and
        Central America and their territories (collectively, the "Western Hemisphere")
        to make, use and sell motorcycles utilizing the CSRV Technology. During 2005,
        the Company sold 9,400 shares of Coates Motorcycle for $5.00 per share and
        realized a gain of $47,000 on the sale.


F-19




The
      Company’s investment in Coates Motorcycle is valued at $-0-, because that was
      the cost basis of the assets and the license agreement exchanged for those
      shares. This investment in Coates Motorcycle is being accounted for under the
      equity method of accounting for investments. As such, the investment is being
      carried at cost, adjusted for the Company’s proportionate share of undistributed
      earnings and losses .




Emerging
      Issues Task Force ("EITF") 98-13, "Accounting by an Equity Method Investor
      for
      Investee Losses When the Investor has Loans to and Investments in Other
      Securities of the Investee", requires an investor using the equity method,
      that
      has reduced the value of the investment to $-0-, but also has loans outstanding
      or other forms of equity such as preferred stock to continue to report its
      share
      of the losses. Accordingly, during the year ended December 31, 2005, the Company
      recorded losses from its investment in Coates Motorcycle in the amount of
      $260,344, which reduced the value of the Company’s investment to $-0-. Had the
      Company continued to record its proportionate share of undistributed earning
      and
      losses after its investment was written down to $ -0-, it would have recorded
      an
      additional share of undistributed losses aggregating approximately $343,000
      through December 31, 2006.




The
      Company computed its share of the losses in accordance with EITF 99-10
      "Percentage Used to Determine the Amount of Equity Method Losses," where the
      percent ownership was based on the assumed conversion of the Preferred Series
      A
      Stock held by the Company.




In
      2007,
      Coates Motorcycle disbursed all of its remaining cash, curtailed all of its
      operations and is currently insolvent. At this time, Coates Motorcycle has
      not
      developed short term plans to address this situation. However, if the value
      of
      its sublicense agreement with us can be demonstrated in the future, to the
      extent we are successful achieving market acceptance of the CSRV technology;
      such market acceptance could improve the likelihood that Coates Motorcycle
      could, in the future, secure additional sources of working capital to fund
      its
      operations.




Summarized
      unaudited information for Coates Motorcycle is as follows:




Unaudited
              December
                31, 2006Current
                assets
            
            $
            87,257Total
                assets
            
            
            128,526Current
                liabilities
            
            
            (496,218
            )Total
                liabilities
            
            
            (1,395,511
            )Stockholders’
                deficiency
            
            
            1,266,985





Unaudited
                Year Ended December 31,2006
            
            2005Revenue
            
            $
            -
            
            $
            -Operating
                expenses
            
            
            1,379,692
            
            
            1,087,331Net
                loss
            
            
            (1,462,791
            )
            
            (1,083,292
            )




The
      Company also made loans to Coates Motorcycle from time to time to provide
      working capital for the development and testing of motorcycle engines which
      incorporate the Company’s technologies. As of December 31, 2004, the total
      outstanding balance of these loans, including accrued interest thereon, was
      $362,200 and was converted into 362,200 shares of Preferred Series A Stock
      of
      Coates Motorcycle. The Company has accounted for its equity in the common stock,
      and ownership of preferred stock of Coates Motorcycle, in accordance with
      Emerging Issues Task Force (“EITF”) Issue No. 98-13 "Accounting by an Equity
      Method Investor for Investee Losses When the Investor has Loans to and
      Investments in Other Securities of the Investee." The Company’s equity
      investment in the common stock and preferred stock of Coates Motorcycle is
      $-0-
      as of December 31, 2006 and 2005.




F-20




During
      the years ended December 31, 2006 and 2005, Mark Goldsmith, former Chief
      Executive Officer and President also served as the Chief Executive Officer,
      President and Interim Chief Financial Officer of Coates Motorcycle pursuant
      to
      an employment agreement. Mr. Goldsmith received salary payments of $185,000,
      a
      portion of which represented deferred salary from the prior year, and $81,500
      from Coates Motorcycle in 2006 and 2005, respectively and was provided with
      a
      leased automobile and medical and dental benefits.





During
      the year ended December 31, 2005, the Company received $76,911 from Coates
      Motorcycle as partial reimbursement for various overhead expenses, incurred
      on
      its behalf.





The
      Coates Trust has made loans to the Company at various times to provide working
      capital. George J. Coates, Bernadette Coates, wife of George J. Coates and
      Gregory Coates are beneficiaries of the Coates Trust. The net outstanding
      balance was $92,337 at December 31, 2006. These borrowings are in the form
      of a
      demand loan which carry no interest and are repaid from time to time depending
      upon cash availability. It is the intention of the Coates Trust to assist the
      Company with its working capital requirements as needed in the future, even
      though it is not legally obligated to do so. In April 2007, this demand loan
      was
      converted to a 6% promissory note due April 4, 2008.




Bernadette
      Coates, George’s wife has made loans to the Company at various times to provide
      working capital. The amount due to Mrs. Coates was repaid in 2006.




The
      Company paid compensation and benefits to George J. Coates, Gregory Coates
      and
      Bernadette Coates for management of the office amounting to approximately
      $184,000, $83,000 and $41,000, respectively in 2006 and amounting to $184,000,
      $83,000 and $41,000, respectively, in 2005. In 2006, the Company paid Gregory
      Coates $25,000 towards a newly created technology in connection with a
      computerized, sequential injection system, which has been included general
      and
      administrative expenses in the accompanying statement of operations.




Barry
      C.
      Kaye, Treasurer and Chief Financial Officer was paid consulting fees of $15,500
      and $3,000 in 2006 and 2005, respectively.




**18.
      NEW ACCOUNTING PRONOUNCEMENTS**





In
      February, 2007, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value
      Option for Financial Assets and Financial Liabilities including an amendment
      of
      FAS 115” (“FAS 159”). This statement provides companies with an option to report
      selected financial assets and liabilities at fair value. This statement is
      effective for fiscal years beginning after November 15, 2007 with early adoption
      permitted. Management is assessing FAS 159 and has not yet determined the impact
      that the adoption of FAS 159 will have on the financial position or results
      of
      operations of the Company, if any.





In
      September 2006, the Securities and Exchange Commission issued Staff Accounting
      Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when
      Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”),
      that requires public companies to utilize a dual approach to assessing the
      quantitative effects of financial misstatements. This dual approach includes
      both an income statement focused assessment and a balance sheet focused
      assessment. SAB 108 is effective for annual financial statements covering the
      first fiscal year ending after November 15, 2006. We are currently assessing
      the
      impact of SAB 108 but do not expect that it will have a material effect on
      our
      results of operations or financial condition.




F-21




In
      September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS
      157"). SFAS 157 defines fair value, establishes a framework for measuring fair
      value, and expands disclosure requirements regarding fair value measurement.
      Where applicable, this statement simplifies and codifies fair value related
      guidance previously issued within generally accepted accounting principles.
      SFAS
      157 is effective for financial statements issued for fiscal years beginning
      after November 15, 2007, and interim periods within those fiscal years. The
      Company is currently reviewing SFAS 157 to determine its impact and any material
      effect of its adoption.





In
      June
      2006, the FASB issued SFAS Interpretation No. 48, "Accounting for Uncertainty
      in
      Income Taxes, an Interpretation of SFAS Statement No. 109" ("FIN 48"), which
      clarifies the accounting and disclosure for uncertain tax positions, as defined.
      FIN 48 seeks to reduce the diversity in practice associated with certain aspects
      of the recognition and measurement related to accounting for income taxes.
      Management does not believe that adoption of FIN 48 will have a material impact
      on the financial position or results of operations of the Company.





**19.
      SUBSEQUENT EVENTS**





Commencement
      of Trading





On
      February 26, 2007, the Company’s common stock commenced trading on the Over the
      Counter Bulletin Board market system under the ticker symbol COTE.





Sale
      of
      Common Stock





In
      March
      and April 2007, the Company sold 2,000,000 shares of its common stock to the
      son
      of a director of the Company and received aggregate gross proceeds of $500,000
      from private sales pursuant to stock purchase agreements.





Issuance
      of 6% Promissory Note





In
      April
      2007, the Company issued a $192,337 principal amount 6% Promissory Note, due
      April 4, 2008 to the Coates Trust in consideration for cash proceeds of $100,000
      and conversion of a non-interest bearing demand loan due to the Coates Trust
      in
      the amount of $92,337. George J. Coates, Bernadette Coates and Gregory Coates
      are beneficiaries of this Trust.





Issuance
      of Convertible Subordinated Notes





In
      March
      2007, the Company issued $120,000 principal amount of 10% Convertible
      Subordinated Notes, due March 2010 (the “Convertible Notes”) to two of its
      outside directors and received proceeds of $120,000. The proceeds from the
      Convertible Notes are being used for working capital purposes. The Convertible
      Notes are convertible into shares of the Company’s common stock at an initial
      conversion rate which shall be equal to the weighted average of the closing
      prices of the Company’s common stock on the Over the Counter Bulletin Board on
      the first ten trading days beginning on the fifth trading day after the Company
      files this annual report on Form 10-KSB with the Securities and Exchange
      Commission. However, such conversion rate shall not be greater than $0.45 per
      share nor less than $0.25 per share. Interest shall accrue at the rate of 10%
      per annum and shall be payable in cash only at maturity.





Sale
      of
      Securities





The
      Company commenced a private placement offering in December 2006 (the “Offering”)
      of “Units” consisting of (i) one share of the Company’s 6% Series A Convertible
      Preferred Stock (the “Preferred Stock”) and (ii) a Warrant to purchase five
      thousand shares of the Company’s Common Stock at an initial exercise price of
      $1.10 per share (the “Warrants”), and terminated the Offering in March 2007.
Each
      share of Preferred Stock is convertible into ten shares of our common stock
      at
      any time.Aggregate proceeds from this Offering, which amounted to
      $420,000 is being used for working capital purposes. In consideration of the
      commencement of trading of the Company’s common stock, the Company is currently
      in the process of obtaining approval from the investors in the Offering to
      directly issue shares of its common stock in lieu of the Preferred Stock. Upon
      obtaining such approval, the Company will issue in the aggregate 420,000 shares
      of its common stock and 42 Warrants for
      the
      42 Units sold.




F-22




Settlement
      Agreement with Prior Accountants





In
      February 2007, the Company entered into a settlement agreement with Rosenberg,
      Rich Baker Berman & Company (“RRBB”) which provided for a mutual release of
      any claims by the parties and that the balance of fees due RRBB would be
      converted to an approximately $50,000 principal amount, promissory note, payment
      of which became accelerated and is now due. RRBB served as the Company’s Independent
      Registered Public Accounting Firm for the year ended December 31,
      2005.





Settlement
      of Litigation





The
      Company, certain of its officers and directors and other related and unrelated
      parties were named as defendants in a lawsuit brought in the Superior Court
      of
      New Jersey captioned H. Alton Neff v. George Coates, Coates International,
      Ltd.
      et al. Plaintiff contends that he is the assignee of 1107 North West Central
      Avenue Inc. ("1107"). Preliminary agreements and an amendment thereto relating
      to purchase of a certain license by 1107 from the Company provided, inter alia,
      that a $500,000 deposit made by 1107 to the Company would convert to stock
      of
      the Company if certain conditions were not met by 1107. The Company maintains
      that 1107 did not fulfill such conditions, and failed to make a certain payment,
      and therefore, the deposit converted into shares of the Company's restricted
      Common Stock. O n February
      13, 2007 ,
      the
      Superior Court of New Jersey dismissed the complaint “with prejudice.” The
      plaintiff and a third party defendant have since filed motions for
      reconsideration which were denied on March 30, 2007. It is anticipated that
      the
      plaintiffs and the third party defendant will appeal. The Company has proposed
      to dismiss, without prejudice, its counterclaim and third party complaint in
      order to avoid the costs associated with a proof hearing.





Departure
      of Executive Officer





In
      late
      March 2007, Mark D. Goldsmith stepped down from his positions as Chief Executive
      Officer and President. Although the Company is considering a possible future
      role for Mr. Goldsmith upon certain conditions being satisfied related to the
      adequacy of the Company’s working capital and requiring a mutual release of any
      claims under an employment agreement between the Company and Mr. Goldsmith,
      there can be no assurance that such conditions will be satisfied. As a result
      of
      his departure, the Company may be obligated to make certain payments to Mr.
      Goldsmith under an employment agreement, dated October 18, 2006. See Note 5
      for
      further discussion of this contingency.






F-23