**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**


**Washington,
      DC 20549**






**FORM
        10-KSB/A**




**(Mark
        One)**
  R
              **ANNUAL
                  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                  ACT OF
                  1934**
  **for
        the fiscal year ended December 31, 2006**
 **or**
  £
              **TRANSITION
                  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                  ACT OF
                  1934**
  **For
        the transition
        period from** **** **to** ****




**** **Commission
        File** **No.:
        000-33155**







**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**




**_______________**





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




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




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




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




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




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




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





**EXPLANATORY
        NOTE: The issuer is amending its filing on Form 10-KSB made on April 17,
        2007 to
        reflect a revision in it’s accounting policy for licensing costs as
        described in Note 1, SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES-Licensing
        Costs
        and to add clarity to Note 17, RELATED PARTY TRANSACTIONS in Part II, Item
        7
        Financial Statements.** In addition, this
        filing has been updated for additional subsequent events and to provide
        additional clarity and conformity to certain sections in Part I, Items 1-4
        and
        Part II, Items 5 and 6.








**COATES
      INTERNATIONAL, LTD.**





**CONTENTS**




******Page**PART
                  IItem
                  1. Description of Business
              2Item
                  1A. Risk Factors
              8Item
                  2. Description of Property
              12Item
                  3. Legal Proceedings
              12Item
                  4. Submission of Matters to a Vote of Security Holders
              12PART
                  IIItem
                  5. Market for Registrant's Common Equity and Related Shareholder
                  Matters
              13Item
                  6. Management's Discussion and Analysis and Plan of Operation
              15Item
                  7. Financial Statements
              20Item
                  8. Changes in and Disagreements with Accountants on Accounting
                  and
                  Financial Disclosure
              20Item
                  8A. Controls and Procedures
              20Item
                  8B. Other Information
              20PART
                  IIIItem
                  9. Directors, Executive Officers, Promoters and Control Persons;
                  Compliance with Sections 16 (a) of the Exchange Act
              22Item
                  10. Executive Compensation
              25Item
                  11. Security Ownership of Certain Beneficial Owners and Management
                  and
                  Related Stockholder Matters
              29Item
                  12. Certain Relationships and Related Transactions
              31Item
                  13. Exhibits
              32Item
                  14. Principal Accountant Fees and Services
              33Signatures
              34Financial
                  Statements
              F-1
                  to F-25





1


**PART
      I**








**Item
      1. Description of Business**





**General**





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





The
      Coates spherical rotary valve system (“CSRV System”) is designed to replace the
      intake and exhaust conventional “poppet valves” currently used in almost all
      piston-driven stationary, automotive, motorcycle and marine engines. Unlike
      conventional valves which protrude into the engine cylinder, the CSRV System
      utilizes spherical valves that rotate in a cavity formed between a two-piece
      cylinder head. The CSRV System utilizes approximately 1/10th 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. The higher the RPM
      range, the greater the volumetric efficiency and thermal efficiency that can
      be
      achieved.





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




Since
        our
        inception, the bulk of our development costs and related operational costs
        have
        been funded primarily through cash generated from the sale of stock, through
        capital contributions, loans made by George Coates, through a sale-and-leaseback
        transaction related to our principal facility, and from the sale of prototype
        models and licensing fees. The Company has only received a minimal amount
        of
        revenues, a number of years ago, from a small number of sales of engines,
        which
        incorporated the CSRV technology 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 losses from operations
        of
        approximately $1,302,000 and $895,000 for the years ended
        December 31, 2006 and 2005, respectively, resulting in an accumulated deficit
        at
        December 31, 2006, of approximately $20,184,000. The Company expects that
        losses
        from operations will continue until the Coates Engine is successfully introduced
        into the marketplace, or the Company receives substantial licensing revenues.
        These losses from operations were substantially related to research and
        development of our intellectual property, patent filing and maintenance costs
        and general and administrative expenses incurred in connection with operating
        the Company.




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








2





**Background**





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





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





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




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





**Markets**





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




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





3





**Strategy**





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




**Operational
      Plan**





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




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




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




**Material
      Agreements**




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




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




4


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




*License
      Agreement - Coates Trust*




We
        did
        not satisfy the working capital funding requirements of our license agreement
        with the Coates Trust, dated October 23, 2006, covering the licensing of
        intellectual property rights for the territory outside of the Western
        Hemisphere. On April 6, 2007, this agreement was formally
        terminated.




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





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





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





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




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




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




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




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




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







5




*License
      Agreement with Coates Motorcycle Company, Ltd.*





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





*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, upon effectiveness of a registration
        statement we are required to file, 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 were obligated to and on May 31, 2007 filed a
        registration statement with the Securities and Exchange Commission covering
        the
        shares of common stock underlying the Investment Agreement within thirty
        (30)
        days after the closing date. In addition, we are obligated to use all
        commercially reasonable efforts to have the registration statement declared
        effective by the SEC within ninety (90) days after the closing
        date.




**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.





6


**Parts
      and Supplies**





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





**Patents
      and Licenses**





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




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




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





**Environmental
      Regulatory Compliance**





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





**Employees**





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





7


**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
          three months ended March 31, 2007, the Company has incurred recurring losses
          from operations, and as of March 31, 2007, had a working capital deficiency
          of
          approximately $592,000 and a Stockholders’ Deficiency of approximately
          $3,177,000 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 12, 2007, as of December 31, 2006 and for the year then
          ended
          that this raises substantial doubt about our ability to continue as a going
          concern.





Management
          has instituted a cost reduction program intended to cut variable costs
          to only
          those expenses that are necessary to complete its activities related to
          making
          engineering refinements to the Coates Engine, identifying additional sources
          of
          working capital and general administrative costs in support of such activity.
          The Company has also been actively undertaking efforts to identify new
          sources
          of working capital. 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:




·
                developing
                    our engineering, administrative and marketing and sales organizations; 
 ·
                expanding
                    manufacturing capacity;


8




·
                conducting
                    testing of the Coates Engine and obtaining requisite governmental
                    approvals; 
 ·
                expanding
                    our research and development programs with respect to the basic
                    CSRV
                    technology and applying the CSRV technology to engines for different
                    applications; and  ·
                implementation
                    of new systems, processes and procedures to support growth.


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 2007; unless we receive
          payments we may be entitled to from Well to Wire Energy Inc., as described
          under
“Material Agreements” above. In addition, we may not be profitable or cash flow
          positive for several additional years after 2007.





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




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





**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.




9


**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.





10


**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 May 24, 2007,
          and
          will therefore be able to unilaterally determine the outcome of all matters
          submitted to our stockholders for approval, including the election of our
          directors and other corporate actions.




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




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




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




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


·
                results
                    of testing of the Coates Engine;  ·
                performance
                    of the Coates Engine in the field;  ·
                improvements
                    in competitive engines; and  ·
                changes
                    in general conditions in the economy or the financial markets. The
            market has also experienced significant volatility which has affected
            the market
            prices of securities issued by many companies; often for reasons unrelated
            to
            their operating performance, and may adversely affect the price of our
            Common
            Stock. The market for our Common Stock is limited. We cannot assure that
            an
            active trading market can be maintained. In such case, our stockholders
            may find
            it difficult to dispose of shares of our Common Stock and, as a result,
            may
            suffer a loss of all or a substantial portion of their
            investment.





**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 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. If our stock
          price
          decreases, then our existing shareholders would experience greater
          dilution.





11


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. Description of Property.**




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




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




**Item
      3. Legal Proceedings.**





The
        Company, 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.
        It
        is anticipated that the plaintiffs and the third party defendant will appeal.
        The Company has proposed to dismiss, without prejudice, its counterclaim
        and
        third party complaint in order to avoid the costs associated with a proof
        hearing. The
        plaintiffs and third party defendant filed notices of appeal on June 12 and
        June
        13, 2007. We intend 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.





In
        late
        March 2007, at the request of the Company, Mark D. Goldsmith stepped down
        from
        his positions as Chief Executive Officer and President. Although we considered
        a
        possible future role for Mr. Goldsmith upon certain conditions being satisfied,
        we were unable to agree on the terms and conditions for such a future role.
        As a
        result of his departure, we may be obligated to make certain payments to
        Mr.
        Goldsmith under an employment agreement dated October 18, 2006. 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 May 11, through an attorney, Mr. Goldsmith notified us that
        he is
        disputing the Company’s position that his termination was with Cause. In his
        letter, he has taken the position that he has resigned for “Good Reason”, as
        defined in his employment agreement  and
        asserted that we are liable to him for breach of his employment contract.
        We are
        of the opinion that Mr. Goldsmith's claim is baseless because we had cause
        to
        terminate our relationship with him. We intend to vigorously contest any
        lawsuit
        instituted by Mr. Goldsmith and will likely assert a counterclaim against
        him. At this time, it is too early to estimate the likely outcome of this
        dispute and, accordingly, no amounts have been accrued subsequent to the
        date of
        termination being asserted by the Company.




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




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




No
      matters were submitted to a stockholder vote in 2006.




12





**PART
      II**





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




**Market**




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




**Holders**




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




**Recent
      Sales of Unregistered Securities**




In
        April
        2007, the Company sold 2,000,000 shares
        of
        its common stock to the son of a director of the Company and received aggregate
        gross proceeds of $500,000 .
        In May
        2007, the Company sold this son of a director an additional 1,333,333 shares
        of
        its common stock and received aggregate gross proceeds of $750,000. These
        transactions were private sales of unregistered securities pursuant to stock
        purchase agreements.





In
        March
        2007, the Company issued $100,000 principal amount of 10% Convertible
        Subordinated Notes, due March 2010 (the “Convertible Notes”) to one of its
        outside directors and received cash proceeds of $100,000. This amount is
        included in non-current liabilities on the accompanying balance sheet. In
        April
        2007, the Company issued an additional $20,000 principal amount of Convertible
        Notes to another outside director and received cash proceeds of $20,000.
        The
        proceeds from the Convertible Notes are being used for working capital purposes.
        The initial conversion rate was not known at the commitment date. The closing
        price of our common stock at that date was $0.35 per share. These convertible
        notes provided for an initial conversion rate equal to the weighted average
        of
        the closing prices of our common stock on the Over the Counter Bulletin Board
        on
        the first ten trading days beginning on the fifth trading day after the Company
        filed its annual report on Form 10-KSB with the Securities and Exchange
        Commission provided, however, that the conversion rate would not be less
        than
        $0.25 per share nor more than $0.45 per share. The initial conversion price
        has
        since been determined to be $0.45 per share. This ceiling price applied because
        the weighted average closing price during the determination period was $1.14.
        As
        the closing price of the Company’s common stock on the commitment date 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. The Company has reserved 266,667
        shares of its common stock for conversion of these notes. On May 16, 2007,
        $100,000 principal amount of these convertible notes was converted into 222,222
        shares of our common stock.





The
        Company commenced a private placement offering in December 2006 (the “Offering”)
        of “Units” consisting of (i) one share of the Company’s 6% Series A Convertible
        Preferred Stock (the “Preferred Stock”) and (ii) a Warrant to purchase five
        thousand shares of the Company’s Common Stock at an initial exercise price of
        $1.10 per share (the “Warrants”), and terminated the Offering in March 2007. Each
        share of Preferred Stock was to be convertible into ten shares of our common
        stock at any time. Aggregate net proceeds of this Offering from 14 accredited investors amounted
        to
        $420,000, which is being used for working capital purposes. There were no
        expenses incurred related to this offering. All of these investors have agreed
        to accept ten shares of our common stock in lieu of each share of Preferred
        Stock purchased through the private offering. On June 1, 2007 the Company
        issued
        in the aggregate 420,000 shares of its common stock and 42 Warrants for the
        Units sold.





There
      were no sales of our Common Stock in 2006. In 2005, the Company issued a total
      of 35,000 shares of its Common Stock in private transactions at a price of
      $5.00
      per share and realized cash proceeds of $175,000 which has been used for working
      capital purposes.






13





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




**Rule
      144**




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




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


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




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




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




**Dividends**




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




**Stock
      Options**




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





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)Plan
                Category
            (a)
            (b)
            (c)Equity
                Compensation plans approved by security holders
            None
            None
            NoneEquity
                Compensation plans without approval by security holders
            1,800,000
            *
            10,700,000Total
            1,800,000
            *
            10,700,000




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


14





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





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





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





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





**Background**




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




**Significant
      Estimates**





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





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




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





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





15




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





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





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





The
      net
      result for the year 2006 was a loss of approximately $1,663,000 or $0.01 per
      share, as compared to a net loss of approximately $1,272,000 or $0.00 per share
      for 2005.





**Liquidity
      and Capital Resources**




We
        have
        incurred recurring losses from operations, and as of December 31, 2006, had
        a
        working capital deficiency of $519,000 and a Stockholders’ Deficiency of
        approximately $2,981,000. These factors raise substantial doubt about our
        ability to continue as a going concern. Our
        Independent Registered Public Accountants have stated in their Auditor’s Report
        dated April 12, 2007 with respects to our Financial Statements as of and
        for the
        year ended December 31, 2006 that these circumstances raise substantial doubt
        about our ability to continue as a going concern.





We
        have
        instituted a cost reduction program intended to cut variable costs to only
        those
        expenses that are necessary to perform activities related to making engineering
        refinements to the Coates Engine, raising additional working capital and
        general
        administrative costs in support of such activities. Since December 31, 2007,
        we
        raised $1,890,000 of new working capital as discussed below. We continue
        to
        actively seek out new sources of working capital, however, there can be no
        assurance that we be successful in these efforts. In April 2007, the Company
        entered into a definitive agreement with Dutchess Private Equities Fund,
        Ltd.
        that could provide up to $10 million of additional funding to the Company,
        upon
        a registration statement filed with the Securities and Exchange Commission
        being
        declared effective. The accompanying financial statements do not include
        any
        adjustments that might be necessary if the Company is unable to continue
        as a
        going concern.






16




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





During
        fiscal 2006, the Company expended significant working capital for our
        activities relating to the research, development, construction and testing
        of
        the production prototype Coates generator engines for WWE and costs incurred
        in
        connection with our effort to raise additional working capital through the
        private placement of our securities. At the end of 2006, we had negative
        working
        capital of approximately ($275,000) compared with positive working capital
        of
        approximately $1,722,000 at the end of 2005. In 2007, the Company closed
        on a
        series of financing and equity transactions that generated aggregate cash
        proceeds of $1,890,000 which are being used for working capital purposes.
        A
        summary of these transactions is as follows:




·
                    In
                        April 2007, the Company issued a $192,337 principal amount
                        6% Promissory
                        Note, due April 4, 2008 to the Coates Trust in consideration
                        for cash
                        proceeds of $100,000 and conversion of a non-interest bearing
                        demand loan
                        due to the Coates Trust in the amount of $92,337. George
                        J. Coates,
                        Bernadette Coates and Gregory Coates are beneficiaries of
                        this Trust. On
                        May 22, 2007, this note was repaid in full, including accrued
                        interest.  ·
                    In
                        April 2007, the Company sold 2,000,000 shares of its common
                        stock to the
                        son of a director of the Company and received aggregate gross
                        proceeds of
                        $500,000. In May 2007, the Company sold this son of a director
                        an
                        additional 1,333,333 shares of its common stock and received
                        aggregate
                        gross proceeds of $750,000. These transactions were private
                        sales of
                        unregistered shares of common stock pursuant to stock purchase
                        agreements.  ·
                    In
                        March 2007, the Company issued $100,000 principal amount
                        of 10%
                        Convertible Subordinated Notes, due March 2010 (the “Convertible Notes”)
                        to one of its outside directors and received cash proceeds
                        of $100,000. In
                        April 2007, the Company issued an additional $20,000 principal
                        amount of
                        Convertible Notes to another outside director and received
                        cash proceeds
                        of $20,000. The proceeds from the Convertible Notes are being
                        used for
                        working capital purposes. The initial conversion rate was
                        not known at the
                        commitment date. The closing price of our common stock at
                        that date was
                        $0.35 per share. These convertible notes provided for an
                        initial
                        conversion rate equal to the weighted average of the closing
                        prices of our
                        common stock on the Over the Counter Bulletin Board on the
                        first ten
                        trading days beginning on the fifth trading day after the
                        Company filed
                        its annual report on Form 10-KSB with the Securities and
                        Exchange
                        Commission provided, however, that the conversion rate would
                        not be less
                        than $0.25 per share nor more than $0.45 per share. The initial
                        conversion
                        price has since been determined to be $0.45 per share. This
                        ceiling price
                        applied because the weighted average closing price during
                        the
                        determination period was $1.14. As the closing price of the
                        Company’s
                        common stock on the commitment date 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. The
                        Company has
                        reserved 266,667 shares of its common stock for conversion
                        of these notes.
                        On May 16, 2007, $100,000 principal amount of these convertible
                        notes was
                        converted into 222,222 shares of our common stock.  ·
                    The
                        Company commenced a private placement offering in December
                        2006 (the
                        “Offering”) of “Units” consisting of (i) one share of the Company’s 6%
                        Series A Convertible Preferred Stock (the “Preferred Stock”) and (ii) a
                        Warrant to purchase five thousand shares of the Company’s Common Stock at
                        an initial exercise price of $1.10 per share (the “Warrants”), and
                        terminated the Offering in March 2007. Each share of Preferred
                        Stock was
                        to be convertible into ten shares of our common stock at
                        any time.
                        Aggregate net proceeds of this Offering from 14 accredited
                        investors
                        amounted to $420,000, which is being used for working capital
                        purposes.
                        There were no expenses incurred related to this offering.
                        All of these
                        investors have agreed to accept ten shares of our common
                        stock in lieu of
                        each share of Preferred Stock purchased through the private
                        offering. On
                        June 1, 2007 the Company issued in the aggregate 420,000
                        shares of its
                        common stock and 42 Warrants for the Units
                        sold.






17




On
        April
        26, 2007, we entered into an Investment Agreement with Dutchess Private Equities
        Fund, Ltd. (the “Investor”). Pursuant to this Agreement, the Investor shall
        commit to purchase up to $10,000,000 of our common stock over the course
        of
        thirty-six (36) months. The amount that we shall be entitled to request from
        each purchase (“Puts”) shall be equal to, at our 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 by us. 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, we shall not be entitled
        to
        deliver another put notice. Further, we shall reserve the right to withdraw
        that
        portion of the Put that is below seventy-five percent (75%) of the lowest
        closing bid prices for the 10-trading day period immediately preceding each
        put
        notice.





We were
        obligated to and on May 31, 2007, filed a registration statement with the
        Securities and Exchange Commission (“SEC”) covering 15,000,000 shares of the
        common stock underlying the Investment Agreement. In addition, we are obligated
        to use all commercially reasonable efforts to have the registration statement
        declared effective by the SEC within 90 days after the April 26, 2007
        closing date. We shall have an ongoing obligation to register additional
        shares
        of our common stock as necessary underlying the draw downs. We also intend
        to
        register approximately 4,230,000 shares of common stock representing the
        266,667
        shares reserved for conversion of the 10% convertible notes, 630,000 shares
        of
        common stock related to the stock and warrants issued in connection with
        the
        private placement of securities and 3,333,333 shares of common stock sold
        in
        April and May 2007 all related to the stock transactions discussed
        above.




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





Current
        liabilities are primarily composed of approximately $782,000 of legal fees
        due
        to a law firm for its representation of us in litigation over the past several
        years, legal fees of approximately $93,000 due to a law firm for representation
        of us for various securities related matters, approximately $41,000 of accrued
        compensation due to a director and former executive officer, approximately
        $60,000 due to our former Independent Registered Public Accountants for audit
        and tax services and a stockholder loan from the Coates Trust for approximately
        $92,000. Payments for interest, real estate taxes and insurance under our
        sale/leaseback agreement amount to approximately $465,000 per year. We have
        employment agreements in place 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.






18





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





**Contractual
      Obligations and Commitments**





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





Amount
                  Due WithinTotal
              
              2007
              
              2008
              
              2009
              
              2010
              
              2011Contractual
                  ObligationsSale/Leaseback
                  Arrangement(1)
              
              $
              1,917,500
              
              $
              390,000
              
              $
              390,000
              
              $
              390,000
              
              $
              390,000
              
              $
              357,500Employment
                  Agreements(2)
              
              
              1,266,000
              
              
              263,000
              
              
              263,000
              
              
              263,000
              
              
              263,000
              
              
              214,000Demand
                  Loan due to related party(3)
              
              
              92,337
              
              
              -
              
              
              92,337
              
              
              -
              
              
              -
              
              
              -Total
              
              $
              3,275,837
              
              $
              653,000
              
              $
              745,337
              
              $
              653,000
              
              $
              653,000
              
              $
              571,500





(1)
              Although
                  the total finance obligation reflected in the Company’s balance sheet at
                  December 31, 2006 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.





(3)
              In
                  April 2007, this demand loan was converted into a 6% promissory
                  note due
                  April 4, 2008 which was repaid in full with accrued interest in
                  May
                  2007.





**Plan
      of Operation**





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




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




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






19




**Item
      7. Financial Statements.**




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




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




None.




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




**Evaluation
      of disclosure controls and procedures:**




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




**Changes
      in internal controls:**




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




**Limitations
      on the effectiveness of controls:**




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




**Item
      8B. Other Information.**




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





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




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




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




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




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


20






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





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





21





**PART
      III**




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





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


**Name**
              
              **Age**
              
              **Position**George
                  J. Coates
              
              67
              
              Director,
                  Chairman of the Board, Chief Executive Officer and
                  PresidentGregory
                  Coates
              
              36
              
              Director
                  and President, Technology Division
  Barry
                    C. Kaye
                
                54
                
                Director,
                    Treasurer and Chief Financial Officer
  Richard
                  W. Evans
              
              75
              
              Director
                  and SecretaryDr.
                  Frank Adipietro
              
              49
              
              Director
                  *, **Glenn
                  Crocker
              
              58
              
              Director
                  *, **, ***Dr.
                  Michael J. Suchar
              
              51
              
              Director
                  *, **Richard
                  Whitworth
              
              58
              
              Director
                  *, **, ***




*  Serves
      as
      an independent director.


**  Serves
      as
      a member of our compensation committee


***  Serves
      as
      a member of our audit committee





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





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





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





22




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




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




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




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




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




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




23




**Board
      Committees**




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




*Audit
      Committee*





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




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





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




*Compensation
      Committee*




The
      compensation committee’s responsibilities will include:





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


·
            determining
                the compensation of our chief executive officer;


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


·
            overseeing
                an evaluation of our senior executives;


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


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





**Corporate
      Governance**




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




**Compensation
      Committee Interlocks and Insider Participation**




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





24


**Liability
      Limitations and Indemnification**




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





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




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


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


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


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





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




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




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





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




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





**Item
      10. Executive Compensation.**





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





25


**Summary
      Compensation Table**





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





(1)  The
        Company executed an amended and restated employment agreement with George
        J.
        Coates (the “GJC Agreement”) that replaces an employment agreement signed in
        2006. The term of the GJC Agreement, which became effective as of October
        23,
        2006, is for five years. The GJC Agreement provides for annual salary of
        $183,549, an annual performance bonus determined by unanimous vote of the
        independent members of the Board of Directors, plus vacation, sick leave
        and
        participation in health, dental and life insurance and any other established
        benefit plans. The GJC Agreement further provides that upon the Company
        achieving a sufficient level of working capital, the amount of annual salary
        shall be increased to $300,000, an automobile will be provided to Mr. Coates
        and
        he will be entitled to a severance payment equal to three years’ annual
        compensation, should he terminate his employment with Good Reason, as defined,
        or upon his death. He will also work with the Company in securing key-man
        life
        insurance. In accordance with the GJC Agreement, 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, at the request of the Company, Mark D. Goldsmith stepped
          down
          from his positions as Chief Executive Officer and President. Although we
          considered a possible future role for Mr. Goldsmith upon certain conditions
          being satisfied, we were unable to agree on the terms and conditions for
          such a
          future role. As a result of his departure, we may be obligated to make
          certain
          payments to Mr. Goldsmith under an employment agreement dated October 18,
          2006.
          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 May 11, through an attorney, Mr. Goldsmith notified
          us
          that he is disputing the Company's position that his termination was with
          Cause.
          In his letter, he has taken the position that he has resigned for "Good
          Reason",
          as defined in his employment agreement and asserted that we are liable
          to him
          for breach of his employment contract. We are of the opinion that Mr.
          Goldsmith's claim is baseless because we had cause to terminate our relationship
          with him. We intend to vigorously contest any lawsuit instituted by Mr
          Goldsmith
          and will likely assert a counterclaim against him. At this time, it is too
          early to estimate the likely outcome of this dispute and, accordingly,
          no
          amounts have been accrued subsequent to the date of termination being asserted
          by the Company.
  (3)  The
          Company executed an amended and restated employment agreement with Mr.
          Kaye (the
“Kaye Agreement”) that replaces an employment agreement signed in 2006. The term
          of the Kaye Agreement, which became effective as of October 18, 2006, is
          for
          three years. The Kaye Agreement initially provides for minimum wages and
          benefits. The Kaye Agreement further provides that upon the Company achieving
          a
          sufficient level of working capital, the amount of annual salary shall
          be
          increased to $125,000, he will become eligible for an annual performance
          bonus
          and he will be entitled to a severance payment equal to one year’s annual
          compensation, should he be terminated by the Company without Cause, as
          defined,
          or if he should terminate his employment with Good Reason, as defined.
          In
          accordance with the Kaye 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.
  (4)  The
          Company executed an amended and restated employment agreement with Gregory
          Coates (the “GC Agreement”) that replaces an employment agreement signed in
          2006. The term of the GC Agreement, which became effective as of October
          23,
          2006, is for five years. The GC Agreement provides for annual salary of
          $79,898,
          plus vacation, sick leave and participation in health, dental and life
          insurance
          and any other established benefit plans. The GC Agreement further provides
          that
          upon the Company achieving a sufficient level of working capital, the amount
          of
          annual salary shall be increased to $250,000, he will become eligible for
          an
          annual performance bonus, an automobile will be provided to Gregory Coates
          and
          he will be entitled to a severance payment equal to two years’ annual
          compensation, should he terminate his employment with Good Reason, as defined.
          He will also be provided with a $2 million life insurance policy and will
          work
          with the Company in securing key-man life insurance. In accordance with
          the GC
          Agreement, the Company committed to grant Mr. Coates 500,000 options to
          purchase
          shares of our common stock at an exercise price of $0.44 per share.





26


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





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





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





**Outstanding
      Equity Awards at Fiscal Year End**





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





Name
              
              Number
                  of Securities Underlying Unexercised Options that are
                  Exercisable
              
              Number
                  of Securities Underlying Unexercised Options that are
                  Unexercisable
              
              Equity
                  Incentive Plan Awards: Number of Securities Underlying Unexercised
                  Unearned Options
              
              Option
                  Exercise Price
              
              Option
                  Expiration DateGeorge
                  J. Coates
              
              0
              
              0
              
              1,000,000(1)
              
              $0.44
              
              10/23/2021Gregory
                  Coates
              
              0
              
              0
              
              500,000(1)
              
              $0.44
              
              10/23/2021Barry
                  C. Kaye
              
              0
              
              0
              
              125,000(2)
              
              $0.44
              
              10/17/2021





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





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





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-fifth of
        these
        stock options will vest on the first five anniversary dates of the grant.




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




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





27
 
  A
        summary
        of the compensation terms under the employment agreements appears in the
        table
        below.


Name
                  & position
              Annual
                  compensation
              Number
                  of stock options4
              Life
                  insurance
              Severance
                  payment5
              Term
                  of the AgreementGeorge
                  Coates, President and Chief Executive Officer
              $
                  183,5491
              1,000,000
              $2,000,000
              Three
                  years salary6
              Five
                  yearsGregory Coates, President Technology Division
              $
                  79,8981
              500,000
              $2,000,000
              Two
                  years salary6
              Five
                  yearsMark
                  D, Goldsmith, former Chief Executive Officer and President2
              $200,0002
              02
              None
              None
              Three
                  YearsBarry
                  C. Kaye, Treasurer and Chief Financial Officer
              $
                  03
              125,000
              None
              One
                  year salary3
              Three
                  years




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


2In late March 2007, at the request of the Company, Mark D. Goldsmith
          stepped down from his positions as Chief Executive Officer and President.
          Although we considered a possible future role for Mr. Goldsmith upon certain
          conditions being satisfied, we were unable to agree on the terms and conditions
          for such a future role. As a result of his departure, we may be obligated
          to
          make certain payments to Mr. Goldsmith under an employment agreement dated
          October 18, 2006. 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 May 11, through an attorney, Mr.
          Goldsmith notified us that he is disputing the Company's position that
          his
          termination was with Cause. In his letter, he has taken the position that
          he has
          resigned for "Good Reason", as defined in his employment agreement and
          asserted
          that we are liable to him for breach of his employment contract. We are
          of the
          opinion that Mr. Goldsmith's claim is baseless because we had cause to
          terminate
          our relationship with him. We intend to vigorously contest any lawsuit
          instituted by Mr Goldsmith and will likely assert a counterclaim against
          him. At
          this time, it is too early to estimate the likely outcome of this dispute
          and,
          accordingly, no amounts have been accrued subsequent to the date of termination
          being asserted by the Company.




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





4 These
        Options, which were granted on April 18, 2007, expire in October 2021. The
        options will be granted with the following vesting schedule:





·
                The
                    options granted to George J. Coates and Gregory Coates vest 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
                on
                April 30, 2007 and the balance in three equal installments on October
                18,
                2007, 2008 and 2009. The options will immediately fully vest in the
                event
                the employee terminates his employment for a good reason, or if we
                terminate his employment without cause.





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




6The
      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.


28


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




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




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





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




·
            each
                of our executive officers and directors;


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


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





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





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


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




(1)
        Includes 1,956,960 shares owned by Mr. Coates' spouse, beneficial ownership
        of
        which is disclaimed by George J. Coates.
 (2)
        Includes 20,000 shares owned by Dr. Suchar's spouse, beneficial ownership
        of
        which is disclaimed by Michael J. Suchar.


29







**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.


30





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





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





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





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





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





The
        Coates Trust has made loans to the Company at various times to provide working
        capital. George J. Coates, Bernadette Coates, wife of George J. Coates and
        Gregory Coates are beneficiaries of the Coates Trust. The net outstanding
        balance was $92,337 at December 31, 2006. These borrowings are in the form
        of a
        demand loan which carry no interest and are repaid from time to time depending
        upon cash availability. No interest was imputed on these loans for the years
        ended December 31, 2006 and 2005 as such amount was not material to the
        financial statements for such periods. It is the intention of the Coates
        Trust
        to assist the Company with its working capital requirements as needed in
        the
        future, even though it is not legally obligated to do so. In April 2007,
        this
        demand loan was converted to a 6% promissory note due April 4, 2008. On May
        22,
        2007, this note was repaid in full, including accrued
        interest.




Bernadette
        Coates, George’s wife has made loans to the Company in 2005 to provide working
        capital. The amount due to Mrs. Coates was repaid in 2006. No interest was
        imputed on these loans for the years ended December 31, 2006 and 2005 as
        such
        amount was not material to the financial statements for such
        periods.




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




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


31


**Item
      13. Exhibits.**


**Exhibit
                    No.**
                
                **Description**3.1
                    @
                -
                Restated
                    Certificate of Incorporation3.1(i)
                    @
                -
                Certificate
                    of Amendment to Certificate of Incorporation filed with the Secretary
                    of
                    State of Delaware on May 22, 20003.1(ii)
                    @
                -
                Certificate
                    of Amendment to Certificate of Incorporation filed with the Secretary
                    of
                    State of Delaware on August 31, 20013.2
                    @
                -
                Bylaws10.6
                    +
                -
                License
                    Agreement, dated September 29, 1999, with Well to Wire Energy,
                    Inc.10.7
                    +
                -
                Amendment
                    No. 1 to License Agreement with Well to Wire Energy Inc. dated
                    April 6,
                    200010.8
                    +
                -
                Amendment
                    No. 2 to License Agreement with Well to Wire Energy Inc. dated
                    July 21,
                    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
                    *
                -
                License
                    Agreement between the Company and Coates Trust dated October
                    23,
                    200610.16
                    *
                -
                Amended
                    and Restated Employment Agreement between the Company and George
                    J. Coates
                    dated April 6, 200710.17
                    *
                -
                Amended
                    and Restated Employment Agreement between the Company and Gregory
                    Coates
                    dated April 6, 200710.18
                    *
                -
                Amended
                    and Restated Employment Agreement between the Company and Barry
                    C. Kaye
                    dated April 6, 200710.19
                    *
                -
                Amended
                    and Restated License Agreement between the Company and George
                    J. Coates
                    and Gregory Coates dated April 6, 200710.20
                    *
                -
                Termination
                    of License Agreement between the Company and Coates Trust dated
                    April 6,
                    200731.1*
                -
                Certification
                    of George J. Coates pursuant to Rule 13a-14(a) of the Securities
                    Exchange
                    Act of 1934.31.2*
                -
                Certification
                    of Barry C. Kaye pursuant to Rule 13a-14(a) under the Securities
                    Exchange
                    Act of 1934.32*
                -
                Certification
                    pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
                    906 of
                  the Sarbanes-Oxley Act of
                    2002.
 _______________
 @
                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 .
 *
                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.


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




32





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





Audit
      Fees:




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





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





Audit-related
      Fees:




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





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





Tax
      Fees:




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





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





All
      Other
      Fees:




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





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








33











**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 June 15, 2007.




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





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





Signature
              Title
              Date/s/
                  George J. Coates
                
                George
                  J. Coates
              Director,
                  Chairman, Chief Executive Officer and President (principal executive
                  officer)
              June
                  15, 2007/s/
                  Gregory Coates
                
                Gregory
                  Coates
              Director,
                  President-Technology Division
              June
                  15, 2007/s/
                  Barry C. Kaye
                Barry
                  C. Kaye
              Director,
                  Treasurer, Chief Financial Officer (principal financial and accounting
                  officer)
              June
                  15,
                  2007/s/
                  Richard W. Evan
                Richard
                  W. Evans
              Director
                  and Secretary
              June
                  15,
                  2007/s/
                  Michael J. Suchar
                Michael
                  J. Suchar
              Director
              June
                  15,
                  2007/s/
                  Frank Adipietro
                Frank
                  Adipietro
              Director
              June
                  15,
                  2007/s/
                  Glenn Crocker
                Glenn
                  Crocker
              Director
              June
                  15,
                  2007/s/
                  Richard Whitworth
                
                Richard
                  Whitworth
              Director
              June
                  15,
                  2007





34







**Coates
      International, Ltd.**





**Index
      to the Financial Statements**





**December
      31, 2006**













PageReport
                  of Weiser LLP, Independent Registered Public Accounting
                  Firm
              
              F-1Report
                  of Rosenberg Rich Berman Baker & Company, Independent Registered
                  Public Accounting Firm
              
              F-2Financial
                  StatementsBalance
                  Sheet
              
              F-3Statements
                  of
                  Operations
              
              F-4Statements
                  of
                  Stockholders' Deficiency
              
              F-5Statements
                  of
                  Cash Flows
              
              F-6Notes
                  to the Financial Statements
              
              F-7
                  to 22




F-0






**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**









To
      the
      Board of Directors and




Stockholders
      of Coates International Ltd.




We
      have
      audited the accompanying balance sheet of Coates International Ltd. as of
      December 31, 2006, and the related statements of operations, stockholders’
deficiency and cash flows for the year then ended. These financial statements
      are the responsibility of the Company’s management. Our responsibility is to
      express an opinion on these financial statements based on our
      audit.




We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audit provides a
      reasonable basis for our opinion.




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




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









/s/
      Weiser LLP





Weiser LLP




New
      York,
      NY


April
      12,
      2007





F-1





**Report
      of Independent Registered Public Accounting Firm**








To
      the
      Board of Directors and Shareholders


Coates
      International, Ltd.




We
      have
      audited the accompanying statements of operations, cash flows and stockholders'
      deficiency of Coates International, Ltd. for the year ended December 31, 2005.
      These financial statements are the responsibility of the Company's management.
      Our responsibility is to express an opinion on these financial statements based
      on our audit.




We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audit provides a
      reasonable basis for our opinion.




In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the results of operations and cash flows of Coates
      International, Ltd., for the year ended December 31, 2005 in conformity with
      accounting principles generally accepted in the United States of
      America.





/s/
      Rosenberg Rich Berman Baker & Company


Rosenberg Rich Berman Baker & Company


Bridgewater,
      New Jersey


February
      28, 2006




F-2











**Coates
      International, Ltd.**


**Balance
      Sheet**


AssetsDecember
                31,2006Current
                AssetsCash
            
            $
            254,242Inventory,
                net of reserve for obsolescence of $144,889
            
            
            350,957Prepaid
                and other assets
            
            
            500Total
                Current Assets
            
            
            605,699Investment
                in related party
            
            
            -Deferred
                offering costs
            
            
            15,180Property,
                plant and equipment, net of accumulated depreciation of $761,909
            
            
            1,495,946Deferred
                licensing costs, net of accumulated amortization of $4,568
            
            
            81,095Security
                deposits
            
            
            197,500Total
                Assets
            
            $
            2,395,420Liabilities
                and Stockholders’ DeficiencyCurrent
                LiabilitiesAccounts
                payable and accrued liabilities
            
            $
            1,032,189Demand
                loan due to related party
            
            
            92,337Total
                Current Liabilities
            
            
            1,124,526License
                deposits
            
            
            375,000Finance
                obligation
            
            
            3,876,607Total
                Liabilities
            
            
            5,376,133Commitments
                and Contingencies
            
            
            -Stockholders'
                DeficiencyPreferred
                stock, Series A, $0.001 par value 14,000,000 shares authorized, no
                shares
                issued or outstanding
            
            
            -Common
                stock, $0.0001 par value, 1,000,000,000 shares authorized,
              266,894,278
                shares issued and outstanding
            
            
            26,689Additional
                paid-in capital
            
            
            17,176,155Accumulated
                deficit
            
            
            (20,183,557
            )Total
                Stockholders' Deficiency
            
            
            (2,980,713
            )Total
                Liabilities and Stockholders' Deficiency
            
            $
            2,395,420







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









F-3


**Coates
      International, Ltd.**


**Statements
      of Operations**











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


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


F-4


**Coates
        International, Ltd.**
 **Statements
        of Stockholders' Deficiency**
 **For
        the Years Ended December 31, 2006 and 2005**
  Common
                  Stock
              
              Additional$0.0001
                  par value per share
              
              Paid
                  in
              
              Accumulated
              
              Shareholders'Shares
              
              Amount
              
              Capital
              
              Deficit
              
              DeficiencyBalance,
                  January 1, 2005
              
              
              265,859,278
              
              $
              26,586
              
              $
              17,001,258
              
              $
              (17,248,825
              )
              $
              (220,981
              )Issuance
                  of common stock for license agreement
              
              
              1,000,000
              
              
              100
              
              
              (100
              )
              
              -
              
              
              -Issuance
                  of common stock for cash
              
              
              29,000
              
              
              2
              
              
              144,998
              
              
              -
              
              
              145,000Issuance
                  of common stock in settlement of accounts payable and accrued
                  interest
              
              
              6,000
              
              
              1
              
              
              29,999
              
              
              -
              
              
              30,000Net
                  loss for the year
              
              
              -
              
              
              -
              
              
              -
              
              
              (1,272,033
              )
              
              (1,272,033
              )Balance,
                  December 31, 2005
              
              
              266,894,278
              
              
              26,689
              
              
              17,176,155
              
              
              (18,520,858
              )
              
              (1,318,014
              )Net
                  loss for the year
              
              
              -
              
              
              -
              
              
              -
              
              
              (1,662,699
              )
              
              (1,662,699
              )Balance,
                  December 31, 2006
              
              
              266,894,278
              
              $
              26,689
              
              $
              17,176,155
              
              $
              (
                  20,183,557
              )
              $
              (2,980,713
              )
 
 The
        accompanying notes are an integral part of these financial
        statements.


F-5




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


F-6





**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
                Systemutilizes significantly fewer moving parts of conventional poppet
                valve
                assemblies.
                As a result of these design improvements, management believes that
                the
                engines incorporating the CSRV System (“Coates Engines”) will last
                significantly longer and will require less lubrication over the life
                of
                the engine, as compared to conventional engines. In addition, CSRV’s can
                be designed with larger openings into the engine cylinder than
                conventional valves so that more fuel and air can be inducted into
                and
                expelled from the cylinder in a shorter period of time. Larger valve
                openings permit higher revolutions-per-minute (RPMs) and permit higher
                compression ratios with lower combustion chamber temperatures, allowing
                the Coates Engine to produce more power than equivalent conventional
                engines. The higher the RPM range, the greater the volumetric efficiency
                and thermal efficiency that can be
                achieved.





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






F-7





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





Revenue
      Recognition





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





Research
      and Development





Research
      and development costs are expensed when incurred.





Advertising
      Costs





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





Share-Based
      Compensation





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





Inventory





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





F-8


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 years ended December 31, 2006 and 2005 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 years
        ended December
        31, 2006 and 2005 was not material. Such amount is reflected in the accompanying
        balance sheet as Deferred Licensing Costs.





Income
      Taxes





Income
      taxes are accounted for under the asset and liability method. Deferred tax
      assets and liabilities are recognized for the future tax consequences
      attributable to differences between the financial statement carrying amounts
      of
      existing assets and liabilities and their respective tax bases, and operating
      loss and tax credit carryforwards. Deferred tax assets and liabilities are
      measured using enacted tax rates expected to apply to taxable income in the
      years in which those temporary differences are expected to be recovered or
      settled. The effect on deferred tax assets and liabilities of a change in tax
      rates is recognized in income in the period that includes the enactment date.





The
      Company records a valuation allowance against any portion of the deferred income
      tax asset when it believes, based on the weight of available evidence, it is
      more likely than not that some portion of the deferred tax asset will not be
      realized. No tax benefit has been recorded related to the Company’s equity in
      undistributed earnings of Coates Motorcycle Company, Ltd., as described in
      Note
      17. The income tax benefit from sales of unutilized state tax net operating
      losses to third parties is recognized in the period of sale.





Net
      Loss
      per Share





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





F-9


Use
      of
      Estimates





The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America (“generally accepted
      accounting principles”) requires management to make estimates and assumptions
      that affect the reported amounts of assets and liabilities and disclosure of
      contingent assets and liabilities at the date of the financial statements and
      the reported amounts of revenues and expenses during the reporting period.
      Actual results could differ from those estimates.





Reclassifications





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








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





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





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





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





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





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





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





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






F-10





**4.
      FAIR VALUE OF FINANCIAL INSTRUMENTS**





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





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





Limitations





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





**5.
      COMMITMENTS**





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





**6.
      INVENTORY**





Inventory
      at December 31, 2006 consists of the following:





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





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





On
      September 29, 1999, the Company signed a license agreement with Well to Wire
      Energy, Inc. ("WWE"), an oil and gas company in Canada. The agreement
      exclusively licenses within Canada the use of the Coates technology for V-8
      engines to be fueled by natural gas to generate electrical power. The agreement
      provided for a license fee of $5,000,000, of which a deposit payment in the
      amount of $300,000 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.





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






F-11





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




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




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




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




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




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




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





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





**8.
      PROPERTY, PLANT AND EQUIPMENT**





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




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





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






F-12





**9.
      SECURITY DEPOSITS**





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





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





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




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




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









F-13


11.
      LICENSING AGREEMENTS AND DEFERRED
      LICENSING COSTS


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




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




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





**12.
      ACCOUNTS PAYABLE AND ACCRUED LIABILITIES**





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





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





**13.
      CAPITAL STOCK**





Common
      Stock





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





Series
      A
      Convertible Preferred Stock




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


F-14





**14.
      EMPLOYMENT AGREEMENTS**





George
      J.
      Coates





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





Barry
      C.
      Kaye





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





F-15


Gregory
      Coates





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





Mark
      D.
      Goldsmith





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





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





F-16


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




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





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





**15.
      STOCK OPTIONS**





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





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.




F-17





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.





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





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




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




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




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




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





F-18




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





**16.
      INCOME TAXES**





The
      current income tax provision is comprised of the following:


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





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





F-19


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





2006Current
                  deferred tax asset - inventory reserve
              
              $
              83,000Non-current
                  Deferred Tax Assets:Net
                  operating loss carryforwards
              
              
              5,457,000Gain
                  on sale of property
              
              
              1,071,000Total
                  long term deferred tax assets
              
              
              6,528,000Total
                  deferred tax assets
              
              
              6,611,000Less:
                  valuation allowance
              
              
              (6,611,000
              )Net
                  deferred tax assets
              
              $
              -





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
















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





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





**17.
      RELATED PARTY TRANSACTIONS**





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





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





F-20


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




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




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




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




Summarized
      unaudited information for Coates Motorcycle is as follows:




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




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








F-21





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





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





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





The
        Coates Trust has made loans to the Company at various times to provide working
        capital. George J. Coates, Bernadette Coates, wife of George J. Coates and
        Gregory Coates are beneficiaries of the Coates Trust. The net outstanding
        balance was $92,337 at December 31, 2006. These borrowings are in the form
        of a
        demand loan which carry no interest and are repaid from time to time depending
        upon cash availability. No interest was imputed on these loans for the years
        ended December 31, 2006 and 2005 as such amount was not material to the
        financial statements for such periods. It is the intention of the Coates
        Trust
        to assist the Company with its working capital requirements as needed in
        the
        future, even though it is not legally obligated to do so. In April 2007,
        this
        demand loan was converted to a 6% promissory note due April 4,
        2008.




Bernadette
        Coates, George’s wife has made loans to the Company at various times to provide
        working capital. The amount due to Mrs. Coates was repaid in 2006. No interest
        was imputed on these loans for the years ended December 31, 2006 and 2005
        as
        such amount was not material to the financial statements for such
        periods.




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




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


F-22






**18.
      NEW ACCOUNTING PRONOUNCEMENTS**





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





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





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





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





**19.
      SUBSEQUENT EVENTS**





Commencement
      of Trading





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





F-23




Sale
      of
      Common Stock





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





Issuance
      of 6% Promissory Note





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





Issuance
      of Convertible Subordinated Notes





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





Sale
      of
      Securities





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








Settlement
      Agreement with Prior Accountants





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




F-24





Settlement
      of Litigation





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





Departure
      of Executive Officer





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




F-25