UNITED
STATES SECURITIES AND EXCHANGE COMMISSION




Washington,
DC 20549









FORM
10-K




(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, 2007


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.:000-33155
 
 coates
                COATES
      INTERNATIONAL, LTD.
  (Name of
small business issuer in its charter)
 
 Delaware
                (State
      or other jurisdiction of incorporation or organization)
              
              22-2925432
                (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
  _______________
 
 Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
 Yes £  No
R
 
 
 Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
 Yes £  No
R
  
  Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
 Yes R  No £
 
 Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.
 R
 
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
 Large
accelerated filer £                                                                                                 Accelerated
filer £
 
 Non-accelerated
filer (Do not check if a smaller reporting company)   £                Smaller
reporting company R
 
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes £      No
R
  State the
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
last sold, or the average bid and asked price of such common equity, as of the
last business day of the registrant’s most recently completed second fiscal
quarter. $26,211,809
 
 Indicate
the number of shares outstanding of each of the registrant’s classes of common
stock, as of the latest practicable
 date.
 
 As of
April 9, 2008, the number of outstanding shares of the registrant’s common
stock, par value $0.0001 per share was 273,426,636.
 COATES
INTERNATIONAL, LTD.
 
 CONTENTS
    PagePART IItem
      1.            Business
                  4Item
      1A.         Risk
      Factors
                  11Item
      2.            Properties
                  15Item
      3.            Legal
      Proceedings
                  15Item
      4.            Submission
      of Matters to a Vote of Security Holders
                  16PART II
                  17Item
      5.           Market
      for Registrant's Common Equity, Related Shareholder Matters and Issuer
      Purchases of Equity
      Securities
                  17Item
      6.           Selected
      Financial Data
                  18Item
      7.           Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
                  19Item
      7A.        Quantitative and
      Qualitative Disclosures About Market Risk
                  22Item
      8.           Financial
      Statements and Supplementary Data
                  22Item
      9.           Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                  22Item
      9A(T).   Controls and Procedures
                  22Item
      9B.         Other
      Information
                  23PART III
                  24Item  10.         Directors,
      Executive Officers and Corporate Governance
                  24Item  11.         Executive
      Compensation
                  27Item  12.         Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                  31Item  13.         Certain
      Relationships and Related Transactions, and Director
      Independence
                  33Item  14.         Principal
      Accounting Fees and Services
                  34PART IV
                  35Item  15.         Exhibits
                  35Signatures
                  37Financial
      Statements
                  F-1
 PART
I
 Item
1.  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 1/10th 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.
Subject to the engine design and application, higher RPM range, greater
volumetric efficiency and thermal efficiency 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 the Coates Trust, 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 and in 2006 from research and
development activities related to the termination of a license agreement. The
Company has never been profitable and has incurred substantial net losses of
approximately $2,539,000 and $1,663,000 for the years ended December 31, 2007
and 2006, respectively, resulting in an accumulated deficit at December 31,
2007, of approximately $22,722,000. 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, write off of
certain offering costs and general and administrative expenses 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-K and 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. Our Code of Business Conduct and Ethics for our
directors, officers and employees can be viewed on our website at
www.coatesengine.com.  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.
 4
  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.Poppet valve engines
cannot use high compression ratios because they will become red hot and
pre-ignition will be experienced.
 
 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 have
adapted our patented technology to industrial engines to power electric
generators, and intend to begin to market engines utilizing our proprietary
designs during 2008.
 
 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; railroads, marine engines; military
equipment; light aircraft and helicopters; and lawn mowers, snow mobiles and jet
ski’s, etc.
 
 According
to data in a table published by the Federal Highway Administration of the U.S.
Department of Transportation titled “Highway Statistic 2003” there were total
U.S. vehicle registrations for the fifty states as follows:
 
 Automobiles
                  Buses
                  Trucks
                  Total135,669,897
                  776,550
                  94,943,551
                  231,389,998
 
 5
 
 Strategy
 
 The
long-term objective of the Company is to become a leader throughout the Americas
in the design, manufacture, licensing to third party manufacturers, sales and
distribution 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 has adapted the CSRV System to manufacture its 14.0 liter
inline, 6-cylinder, 855 cubic inch engine/generator fueled by natural gas. 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
 
 The
Company has recently completed development of the CSRV System-based generator
engine and is preparing to commence the production phase of its operations.
Initially, the Company intends to sell the engine/generators to a Well to Wire
Energy, Inc. (“WWE”), a Canadian based entity which provides services to oil
field equipment for oil and gas producing companies throughout Canada. WWE has
expressed indications of interest to purchase a substantial number of Coates
Engines intended to be installed in oil fields throughout Canada. 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 once production
      commences.
  ·
                  Licensing
      the technology to Original Equipment Manufacturers (“OEM”) – to take
      advantage of third party manufacturers’ production capacity 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.
  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 in the licensed territory.
  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, 2007, this agreement was formally
terminated.
  6
  Agreements with Well to
Wire Energy, Inc.
  Canadian License and
Research and Development Agreements
 
 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
      that provides as follows:
  ·
                    Upon
      taking possession by WWE of 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”), 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.
  The third power unit of
the Company’s generator for up to 300 kilowatts, which has been completed and
satisfactorily tested at our facility by WWE, is ready for shipment by WWE. WWE
is in the process of working out the logistics and appropriate timing of
transporting this generator over the road on the approximately 3,000 mile long
journey to an oil field in Canada in winter conditions. Our generator weighs in
excess of three tons.
 Escrow Agreement and
Conditional U. S. License Agreement with WWE
 
 In April
2008, we entered into a
conditional second license agreement with WWE for the territory of the United
States. (the “US License”). The US License provides for a license fee of $50
million and annual minimum purchases of Coates CSRV Systems as a condition of
exclusivity.  The US license has been deposited into an escrow account
and the grant under the license is not effective until the conditions for
release from escrow are satisfied.
 
 The
escrow agreement was established to provide a more secure mechanism for the
Company to collect payments due under both the prior Canadian licensing and
research and development agreements and the new $50 million US License (the
“Escrow Agreement”).  The Escrow Agreement provides that the US
License shall be held until WWE remits a release payment (the “Release
Payment”). The
Release Payment consists of (i) of an initial down payment required under the US
License of $1 million and (ii) $8.5 million in payment of the balance of the
monies due to us in connection with the license for the territory of Canada,
including the Canadian license agreement and the research and development
agreement (the “Canadian Agreements”). While the US License is held in escrow
there shall not be any grant of license to WWE. WWE is expected to
make non-refundable periodic payments to the Company in unspecified amounts as
partial payments of the Release Payment until the Release Payment has been paid
in full. Upon full satisfaction of the Release Payment, WWE would be granted a
license for the territory of the United States under the US License
agreement.
 
 WWE is a
privately held company and its ability to make the license payments due to us
and to honor the minimum purchase requirements under the licenses is dependent
on the success of its efforts to raise new equity capital.  Thus far,
WWE has made nonrefundable payments to us totaling $1.5 million in prior years
and $375,000 in 2008. To the extent that WWE is not successful or experiences
delays in raising such additional new equity capital, our cash flow, results of
operations and financial position could be adversely affected.
 7
  Under the
Escrow Agreement, WWE is required to remit the full amount of the Release
Payment by June 30, 2008 (the “Payment Period”). Should WWE be unable to make
the Release Payment within the Payment Period, the Canadian license agreement
shall automatically become non-exclusive. However, provided that WWE shall have
paid at least $500,000 on account of the Release Payment, the Payment Period
shall be extended until September 30, 2008 (the “Extended Payment Period”).
Should WWE be able to make the entire Release Payment within the
Extended Payment Period, the exclusivity of the Canadian license agreement
shall be reinstated.
  The
failure of WWE to make the entire Release Payment within the Payment Period
or within the Extended Payment Period should it be extended, shall
constitute a breach of the Escrow Agreement, the Canadian license agreement and
the US License. In such event, we would be entitled to (i) retain any and all
monies received from WWE and (ii) immediately, without notice to WWE, cancel the
Escrow Agreement, the Canadian license agreement and the US License without
providing WWE any right of redemption or reinstatement.
 
 The US
License would, if WWE is able to satisfy the Escrow Agreement release
provisions, grant to WWE the right to use, sell and lease Licensed Products,
manufactured by us as the power source for the generation of electrical energy
for the oil and gas industry and from landfills.  Licensed Products
consist of CSRV Valve Systems, CSRV Valve Seals, CSRV Rotary Valve Spheres, CSRV
Valve Components and CSRV Engines for the Oil and Gas Industry and
Landfills.
 
 The
manufacture of any Licensed Products by WWE is prohibited.  WWE is
required to procure all internal combustion engines incorporating the CSRV Valve
System from us or our designee. The license granted to WWE is exclusive within
the Territory, provided that WWE satisfies the minimum annual purchase
commitment of 120 internal combustion engines incorporating the CSRV Valve
System, the Coates Engines and all component parts. The agreement also grants
WWE a right of first refusal in the event that we negotiate an offer with
another third party for a worldwide license to use the Licensed
Product.
 
 After
payment of the Release Payment required under the Escrow Agreement, the
remaining unpaid balance of the US License fee of $49 million is payable in
quarterly installments commencing 180 days from the earlier to occur of (i) the
date the third prototype engine provided for in the Canadian Agreements is
collected by WWE, or (ii) April 30, 2008. The amount of the quarterly
installment payments shall be equal to 5% of WWE’s net profits over the next
five years; however, in any event, the entire balance of the licensing fee must
be paid in full on or before February 12, 2012.
 
 Acceleration
of the balance of the licensing fee payments shall be required in the event that
WWE completes a stock offering or private placement offering.  The
entire unpaid balance of the licensing fee shall become due and payable if WWE
raises $100 million or more from such offering.  If WWE raises $25
million or less from any such offering, then WWE must pay us 20% of the amount
raised towards the licensing fee.
 
 Pricing
of the Licensed Products shall be set forth in a separate agreement to be
executed between the parties. We are solely responsible for protecting the
Patent Rights, as defined, in connection with the Licensed Products at our
own cost and expense.  The term of the agreement shall expire upon the
expiration of the last to expire of the patents comprising the Patent
Rights.
 
 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”).  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. At this time, Coates
Motorcycle has expended all of its cash and has curtailed its
operations.
 8
  Transaction
with Dutchess Private Equities Fund, Ltd.
  On April
26, 2007, we entered into an Investment Agreement (the “Agreement”) with
Dutchess Private Equities Fund, Ltd. (“Dutchess”) to provide us with an equity
line of credit. Pursuant to this Agreement, Dutchess is contractually
obligated to purchase up to $10,000,000 of our Stock over the course
of up to 36 months (“Line Period”), after a  registration statement
has been declared effective (“Effective Date”). The amount that we shall be
entitled to request from each of the purchase “Puts”, shall be equal to either
1) $500,000 or 2) 200% of the average daily volume (U.S. market only) (“ADV”),
multiplied by the average of the three (3) daily closing prices immediately
preceding the Put Date.  The ADV shall be computed using the ten (10)
trading days prior to the Put Date. The Purchase Price for the common stock
identified in the Put Notice shall be set at ninety-three percent (93%) of the
lowest closing bid price of the common stock during the Pricing Period. The
pricing period shall be the five (5) consecutive trading days immediately after
the put notice date. There are put restrictions applied on days between the Put
Date and the Closing Date with respect to that Put.  During this time, we
shall not be entitled to deliver another Put Notice.
 
 We shall
automatically withdraw that portion of the put notice amount, if the Market
Price with respect to that Put does not meet the Minimum Acceptable Price.
 The Minimum Acceptable Price is defined as seventy-five (75%) of the
closing bid price of the common stock for the three (3) trading days prior to
the Put Date.
 
 In
connection with the Agreement, we entered into a Registration Rights Agreement
with Dutchess (“Registration Agreement”). Pursuant to the Registration
Agreement, we filed a registration statement with the Securities and Exchange
Commission covering the shares of common stock underlying the Investment
Agreement. This registration statement was declared effective by the SEC on June
22, 2007. During the year ended December 31, 2007, the Company sold 2,341,803
shares of its common stock under this equity line of credit and received
proceeds of $1,215,855.
 
 Placement
Agency Agreement with Stonegate Securities, Inc.
 
 On
December 21, 2007, the Company entered into a placement agent agreement with
Stonegate Securities, Inc. (“Stonegate”) to act as its placement
agent.  The agreement is for an initial ninety (90) day period in
which Stonegate shall be the Company’s exclusive placement
agent (“Exclusivity Period”) and thereafter, the agreement shall be
non-exclusive until cancelled by either party on ten (10) days written
notice.  During the Exclusivity Period, Stonegate has the exclusive
right to identify for the Company prospective purchasers in one or more
placements of debt and/or equity securities to be issued by the Company, the
type and dollar amount being as mutually agreed to by the Parties (the
“Securities”).  After the Exclusivity Period, as the non-exclusive
placement agent to the Company, Stonegate will have the non-exclusive right
during the Contract Period to identify for the Company prospective Purchasers in
one or more Placements of Securities, the type and dollar amount being as
mutually agreed to by the Parties.
  As
compensation for services rendered by Stonegate in connection with the
Placements, the Company has agreed to pay Stonegate a fee of eight percent (8%)
of the gross proceeds from the sale of Securities in the
Placements.  Except during the Exclusivity Period, or any extension
thereof, no fees would be due and payable in connection with sales of Securities
in the Placement to investors not introduced to the Company by Stonegate or by a
direct or indirect party previously introduced to the Company as a result of the
efforts of Stonegate. As compensation for its initial due diligence efforts, in
2007, the Company has delivered to Stonegate’s designee 200,000 fully paid
non-assessable restricted shares of common stock of the Company.  The
value of these shares on the date of issuance was approximately $85,000,
and was included in general and administrative costs for the year ended
December 31, 2007.
  Upon
closing of the Placement, the Company agrees to issue to Stonegate restricted
shares of common stock of the Company in an amount that is equal to two percent
(2%) of the total number of shares of common stock sold, and/or in the event of
a sale of convertible securities, the number of shares of common stock that
would be potentially received upon a conversion of any convertible securities
sold in the Placement.  Such number of shares to be issued to
Stonegate shall be reduced by the 200,000 shares set forth above.
  The
Company shall also reimburse Stonegate for reasonable, actual out-of-pocket
expenses incurred by Stonegate, provided, however, that such amount in total
shall not exceed one percent (1%) of the gross proceeds of securities placed
pursuant to this Placement Agreement.
  9
  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.
 
 Licenses
and Patents
 
 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. These patents are owned by George J.
Coates and Gregory Coates.  Under our license agreement, we are
responsible for all costs incurred relating to the ongoing maintenance of the
patents. For a description of 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.
 
 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. When selling individual engines, we are not
subject to the governmental standards as set forth in 40CFR (Code of Federal
Regulations) 1048, which regulates environmental standards for natural
gas-powered industrial engines. In this case, the purchaser or Licensee becomes
responsible for complying with applicable governmental standards in their
territory.  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.
 10
  Employees
 
 At
December 31, 2007, 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, 2007 and 2006, the Company paid approximately $3,000 and $42,000,
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.
 
 The
following risk factors relate to our financial condition:
 
 Going
Concern
 
 As shown
in the accompanying financial statements beginning on Page F-1 as of and for the
year ended December 31, 2007, the Company has incurred recurring losses from
operations, and as of December 31, 2007, had a Stockholders’ Deficiency of
approximately $2,108,000 and we have never been profitable. These factors raise
substantial doubt about the Company’s ability to continue as a going concern.
Our independent registered public accounting firm has stated in their Auditors’
Report dated April 11, as of December 31, 2007 and for the year then ended that
this raises substantial doubt about our ability to continue as a going
concern.
 
 Management
has been closely monitoring variable costs and intends to restrict such
variable costs to those expenses that are necessary to complete activities
related to preparing for commencement of the production phase of operations,
identifying additional sources of working capital and general administrative
costs in support of such activities. The Company continues to actively seek new
sources of working capital. The accompanying financial statements do not include
any adjustments that might be necessary if the Company is unable to continue as
a going concern.
 
 We
have significant immediate capital needs, and our ability to raise funds is
highly uncertain.
  We will
need additional financing in the near future for a number of uses,
including:
 
 ·
                    Purchasing
      raw material inventory and hiring plant workers to commence our production
      phase;
 
 ·
                    expanding
      manufacturing capacity;
 
  11
  ·
                    developing
      an expanded management team to oversee the expanded scope of our operating
      activities upon commencement of
production;
 
 ·
                    developing
      our engineering, administrative and marketing and sales
      organizations;
 
 ·
                    expanding
      our research and development programs with respect to the basic CSRV
      technology and applying the CSRV technology to engines used in various
      commercially viable applications;
and
 
 ·
                    implementation
      of new systems, processes and procedures to support
  growth.
 
 Additional
financing may not be available on terms acceptable to us or may not be available
at all.
 
 The
following risk factors relate to our Product Development:
 
 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 in
2006 from research and development activities in connection with a terminated
license agreement and we have never been profitable.
  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 2008; unless we receive
payments from WWE as described under “Material Agreements” above. In addition,
we may not be profitable or cash flow positive for several additional years
after 2008.
 
 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.
 
 The
following risk factors relate to our Business:
 
 We
are significantly dependent on our founder, George J. Coates.
  We are
significantly 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 was 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
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.
 
 Our
short term business success is highly dependent upon our United States and
Canadian licensing and research and development agreements with
WWE.
  12
  The
initial monies due under the United States and Canadian licensing agreements and
the research and development agreement with WWE represent potential new sources
of cash due to the Company totaling approximately $9.5 million during 2008. In
addition, the annual minimum purchase requirements under the both the United
States and Canadian licensing agreements of 120 engine generators per year will
also become effective beginning in 2008 and beyond.  WWE is a
privately held company. Its ability to make the license payments due to us and
to honor the minimum purchase requirements under the licenses is dependent on
its success in raising new equity capital. Thus far, WWE has made nonrefundable
payments to us totaling $1.5 million in prior years and $375,000 in 2008. There
can be no assurance that WWE will be successful in raising the additional equity
capital required for this purpose.  To the extent that WWE is not
successful or experiences delays in raising such new equity capital, our cash
flow, results of operations and financial position could be adversely
affected.  We are continuing discussions with a number of other third
parties for the licensing of our technology; however, there can be no assurance
that we will be able to secure new licensing agreements.
  We
have no marketing and sales experience.
  We have
no marketing or 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. We 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.
  We need
to hire, train and retain additional employees for all aspects of our business
if we are to achieve our sales goals. 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.  In particular, we need trained engineers and sales personnel to
educate potential customers and provide post-installation customer
support.
 
 The
following risk factors relate to our common stock:
  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.
  13
  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 April 8, 2008 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.
  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:
 
 
                    Our
      success in commencing our production phase of
  operations;
 
 
                    results
      of testing of the CSRV technology as it designed into various commercially
      feasible applications;
 
 
                    our
      prospects for entering into new potentially profitable license agreements
      for our technology;
 
 
                    performance
      of the Coates Engine in the field;
 
 
                    improvements
      in engine technology by our competitors;
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.
 
 Existing
stockholders may experience significant dilution from the sale of our common
stock pursuant to the investment agreement.
 
 The sale
of our common stock to Dutchess Private Equities Fund, Ltd. in
accordance with the Investment Agreement will have a dilutive impact on our
shareholders.  As a result, our net income per share, if any, could
decrease in future periods and the market price of our common stock could
decline. In addition, the lower our stock price is at the time we exercise our
put option, the more shares of our common stock we will have to issue to
Dutchess Private Equities Fund, Ltd. in order to drawdown on the Equity Line of
Credit. If our stock price decreases, then our existing shareholders would
experience greater dilution.
 
  14
  The
perceived risk of dilution may cause our stockholders to sell their shares,
which would contribute to a decline in the price of our common stock. Moreover,
the perceived risk of dilution and the resulting downward pressure on our stock
price could encourage investors to engage in short sales of our common stock. By
increasing the number of shares offered for sale, material amounts of short
selling could further contribute to progressive price declines in our common
stock.
 
 Dutchess
Private Equities Fund, Ltd. will pay less than the then-prevailing market price
of our common stock which could cause the price of our common stock to
decline.
 
 Our
 common  stock to be issued  under the  Investment
 Agreement  will be purchased at a seven percent (7%) discount
 to the lowest  closing  bid price  during the five trading
days immediately following our notice to Dutchess Private Equities Fund, Ltd. of
our election to exercise our “put” right.  Each issuance of shares of our
common stock will dilute the value of each share of common stock due to the
increase in the number of outstanding shares. Dutchess Private Equities Fund,
Ltd. has a financial incentive to sell our shares immediately upon
receiving the shares to realize the profit between the
discounted price and the market price. If Dutchess Private Equities Fund,
Ltd. sells our shares, the price of our common stock may decrease.  If our
stock price decreases, Dutchess Private Equities Fund, Ltd. may have a
further incentive to sell such shares.  Accordingly, the discounted
sales price in the Investment Agreement may cause the price of our
common stock to decline.
 
 Item
2.  Properties.
 
 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 for $5,200,000, which, if not exercised, will lapse in
the fourth quarter of 2008.  This 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, 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 restricted
common 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. 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 dismissed, without prejudice, its
counterclaim and third party complaint in order to avoid the costs associated
with a proof hearing. The plaintiffs and the third party defendant filed notices
of appeal on June 12, 2007 and June 13, 2007.  The Company intends to
vigorously contest those appeals.
 
 In April
2007, we received a demand letter from a law firm requesting payment of
approximately $77,000 in connection with a promissory note issued to the law
firm as security for the payment of future services to the Company. We have
notified the holder of this note that it does not intend to honor the promissory
note because the law firm did not provide the services contemplated to be
performed as consideration for the promissory note. No further action to pursue
collection of this promissory note has been taken to date by the holder. At this
time, it is not possible to reasonably estimate the outcome of this matter, and,
accordingly, no amount has been accrued.
 15
  In late
March 2007, at the request of the Company, Mark D. Goldsmith stepped down from
his positions as Chief Executive Officer and President. Despite his resignation,
Mr. Goldsmith contended that he was entitled to certain rights under an
employment agreement with the Company. Therefore, on April 17, 2007, the Company
notified Mr. Goldsmith in writing that he was being terminated as a director,
officer and employee with “Cause”, as defined in his employment agreement. On
January 25, 2008, a complaint was filed with the Superior Court of New Jersey
Law Division on behalf of Mr. Goldsmith, as the plaintiff, which named the
Company, Coates Motorcycle Company, Ltd. and George J. Coates as defendants. The
complaint alleges breach of contract with respect to Mr. Goldsmith’s employment
agreements with the Company and Coates Motorcycle and seeks compensatory damages
consisting of compensation, severance, stock options and other employee
benefits, punitive damages, interest and attorney’s fees. To date,
interrogatories, a notice to produce documents and a notice to take the
deposition of Mr. Goldsmith have been served.  On April 8, 2008,
notice was received advising that the court has assigned this matter to
mandatory mediation.
 
 In the
opinion of management this complaint is without merit and we intend to
vigorously defend against this complaint asserted by Mr. Goldsmith. We are
currently preparing a counterclaim against Mr. Goldsmith asserting that he
misrepresented his background and capabilities in order to induce the Company to
hire him and that certain of his business decisions were made to further his
self interest rather than the interests of the Company. We have without
prejudice to our position, accrued compensation under his employment agreement
for accounting purposes only, of approximately $96,000 of his salary through
April 13, 2007, the date the Company believes that Mr. Goldsmith was terminated
with Cause. Although we do not intend to make any payments to Mr. Goldsmith in
connection with this employment agreement, this amount has been included in
accounts payable and accrued liabilities in the accompanying financial
statements.
 
 We are
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 2007.  However, the
following actions were ratified or carried on behalf of the stockholders by the
action of a written consent by the majority stockholder in lieu of a meeting,
dated September 21, 2007:
  ·
                    An
      amendment to  the Company’s Certificate of Incorporation to
      cancel all 14,000,000 shares of the Company’s Series A Convertible
      Preferred Stock and authorize 100,000,000 new shares of the Company’s
      Preferred Stock, which upon approval of the Board of Directors, may be
      issued in one or more series and the relative terms, rights, preferences
      and limitations may be fixed,
  ·
                    Approval
      of the Company’s 2006 Stock Option and Incentive Plan (the “Stock Option
      Plan”), which was adopted by the Company’s Board of Directors in October
      2006; and,
  Election
of eight Directors of the Company to hold office until their successors have
been duly elected and qualified.
 
  16
   PART
II
 
 Item
5.  Market for Registrant’s Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.
 
 Market
  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 April 9, 2008 was $0.35 per share. The high and low bid
prices for the partial trading period in the 1st Qtr of
the 2007 and the three full quarters of 2007 are as follows:
 
 For
      the trading period from February 26 to March 31, 2007
                    2nd
      Quarter
                      2007
                    3rd
      Quarter
                      2007
                    4th
      Quarter
                      2007High
                    $4.00
                    $2.05
                    $0.85
                    $0.85Low
                    $0.15
                    $0.2465
                    $0.25
                    $0.25
 
 
 Holders
  At April
9, 2008, the number of holders of record of the common stock was
825.
 
 Recent
Sales of Unregistered Securities
  During
2007, the Company sold in a series of three transactions, 3,333,333 shares of
its common stock to the son of a director of the Company and received aggregate
gross proceeds of $1,250,000. These transactions were private sales of
unregistered securities pursuant to stock purchase agreements.
 
 In March
2007, the Company issued a 10% Convertible Subordinated Note, due March 2010
(“Convertible Note”) in the principal amount of $100,000 to one of its outside
directors and received cash proceeds of $100,000. In April 2007, the Company
issued an additional 10% Convertible Note in the principal amount of
$20,000 to another outside director and received cash proceeds of $20,000. The
proceeds from the Convertible Notes were used for working capital purposes. The
Convertible Notes are convertible at the option of the holder into shares of the
Company’s common stock at an initial conversion rate that is determined by
dividing the principal amount of notes being converted by $0.45. As the closing
price of the Company’s common stock on the date of the transaction was $0.35 per
share, there was no beneficial conversion feature. Interest accrues at the rate
of 10% per annum and is payable in cash, only at maturity. All interest shall be
forfeited upon conversion, in which case the holder would be entitled to
dividends declared, if any, on the Company’s common stock during the time the
convertible note was outstanding. On May 16, 2007, $100,000 principal amount of
these convertible notes was converted into 222,222 shares of our common stock.
The Company has reserved 44,445 shares of its common stock for conversion of the
balance of these notes.
 
 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.
Aggregate net proceeds from this Offering, which amounted to $420,000 was used
for working capital purposes. There were no expenses incurred related to this
offering. All of the investors have accepted ten shares of our common stock in
lieu of each share of Preferred Stock purchased through the private offering. No
shares of Preferred Stock were issued. In June 2007, the Company issued in the
aggregate 420,000 shares of its common stock and 42 Warrants in connection with
the Units sold. The amount received for the 420,000 shares of common stock is
reflected in common stock and additional paid in capital in the accompanying
balance sheet as of December 31, 2007.
 
 The net
proceeds from all of these sales of our common stock was used for general
working capital purposes.
 
 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.
 
 17
 
 Dividends
  We have
never declared or paid any cash dividends on shares of our common or preferred
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.
 
 Securities
Authorized for Issuance Under Equity Compensation Plans
  The
following table sets forth information with respect to our securities authorized
for issuance as of April 11, 2008, under our 2006 Stock Option and Incentive
Plan:
  
 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
                    1,800,000
                    $0.44
                    10,700,000Equity
      Compensation plans without approval by security holders
                    None
                    N/A
                    N/ATotal
                    1,800,000
                    $0.44
                    10,700,000
 
 The
Company’s 2006 Stock Option and Incentive Plan (the “Stock Plan”) was adopted by
the Company’s Board of Directors in October 2006.  In September 2007,
the Stock Plan, by consent of George J. Coates, majority shareholder, was
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.
 
 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.
  Issuer Purchases of Equity Securities
  None.
 Item
6. Selected Financial Data.
  N/A
  18
  Item
7.  Management’s Discussion and Analysis of Financial Condition and
Results of Operation.
  We have
completed the development of the Coates spherical rotary valve engine. We are
currently preparing to commence production of our CSRV engine generators
pursuant to our licensing agreement with WWE. We are also currently engaged in
new research and development activities in connection with applying to this
technology to other commercially feasible internal combustion engine
applications and intend to manufacture engines and/or license the technology to
third party original equipment manufacturers 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, determining an appropriate amount to reserve for
obsolete and slow moving inventory, assigning expected lives to our stock
options granted and selecting a volatility factor for our stock options in order
to estimate the fair value of our stock options on the date of grant.
 
 Results
of Operations for the Years Ended December 31, 2007 and 2006
  The
Company did not have any revenues in 2007 and recognized revenues of $565,000 in
2006 in connection with the termination of a license agreement with one of its
sublicensees. The Company's principal business activities and efforts during
2007 and 2006 were devoted to (i) the continuation and completion of the
research, development, construction and testing of the prototype Coates Engines
for WWE and (ii) undertaking efforts to raise additional working capital through
the private placement of securities.
 
 Research
and development expenses increased to approximately $606,000 in 2007 from
approximately $437,000 in 2006 primarily as a result of an increase in research
and development labor costs to approximately $284,000 in 2007 from approximately
$193,000 in 2006, stock based compensation expense included in research and
development expenses amounting to approximately $286,000, compared with 2006
when no stock based compensation expense was incurred, inventory utilized in
research and development activities in 2007 amounting to approximately $30,000,
compared with 2006 when no inventory was utilized for research and development
offset by a reduction in the provision for slow moving and obsolete inventory to
approximately $6,000 from $244,000 in 2006.
 
 General
and administrative expenses increased to approximately $1,493,000 in 2007 from
approximately $1,373,000 in 2006. This approximately $120,000, or 8.7% increase
primarily resulted from stock based compensation expense included general and
administrative expenses amounting to approximately $128,000, compared with 2006
when no stock based compensation expense was incurred, an increase in marketing
and trade show expenses of approximately $66,000 in 2007, an increase in testing
expenses of approximately $46,000 in 2007 in connection with testing the
performance of the CSRV engine generator, whose development was completed in
2007, an increase in patent maintenance expenses of approximately $44,000 in
2007 and an increase in other general administrative expenses of approximately
$36,000 primarily resulting from higher printing, postage and utilities
expenses, offset by a reduction in legal and professional fees of approximately
$142,000 in 2007, a reduction in compensation expense of approximately $38,000
and a reduction in the amount of inventory scrapped in 2007 of approximately
$19,000.
 
 Depreciation
and amortization expense decreased to approximately $49,000 from approximately
$57,000 in 2006 primarily as a result of discontinuing depreciation on equipment
that became fully depreciated.
 
 Total
operating expenses for the years ended December 31, 2007 and 2006 were
approximately $2,148,000 and $1,867,000, respectively, representing an increase
of approximately 15.0%, which was primarily attributable to the Company's higher
research and development costs relating to its prototype CSRV engine generator
during all of 2007 compared with 2006 when the bulk of such efforts were only
underway during the second half of the year and non-cash stock based
compensation expense in 2007 compared with no stock based compensation expense
being incurred in 2006. Approximately $404,000 and $429,000 for the years ended
December 31, 2007 and 2006, respectively, represented labor
charges.
 
 Interest
expense remains relatively constant with a small increase to approximately
$394,000 from approximately $390,000 in 2007 related to interest on the
capitalized lease assumed in 2007 and accrued interest on the 10% convertible
notes issued in 2007.
 
 In 2007
and 2006, the change in deferred taxes was fully offset by a valuation
allowance, resulting in a $-0- net income tax provision.
 19
 The net
result for the year 2007 was a loss of approximately $2,539,000 or $0.01 per
share, as compared to a net loss of approximately $1,663,000 or $0.01 per share
for 2006.
 
 Liquidity
and Capital Resources
  We have
incurred recurring losses from operations, and as of December 31, 2007, had a
Stockholders’ Deficiency of approximately $2,108,000. These factors raise
substantial doubt about our ability to continue as a going concern. Our
Independent Registered Public Accountants have stated in their Auditor’s Report
dated March __, 2008 with respect to our financial statements as of and for the
year ended December 31, 2007 that these circumstances raise substantial doubt
about our ability to continue as a going concern.
 
 During
2007, we restricted variable costs to only those expenses that are necessary to
perform activities related to completing development by making engineering
refinements to the Coates Engine, raising additional working capital and general
administrative costs in support of such activities. Since December 31, 2006, we
raised approximately $3,006,000 of new working capital from sales of our common
stock and from issuance of convertible notes.
 
 We
continue to actively seek out new sources of working capital, however, there can
be no assurance that we will be successful in these efforts. Under our
definitive agreement with Dutchess Private Equities Fund, Ltd., at our option we
can access to up to an additional $8,776,000 funding to the Company through
further sales of our common stock. The accompanying financial statements do not
include any adjustments that might be necessary if the Company is unable to
continue as a going concern.
 
 The
initial monies due under the United States and Canadian licensing agreements and
the research and development agreement with WWE represent potential new sources
of cash due to the Company totaling approximately $9.5 million during 2008. In
addition, the annual minimum purchase requirements under the both the United
States and Canadian licensing agreements of 120 engine generators per year will
also become effective beginning in 2008 and beyond.  WWE is a
privately held company. Its ability to make the license payments due to us and
to honor the minimum purchase requirements under the licenses is dependent on
its success in raising new equity capital. Thus far, WWE has made nonrefundable
payments to us totaling $1.5 million in prior years and $375,000in 2008. There can be no assurance that WWE will be successful in raising
the additional equity capital required for this purpose.  We are
continuing discussions with a number of other third parties for the licensing of
our technology; however, there can be no assurance that we will be able to
secure new licensing agreements.
 
 On
December 21, 2007, the Company entered into a placement agent agreement with
Stonegate Securities, Inc. (“Stonegate”) to act as its placement
agent.  The agreement is for an initial ninety (90) day period in
which Stonegate shall be the Company’s exclusive placement
agent (“Exclusivity Period”) and thereafter, the agreement shall be
non-exclusive until cancelled by either party on ten (10) days written
notice.  During the Exclusivity Period, Stonegate has the exclusive
right to identify for the Company prospective purchasers in one or more
placements of debt and/or equity securities to be issued by the Company, the
type and dollar amount being as mutually agreed to by the Parties (the
“Securities”).  After the Exclusivity Period, as the non-exclusive
placement agent to the Company, Stonegate will have the non-exclusive right
during the Contract Period to identify for the Company prospective Purchasers in
one or more Placements of Securities, the type and dollar amount being as
mutually agreed to by the Parties.  The Company is considering an
undertaking during 2008, to raise new equity funds though a private placement
offering with the assistance of Stonegate.
  We have
completed development and testing of the Coates generator engine, including the
third power unit of the Company’s generator for up to 300 kilowatts for WWE
which has been completed and satisfactorily tested at our facility by WWE. This
unit is ready for shipment and WWE is in the process of working out the
logistics and appropriate timing of transporting this generator over the road on
the approximately 3,000 mile long journey to an oil field in Canada in winter
conditions. Our generator weighs in excess of three tons. 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 licensing 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 of the
third prototype engine, and subject to meeting WWE expectations as mentioned
above.
 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.
 
 20
 
 At the
end of 2007, we had working capital of approximately $416,000 compared with
negative working capital of approximately ($519,000) at the end of
2006.  In 2007, the Company closed on a series of financing and equity
transactions that generated aggregate cash proceeds of $3,006,000 which are
being used for working capital purposes.
 
 The
Company will continue its efforts to seek new sources of additional funding for
its working capital in 2008 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, (v) proceeds of stock issued to Dutchess Capital Equity Fund, Ltd.
in connection with the Equity Line of Credit facility with Dutchess; (vi) a
private placement of equity securities with the assistance of Stonegate and,
(vii) 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 $627,000 of legal fees due
to a law firm for its representation of us in litigation over the past several
years, legal fees of approximately $120,000 due to a law firm for representation
of us for various securities related matters, approximately $96,000 of accrued
compensation due to a director/ former executive officer.  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 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.
 
 Contractual
Obligations and Commitments
 
 The
following table summarizes our contractual obligations and commitments at
December 31, 2007:
 
 Amount
      Due WithinTotal
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2011Contractual ObligationsSale/Leaseback
      Arrangement(1)
                    
                    $
                    1,527,500
                    
                    
                    $
                    390,000
                    
                    
                    $
                    390,000
                    
                    
                    $
                    390,000
                    
                    
                    $
                    357,500Employment
      Agreements(2)
                    
                    
                    1,003,000
                    
                    
                    
                    263,000
                    
                    
                    
                    263,000
                    
                    
                    
                    263,000
                    
                    
                    
                    214,000Capital
      lease obligation
                    
                    
                    8,000
                    
                    
                    
                    8,000
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Total
                    
                    $
                    2,538,500
                    
                    
                    $
                    661,000
                    
                    
                    $
                    653,000
                    
                    
                    $
                    653,000
                    
                    
                    $
                    571,500
 
 (1)Although
      the total finance obligation reflected in the Company’s balance sheet at
      December 31, 2007 amounts to approximately $3,877,000, only the amounts
      reflected in the above table constitute a contractual
      commitment.  This is a result of the required finance method of
      accounting treatment for the underlying sale/leaseback transaction. This
      accounting treatment is being applied because the Company’s option to
      repurchase this property through November 2008, represents a continuing
      interest in the property. Under this method, the property and the finance
      obligation continue to be reported on the Company’s balance sheet until
      the exercise or expiration of the repurchase option. The above payments,
      which will be charged to interest expense under this finance method of
      accounting equate to an annual interest rate of
  10.06%.
 
 (2)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.
 
 Total
compensation cost related to nonvested stock options at December 31, 2007 that
has not been recognized was approximately $291,000. This non-cash compensation
expense will be recognized in the future over a remaining weighted average
period of approximately 3.3 years.
 
 21
 
 Plan
of Operation
 
 We have
completed development of the CSRV System-based generator engine are preparing to
commence the production phase of our operations. Initially, the Company intends
to sell the engine/generators to WWE based on indications of interest to
purchase Coates Engines for installation in oil fields throughout Canada. 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
7A. Quantitative and Qualitative Disclosures About Market Risk.
  N/A
  Item
8.  Financial Statements and Supplementary Data.
  Reference
is made to the Index to Financial Statements on page F-1.
  
 Item
9.  Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
  None.
 
 Item
9A(T).  Controls and Procedures.
  Pursuant
to Rule 13a-15(b) under the Securities Exchange Act of 1934 (“Exchange Act”),
the Company carried out an evaluation, with the participation of the Company’s
management, including the Company’s Chief Executive Officer (“CEO”) and Chief
Accounting Officer (“CAO”) (the Company’s principal financial and accounting
officer), of the effectiveness of the Company’s disclosure controls and
procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of the
end of the period covered by this report. Based upon that evaluation, the
Company’s CEO and CAO concluded that the Company’s disclosure controls and
procedures are effective to ensure that information required to be disclosed by
the Company in the reports that the Company files or submits under the Exchange
Act, is recorded, processed, summarized and reported, within the time periods
specified in the SEC’s rules and forms, and that such information is accumulated
and communicated to the Company’s management, including the Company’s CEO and
CAO, as appropriate, to allow timely decisions regarding required
disclosure.
 
 Management’s Report on
Internal Controls over Financial Reporting
 
 Internal
control over financial reporting is a process to provide reasonable assurance
regarding the reliability of consolidated financial reporting and the
preparation of financial statements for external purposes in accordance with
U.S. generally accepted accounting principles.  There has been no change in
the Company’s internal control over financial reporting during the year ended
December 31, 2007 that has materially affected, or is reasonably likely to
materially affect, the Company’s internal control over financial
reporting.
  The
Company’s management, including the Company’s CEO and CAO, does not expect that
the Company’s disclosure controls and procedures or the Company’s internal
controls will prevent all errors and all fraud. 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. Further, the design
of a control system must reflect the fact that there are resource constraints,
and the benefits of controls must be considered relative to their costs. Because
of the inherent limitations in all control systems, no evaluation of the
controls can provide absolute assurance that all control issues and instances of
fraud, if any, within the Company have been detected.
 
 22
 
 Management
conducted an evaluation of the effectiveness of our internal control over
financial reporting based on the framework in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on this evaluation, management concluded that the
company’s internal control over financial reporting was effective as of December
31, 2007.
 
 This
annual report does not include an attestation report of the Company's registered
public accounting firm regarding internal control over financial reporting.
Management's report was not subject to attestation by the Company's registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit the Company to provide only management's report
in this annual report.
 
 Item
9B.  Other Information.
  None
 
 23
 
 PART
III
 
 Item 10.  Directors,
Executive Officers and Corporate Governance.
 
 The
following table lists the current members of our board of directors and our
executive officers as of April 11, 2008. Our directors hold office until their
successors have been duly elected and qualified. 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
                    
                    PositionGeorge
      J. Coates
                    
                    68
                    
                    Director,
      Chairman of the Board, Chief Executive Officer and
    PresidentGregory
      Coates
                    
                    37
                    
                    Director
      and President, Technology DivisionBarry
      C. Kaye
                    
                    54
                    
                    Director,
      Treasurer and Chief Financial OfficerRichard
      W. Evans
                    
                    76
                    
                    Director
      and SecretaryDr.
      Frank Adipietro
                    
                    50
                    
                    Director
      *, **Glenn
      Crocker
                    
                    59
                    
                    Director
      *, **, ***Dr.
      Michael J. Suchar
                    
                    52
                    
                    Director
      *, **Richard
      Whitworth
                    
                    59
                    
                    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 in March 2007.
 
 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, a hydraulic suspension, patented the
Coates rotary valve system and patented a turbine engine. George Coates is 68
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.
 
 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.  Mr. Kaye
is also 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. From 1999 to
2007, he was an Executive Business Consultant with BCK Business Consulting which
provided 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.
 
 
 24
 
 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. Adipietrobecame 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 Crockerbecame 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.
 
 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. The members of our audit committee are Richard
Whitworth and Glenn Crocker.
 
 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.
 
 25
 
 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. The Company has not been able to identify a qualified audit committee
financial expert to serve in such capacity.
 
 In
connection with the audit of our financial statements as of and for the years
ended December 31, 2007 by Weiser, LLP (“Weiser”), our Independent Public
Accounting Firm, our audit committee has discussed with Weiser the matters
required to be discussed by the Statement on Auditing Standards No. 61 as
adopted by the Public Company Accounting Oversight Board in Rule
3200T.  In addition, the audit committee has received the written
disclosures and the letter from Weiser required by Independence Standards Board
Standard No. 1 as adopted by the Public Company Accounting Oversight Board in
Rule 3600T and has discussed with Weiser their independence.
 
 The audit
committee has reviewed and discussed our audited financial statements as of and
for the years ended December 31, 2007 with management and based on this review
and discussion has recommended to the board of directors that such audited
financial statements be included in this annual report on Form 10-K for filing
with the Securities and Exchange Commission.
 
 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. Our code of business
conduct and ethics can be viewed on our website at
www.coatesengine.com.
 
 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.
 
 26
 
 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.
 
 Section
16(a) Beneficial Ownership Reporting Compliance
 
 The
Company knows of no person, who, at any time during the fiscal year ended
December 31, 2007 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 11. Executive
Compensation.
 
 The
following table sets forth the compensation of specified executive officers for
fiscal 2007 and 2006:
 
 Summary
Compensation Table
 
 Option
                    
                    
                    All
      OtherName and Principal Position
                    Year
                    
                    Salary
                    
                    
                    Awards
                    
                    
                    CompensationGeorge
      J. Coates (1)
                      Chief
      Executive Officer and President
                    2007
                    
                    $
                    190,346
                    (1)
                    
                    
                    (1)
                    
                    
                    
                    (5),
      (6)2006
                    
                    $
                    183,549
                    (1)
                    
                    
                    (1)
                    
                    
                    
                    (5),
      (6)Mark
      D. Goldsmith (2)
                      Former
      Chief Executive Officer and President
                    2007
                    
                    $
                    55,342
                    (2)
                    
                    $
                    0
                    
                    
                    $
                    02006
                    
                    $
                    41,096
                    (2)
                    
                    $
                    0
                    
                    
                    $
                    0Barry
      C. Kaye (3)
                      Chief
      Financial Officer and Treasurer
                    2007
                    
                    $
                    0
                    (3)
                    
                    
                    (3)
                    
                    
                    $
                    80,000
      (5)2006
                    
                    $
                    0
                    (3)
                    
                    
                    (3)
                    
                    
                    $
                    15,500
      (5)Gregory
      Coates (4)
                      President,
      Technology Division
                    2007
                    
                    $
                    86,044
                    (4)
                    
                    
                    (4)
                    
                    
                    
                    (6)2006
                    
                    $
                    82,971
                    (4)
                    
                    
                    (4)
                    
                    
                    
                    (6)
 
 
 27
 
 (1)           In April 2007,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, on
April 18, 2007 we granted Mr. Coates 1,000,000 stock options to purchase shares
of our common stock at an exercise price of $0.44 per share.
 
 (2) In late
March 2007, Mark D. Goldsmith stepped down from his positions as Chief Executive
Officer and President, and on April 17, 2007, we notified Mr. Goldsmith in
writing that he was being terminated as a director, officer and employee with
“Cause”, as defined in his employment agreement.
 
 On
January 25, 2008, a complaint was filed with the Superior Court of New Jersey
Law Division on behalf of Mr. Goldsmith, as the plaintiff, which named the
Company, Coates Motorcycle Company, Ltd. and George J. Coates as defendants. The
complaint alleges breach of contract with respect to Mr. Goldsmith’s employment
agreements with the Company and Coates Motorcycle and seeks compensatory damages
consisting of compensation, severance, stock options and other employee
benefits, punitive damages, interest and attorney’s fees.
 
 In the
opinion of management this complaint is without merit and the Company intends to
vigorously defend against this complaint asserted by Mr. Goldsmith. The Company
is evaluating the desirability of filing a counterclaim against Mr. Goldsmith.
The Company has without prejudice to its position, accrued compensation under
his employment agreement for accounting purposes only, of approximately $96,000
of his salary through April 13, 2007, the date the Company believes that Mr.
Goldsmith was terminated with Cause. Although the Company does not intend to
make any payments to Mr. Goldsmith in connection with this employment agreement,
this amount has been included in accounts payable and accrued liabilities in the
accompanying balance sheet.
 
 (3)           In April 2007,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,
on April 18, 2007, we granted to Mr. Kaye 125,000 options to purchase shares of
our common stock at an exercise price of $0.44 per
share.
 
 28
  (4)           In April 2007,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, on April 18, 2007, we granted to Mr. Coates
500,000 options to purchase shares of our common stock at an exercise price of
$0.44 per share.
 
 (5)           This
amount represents payments to Mr. Kaye for consulting services provided to the
Company during 2007 and 2006, respectively.
 
 (6)           George
J. Coates and Gregory Coates were provided with health care, dental care and
life insurance benefits amounting to approximately $8,600 and $11,800,
respectively, in 2007 and amounting to approximately $9,800 and $9,100,
respectively in 2006.
 
 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
                    
                    
                    333,333
                    
                    
                    
                    666,667
                    (1)
                    
                    
                    -
                    
                    
                    $
                    0.44
                    
                    10/23/2021Gregory
      Coates
                    
                    
                    166,667
                    
                    
                    
                    333,333
                    (1)
                    
                    
                    -
                    
                    
                    $
                    0.44
                    
                    10/23/2021Barry
      C. Kaye
                    
                    
                    58,333
                    
                    
                    
                    66,667
                    (2)
                    
                    
                    -
                    
                    
                    $
                    0.44
                    
                    10/17/2021
 
 (1)
One-third of these stock options vested on April 30, 2007 and the balance shall
vest in two equal installments on October 23, 2008 and 2009.
 
 (2) The
options granted to Mr. Kaye vest as follows: 25,000 stock options vested on
April 30, 2007, 33,333 stock options vested on October 18, 2007 and the balance
shall vest in two equal installments on October 18, 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.
 
 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 of $0.44 per share. One-fourth of these
stock options will vest on each of the first four annual anniversary dates after
the date of grant.
 
 29
 
 The
following table summarizes the components Director compensation for the year
ended December 31, 2007.
 
 Name of Director
                    
                    Fees
      Earned of Paid in
Cash
                    
                    
                    Stock
      Options Awarded
                    
                    
                    Total
      CompensationDr.
      Frank Adipietro
                    
                    $
                    1,000
                    
                    
                    $
                    5,125
                    
                    
                    $
                    6,125Glenn
      Crocker
                    
                    $
                    1,000
                    
                    
                    $
                    5,125
                    
                    
                    $
                    6,125Richard
      W. Evans
                    
                    $
                    1,000
                    
                    
                    $
                    5,125
                    
                    
                    $
                    6,125Dr.
      Michael J. Suchar
                    
                    $
                    1,000
                    
                    
                    $
                    5,125
                    
                    
                    $
                    6,125Richard
      Whitworth
                    
                    $
                    1,000
                    
                    
                    $
                    5,125
                    
                    
                    $
                    6,125
 
 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 April 17, 2007, Mr. Goldsmith was removed from these positions
and terminated for Cause as defined in his employment agreement.
 
 A summary
of the compensation terms under the employment agreements appears in the table
below.
 
 Name & position
                    
                    Annual
      compensation
                    
                    
                    Number
      of
                      stock options3
                    
                    
                    Life
      insurance
                    
                    Severance
      payment4
                    Term
      of the AgreementGeorge
      Coates, President and Chief Executive Officer
                    
                    $
                    183,549
                    1
                    
                    
                    1,000,000
                    
                    
                    $
                    2,000,000
                    
                    Three
      years salary5
                    Five
      yearsGregory
      Coates, President Technology Division
                    
                    $
                    79,898
                    1
                    
                    
                    500,000
                    
                    
                    $
                    2,000,000
                    
                    Two
      years salary5
                    Five
      yearsBarry
      C. Kaye, Treasurer and Chief Financial Officer
                    
                    $
                    0
                    2
                    
                    
                    125,000
                    
                    
                    None
                    
                    One
      year salary2
                    Three
      years
 
 1The
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.
 
 2Mr.
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 2007 and 2006, Mr. Kaye received $80,000 and
$15,500, respectively, in consulting fees from the Company.
 
 3These
Options, which were granted on April 18, 2007, expire in October 2021. The
options provide for the following vesting schedule:
 
 ·
                    The
      options granted to George J. Coates and Gregory Coates vest as follows:
      one-third vested on 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
      vested on April 30, 2007, 33,333 stock options vested on October 18, 2007
      and the balance shall vest in two equal installments on October 18, 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.
 
 
 30
 
 4The
entitlement for the severance payment is subject to the employee terminating his
employment for a good reason.
 
 5The
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 ‘Licenses and
Patents’. Under their employment agreements we are not entitled to terminate
either George or Gregory Coates employment unless they are terminated for
cause.
 
 Item
12.  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 April 8, 2008 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.
 
 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 273,426,636 shares outstanding as of April
9, 2008. Addresses of named beneficial owners are care of Coates International,
Ltd., Highway 34 & Ridgewood Road, Wall Township, New Jersey
07719.
 
 Beneficial
      OwnershipOutstanding
      Shares
                    
                    
                    Acquire
      Right to Within 60 Days After
                    
                    
                    Shares
      BeneficiallyName
      and Address of Beneficial Owner
                    
                    Beneficially
      Owned
                    
                    
                    December31,
      2007
                    
                    
                    Owned
                      Number
                    
                    
                    PercentageGeorge
      J Coates
                    
                    
                    208,272,760
                    1
                    
                    
                    333,333
                    
                    
                    
                    208,606,093
                    1
                    
                    
                    76.08%Gregory
      Coates
                    
                    
                    14,032,520
                    
                    
                    
                    166,667
                    
                    
                    
                    14,199,187
                    
                    
                    
                    5.18%Frank
      Adipietro
                    
                    
                    1,032,722
                    
                    
                    
                    -
                    
                    
                    
                    1,032,722
                    
                    
                    
                    0.37%Richard
      Evans
                    
                    
                    660,000
                    
                    
                    
                    -
                    
                    
                    
                    660,000
                    
                    
                    
                    0.24%Michael
      J. Suchar
                    
                    
                    241,600
                    2
                    
                    
                    44,444
                    
                    
                    
                    286,044
                    2
                    
                    
                    0.17%Barry
      C. Kaye
                    
                    
                    49,800
                    
                    
                    
                    58,333
                    
                    
                    
                    108,133
                    
                    
                    
                    0.04%All
      executive officers and directors as a group (6 persons)
                    
                    
                    224,289,402
                    
                    
                    
                    602,777
                    
                    
                    
                    224,892,179
                    
                    
                    
                    82.08%
 
 
 31
  (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.
 
 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.
  32
  Item
13.  Certain Relationships and Related Transactions, and Director
Independence.
  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, 2007 and 2006, the Company paid approximately $3,000 and $42,000,
respectively, for these services.
 
 On April
30, 2003, the Company entered into a sublicense agreement with Coates Motorcycle
Company, Ltd (“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. At
this time, Coates Motorcycle has expended all of its cash and has curtailed its
operations.
 
 During
the period through March 2007 and for the year ended December 31, 2006, 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 $25,000 and $185,000, a portion of which represented
deferred salary from the prior year from Coates Motorcycle in 2007 and 2006,
respectively. He was also provided with a leased automobile and medical and
dental benefits.
 
 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. In April 2007, the Coates
Trust advanced $100,000 in the form of a 6% promissory note. At the same time,
the outstanding balance of the prior loans of $92,337 was converted to and
included in this promissory note. No interest was imputed on these loans for the
period prior to the time they were converted to the 6% promissory note. In May
2007, the entire $192,337 principal amount of the 6% promissory note was repaid,
along with accrued interest of approximately $1,500.
  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. No interest
was imputed on these loans for the year ended December 31, 2006 as such amount
was not material.
  The
approximate amount of compensation and benefits paid to George J. Coates,
Gregory Coates and Bernadette Coates, exclusive of non-cash stock based
compensation for employee stock options granted to George J. Coates and Gregory
Coates, for the two years ended December 31, 2007, is summarized as
follows:
 
 For
      the Year Ended December 31,2007
                    
                    2006(a)George
      J. Coates (b)
                    
                    $
                    199,000
                    
                    
                    $
                    193,000Gregory
      Coates
                    
                    
                    98,000
                    
                    
                    
                    92,000Bernadette
      Coates
                    
                    
                    51,000
                    
                    
                    
                    49,000
 
 (a)
                    In
      our annual report on Form 10-K, the amounts reported did not include
      certain employee benefits which have been included to provide a proper
      comparison to the amount reported herein for
  2007.
 (b)
                    Includes
      compensation paid in 2007 for 2006 vacation earned but not
      taken.
 
  Barry C.
Kaye, Treasurer and Chief Financial Officer was paid consulting fees of
approximately $80,000 and $15,500 in 2007 and 2006, respectively.
 
 33
 Director
Independence
  The
following table sets forth the members of our Board of Directors that are
independent and certain board committee assignments:
  Dr.
      Frank Adipietro
                      
                      
                      Director
      *, **Glenn
      Crocker
                      
                      
                      Director
      *, **, ***Dr.
      Michael J. Suchar
                      
                      
                      Director
      *, **Richard
      Whitworth
                      
                      
                      Director
      *, **, ***
 
 *           Serves
as an independent director.
 **           Serves
as a member of our compensation committee
 ***           Serves
as a member of our audit committee
  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").
 
 In 2007,
Weiser billed us in the aggregate $123,620 for professional services rendered
for their audit of our annual financial statements for the year ended December
31, 2006 included in our Form 10-KSB and their reviews of the quarterly
financial statements included in our Forms 10-QSB for each of the three quarters
in 2007.
 
 In 2006,
Rosenberg billed us in the aggregate amount of $44,625 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 for the year ended
December 31, 2005 and their reviews of the quarterly financial statements
included in our Forms 10-QSB for each of the three quarters in
2006.
 
 Audit-related
Fees:
  In 2007,
Weiser billed us for services in connection with our filing of a registration
statement on Form SB-2 in the amount of approximately $25,000 and in connection
with addressing and responding to a comment letter received from the Securities
and Exchange Commission in the amount of approximately $6,000 and did not bill
us for or perform any  audit related services in 2006.
 
 In 2007,
Rosenberg billed us for services in connection with our filing of a registration
statement on Form SB-2 in the amount of approximately $6,000 and did not bill us
for or perform any audit related services in 2006.
 
 Tax
Fees:
  In 2007,
Weiser billed us approximately $5,000 for professional services rendered for tax
related services for the taxable year ended December 31, 2006.
 
 In 2006,
Rosenberg billed us approximately $3,000 for professional services rendered for
tax related services for the taxable year ended December 31, 2005.
 
 All Other
Fees:
  Weiser
did not perform nor bill the Company for any other services during the last two
fiscal years.
 
 Rosenberg
did not perform nor bill the Company for any other services during the last two
fiscal years.
 
  34
  
 PART
IV
 
 Item
15.  Exhibits.
 
 
 Exhibit No.
                      
                      Description3.1
      @
                      -
                      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, 20013.1(iii)
      u
                      -
                      Certificate  of
      Amendment to  Certificate
      of  Incorporation  filed with the Secretary of State
      of Delaware on September 12, 20073.2
      @
                      -
                      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,
      200010.11
      #
                      -
                      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
      R
                      -
                      License
      Agreement between the Company and Coates Trust dated October 23,
      200610.16
      R
                      -
                      Amended
      and Restated Employment Agreement between the Company and George J. Coates
      dated April 6, 200710.17
      R
                      -
                      Amended
      and Restated Employment Agreement between the Company and Gregory Coates
      dated April 6, 200710.18
      R
                      -
                      Amended
      and Restated Employment Agreement between the Company and Barry C. Kaye
      dated April 6, 200710.19
      R
                      -
                      Amended
      and Restated License Agreement between the Company and George J. Coates
      and Gregory Coates dated April 6, 200710.20
      R
                      -
                      Termination
      of License Agreement between the Company and Coates Trust dated April 6,
      2007
  35
  10.21
      †
                      -
                      Letter
      from Rosenberg Rich Berman Baker and Company to the Securities and
      Exchange Commission dated February 8, 2007 regarding the circumstances of
      their dismissal by the Company as its Independent Registered Public
      Accounting Firm10.22
      p
                      -
                      Investment
      Agreement between the Company and Dutchess Private Equities Fund, Ltd.
      dated April 26, 200710.23
      p
                      -
                      Registration
      Rights Agreement between the Company and Dutchess Private Equities Fund,
      Ltd. dated April 26, 200710.24
      ¢
                      -
                      Placement
      Agency Agreement between the Company and Stonegate Securities, Inc. dated
      December 21, 200710.25Ã
                      -
                      License
      Agreement between the Company and Well to Wire Energy, Inc. dated January
      29, 2008 and executed on April 7, 200810.26Ã
                      -
                      Escrow
      Agreement between the Company and Well to Wire Energy, Inc. dated April
      11, 200831.1Ý
                      -
                      Certification
      of George J. Coates pursuant to Rule 13a-14(a) of the Securities Exchange
      Act of 1934.31.2Ý
                      -
                      Certification
      of Barry C. Kaye pursuant to Rule 13a-14(a) under the Securities Exchange
      Act of 1934.32Ý
                      -
                      Certification
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
      of
                        the Sarbanes-Oxley Act of 2002.
 _______________
 @ Incorporated
      by reference from the Company’s Registration Statement filed May 31, 2007
      on Form SB-2 with the Securities and Exchange Commission, File No.
      000-33155 .
 R    Incorporated
by reference from the Company’s Form 10-KSB for the year ended December 31,
2006.
 +  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.
  †  Incorporated
      by reference from the Company’s Form 8-K file with the Securities and
      Exchange Commission on February 12,
2007.
  p
      Incorporated by reference from the Company’s Form 8-K file with the
      Securities and Exchange Commission on May 1,
  2007.
  u Incorporated by
      reference from the Company’s Schedule 14C DEF file with the Securities and
      Exchange     Commission on October 1,
      2007.
  ¢
                      Incorporated
      by reference from the Company’s Form 8-K file with the Securities and
      Exchange Commission on January 3,
2008.
  Ã  Incorporated
      by reference from the Company’s Form 8-K file with the Securities and
      Exchange Commission on April
  11,  2008.
  Ý   Filed
herewith.
 
 All
reports required to be filed on Form 8-K during the last quarter of the fiscal
year ended December 31, 2007 were timely filed with the Securities and Exchange
Commission.
 
  36
 
 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 11, 2008.
  COATES
      INTERNATIONAL, LTD.By:
                        /s/ George
      J. CoatesGeorge
      J. CoatesChairman
  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
      11, 2008/s/ Gregory
      Coates
                        Gregory
      Coates
                      Director,
      President-Technology Division
                      April
      11, 2008/s/ Barry C.
      Kaye
                        Barry
      C. Kaye
                      Director,
      Treasurer, Chief Financial Officer (principal financial and accounting
      officer)
                      April
      11, 2008/s/ Richard W.
      Evans
                        Richard
      W. Evans
                      Director
      and Secretary
                      April
      11, 2008/s/ Michael J.
      Suchar
                        Michael
      J. Suchar
                      Director
                      April
      11, 2008/s/ Frank
      Adipietro
                        Frank
      Adipietro
                      Director
                      April
      11, 2008/s/ Glenn
      Crocker
                        Glenn
      Crocker
                      Director
                      April
      11, 2008/s/ Richard
      Whitworth
                        Richard
      Whitworth
                      Director
                      April
      11, 2008
 
 37
  Coates
International, Ltd.
 
 Index
to the Financial Statements
 
 December
31, 2007 and 2006
 
 
 
 PageReport of Weiser
      LLP, Independent Registered Public Accounting Firm
                        F-1Financial
      Statements
                        F-2Balance
    Sheets
                        F-2Statements of
      Operations
                        F-3Statements of
      Stockholders' Deficiency
                        F-4Statements of Cash
      Flows
                        F-5Notes to the
      Financial Statements
                        F-6
 REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
  
  To the
Board of Directors and
 Stockholders
of Coates International Ltd.
  We have
audited the accompanying balance sheets of Coates International Ltd. as of
December 31, 2007 and 2006, and the related statements of operations,
stockholders’ deficiency and cash flows for the years then ended. These
financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
  We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
  In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Coates International Ltd. as of
December 31, 2007 and 2006 and the results of its operations and its cash flows
for the years 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, negative cash
flows from operations, 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 in Note 1.  The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
  /s/
Weiser LLP
  
  New York,
N.Y.
  April 11,
2008
 
  F-1
  Coates
International, Ltd.
 Balance
Sheets
  AssetsDecember 31,2007
                          
                          2006Current
      AssetsCash
                          
                          $
                          959,181
                          
                          
                          $
                          254,242Inventory, net
                          
                          
                          402,191
                          
                          
                          
                          350,957Prepaid
      and other assets
                          
                          
                          2,223
                          
                          
                          
                          500Total Current
      Assets
                          
                          
                          1,363,595
                          
                          
                          
                          605,699Investment
      in related party
                          
                          
                          -
                          
                          
                          
                          -Deferred
      offering costs
                          
                          
                          -
                          
                          
                          
                          15,180Property,
      plant and equipment, net
                          
                          
                          1,474,023
                          
                          
                          
                          1,495,946Deferred
      licensing costs, net of accumulated amortization of $8,947 and $4,568 in
      2007 and 2006, respectively
                          
                          
                          76,716
                          
                          
                          
                          81,095Security
      deposits
                          
                          
                          197,500
                          
                          
                          
                          197,500Total Assets
                          
                          $
                          3,111,834
                          
                          
                          $
                          2,395,420Liabilities
      and Stockholders’ DeficiencyCurrent
      LiabilitiesAccounts
      payable and accrued liabilities
                          
                          $
                          947,901
                          
                          
                          $
                          1,032,189Demand
      loan due to related party
                          
                          
                          -
                          
                          
                          
                          92,337Total Current
      Liabilities
                          
                          
                          947,901
                          
                          
                          
                          1,124,526License
      deposits
                          
                          
                          375,000
                          
                          
                          
                          375,00010%
      Convertible Note Payable
                          
                          
                          20,000
                          
                          
                          
                          -Finance
      obligation
                          
                          
                          3,876,607
                          
                          
                          
                          3,876,607Total
    Liabilities
                          
                          
                          5,219,508
                          
                          
                          
                          5,376,133Commitments
      and Contingencies
                          
                          
                          -
                          
                          
                          
                          -Stockholders'
      DeficiencyPreferred
      stock, $0.001 par value 100,000,000 and 14,000,000 shares authorized in
      2007 and 2006, respectively, no shares  issued or
      outstanding
                          
                          
                          -
                          
                          
                          
                          -Common
      stock, $0.0001 par value, 1,000,000,000 shares authorized, 273,411,636 and
      266,894,278 shares issued and outstanding in 2007 and 2006,
      respectively
                          
                          
                          27,341
                          
                          
                          
                          26,689Additional paid-in
      capital
                          
                          
                          20,587,403
                          
                          
                          
                          17,176,155Accumulated
    deficit
                          
                          
                          (22,722,418
                          )
                          
                          
                          (20,183,557
                          )Total Stockholders'
      Deficiency
                          
                          
                          (2,107,674
                          )
                          
                          
                          (2,980,713
                          )Total Liabilities and
      Stockholders' Deficiency
                          
                          $
                          3,111,834
                          
                          
                          $
                          2,395,420
  The
accompanying notes are an integral part of these finincial
statements.
  F-2
  Coates
International, Ltd.
 Statements
of Operations
 For the Years Ended December
      31,2007
                      
                      
                      2006Research
      and development revenue
                      
                      $
                      -
                      
                      
                      $
                      565,000Operating
      expenses:Research and development
      costs
                      
                      
                      606,491
                      
                      
                      
                      437,307General and administrative
      expenses
                      
                      
                      1,493,011
                      
                      
                      
                      1,373,049Depreciation and
      amortization
                      
                      
                      48,695
                      
                      
                      
                      57,084Total Operating
      Expenses
                      
                      
                      2,148,197
                      
                      
                      
                      1,867,440Loss
      from operations
                      
                      
                      (2,148,197
                      )
                      
                      
                      (1,302,440
                      )Other
      income (expense):Interest income
                      
                      
                      3,288
                      
                      
                      
                      30,127Interest expense
                      
                      
                      (393,952
                      )
                      
                      
                      (390,386
                      )Other expense,
    net
                      
                      
                      (390,664
                      )
                      
                      
                      (360,259
                      )Loss
      before income taxes
                      
                      
                      (2,538,861
                      )
                      
                      
                      (1,662,699
                      )Provision
      for income taxes
                      
                      
                      -
                      
                      
                      
                      -Net
      loss
                      
                      $
                      (2,538,861
                      )
                      
                      $
                      (1,662,699
                      )Basic
      and diluted net loss per share
                      
                      $
                      (0.01
                      )
                      
                      $
                      (0.01
                      )Basic
      and diluted weighted average number of shares
                      
                      
                      269,618,004
                      
                      
                      
                      266,894,278
   F-3
 
 Coates
International, Ltd.
 Statements
of Stockholders' Deficiency
 For
the Years Ended December 31, 2007 and 2006
 
 Common
      Stock
                      
                      
                      Additional$0.0001
      par value per share
                      
                      
                      Paid in
                      
                      
                      Accumulated
                      
                      
                      Shareholders'Shares
                      
                      
                      Amount
                      
                      
                      Capital
                      
                      
                      Deficit
                      
                      
                      DeficiencyBalance,
      January 1, 2006
                      
                      
                      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
                      )Sales
      of common stock through a private placement offering
                      
                      
                      420,000
                      
                      
                      
                      42
                      
                      
                      
                      419,958
                      
                      
                      
                      -
                      
                      
                      
                      420,000Sales
      of common stock to the son of a Director
                      
                      
                      3,333,333
                      
                      
                      
                      333
                      
                      
                      
                      1,249,667
                      
                      
                      
                      -
                      
                      
                      
                      1,250,000Issuance
      of common stock under equity line of credit with   Dutchess
      Private Equities Fund, Ltd., net of offering costs
                      
                      
                      2,341,803
                      
                      
                      
                      235
                      
                      
                      
                      1,142,665
                      
                      
                      
                      -
                      
                      
                      
                      1,142,900Issuance
      of shares of common stock to Stonegate Securities, Inc. in connection with
      Private Placement Agreement
                      
                      
                      200,000
                      
                      
                      
                      20
                      
                      
                      
                      84,980
                      
                      
                      
                      -
                      
                      
                      
                      85,000Conversion
      of 10% convertible notes
                      
                      
                      222,222
                      
                      
                      
                      22
                      
                      
                      
                      99,978
                      
                      
                      
                      -
                      
                      
                      
                      100,000Stock
      based compensation expense
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      414,000
                      
                      
                      
                      -
                      
                      
                      
                      414,000Net
      loss for the year
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (2,538,861
                      )
                      
                      
                      (2,538,861
                      )Balance,
      December 31, 2007
                      
                      
                      273,411,636
                      
                      
                      $
                      27,341
                      
                      
                      $
                      20,587,403
                      
                      
                      $
                      (22,722,418
                      )
                      
                      $
                      (2,107,674
                      )
  
 F-4
 
 Coates
International, Ltd.
 Statements
of Cash Flows
 
 2007
                      
                      
                      2006Cash
      Flows From Operating Activities:Net
      Loss
                      
                      $
                      (2,538,861
                      )
                      
                      $
                      (1,662,699
                      )Adjustments to Reconcile Net Loss
      to Net Cash Used inOperating Activities
      -Stock based compensation expense
                      
                      
                      414,000
                      
                      
                      
                      -Non-cash
      general and administrative expenses
                      
                      
                      85,000
                      
                      
                      
                      -Depreciation and
      amortization
                      
                      
                      48,695
                      
                      
                      
                      57,084Write off of deferred offering
      costs
                      
                      
                      15,181
                      
                      
                      
                      -Provision
      for inventory obsolescence
                      
                      
                      6,292
                      
                      
                      
                      262,897Changes
      in Operating Assets and Liabilities -Inventory
                      
                      
                      (57,526
                      )
                      
                      
                      (204,554
                      )Prepaid
      expenses
                      
                      
                      500
                      
                      
                      
                      191,144License
      deposits
                      
                      
                      -
                      
                      
                      
                      (565,000
                      )Accounts
      payable and accrued liabilities
                      
                      
                      (92,082
                      )
                      
                      
                      542,163Income
      taxes payable
                      
                      
                      -
                      
                      
                      
                      (127,156
                      )Net
      Cash Used in Operating Activities
                      
                      
                      (2,118,801
                      )
                      
                      
                      (1,506,121
                      )Cash
      Flows From Investing Activities:Acquisition
      of property, plant and equipment
                      
                      
                      (7,784
                      )
                      
                      
                      (47,070
                      )Costs
      for patents
                      
                      
                      -
                      
                      
                      
                      (30,205
                      )Net
      Cash Used in Investing Activities
                      
                      
                      (7,784
                      )
                      
                      
                      (77,275
                      )Cash
      Flows From Financing Activities:Proceeds
      from issuance of common stock
                      
                      
                      2,885,855
                      
                      
                      
                      -Issuance
      of 10% convertible notes
                      
                      
                      120,000
                      
                      
                      
                      -Proceeds
      of promissory note from related party
                      
                      
                      100,000
                      
                      
                      
                      -Repayment
      of promissory note from related party
                      
                      
                      (100,000
                      )
                      
                      
                      -Repayment
      of demand loan from related party
                      
                      
                      (92,337
                      )
                      
                      
                      (45,300
                      )Deferred
      offering costs paid
                      
                      
                      (72,955
                      )
                      
                      
                      (45,185
                      )Repayments of capital lease
      obligation
                      
                      
                      (9,039
                      )
                      
                      
                      -Net
      Cash Provided by (Used in) Financing Activities
                      
                      
                      2,831,524
                      
                      
                      
                      (90,485
                      )Net Increase (Decrease) in
      Cash
                      
                      
                      704,939
                      
                      
                      
                      (1,673,881
                      )Cash - Beginning of
      Period
                      
                      
                      254,242
                      
                      
                      
                      1,928,123Cash - End of
    Period
                      
                      $
                      959,181
                      
                      
                      $
                      254,242Schedule
      of Supplemental Cash Flow Data:Cash
      paid for:Income
      Taxes
                      
                      $
                      -
                      
                      
                      $
                      141,309Interest
                      
                      $
                      392,472
                      
                      
                      $
                      227,886
  F-5
 
 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 than 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.
 
 
 F-6
 Coates
International, Ltd.
 Notes
to Financial Statements
  As shown
in the accompanying financial statements, the Company has incurred recurring
losses from operations, and as of December 31, 2007, had a Stockholders’
Deficiency of approximately $2,108,000. These factors raise substantial doubt
about the Company’s ability to continue as a going concern. Management has
instituted a cost control program intended to cut variable costs to only those
expenses that are necessary to complete its activities related to entering the
production phase of our operations, develop additional commercially feasible
applications of the CSRV technology, seeking additional sources of working
capital and general administrative costs in support of such activities. The
Company has been actively undertaking efforts to secure new sources of working
capital. At the end of 2007, we had working capital of approximately $416,000
compared with negative working capital of approximately ($519,000) at the end of
2006.  In 2007, the Company closed on a series of financing and equity
transactions that generated aggregate cash proceeds of $3,006,000 which are
being used for working capital purposes. 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.
 
 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 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 $40,569 and $6,643 for
the years ended December 31, 2007 and 2006, respectively.
 
 Share-Based
Compensation
 
 Compensation 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. In March 2007, stock
options were granted to employees, directors and an outside
consultant.  (See Note 15). No stock options had been granted to any
employees for the year ended December 31, 2006.
 
 F-7
 Coates
International, Ltd.
 Notes
to Financial Statements
 Inventory
 
 Inventory
consists of raw materials, work-in-process and finished goods, 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.
 
 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. Such costs are expensed as
incurred. For the year ended December 31, 2006 only, the
Company  capitalized such licensing costs, which are being
amortized  on a straight-line basis over 20 years. The effect of
capitalizing such costs for the year ended December 31, 2006 was not material.
Such amount is reflected in the accompanying balance sheets 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. (See Note 20). The
income tax benefit from sales of unutilized state tax net operating losses to
third parties is recognized in the period of sale.
 
 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. Adoption of
FIN 48 did not have a material impact on the financial position or results of
operations of the Company.
  F-8
  Coates
International, Ltd.
 Notes
to Financial Statements    Net Loss
per Share
 
 Basic net
loss per share is based on the weighted average number of common shares
outstanding without consideration of potentially dilutive shares of common
stock. There were no shares of preferred stock outstanding during the years
ended December 31, 2007 and 2006. Diluted net loss per share is based on the
weighted average number of common and potentially dilutive common shares
outstanding.
  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.
 
 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.
 As compensation for its
initial due diligence efforts, in 2007, the Company has delivered to Stonegate's
designee 200,000 fully paid non-assessable restricted shares of common stock of
the the Company. The value of these shares on the date of issuance was
approximately $85,000 and, was included included in general and administrative
costs for the year ended December 31, 2007 (see Note17).
 
 3.
CONCENTRATIONS OF CREDIT AND BUSINESS RISK
 
 The
Company maintains cash balances with a major financial institution. Accounts at
this institution are insured by the Federal Deposit Insurance Corporation up to
$100,000. The Company's accounts may, at times, exceed the federally-insured
limits. At December 31, 2007, the amount by which the balances in the Company’s
accounts exceeded the insured limit was approximately $878,000.
  F-9
  Coates
International, Ltd.
 Notes
to Financial Statements
  Development
of the CSRV System technology, which 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.
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 this promissory note was paid in full in April 2007. RRBB served as the
Company’s Independent Registered Public Accounting Firm for the year ended
December 31, 2005.
  6.
INVENTORY
 
 Inventory
at December 31, consisted of the following:
 
 2007
                          
                          
                          2006Raw materials
                          
                          $
                          278,264
                          
                          
                          $
                          255,846Work in process
                          
                          
                          35,109
                          
                          
                          
                          240,000Finished
      goods
                          
                          
                          240,000
                          
                          
                          
                          -Reserve
      for obsolescence
                          
                          
                          (151,182
                          )
                          
                          
                          (144,889
                          )Total
                          
                          $
                          402,191
                          
                          
                          $
                          350,957
 
  F-10
  Coates
International, Ltd.
 Notes
to Financial Statements
 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 was made at that time. The Company was also paid $1,200,000
by WWE under a separate research and development agreement which provides for
development and delivery of certain prototype engines.  The research
and development agreement has not been reduced to the form of a signed written
agreement.
 
 On July
7, 2006, the Company and WWE signed a confirmation letter agreement that
provides as follows:
 
 ·
                            Upon
      taking possession by WWE of 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”), 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 electric power
      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
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.
 
 8.
PROPERTY, PLANT AND EQUIPMENT
 
   F-11
  Coates
International, Ltd.
 Notes
to Financial Statements
  2007
                              
                              
                              2006Land
                              
                              $
                              920,550
                              
                              
                              $
                              920,550Building
                              
                              
                              579,450
                              
                              
                              
                              579,450Building
      improvements
                              
                              
                              219,371
                              
                              
                              
                              219,371Machinery
      and equipment
                              
                              
                              521,582
                              
                              
                              
                              499,189Furniture
      and fixtures
                              
                              
                              39,295
                              
                              
                              
                              39,2952,280,248
                              
                              
                              
                              2,257,855Less:  Accumulated
      depreciation
                              
                              
                              (806,225
                              )
                              
                              
                              (761,909
                              )Total
                              
                              $
                              1,474,023
                              
                              
                              $
                              1,495,946
 
 Depreciation
expense amounted to $44,316 and $53,618 for the years ended December 31, 2007
and 2006, 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.
(See 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 in the accompanying statement of operations for each of the years ended
December 31, 2007 and 2006.
  Had this
transaction qualified for sale reporting, the Company would have realized a net
gain of $2,411,579.  This gain on this transaction which has
previously been recognized for income tax reporting purposes, will be recognized
for financial reporting purposes upon expiration or exercise of the option to
repurchase which expires in November 2008. This lease agreement, 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,
                                
                                Amount2008
                                
                                $
                                390,0002009
                                
                                
                                390,0002010
                                
                                
                                390,0002011
                                
                                
                                357,500Total
                                
                                $
                                1,527,500
 
  F-12
  Coates
International, Ltd.
 Notes
to Financial Statements
 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”). 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, 2007 and 2006, deferred licensing costs comprised of expenditures
for patent costs incurred pursuant to the CSRV licensing agreement, net of
accumulated amortization amounted to $76,716 and $81,095,
respectively.
 
 12.
ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
 
 Accounts
payable and accrued expenses at December 31 are comprised of the
following:
 
 2007
                              
                              
                              2006Legal and professional
      fees
                              
                              $
                              803,089
                              
                              
                              $
                              967,917Accrued
      compensation
                              
                              
                              119,233
                              
                              
                              
                              41,096Other
                              
                              
                              25,579
                              
                              
                              
                              23,176Total
                              
                              $
                              947,901
                              
                              
                              $
                              1,032,189
 
 13.
CAPITAL STOCK
 
 Common
Stock
 
 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.
 
 During
the year ended December 31, 2007, the Company sold 2,341,803 shares of its
common stock under an equity line of credit with Dutchess Private Equities Fund,
Ltd. and received proceeds of $1,215,855. (See Note 16). The amount recorded to
additional paid in capital was reduced by offering costs approximating
$73,000.
 
 In a
connection with a placement agency agreement with Stonegate Securities, Inc.,
which is discussed in more detail in Note 16, as compensation for its initial
due diligence efforts, in 2007, the Company has delivered to Stonegate’s
designee 200,000 fully paid non-assessable restricted shares of common stock of
the Company.
  F-13
  Coates
International, Ltd.
 Notes
to Financial Statements
 During
2007, the Company sold in a series of three transactions, 3,333,333 shares of
its common stock to the son of a director of the Company and received aggregate
gross proceeds of $1,250,000. These transactions were private sales of
unregistered securities pursuant to stock purchase agreements.
 
 In March
2007, the Company issued a 10% Convertible Subordinated Note, due March 2010
(“Convertible Note”) in the principal amount of $100,000 to one of its outside
directors and received cash proceeds of $100,000. In April 2007, the Company
issued an additional 10% Convertible Note in the principal amount of $20,000 to
another outside director and received cash proceeds of $20,000. This amount is
included in non-current liabilities on the accompanying balance sheet. The
proceeds from the Convertible Notes were used for working capital purposes. The
Convertible Notes are convertible at the option of the holder into shares of the
Company’s common stock at an initial conversion rate that is determined by
dividing the principal amount of notes being converted by $0.45. As the closing
price of the Company’s common stock on the date of the transaction was $0.35 per
share, there was no beneficial conversion feature. Interest shall accrue at the
rate of 10% per annum and shall be payable in cash only at maturity. All
interest shall be forfeited upon conversion, in which case the holder would be
entitled to dividends declared, if any, on the Company’s common stock during the
time the convertible note was outstanding. On May 16, 2007, $100,000 principal
amount of these convertible notes was converted into 222,222 shares of our
common stock. The Company has reserved 44,444 shares of its common stock for
conversion of the balance of these notes.
 
 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.
Aggregate net proceeds from this Offering, which amounted to $420,000, was used
for working capital purposes. There were no expenses incurred related to this
offering. All of the investors have accepted ten shares of our common stock in
lieu of each share of Preferred Stock purchased through the private offering. No
shares of Preferred Stock were issued. In June 2007, the Company issued in the
aggregate 420,000 shares of its common stock and 42 Warrants in connection with
the Units sold. The amount received for the 420,000 shares of common stock is
reflected in common stock and additional paid in capital in the accompanying
balance sheet as of December 31, 2007.
 
 There
were no sales of our common stock in 2006.
 
 Convertible
Preferred Stock
 
 In
September 2007, the Company amended its certificate of incorporation canceling
all of the 14,000,000 shares of Series A Convertible Preferred Stock, par value
$0.001 per share and authorizing 100,000,000 new shares of Preferred Stock, par
value, $0.001 par value per share (the “Preferred Stock”).  The
Company may issue any class of the Preferred Stock in any series. The Board of
Directors shall have authority to establish and designate series, and to fix the
number of shares included in each such series and the variations in the relative
rights, preferences and limitations as between series, provided that, if the
stated dividends and amounts payable on liquidation are not paid in full, the
shares of all series of the same class shall share ratably in the payment of
dividends including accumulations, if any, in accordance with the sums which
would be payable on such shares if all dividends were declared and paid in full,
and in any distribution of assets other than by way of dividends in accordance
with the sums which would be payable on such distribution if all sums payable
were discharged in full. Shares of each such series when issued shall be
designated to distinguish the shares of each series from shares of all other
series.
  F-14
  Coates
International, Ltd.
 Notes
to Financial Statements
  14.
LOSS PER SHARE
 
 At
December 31, 2007, the Company had 814,445 shares of common stock potentially
issuable upon assumed conversion of (i) $20,000 principal amount of 10%
convertible notes, (ii) 42 outstanding warrants to purchase 210,000 shares of
common stock; and, (iii) 588,333 vested stock options, respectively, that were
not included in the dilutive calculation because the Company incurred a net loss
for the period and the effect of including them in the calculation would have
been anti-dilutive. There was no effect on net loss per share as a result of
potential dilution.
 
 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. In September 2007, the Stock
Plan, by consent of George J. Coates, majority shareholder, was 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, 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.
 
 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.
 
  F-15
  Coates
International, Ltd.
 Notes
to Financial Statements
 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.
 
 There
were no stock options outstanding at the beginning of 2007. The Company granted
options to purchase 1,775,000 shares of common stock (1,750,000 shares to
officers and directors) on April 18, 2007 at an exercise price of $0.44 per
share. These stock options expire in 2021 and 2022. The options vest equitably
over a 3-4 year vesting period. The weighted-average fair value of stock options
granted during the year ended December 31, 2007 was approximately $705,000. The
weighted-average fair value of 588,333 stock options which vested during the
year ended December 31, 2007 was approximately $235,000. The weighted-average
fair value of 1,186,667 nonvested stock options at December 31, 2007 was
approximately $475,000. Total compensation cost related to nonvested stock
options at December 31, 2007 that has not been recognized was approximately
$291,000. This non-cash compensation expense will be recognized in the future
over a remaining weighted average period of approximately 3.3
years.
  F-16
  Coates
International, Ltd.
 Notes
to Financial Statements
 The
Company also granted 25,000 four-year non-employee stock options to its
corporate general counsel on April 18, 2007 at an exercise price of $0.44 per
share, which will be accounted for in accordance with the guidance in Emerging
Issues Task Force Issue No. 96-18, “Accounting for Equity Instruments That are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services.”. In accordance therewith, the fair value of each option is
estimated on the balance sheet date for non-vested options and on the vesting
date for vested options. Upon issuance, 5,000 stock options vested and the
remaining 20,000 stock options vest in equal amounts over 4 years. The fair
value of the portion of these stock options that vested through December 31,
2007, was approximately $1,900. At December 31, 2007, the fair value of the
unvested portion of these stock options was approximately $7,400.
  For the
year ended December 31, 2007, the Company recorded non-cash stock based
compensation expense amounting to approximately $414,000 relating to stock
option grants. For the year ended December 31, 2007, approximately $286,000 of
this amount is included in research and development expenses and approximately
$128,000 of this amount is included in general and administrative expenses in
the accompanying statements of operations.
 
 Asummary of the activity in
the Company’s Stock Option Plan for employees and directors is as
follows:
 
 Exercise
      Price Per Share
                    
                    
                    Number
      Outstanding
                    
                    
                    Weighted
      Average Remaining Contractual Life
                    
                    
                    Number
      Exercisable
                    
                    
                    Weighted
      Average Exercise Price
                    
                    
                    Weighted
      Average Fair Value at Date of GrantBalance,
      1/1/07
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Granted
                    
                    $
                    0.44
                    
                    
                    
                    1,625,000
                    
                    
                    
                    15
                    
                    
                    
                    558,333
                    
                    
                    $
                    0.44
                    
                    
                    $
                    0.40Granted
                    
                    $
                    0.44
                    
                    
                    
                    150,000
                    
                    
                    
                    15
                    
                    
                    
                    30,000
                    
                    
                    $
                    0.44
                    
                    
                    $
                    0.40Balance,
      12/31/07
                    
                    $
                    0.44
                    
                    
                    
                    1,775,000
                    
                    
                    
                    15
                    
                    
                    
                    588,333
                    
                    
                    $
                    0.44
 
 No stock
options were exercised, forfeited or expired during the year ended December 31,
2007. The weighted average fair value of the Company's stock-based compensation
expense of $0.40 per share was estimated using the Black-Scholes option pricing
model which requires highly subjective assumptions including the expected stock
price volatility. These assumptions were as follows:
  ●
                    Historical
      stock price volatility
                    
                    
                    180
                    %●
                    Risk-free
      interest rate
                    
                    
                    4.56%-4.64
                    %●
                    Expected
      life (in years)
                    
                    
                    4●
                    Dividend
      yield
                    
                    
                    0.00
 
 The
valuation assumptions were determined as follows:
  ●
                    Historical
      stock price volatility: The Company obtained the volatility factor of
      other publicly traded engine manufacturers that were also in the research
      and development stage.●
                    Risk-free
      interest rate: The Company bases the risk-free interest rate on the
      interest rate payable on U.S. Treasury securities in effect at the time of
      the grant for a period that is commensurate with the assumed expected
      option life.
  F-17
  Coates
International, Ltd.
 Notes
to Financial Statements
 
 ●
                    Expected
      life: The expected life of the options represents the period of time
      options are expected to be outstanding. The Company has no historical data
      on which to base this estimate. Accordingly, the Company estimated the
      expected life based on its expectation that the executives will be subject
      to frequent black out periods during the time that the stock
      options will be exercisable and based on the Company’s expectation
      that it will complete its research and development phase and commence its
      initial production phase. The vesting period of these options was also
      considered in the determination of the expected life of each stock option
      grant.
  ●
                    No
      expected dividends.
  The same
methodology and assumptions were utilized in estimating the fair value of
non-employee stock options granted to the Company’s general corporate counsel,
as discussed above.
  In
connection with the employment agreements entered into with George J. Coates,
Gregory Coates and Barry C. Kaye, the Company granted non-qualified stock
options to purchase shares of the Company’s common stock with an exercise price
of $0.44 per share to these employees. At the same time, the Company also
granted 25,000 stock options to purchase shares of the Company’s common stock
with an exercise price of $0.44 per share to each of its outside directors. The
Company also granted 25,000 stock options to purchase shares of the Company’s
common stock with an exercise price of $0.44 per share to its 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 vested on April 30, 2007 and the balance
      shall vest in two equal installments on October 23, 2008 and
      2009.
   F-18
  Coates
International, Ltd.
 Notes
to Financial Statements
 (2)
      During 2007, 25,000 of these optons vested on April 30, 2007, 33,333 of
      these stock options vested on October 23, 2007 and the balance shall vest
      in two equal installments on October 18, 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. 
INVESTMENT AGREEMENT WITH DUTCHESS PRIVATE EQUITIES FUND, LTD. AND REGISTRATION
OF SECURITIES
 
 On April
26, 2007, the Company entered into an Investment Agreement with Dutchess Private
Equities Fund, Ltd. (the “Investor”). Pursuant to this Agreement, the Investor
has committed to purchase up to $10,000,000 of our common stock over the course
of thirty-six (36) months. The amount that the Company shall be entitled to
request from each purchase (“Puts”) shall be equal to, at the Company’s
election, either (i) up to $500,000 or (ii) 200% of the average daily volume
(U.S. market only) of the common stock for the ten (10) trading days prior to
the applicable put notice date, multiplied by the average of the three (3) daily
closing bid prices immediately preceding the put date. The put date shall be the
date that the Investor receives a put notice of a draw down from the Company.
The purchase price shall be set at ninety-three percent (93%) of the lowest
closing Best Bid price of the common stock during the pricing period. The
pricing period shall be the five (5) consecutive trading days immediately after
the put notice date. There are put restrictions applied on days between the put
date and the closing date with respect to that particular Put. During this time,
the Company is not entitled to deliver another put notice. Further, the Company
shall reserve the right to withdraw that portion of the Put that is priced below
seventy-five percent (75%) of the lowest closing bid prices for the 10-trading
day period immediately preceding each put notice.
 
 In
connection with this transaction, the Company filed a registration statement on
Form SB-2 with the Securities and Exchange Commission (“SEC”) covering
15,000,000 shares of the common stock underlying the Investment Agreement. This
registration statement was declared effective by the SEC on June 22, 2007. The
Company shall have an ongoing obligation to register additional shares of our
common stock as necessary underlying the draw downs. The Company also included
in this registration statement the registration of approximately 4,230,000
shares of common stock representing the 266,667 shares reserved for conversion
of the 10% convertible notes (222,222 of which were converted in May 2007),
630,000 shares of common stock related to the stock and warrants issued in
connection with a completed private placement of securities and 3,333,333 shares
of common stock sold in April and May 2007.
 
 During
the year ended December 31, 2007, the Company sold 2,341,803 shares of its
common stock under this equity line of credit and received proceeds of
$1,215,855. The amount recorded to additional paid in capital was reduced by
offering costs approximating $73,000.
 
  F-19
  Coates
International, Ltd.
 Notes
to Financial Statements    17.
PLACEMENT AGENCY AGREEMENT WITH STONEGATE SECURITIES, INC.
 
 On
December 21, 2007, the Company entered into a placement agent agreement with
Stonegate Securities, Inc. (“Stonegate”) to act as its placement
agent.  The agreement is for an initial ninety (90) day period in
which Stonegate shall be the Company’s exclusive placement
agent (“Exclusivity Period”) and thereafter the agreement shall be
non-exclusive until cancelled by either party on ten (10) days written
notice.  During the Exclusivity Period, Stonegate has the exclusive
right to identify for the Company prospective purchasers in one or more
placements of debt and/or equity securities to be issued by the Company, the
type and dollar amount being as mutually agreed to by the Parties (the
“Securities”).  After the Exclusivity Period, as the non-exclusive
placement agent to the Company, Stonegate will have the non-exclusive right to
identify for the Company prospective Purchasers in one or more Placements of
Securities, the type and dollar amount being as mutually agreed to by the
Parties.
  As
compensation for services rendered by Stonegate in connection with the
Placements, the Company has agreed to pay Stonegate a fee of eight percent (8%)
of the gross proceeds from the sale of Securities in the
Placements.  Except during the Exclusivity Period, or any extension of
same, no fees shall be due and payable in connection with sales of Securities in
the Placement to investors not introduced to the Company by Stonegate or by a
direct or indirect party previously introduced to the Company as a result of the
efforts of Stonegate. As compensation for its initial due diligence efforts, the
Company has delivered to Stonegate’s designee 200,000 fully paid non-assessable
restricted shares of common stock of the Company. The value of these shares on
the date of issuance was approximately $85,000, and was included in
general and administrative costs for the year ended December 31,
2007.
  Upon
closing of the Placement, the Company agrees to issue to Stonegate restricted
shares of common stock of the Company in an amount that is equal to two percent
(2%) of the total number of shares of common stock sold, and/or in the event of
a sale of convertible securities, the number of shares of common stock that
would be potentially received upon a conversion of any convertible securities
sold in the Placement.  Such number of shares to be issued to
Stonegate shall be reduced by the 200,000 shares set forth above.
  The
Company shall also reimburse Stonegate for reasonable, actual out-of-pocket
expenses incurred by Stonegate, provided, however, that such amount in total
shall not exceed one percent (1%) of the gross proceeds of securities placed
pursuant to this Placement Agreement.
  18.
EMPLOYMENT AGREEMENTS
 
 George J.
Coates
 
 In April
2007, 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 granted Mr. Coates 1,000,000 stock options at an exercise
price of $0.44 per share. These stock options were granted with a service
inception date equal to the effective date of the GJC Agreement.
 
  F-20
  Coates
International, Ltd.
 Notes
to Financial Statements   Barry C.
Kaye
 
 In April
2007 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
granted Mr. Kaye 125,000 stock options at an exercise price of $0.44 per share.
These stock options were granted with a service inception date equal to the
effective date of the Kaye Agreement.
 
 Gregory
Coates
 
 In April,
2007, 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 granted Gregory Coates 500,000
stock options at an exercise price of $0.44 per share. These stock options were
granted with a service inception date equal to the effective date of the GC
Agreement.
 
 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. The amount of compensation that could be due
Mr. Goldsmith for his employment in 2007 and 2006, has without prejudice to its
position, accrued for accounting purposes only, approximately $96,000 through
April 13, 2007, the date the Company believes that Mr. Goldsmith was terminated
with Cause. This amount has been included in accounts payable and accrued
liabilities in the accompanying balance sheet. As discussed in more detail in
Note 20, Mr. Goldsmith has asserted a claim for breach of his employment
contract and is seeking compensatory and punitive damages in connection
therewith. In the opinion of management this complaint is without merit and the
Company intends to vigorously defend against it.  The Company does not
intend to make any payments to Mr. Goldsmith in connection with this employment
agreement.
  F-21
  Coates
International, Ltd.
 Notes
to Financial Statements   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)2008
                          
                          $
                          263,0002009
                          
                          
                          263,0002010
                          
                          
                          263,0002011
                          
                          
                          214,000Total
                          
                          $
                          1,003,000
 
 (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.
 
 19.
INCOME TAXES
 
 The
current income tax provision is comprised of the
following:
 2007
                          
                          
                          2006Federal
                          
                          $
                          -
                          
                          
                          $
                          -State
                          
                          $
                          -
                          
                          
                          $
                          -
 
 Total
deferred tax assets and valuation allowances are approximately as follows at
December 31:
 
 2007
                          
                          
                          2006Current
      deferred tax asset - inventory reserve
                          
                          $
                          85,000
                          
                          
                          $
                          83,000Non-current
      Deferred Tax Assets:Net
      operating loss carryforwards
                          
                          
                          6,271,000
                          
                          
                          
                          5,457,000Gain
      on sale of property
                          
                          
                          980,000
                          
                          
                          
                          1,071,000Stock
      based compensation expense
                          
                          
                          166,000
                          
                          
                          
                          -Other
                          
                          
                          (3,000
                          )
                          
                          
                          -Total
      long-term deferred tax assets
                          
                          
                          7,413,000
                          
                          
                          
                          6,528,000Total
      deferred tax assets
                          
                          
                          7,498,000
                          
                          
                          
                          6,611,000Less:
      valuation allowance
                          
                          
                          (7,498,000
                          )
                          
                          
                          (6,611,000
                          )Net
      deferred tax assets
                          
                          $
                          -
                          
                          
                          $
                          -
 
  F-22
  Coates
International, Ltd.
 Notes
to Financial Statements   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:
 
 2007
                            
                            
                            2006Federal
      tax benefit at the statutory rate
                            
                            
                            34.0
                            %
                            
                            
                            34.0
                            %State
      income taxes, net of federal benefit
                            
                            
                            -
                            
                            
                            
                            -Stock
      based compensation expense
                            
                            
                            (5.5
                            )
                            
                            
                            -Inventory
      reserves
                            
                            
                            (0.1
                            )
                            
                            
                            (5.0
                            )Depreciation
      deduction for financial reporting purposes
                            
                            
                            (0.3
                            )
                            
                            
                            (0.4
                            )Valuation
      allowance
                            
                            
                            (28.1
                            )
                            
                            
                            (28.6
                            )Effective
      tax rate
                            
                            
                            0.0
                            %
                            
                            
                            0.0
                            %
 
 At
December 31, 2007, the Company had available approximately $18,433,000 of net
operating loss carryforwards which may be used to reduce future federal taxable
income, which expire between December 31, 2008 and 2025.  There are no
net operating loss carryforwards available for state income tax purposes. For
the years ended December 31, 2007 and 2006, the valuation allowance increased by
approximately $887,000 and $314,000, respectively.
 
 20.
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, 2007 and 2006, the Company paid approximately $3,000 and
$42,000, respectively, for these services.
 
 On April
30, 2003, the Company amended its license agreement with Coates Motorcycle (the
“Amended Motorcycle License Agreement”). 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 an approximately 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.
 
 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. The Company’s cumulative equity in the losses of Coates
Motorcycle since the initial acquisition of its investment in Coates Motorcycle
reduced the value of the Company’s investment to $-0-. Had the Company continued
to record its proportionate share of undistributed losses after its investment
was written down to $ -0-, it would have recorded an additional share of
undistributed losses aggregating approximately $492,000 through December 31,
2007.
   F-23
  Coates
International, Ltd.
 Notes
to Financial Statements
 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.
  In April
2007, the Company acquired approximately $15,000 equipment from Coates
Motorcycle in consideration for it assuming the remaining obligations on a
capital lease on such equipment which terminates in August 2008.  At
December 2007, the balance of this capitalized lease was approximately $8,000,
which is reflected in the accompanying balance sheet as capital lease
obligation.
  Summarized
unaudited information for Coates Motorcycle is as follows:
 
 UnauditedDecember 31,2007
                    
                    
                    2006Current assets
                    
                    $
                    175
                    
                    
                    $
                    87,257Total
      assets
                    
                    
                    175
                    
                    
                    
                    128,526Current
      liabilities
                    
                    
                    (579,020
                    )
                    
                    
                    (496,218
                    )Total
      liabilities
                    
                    
                    (1,470,520
                    )
                    
                    
                    (1,395,511
                    )Stockholders’
      deficiency
                    
                    
                    1,470,345
                    
                    
                    
                    1,266,985UnauditedYears Ended December 31,2007
                    
                    
                    2006Revenue
                    
                    $
                    -
                    
                    
                    $
                    -Operating
      expenses
                    
                    
                    410,747
                    
                    
                    
                    1,379,692Net
      loss
                    
                    
                    (554,860
                    )
                    
                    
                    (1,462,791
                    )
 
 During
the period through March 2007 and for the year ended December 31, 2006, 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 $25,000 and $185,000, a portion of which represented
deferred salary from the prior year from Coates Motorcycle in 2007 and 2006,
respectively. He was also provided with a leased automobile and medical and
dental benefits.
 
 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. In April 2007, the Coates
Trust advanced $100,000 in the form of a 6% promissory note. At the same time,
the outstanding balance of the prior loans of $92,337 was converted to and
included in this promissory note. No interest was imputed on these loans for the
period prior to the time they were converted to the 6% promissory note. In May
2007, the entire $192,337 principal amount of the 6% promissory note was repaid,
along with accrued interest of approximately $1,500.
   F-24
  Coates
International, Ltd.
 Notes
to Financial Statements
 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. No interest
was imputed on these loans for the year ended December 31, 2006 as such amount
was not material to the financial statements for such periods.
  The
approximate amount of compensation and benefits paid to George J. Coates,
Gregory Coates and Bernadette Coates, exclusive of non-cash stock based
compensation for employee stock options granted to George J. Coates and Gregory
Coates, for the two years ended December 31, 2007, is summarized as
follows:
 
 For
      the Year Ended December 31,2007
                    
                    2006George
      J. Coates (a)
                    
                    $
                    199,000
                    
                    
                    $
                    193,000Gregory
      Coates (b)
                    
                    
                    98,000
                    
                    
                    
                    92,000Bernadette
      Coates
                    
                    
                    51,000
                    
                    
                    
                    49,000
 
 (a)
                    Includes
      compensation paid in 2007 for 2006 vacation earned but not
      taken.
 (b)
                    Does
      not include $10,000 and $25,000 paid in 2007 and 2006, respectively, as
      initial payments toward a new technology that provides computerized
      control of sequential fuel injection, a key component of the natural gas
      powered CSRV engine generator. This technology is in the process of being
      patented.
  Barry C.
Kaye, Treasurer and Chief Financial Officer was paid consulting fees of
approximately $80,000 and $15,500 in 2007 and 2006, respectively.
  21.
LITIGATION AND CONTINGENCIES
 
 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. 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. The
Company has dismissed, without prejudice, its counterclaim and third party
complaint in order to avoid the costs associated with a proof hearing. The
plaintiffs and the third party defendant filed notices of appeal on June 12,
2007 and June 13, 2007.  The Company intends to vigorously contest
those appeals.
 
 In April
2007, the Company received a demand letter from a law firm requesting payment of
approximately $77,000 in connection with a promissory note issued to the law
firm as security for the payment of future services to the Company. The Company
has notified the holder of this note that it does not intend to honor the
promissory note because the law firm did not provide the services contemplated
to be performed as consideration for the promissory note. No further action to
pursue collection of this promissory note has been taken to date by the holder.
At this time, it is not possible to reasonably estimate the outcome of this
matter, and, accordingly, no amount has been accrued.
  F-25
  Coates
International, Ltd.
 Notes
to Financial Statements
 In late
March 2007, at the request of the Company, Mark D. Goldsmith stepped down from
his positions as Chief Executive Officer and President. Despite his resignation,
Mr. Goldsmith contended that he was entitled to certain rights under an
employment agreement with the company. Therefore, on April 17, 2007, the Company
notified Mr. Goldsmith in writing that he was being terminated as a director,
officer and employee with “Cause”, as defined in his employment agreement. On
January 25, 2008, a complaint was filed with the Superior Court of New Jersey
Law Division on behalf of Mr. Goldsmith, as the plaintiff, which named the
Company, Coates Motorcycle Company, Ltd. and George J. Coates as defendants. The
complaint alleges breach of contract with respect to Mr. Goldsmith’s employment
agreements with the Company and Coates Motorcycle and seeks compensatory damages
consisting of compensation, severance, stock options and other employee
benefits, punitive damages, interest and attorney’s fees. To date,
interrogatories, a notice to produce documents and a notice to take the
deposition of Mr. Goldsmith have been served.  On April 8, 2008,
notice was received advising that the court has assigned this matter to
mandatory mediation.
 
 In the
opinion of management this complaint is without merit and the Company intends to
vigorously defend against this complaint asserted by Mr. Goldsmith. The Company
is currently preparing a counterclaim against Mr. Goldsmith asserting the he
misrepresented his background and capabilities in order to induce the Company to
hire him and that certain of his business decisions were made to further his
self interest rather than the interests of the Company. The Company has without
prejudice to its position, accrued compensation under his employment agreement
for accounting purposes only, of approximately $96,000 of his salary through
April 13, 2007, the date the Company believes that Mr. Goldsmith was terminated
with Cause. Although the Company does not intend to make any payments to Mr.
Goldsmith in connection with this employment agreement, this amount has been
included in accounts payable and accrued liabilities in the accompanying balance
sheet.
 
 22.
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 FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS
157"). SFAS 157 which was amended in February 2008 and 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, 2008, 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.
  F-26
  Coates
International, Ltd.
 Notes
to Financial Statements    23.
SUBSEQUENT EVENTS
 
 Sale of Shares of Common
Stock
 
 In
January 2008, the Company sold 15,000 shares of its common stock under the
equity line of credit with Dutchess Private Equities Fund, Ltd. and received
proceeds of approximately $8,000.
 
 Escrow
Agreement and Conditional U. S. License Agreement with WWE
  In April
2008, the Company entered into a conditional second license agreement with
WWE for the territory of the United States (the “US License”). The US
License provides for a license fee of $50 million and annual minimum purchases
of Coates CSRV Systems as a condition of exclusivity.  The US license
has been deposited in to an escrow account and the grant under the license is
not effective until the conditions for release from escrow are
satisfied.
 
 The
escrow agreement was established to provide a more secure mechanism for the
Company to collect payments due under both the prior Canadian licensing and
research and development agreements and the new $50 million US License (the
“Escrow Agreement”).  The Escrow Agreement provides that the US
License shall be held until WWE remits a release payment (the “Release
Payment”). The
Release Payment consists of (i) of an initial down payment required under the US
License of $1 million and (ii) $8.5 million in payment of the balance of the
monies due to the Company in connection with the license for the
territory of Canada, including the Canadian license agreement and the research
and development agreement (the “Canadian Agreements”). While the US License is
held in escrow there shall not be any grant of license to WWE. WWE
is expected to make non-refundable periodic payments to the Company in
unspecified amounts as partial payments of the Release Payment until the Release
Payment has been paid in full. Upon full satisfaction of the Release Payment,
WWE would be granted a license for the territory of the United States under the
US License agreement.
 
 WWE is a
privately held company and its ability to make the license payments due to us
and to honor the minimum purchase requirements under the licenses is dependent
on the success of its continued efforts to raise new equity
capital.  Thus far, WWE has made nonrefundable payments to us totaling
$1.5 million in prior years and $375,000 in 2008. To the extent that WWE is
not successful or experiences delays in raising such additional new equity
capital, the Company’s cash flow, results of operations and financial position
could be adversely affected.
 
 Under the
Escrow Agreement, WWE is required to remit the full amount of the Release
Payment by June 30, 2008 (the “Payment Period”). Should WWE be unable to make
the Release Payment within the Payment Period, the Canadian license agreement
shall automatically become non-exclusive. However, provided that WWE shall have
paid at least $500,000 on account of the Release Payment, the Payment Period
shall be extended until September 30, 2008 (the “Extended Payment Period”).
Should WWE be able to make the entire Release Payment within the
Extended Payment Period, the exclusivity of the Canadian license agreement
shall be reinstated.
 
 F-27
 
 Coates
International, Ltd.
 Notes
to Financial Statements
  The
failure of WWE to make the entire Release Payment within the Payment Period
or within the Extended Payment Period should it be extended, shall
constitute a breach of the Escrow Agreement, the Canadian license agreement and
the US License. In such event, the Company would be entitled to (i) retain any
and all monies received from WWE and (ii) immediately, without notice to WWE,
cancel the Escrow Agreement, the Canadian license agreement and the US License
without providing WWE any right of redemption or reinstatement.
 
 The US
License would, if WWE is able to satisfy the Escrow Agreement release
provisions, grant to WWE the right to use, sell and lease Licensed Products,
manufactured by the Company as the power source for the generation of electrical
energy for the oil and gas industry and from landfills.  Licensed
Products consist of  CSRV Valve Systems, CSRV Valve Seals, CSRV Rotary
Valve Spheres, CSRV Valve Components and CSRV Engines for the Oil and Gas
Industry and Landfills.
 
 The
manufacture of any Licensed Products by WWE is prohibited.  WWE is
required to procure all internal combustion engines incorporating the CSRV Valve
System from the Company or its designee. The license granted to WWE is exclusive
within the Territory, provided that WWE satisfies the minimum annual purchase
commitment of 120 internal combustion engines incorporating the CSRV Valve
System, the Coates Engines and all component parts. The agreement also grants
WWE a right of first refusal in the event that the Company negotiates an offer
with another third party for a worldwide license to use the Licensed
Product.
 
 After
payment of the Release Payment required under the Escrow Agreement, the
remaining unpaid balance of the US License fee of $49 million is payable in
quarterly installments commencing 180 days from the earlier to occur of (i) the
date the third prototype engine provided for in the Canadian Agreements is
collected by WWE, or (ii) April 30, 2008. The amount of the quarterly
installment payments shall be equal to 5% of WWE’s net profits over the next
five years; however, in any event, the entire balance of the licensing fee must
be paid in full on or before February 12, 2012.
 
 Acceleration
of the balance of the licensing fee payments shall be required in the event that
WWE completes a stock offering or private placement offering.  The
entire unpaid balance of the licensing fee shall become due and payable if WWE
raises $100 million or more from such offering.  If WWE raises $25
million or less from any such offering, then WWE must pay us 20% of the amount
raised towards the licensing fee.
 
 Pricing
of the Licensed Products shall be set forth in a separate agreement to be
executed between the parties. The Company is solely responsible for protecting
the Patent Rights, as defined, in connection with the Licensed Products at its
own cost and expense.  The term of the agreement shall expire upon the
expiration of the last to expire of the patents comprising the Patent
Rights.